Category: 1031 Exchange General

Recently, I have spoken with a number of taxpayers who have heard about Opportunity Zones and want to know if they are a viable alternative to a 1031 exchange. My answer is usually “it depends.” Here, I provide an overview of opportunity zones and their differences from 1031 exchanges.
Qualified Opportunity Funds
An investment under the O-Zone code provision and proposed regulations has to be into a qualified opportunity zone listed by the Community Development Financial Institutions Fund. Typically, the zones are areas where most of the population live well below the poverty level and the O-Zone provisions are obviously designed to encourage investment into Qualified Opportunity Funds (QOF) that have, in turn, invested in qualifying new or used property or qualified businesses after December 31, 2017. These investments may not fit the taxpayer’s property investment goals.
Much like Section 1031, the reinvestment window for a QOF investment is 180 days after the sale. However, unlike Section 1031, the taxpayer has to purchase shares of stock or partnership interest in a QOF invested in the O-Zone. The upside for the taxpayer is that unlike the typical 1031 exchange, which requires a reinvestment of 100% of exchange value for 100% gain deferral, the investor in an O-Zone only has to reinvest the capital gain portion and can draw out the basis on the sale of the relinquished asset. The trade-off for being able to pull out the cash is the obligation to comply with the myriad of rules designed to ensure that the QOF meets the O-Zone requirements.
Partial Ownership of Real Estate
When a taxpayer invests into a qualified opportunity zone, they are not purchasing a discrete, solely-owned real property interest (although the taxpayer could conceivably create their own QOF). Most often the investment will comprise ownership of stock or partnership interest in the QOF. This may be an issue for most taxpayers who are used to sole control of their investments. These are the same investors who are uncomfortable with TIC or DST ownership interests.
Potential for Capital Gains Deferral
Investing in an O-Zone results in something different than the potential 100% deferral of capital gains achieved with Section 1031 exchanges over the course of ownership of investment or business use property. With an O-Zone investment, the taxpayer can obtain a potential exclusion of capital gain up to 15% between the acquisition of the property during the 2018-2019 window and the end of 2026 (or the earlier sale of the QOF interest). The taxpayer may also achieve 100% capital gain exclusion if the investment is held for 10 years and sale occurs before 2047. Realistically, the gain will probably only be deferred for eight years or the end of 2026, and the gain will have to be reported on the taxpayer’s 2026 return.
Opportunity Zone Regulations
Finally, the proposed regulations for O-Zones are complicated and are still a work in progress. For example, there is still no clear definition of what “substantially all” means for purposes of the holdings of the QOF within the qualified O-Zone. There are ongoing annual certification requirements, strict timetables for reinvestment if a QOF investment is sold, a new set of forms for election of deferral and certification, minimum investment requirements for property types, etc.
Summary
While O-Zone investments are not a replacement for 1031 real property exchanges, they afford benefits to taxpayers who are willing to invest in the types of properties present in the designated zones and limit their gain deferral to less than the potential 100% deferral available in a 1031 exchange. Certainly, the Treasury will continue to refine the O-Zone regulations, and most likely a whole industry will emerge around these kinds of investments. The key for taxpayers is to learn of the pitfalls and the potential benefits, find advisors who know the rules, perform their due diligence and not to get lost in the O-Zone.

The safe harbor transactions fit within the parameters of the safe harbor created in September 2000 by Revenue Procedure 2000-37 and governs those transactions in which the property is parked no longer than 180 days. However, there are instances in which, for a number of reasons, the replacement property must be parked for longer than 180 days.  Common examples are those in which the relinquished property will take longer to market and sell than 180 days or in which construction of improvements are required on the replacement property.
While Revenue Procedure 2000-37 does not cover so-called non-safe harbor transactions, it takes the position of no negative inference merely because certain structures are pre-approved due to the safe harbor:

Further, the Service recognizes that ‘parking’ transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of ‘parking’ transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.

Some exchangers mistakenly believe that if a parking period extends past the 180-day deadline they can somehow allow the transaction to keep running and simply conclude their exchange without any adverse consequences. This approach to “blown” safe harbor deals has apparently found some support in a recent court case, Bartell v. Commissioner, 147 T.C. No. 5,   decided August 10, 2016.  In Bartell, the U.S. Tax Court ruled, among other things, that even though the taxpayer entered into what was essentially a safe harbor transaction on August 1, 2000 and the parking period lasted until December 31, 2001, the taxpayer’s 1031 exchange should not have been disallowed by the IRS.  
In Bartell, the court overlooked the 17-month timeline even though the property was purchased by an exchange facilitator with loan funds secured by the taxpayer, the taxpayer managed the construction portion of the deal and the taxpayer was in possession of the property during the parking period.  It is clear the parking entity did not really have any true benefits and burdens of ownership.  Accruit believes the Bartell case should not be relied on in current similar situations for a number of reasons including the facts that the parking transaction was commenced prior to the issuance of Rev. Proc. 2000-37, it originated in the taxpayer friendly 9th Circuit and, most importantly, the IRS has since made it clear they will not acquiesce to the decision as precedent in other cases.
When, for any number of reasons, more than 180 days is required, the best approach may be to utilize what is referred to as a non-safe harbor reverse exchange which is specifically structured to last longer than 180 days and create true benefits and burdens of ownership in the parking entity.  Since these are not typical parking arrangements, each transaction must be structured differently based upon the facts presented.  The taxpayer’s CPA’s, attorneys and other advisors working for the taxpayer need to be involved in the process.  Accruit has the necessary experience and expertise to assist the taxpayer and all of the other essential parties to the exchange process in navigating transactions outside the safe harbor.

The safe harbor transactions fit within the parameters of the safe harbor created in September 2000 by Revenue Procedure 2000-37 and governs those transactions in which the property is parked no longer than 180 days. However, there are instances in which, for a number of reasons, the replacement property must be parked for longer than 180 days.  Common examples are those in which the relinquished property will take longer to market and sell than 180 days or in which construction of improvements are required on the replacement property.
While Revenue Procedure 2000-37 does not cover so-called non-safe harbor transactions, it takes the position of no negative inference merely because certain structures are pre-approved due to the safe harbor:

Further, the Service recognizes that ‘parking’ transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of ‘parking’ transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.

Some exchangers mistakenly believe that if a parking period extends past the 180-day deadline they can somehow allow the transaction to keep running and simply conclude their exchange without any adverse consequences. This approach to “blown” safe harbor deals has apparently found some support in a recent court case, Bartell v. Commissioner, 147 T.C. No. 5,   decided August 10, 2016.  In Bartell, the U.S. Tax Court ruled, among other things, that even though the taxpayer entered into what was essentially a safe harbor transaction on August 1, 2000 and the parking period lasted until December 31, 2001, the taxpayer’s 1031 exchange should not have been disallowed by the IRS.  
In Bartell, the court overlooked the 17-month timeline even though the property was purchased by an exchange facilitator with loan funds secured by the taxpayer, the taxpayer managed the construction portion of the deal and the taxpayer was in possession of the property during the parking period.  It is clear the parking entity did not really have any true benefits and burdens of ownership.  Accruit believes the Bartell case should not be relied on in current similar situations for a number of reasons including the facts that the parking transaction was commenced prior to the issuance of Rev. Proc. 2000-37, it originated in the taxpayer friendly 9th Circuit and, most importantly, the IRS has since made it clear they will not acquiesce to the decision as precedent in other cases.
When, for any number of reasons, more than 180 days is required, the best approach may be to utilize what is referred to as a non-safe harbor reverse exchange which is specifically structured to last longer than 180 days and create true benefits and burdens of ownership in the parking entity.  Since these are not typical parking arrangements, each transaction must be structured differently based upon the facts presented.  The taxpayer’s CPA’s, attorneys and other advisors working for the taxpayer need to be involved in the process.  Accruit has the necessary experience and expertise to assist the taxpayer and all of the other essential parties to the exchange process in navigating transactions outside the safe harbor.

The safe harbor transactions fit within the parameters of the safe harbor created in September 2000 by Revenue Procedure 2000-37 and governs those transactions in which the property is parked no longer than 180 days. However, there are instances in which, for a number of reasons, the replacement property must be parked for longer than 180 days.  Common examples are those in which the relinquished property will take longer to market and sell than 180 days or in which construction of improvements are required on the replacement property.
While Revenue Procedure 2000-37 does not cover so-called non-safe harbor transactions, it takes the position of no negative inference merely because certain structures are pre-approved due to the safe harbor:

Further, the Service recognizes that ‘parking’ transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of ‘parking’ transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.

Some exchangers mistakenly believe that if a parking period extends past the 180-day deadline they can somehow allow the transaction to keep running and simply conclude their exchange without any adverse consequences. This approach to “blown” safe harbor deals has apparently found some support in a recent court case, Bartell v. Commissioner, 147 T.C. No. 5,   decided August 10, 2016.  In Bartell, the U.S. Tax Court ruled, among other things, that even though the taxpayer entered into what was essentially a safe harbor transaction on August 1, 2000 and the parking period lasted until December 31, 2001, the taxpayer’s 1031 exchange should not have been disallowed by the IRS.  
In Bartell, the court overlooked the 17-month timeline even though the property was purchased by an exchange facilitator with loan funds secured by the taxpayer, the taxpayer managed the construction portion of the deal and the taxpayer was in possession of the property during the parking period.  It is clear the parking entity did not really have any true benefits and burdens of ownership.  Accruit believes the Bartell case should not be relied on in current similar situations for a number of reasons including the facts that the parking transaction was commenced prior to the issuance of Rev. Proc. 2000-37, it originated in the taxpayer friendly 9th Circuit and, most importantly, the IRS has since made it clear they will not acquiesce to the decision as precedent in other cases.
When, for any number of reasons, more than 180 days is required, the best approach may be to utilize what is referred to as a non-safe harbor reverse exchange which is specifically structured to last longer than 180 days and create true benefits and burdens of ownership in the parking entity.  Since these are not typical parking arrangements, each transaction must be structured differently based upon the facts presented.  The taxpayer’s CPA’s, attorneys and other advisors working for the taxpayer need to be involved in the process.  Accruit has the necessary experience and expertise to assist the taxpayer and all of the other essential parties to the exchange process in navigating transactions outside the safe harbor.

Two terms common to the sale and purchase of real estate are “earnest money” and “down payment.” In this blog post, I will review the definitions of each of these terms and how they are used in the context of real estate and escrow.  
What is Earnest Money?
According to Merriam-Webster, earnest money has various definitions, including:

a serious and intent mental state
something of value given by a buyer to a seller to bind a bargain
a token of what is to come

Earnest money is exactly these things.  In the purchase of an asset, it represents an advance deposit made by the purchaser toward the final purchase price.  Earnest money establishes the purchaser’s intent to acquire, through the contribution of value as a “token of what is to come.”  These dollars are frequently held by a third-party escrow agent, in trust, until conditions for release have been met.
Conditions for release of these funds are negotiated between the seller and purchaser, and the earnest money can be applied against the purchase price of the asset after certain conditions are met, such as:

Completion of inspection(s) or testing
Completions of due diligence
Purchaser’s procurement of additional financing

The terms of the purchase or sale contract will determine whether the earnest money is refunded to the purchaser or retained by the seller.  Ultimately, earnest money can effectively be used to protect both parties.  If the purchaser is unable to fulfill certain contracted obligations, then the seller may retain the funds and avoid the burden of a settlement through the court system.  On the flip side, the purchaser is protected and can get funds back if the seller terminates the agreement or if inspections or due diligence produce a failing event.
What is a Down Payment?
Back to Merriam-Webster for the definition of a down payment:

a part of the full price paid at the time of purchase or delivery with the balance to be paid later

A down payment differs from earnest money in that, in the case of a down payment, the purchaser and the seller have moved successfully through contracted requirements and have arrived at a lender requirement for the purchaser to place a certain amount of their own money toward the acquisition price of the asset.
 
Down payments can vary in amount, depending upon lender requirements and how much the purchaser can reasonably afford.  As a general rule, the more the purchaser can apply as a down payment, the better, as the larger amount can make:

the loan approval process easier,
the amount of the loan smaller, and
the resulting payments and interest costs lower.

Summary
While different, earnest money and down payments are a very important part of the sale and purchase process.  As stated above, the more a purchaser can apply as earnest money or as a down payment, the better.  Large earnest money deposits can encourage the seller toward temporarily taking the asset off the market and accepting the purchaser’s offer.  In highly competitive scenarios, earnest money is a powerful tool for the purchaser.  Down payments represent another powerful tool for the purchaser, as they indicate a strong commitment to the lender regarding shared risk in the investment. 

Two terms common to the sale and purchase of real estate are “earnest money” and “down payment.” In this blog post, I will review the definitions of each of these terms and how they are used in the context of real estate and escrow.  
What is Earnest Money?
According to Merriam-Webster, earnest money has various definitions, including:

a serious and intent mental state
something of value given by a buyer to a seller to bind a bargain
a token of what is to come

Earnest money is exactly these things.  In the purchase of an asset, it represents an advance deposit made by the purchaser toward the final purchase price.  Earnest money establishes the purchaser’s intent to acquire, through the contribution of value as a “token of what is to come.”  These dollars are frequently held by a third-party escrow agent, in trust, until conditions for release have been met.
Conditions for release of these funds are negotiated between the seller and purchaser, and the earnest money can be applied against the purchase price of the asset after certain conditions are met, such as:

Completion of inspection(s) or testing
Completions of due diligence
Purchaser’s procurement of additional financing

The terms of the purchase or sale contract will determine whether the earnest money is refunded to the purchaser or retained by the seller.  Ultimately, earnest money can effectively be used to protect both parties.  If the purchaser is unable to fulfill certain contracted obligations, then the seller may retain the funds and avoid the burden of a settlement through the court system.  On the flip side, the purchaser is protected and can get funds back if the seller terminates the agreement or if inspections or due diligence produce a failing event.
What is a Down Payment?
Back to Merriam-Webster for the definition of a down payment:

a part of the full price paid at the time of purchase or delivery with the balance to be paid later

A down payment differs from earnest money in that, in the case of a down payment, the purchaser and the seller have moved successfully through contracted requirements and have arrived at a lender requirement for the purchaser to place a certain amount of their own money toward the acquisition price of the asset.
 
Down payments can vary in amount, depending upon lender requirements and how much the purchaser can reasonably afford.  As a general rule, the more the purchaser can apply as a down payment, the better, as the larger amount can make:

the loan approval process easier,
the amount of the loan smaller, and
the resulting payments and interest costs lower.

Summary
While different, earnest money and down payments are a very important part of the sale and purchase process.  As stated above, the more a purchaser can apply as earnest money or as a down payment, the better.  Large earnest money deposits can encourage the seller toward temporarily taking the asset off the market and accepting the purchaser’s offer.  In highly competitive scenarios, earnest money is a powerful tool for the purchaser.  Down payments represent another powerful tool for the purchaser, as they indicate a strong commitment to the lender regarding shared risk in the investment. 

Two terms common to the sale and purchase of real estate are “earnest money” and “down payment.” In this blog post, I will review the definitions of each of these terms and how they are used in the context of real estate and escrow.  
What is Earnest Money?
According to Merriam-Webster, earnest money has various definitions, including:

a serious and intent mental state
something of value given by a buyer to a seller to bind a bargain
a token of what is to come

Earnest money is exactly these things.  In the purchase of an asset, it represents an advance deposit made by the purchaser toward the final purchase price.  Earnest money establishes the purchaser’s intent to acquire, through the contribution of value as a “token of what is to come.”  These dollars are frequently held by a third-party escrow agent, in trust, until conditions for release have been met.
Conditions for release of these funds are negotiated between the seller and purchaser, and the earnest money can be applied against the purchase price of the asset after certain conditions are met, such as:

Completion of inspection(s) or testing
Completions of due diligence
Purchaser’s procurement of additional financing

The terms of the purchase or sale contract will determine whether the earnest money is refunded to the purchaser or retained by the seller.  Ultimately, earnest money can effectively be used to protect both parties.  If the purchaser is unable to fulfill certain contracted obligations, then the seller may retain the funds and avoid the burden of a settlement through the court system.  On the flip side, the purchaser is protected and can get funds back if the seller terminates the agreement or if inspections or due diligence produce a failing event.
What is a Down Payment?
Back to Merriam-Webster for the definition of a down payment:

a part of the full price paid at the time of purchase or delivery with the balance to be paid later

A down payment differs from earnest money in that, in the case of a down payment, the purchaser and the seller have moved successfully through contracted requirements and have arrived at a lender requirement for the purchaser to place a certain amount of their own money toward the acquisition price of the asset.
 
Down payments can vary in amount, depending upon lender requirements and how much the purchaser can reasonably afford.  As a general rule, the more the purchaser can apply as a down payment, the better, as the larger amount can make:

the loan approval process easier,
the amount of the loan smaller, and
the resulting payments and interest costs lower.

Summary
While different, earnest money and down payments are a very important part of the sale and purchase process.  As stated above, the more a purchaser can apply as earnest money or as a down payment, the better.  Large earnest money deposits can encourage the seller toward temporarily taking the asset off the market and accepting the purchaser’s offer.  In highly competitive scenarios, earnest money is a powerful tool for the purchaser.  Down payments represent another powerful tool for the purchaser, as they indicate a strong commitment to the lender regarding shared risk in the investment.