Category: 1031 Exchange General

The Tax Cuts and Jobs Act of 2017 (TCJA) that took effect on January 1, 2018 was a major overhaul of the Internal Revenue Code. Late in 2017, while changes to Section 1031 were being contemplated by Congress, Accruit posted https://www.accruit.com/blog/what-are-effects-tax-reform-1031-tax-defer… blog article concerning some of the proposed amendments or even total repeal of Section 1031 being contemplated in Washington, D.C. and the potential adverse effects on tax deferred exchanges.
Fortunately, the TCJA passed by Congress and signed into law by the President generally preserved like-kind exchanges under Section 1031 of the Code. Although Section 1031 has been around for nearly one hundred years, the TCJA now limits the non-recognition treatment to only like-kind exchanges of real estate. While 1031 exchanges relating to real property remain unchanged, the TCJA completely eliminates the ability of a taxpayer to defer the gain on all types of personal property assets after January 1, 2018, such as:

Aircraft
Railcars
Franchise and dealership rights
Art and other collectibles
Equipment and machinery
Off-lease assets
Patents and other intellectual property
Vehicles, trucks and trailers

As a result of personal property now being excluded from Section 1031 exchanges under the Code, the taxpayer could realize a sizable gain in exchanges of real property that include a significant amount of personal property. For example, transactions involving multi-unit apartment buildings, hotels and restaurants may include substantial personal property to be conveyed in addition to the real estate.
Although the real property may qualify for a 1031 like-kind exchange, the personal property transferred with the real estate cannot be simply disregarded under the TCJA. The taxpayer will need to allocate the portions of purchase price attributable to the real estate and personal property. Unfortunately, the personal property included would likely be considered taxable “boot” in the real property exchange. In such instances the taxpayer should consider the TCJA bonus depreciation and immediate expensing provisions. The accelerated depreciation rules can take much of the sting out to the inability to do an exchange for personal property
Interestingly, the changes implemented by the TCJA also materially affect the world of professional sports. Pro sports teams that trade players are seen as effectively trading those players’ contracts which are regarded as assets for tax purposes. Consequently, it is possible that sports franchises may seek to trade fewer players now that they can no longer use Section 1031 for like-kind exchanges to make player trades on a tax-deferred basis and have to pay taxes each time they make a trade.
Congress enacted significant changes to the like-kind exchange rules under Section 1031 by way of the TCJA. The removal of personal property from like-kind exchanges has adversely affected many taxpayers and greatly impacted other industries. There are no guarantees that will not revisit the notion of repealing Section 1031 exchanges altogether. It is more important than ever before to consult with your legal and tax professionals, as well as the professionals at Accruit, as soon as possible concerning the new law and its impact on your next like-kind exchange of real estate.

The Tax Cuts and Jobs Act of 2017 (TCJA) that took effect on January 1, 2018 was a major overhaul of the Internal Revenue Code. Late in 2017, while changes to Section 1031 were being contemplated by Congress, Accruit posted https://www.accruit.com/blog/what-are-effects-tax-reform-1031-tax-defer… blog article concerning some of the proposed amendments or even total repeal of Section 1031 being contemplated in Washington, D.C. and the potential adverse effects on tax deferred exchanges.
Fortunately, the TCJA passed by Congress and signed into law by the President generally preserved like-kind exchanges under Section 1031 of the Code. Although Section 1031 has been around for nearly one hundred years, the TCJA now limits the non-recognition treatment to only like-kind exchanges of real estate. While 1031 exchanges relating to real property remain unchanged, the TCJA completely eliminates the ability of a taxpayer to defer the gain on all types of personal property assets after January 1, 2018, such as:

Aircraft
Railcars
Franchise and dealership rights
Art and other collectibles
Equipment and machinery
Off-lease assets
Patents and other intellectual property
Vehicles, trucks and trailers

As a result of personal property now being excluded from Section 1031 exchanges under the Code, the taxpayer could realize a sizable gain in exchanges of real property that include a significant amount of personal property. For example, transactions involving multi-unit apartment buildings, hotels and restaurants may include substantial personal property to be conveyed in addition to the real estate.
Although the real property may qualify for a 1031 like-kind exchange, the personal property transferred with the real estate cannot be simply disregarded under the TCJA. The taxpayer will need to allocate the portions of purchase price attributable to the real estate and personal property. Unfortunately, the personal property included would likely be considered taxable “boot” in the real property exchange. In such instances the taxpayer should consider the TCJA bonus depreciation and immediate expensing provisions. The accelerated depreciation rules can take much of the sting out to the inability to do an exchange for personal property
Interestingly, the changes implemented by the TCJA also materially affect the world of professional sports. Pro sports teams that trade players are seen as effectively trading those players’ contracts which are regarded as assets for tax purposes. Consequently, it is possible that sports franchises may seek to trade fewer players now that they can no longer use Section 1031 for like-kind exchanges to make player trades on a tax-deferred basis and have to pay taxes each time they make a trade.
Congress enacted significant changes to the like-kind exchange rules under Section 1031 by way of the TCJA. The removal of personal property from like-kind exchanges has adversely affected many taxpayers and greatly impacted other industries. There are no guarantees that will not revisit the notion of repealing Section 1031 exchanges altogether. It is more important than ever before to consult with your legal and tax professionals, as well as the professionals at Accruit, as soon as possible concerning the new law and its impact on your next like-kind exchange of real estate.

The descriptions of these entities are organized according to their functional characteristics, such as formation, management and conduct of business, firm property, ownership interests, dissociation of owners, and dissolution of the firm. This allows the reader to compare and contrast the alternatives offered by the various forms.
Tax Law and Business Law Considerations of Real Estate Entities
Investors can choose from several different organizational forms for purposes of purchasing real estate. Most organizational entities are separate and apart from the assets and liabilities of any other entity or owner. The choice of entities in owning real estate is usually dependent upon a combination of business law and tax factors.
Tax law considerations include:

Federal and state income tax treatment and consequences

The nature of the property to be owned by the investors

Distributions of cash and appreciated property

Organization, re-organization, sale, and the ability to do business in another state

Business law considerations include:

The number of individual investors

An investor’s anticipated involvement in the operation and management of the real estate

The risk involved in the investment

Personal liability

Allocations of management authority within the entity

Qualifications of owners

Sharing of profits and losses

Duration of the entity, transferability of interests, exit strategies, and liquidation

Common Organizational Structures for Owning Real Estate
Several different ownership structures exist for purposes of owning real estate. Some of the more common forms include:

Individual/Sole Proprietorship

Tenancy in Common

Land Trust

General Partnership

Limited Partnership

Corporation (C-corp & S-corp)

Limited Liability Company (LLC)

Many investors choose a limited liability company as their organizational form to purchase real estate because of its tax treatment, flexibility in power structure and management responsibilities, and limited liability. The best way to understand the unique features of an LLC is to distinguish it from the other entities.
We will begin our discussion with the most basic of all forms: a sole proprietorship.
Sole Proprietorships
A sole proprietorship is owned by a single person and exists absent a statutory scheme. It has no separate legal existence from its owner. In other words, no legal formalities are required to bring this form into existence. There are no organizational or operational costs, and no qualification requirements exist for doing business in other states.
The sole proprietor may hire employees or independent contractors; however, all the decision-making is centered with the individual owner. The owner is not insulated from liability and directly assigned all profits and losses. Also, the sole owner does not need to file a separate tax return. Only minimal reporting to is required through Form 1040 and Schedule C. The income or loss of Schedule C is added or subtracted to the 1040 to determine tax liability. Business profits are subject to only one tax at the individual level.
Tenants in Common
Another way to hold an interest in real estate is as tenants in common. Tenancy in common (TIC) is the ownership of real estate by more than one person, with each owner retaining an undivided interest in the property. Like the sole proprietorship, no entity is formed to own that interest. An investor can own the interest as he wants on his tax return.
Tenancy in common also allows for continuous ownership upon death or bankruptcy of any other owner. The owner may sell his interest, initiate a sale and partition suit (which is essentially a forced sale which generally occurs because the owners of property are unable to agree upon certain aspects of the ownership), or dissolve the tenancy in common. The TIC interest goes to the heirs of that owner rather than to the other tenants in common. The agreements between tenants in common usually deal with the sharing of expenses and provide one owner with the right to buy out the other owner when used.
Summary
In the first of this series on selecting a real estate entity, we looked at the sole proprietorship and tenant in common entities, each of which have distinct characteristics that could influence why one may or may not choose to select them. In our next installment on entities for real estate purchase, we discuss partnerships.

The descriptions of these entities are organized according to their functional characteristics, such as formation, management and conduct of business, firm property, ownership interests, dissociation of owners, and dissolution of the firm. This allows the reader to compare and contrast the alternatives offered by the various forms.
Tax Law and Business Law Considerations of Real Estate Entities
Investors can choose from several different organizational forms for purposes of purchasing real estate. Most organizational entities are separate and apart from the assets and liabilities of any other entity or owner. The choice of entities in owning real estate is usually dependent upon a combination of business law and tax factors.
Tax law considerations include:

Federal and state income tax treatment and consequences

The nature of the property to be owned by the investors

Distributions of cash and appreciated property

Organization, re-organization, sale, and the ability to do business in another state

Business law considerations include:

The number of individual investors

An investor’s anticipated involvement in the operation and management of the real estate

The risk involved in the investment

Personal liability

Allocations of management authority within the entity

Qualifications of owners

Sharing of profits and losses

Duration of the entity, transferability of interests, exit strategies, and liquidation

Common Organizational Structures for Owning Real Estate
Several different ownership structures exist for purposes of owning real estate. Some of the more common forms include:

Individual/Sole Proprietorship

Tenancy in Common

Land Trust

General Partnership

Limited Partnership

Corporation (C-corp & S-corp)

Limited Liability Company (LLC)

Many investors choose a limited liability company as their organizational form to purchase real estate because of its tax treatment, flexibility in power structure and management responsibilities, and limited liability. The best way to understand the unique features of an LLC is to distinguish it from the other entities.
We will begin our discussion with the most basic of all forms: a sole proprietorship.
Sole Proprietorships
A sole proprietorship is owned by a single person and exists absent a statutory scheme. It has no separate legal existence from its owner. In other words, no legal formalities are required to bring this form into existence. There are no organizational or operational costs, and no qualification requirements exist for doing business in other states.
The sole proprietor may hire employees or independent contractors; however, all the decision-making is centered with the individual owner. The owner is not insulated from liability and directly assigned all profits and losses. Also, the sole owner does not need to file a separate tax return. Only minimal reporting to is required through Form 1040 and Schedule C. The income or loss of Schedule C is added or subtracted to the 1040 to determine tax liability. Business profits are subject to only one tax at the individual level.
Tenants in Common
Another way to hold an interest in real estate is as tenants in common. Tenancy in common (TIC) is the ownership of real estate by more than one person, with each owner retaining an undivided interest in the property. Like the sole proprietorship, no entity is formed to own that interest. An investor can own the interest as he wants on his tax return.
Tenancy in common also allows for continuous ownership upon death or bankruptcy of any other owner. The owner may sell his interest, initiate a sale and partition suit (which is essentially a forced sale which generally occurs because the owners of property are unable to agree upon certain aspects of the ownership), or dissolve the tenancy in common. The TIC interest goes to the heirs of that owner rather than to the other tenants in common. The agreements between tenants in common usually deal with the sharing of expenses and provide one owner with the right to buy out the other owner when used.
Summary
In the first of this series on selecting a real estate entity, we looked at the sole proprietorship and tenant in common entities, each of which have distinct characteristics that could influence why one may or may not choose to select them. In our next installment on entities for real estate purchase, we discuss partnerships.

The descriptions of these entities are organized according to their functional characteristics, such as formation, management and conduct of business, firm property, ownership interests, dissociation of owners, and dissolution of the firm. This allows the reader to compare and contrast the alternatives offered by the various forms.
Tax Law and Business Law Considerations of Real Estate Entities
Investors can choose from several different organizational forms for purposes of purchasing real estate. Most organizational entities are separate and apart from the assets and liabilities of any other entity or owner. The choice of entities in owning real estate is usually dependent upon a combination of business law and tax factors.
Tax law considerations include:

Federal and state income tax treatment and consequences

The nature of the property to be owned by the investors

Distributions of cash and appreciated property

Organization, re-organization, sale, and the ability to do business in another state

Business law considerations include:

The number of individual investors

An investor’s anticipated involvement in the operation and management of the real estate

The risk involved in the investment

Personal liability

Allocations of management authority within the entity

Qualifications of owners

Sharing of profits and losses

Duration of the entity, transferability of interests, exit strategies, and liquidation

Common Organizational Structures for Owning Real Estate
Several different ownership structures exist for purposes of owning real estate. Some of the more common forms include:

Individual/Sole Proprietorship

Tenancy in Common

Land Trust

General Partnership

Limited Partnership

Corporation (C-corp & S-corp)

Limited Liability Company (LLC)

Many investors choose a limited liability company as their organizational form to purchase real estate because of its tax treatment, flexibility in power structure and management responsibilities, and limited liability. The best way to understand the unique features of an LLC is to distinguish it from the other entities.
We will begin our discussion with the most basic of all forms: a sole proprietorship.
Sole Proprietorships
A sole proprietorship is owned by a single person and exists absent a statutory scheme. It has no separate legal existence from its owner. In other words, no legal formalities are required to bring this form into existence. There are no organizational or operational costs, and no qualification requirements exist for doing business in other states.
The sole proprietor may hire employees or independent contractors; however, all the decision-making is centered with the individual owner. The owner is not insulated from liability and directly assigned all profits and losses. Also, the sole owner does not need to file a separate tax return. Only minimal reporting to is required through Form 1040 and Schedule C. The income or loss of Schedule C is added or subtracted to the 1040 to determine tax liability. Business profits are subject to only one tax at the individual level.
Tenants in Common
Another way to hold an interest in real estate is as tenants in common. Tenancy in common (TIC) is the ownership of real estate by more than one person, with each owner retaining an undivided interest in the property. Like the sole proprietorship, no entity is formed to own that interest. An investor can own the interest as he wants on his tax return.
Tenancy in common also allows for continuous ownership upon death or bankruptcy of any other owner. The owner may sell his interest, initiate a sale and partition suit (which is essentially a forced sale which generally occurs because the owners of property are unable to agree upon certain aspects of the ownership), or dissolve the tenancy in common. The TIC interest goes to the heirs of that owner rather than to the other tenants in common. The agreements between tenants in common usually deal with the sharing of expenses and provide one owner with the right to buy out the other owner when used.
Summary
In the first of this series on selecting a real estate entity, we looked at the sole proprietorship and tenant in common entities, each of which have distinct characteristics that could influence why one may or may not choose to select them. In our next installment on entities for real estate purchase, we discuss partnerships.

1031 tax-deferred exchanges were established as part of United States tax law in 1921, yet there are still misconceptions about like-kind exchanges and how they work. Let’s clear up a few in this post.
I can receive tax deferral by rolling over my gain into new property
No, this is not the case. In order to receive full deferral, the value of the property must be replaced, net of the closing costs. In other words, the net proceeds from the sale of the relinquished property must be rolled over and new debt must be on the new property in an amount equal or greater than the amount of debt paid off in the sale of the relinquished property. The first dollars not rolled over will be considered return of the gain, not return of the capital investment nor prorated between the gain and capital investment.
If I trade up or even in value, I am deferring all my gain.
Yes and no. More specifically, a taxpayer has to use up all the net cash and have equal or greater debt than was paid off upon sale of the relinquished property. And while excess cash can be added to replacement property to replace debt retired, the corollary is not true; excess debt on replacement property will not offset cash received upon the sale of the relinquished property.
If I or my attorney holds the buyer’s earnest money, my exchange will fail due to the receipt of funds.
While it is true that actual receipt, in which you hold the buyer’s earnest money, or constructive receipt, in which your attorney or agent holds the buyer’s earnest money, will violate the rule that a taxpayer can have no right to “receive, pledge or otherwise obtain the benefits of money,” technically these rules do not come into being until the time of the exchange event, i.e. the sale of the relinquished property. As such, holding the funds prior to that time is not a problem so long as the funds are turned over to the qualified intermediary directly or through the settlement agent at the time of closing.
If I elect to terminate the exchange and pay full taxes owed, I can receive my exchange funds at any time.
The exchange regulations appear to be contrary to this common sense position. The regulations allow return of funds only upon the failure to identify replacement property within 45 days of the sale of relinquished property or upon taxpayer’s receipt of all identified property which the taxpayer is entitled to acquire or upon the expiration of the 180 day exchange period. In the year 2000, the IRS issued a Private Letter Ruling underscoring these rules. Even if a taxpayer is not concerned about a violation of these rules in the event of a failed exchange, the qualified intermediary abides by the rules in order to establish a course of conduct consistent with the rules.
I cannot effectuate an exchange if my contract fails to contain an Exchange Cooperation Clause.
Not so. Early in the history of exchanges, a buyer had to actively participate in the exchange in order for the taxpayer to be able to complete an exchange. Modern day rules only require that the buyer of the old property and the seller of the new property receive written notice that the taxpayer has assigned the rights (but not the liabilities or obligations) to the qualified intermediary. No signature nor other affirmative action is required by the other parties. So unless the property is in one of the few states, like New York, where assignments are not permitted without a provision in the contract, they are otherwise freely assignable.
So long as written notice of the assignment of rights is given to the buyer of the relinquished property and the seller of the replacement property, I have conformed to the requirements under the regulations.
In most cases this is true. However the regulations state that all parties to the contract must be given written notice of the assignment. So in the case of multiple sellers or multiple buyers on the taxpayer’s side of a transaction, all co-sellers or co-buyers must also receive written notice for compliance. In one recent instance being handled by our office, the escrow agent was named as a party to the contract and the client’s attorney was instructed to ensure that the agent also received written notice of the assignment.
Identification of replacement property has to be made to the qualified intermediary.
Although it is most common to make the 45-day identification to the qualified intermediary, the regulations actually allow the identification to be made to the seller or “any other person involved in the exchange other than the taxpayer or a disqualified person.” Examples provided in the regulations include the buyer of the relinquished property, the intermediary, the title company and the escrow agent. So a valid indication can be made to these parties and not necessarily to the intermediary. For example, a provision in the replacement property contract could indicate that the buyer is identifying the property as his replacement property for his exchange.
A taxpayer can direct the qualified intermediary to pay legal or accounting fees from the exchange account.
Perhaps. Certain transactional costs can come from the exchange account however the expense must (i) pertain only to the exchange transaction and (ii) would be an expense that would “appear under local standards in the typical closing statement as the responsibility of a buyer or seller.” Attorney’s fees may typically appear on a closing statement in certain locales, but one would not expect to see accountant’s fees on a closing statement. Payment for transactional costs should be done with care and only if they fall within the above two prong test. Examples appearing in the regulations include real estate commissions, prorate taxes, recording or transfer taxes and title company fees.
A taxpayer can pay loan-related costs for the replacement property from the exchange account.
No. Not every cost associated with the acquisition of replacement property can be paid out of exchange funds. Remember, these are like-kind exchanges. Real estate is exchanged for real estate, not for loan costs. So such items as loan commitment fees, points, appraisal and credit reports should be paid from separate funds.
A limited liability company member or a partner in a partnership can do their own exchange upon sale of property owned by the LLC or partnership.
This is the most common question or misconception seen by qualified intermediaries. Unfortunately, the Internal Revenue Code does not allow an individual member or partner to do an exchange; it can only be done at the entity level. In order to get around this restriction, it was somewhat common to cause the LLC or partnership to deed a fractional interest in the property to the individual immediately before the sale so that she would not be selling in her capacity of a member or partner. The interest was “dropped” to her so she could “swap” it as part of an exchange. These are known as Drop & Swap techniques. Because a proper exchange requires a period of “holding” the property before the sale, this technique is frowned upon by the IRS unless the “drop” takes place well in advance of the sale and ideally in advance of the property going under contract.
If multiple properties are being sold by one seller under one contract, they are considered one property for the purpose of the three-property rule
Probably not. If there are contiguous lots and multiple permanent index numbers, an argument can be made that they cannot be sold separately and therefor only constitute one property. However if they are not contiguous and/or are capable of being sold separately (despite the seller’s preference not to) they are likely considered separate properties for purpose of this rule. Taxpayers commonly identify Delaware Statutory Trust (DST) investments. A single investment might be comprised of a fractional share in a portfolio of properties. This is an example of each property being considered a separate property for purposes of the three-property rule (although it may still work under the separate 200% rule).
Summary
If you have questions about any of these points or want to get clear on other questions about how 1031 exchanges work, please contact us. We will be happy to provide more information.
 
 
 
 
 
 
 
 

1031 tax-deferred exchanges were established as part of United States tax law in 1921, yet there are still misconceptions about like-kind exchanges and how they work. Let’s clear up a few in this post.
I can receive tax deferral by rolling over my gain into new property
No, this is not the case. In order to receive full deferral, the value of the property must be replaced, net of the closing costs. In other words, the net proceeds from the sale of the relinquished property must be rolled over and new debt must be on the new property in an amount equal or greater than the amount of debt paid off in the sale of the relinquished property. The first dollars not rolled over will be considered return of the gain, not return of the capital investment nor prorated between the gain and capital investment.
If I trade up or even in value, I am deferring all my gain.
Yes and no. More specifically, a taxpayer has to use up all the net cash and have equal or greater debt than was paid off upon sale of the relinquished property. And while excess cash can be added to replacement property to replace debt retired, the corollary is not true; excess debt on replacement property will not offset cash received upon the sale of the relinquished property.
If I or my attorney holds the buyer’s earnest money, my exchange will fail due to the receipt of funds.
While it is true that actual receipt, in which you hold the buyer’s earnest money, or constructive receipt, in which your attorney or agent holds the buyer’s earnest money, will violate the rule that a taxpayer can have no right to “receive, pledge or otherwise obtain the benefits of money,” technically these rules do not come into being until the time of the exchange event, i.e. the sale of the relinquished property. As such, holding the funds prior to that time is not a problem so long as the funds are turned over to the qualified intermediary directly or through the settlement agent at the time of closing.
If I elect to terminate the exchange and pay full taxes owed, I can receive my exchange funds at any time.
The exchange regulations appear to be contrary to this common sense position. The regulations allow return of funds only upon the failure to identify replacement property within 45 days of the sale of relinquished property or upon taxpayer’s receipt of all identified property which the taxpayer is entitled to acquire or upon the expiration of the 180 day exchange period. In the year 2000, the IRS issued a Private Letter Ruling underscoring these rules. Even if a taxpayer is not concerned about a violation of these rules in the event of a failed exchange, the qualified intermediary abides by the rules in order to establish a course of conduct consistent with the rules.
I cannot effectuate an exchange if my contract fails to contain an Exchange Cooperation Clause.
Not so. Early in the history of exchanges, a buyer had to actively participate in the exchange in order for the taxpayer to be able to complete an exchange. Modern day rules only require that the buyer of the old property and the seller of the new property receive written notice that the taxpayer has assigned the rights (but not the liabilities or obligations) to the qualified intermediary. No signature nor other affirmative action is required by the other parties. So unless the property is in one of the few states, like New York, where assignments are not permitted without a provision in the contract, they are otherwise freely assignable.
So long as written notice of the assignment of rights is given to the buyer of the relinquished property and the seller of the replacement property, I have conformed to the requirements under the regulations.
In most cases this is true. However the regulations state that all parties to the contract must be given written notice of the assignment. So in the case of multiple sellers or multiple buyers on the taxpayer’s side of a transaction, all co-sellers or co-buyers must also receive written notice for compliance. In one recent instance being handled by our office, the escrow agent was named as a party to the contract and the client’s attorney was instructed to ensure that the agent also received written notice of the assignment.
Identification of replacement property has to be made to the qualified intermediary.
Although it is most common to make the 45-day identification to the qualified intermediary, the regulations actually allow the identification to be made to the seller or “any other person involved in the exchange other than the taxpayer or a disqualified person.” Examples provided in the regulations include the buyer of the relinquished property, the intermediary, the title company and the escrow agent. So a valid indication can be made to these parties and not necessarily to the intermediary. For example, a provision in the replacement property contract could indicate that the buyer is identifying the property as his replacement property for his exchange.
A taxpayer can direct the qualified intermediary to pay legal or accounting fees from the exchange account.
Perhaps. Certain transactional costs can come from the exchange account however the expense must (i) pertain only to the exchange transaction and (ii) would be an expense that would “appear under local standards in the typical closing statement as the responsibility of a buyer or seller.” Attorney’s fees may typically appear on a closing statement in certain locales, but one would not expect to see accountant’s fees on a closing statement. Payment for transactional costs should be done with care and only if they fall within the above two prong test. Examples appearing in the regulations include real estate commissions, prorate taxes, recording or transfer taxes and title company fees.
A taxpayer can pay loan-related costs for the replacement property from the exchange account.
No. Not every cost associated with the acquisition of replacement property can be paid out of exchange funds. Remember, these are like-kind exchanges. Real estate is exchanged for real estate, not for loan costs. So such items as loan commitment fees, points, appraisal and credit reports should be paid from separate funds.
A limited liability company member or a partner in a partnership can do their own exchange upon sale of property owned by the LLC or partnership.
This is the most common question or misconception seen by qualified intermediaries. Unfortunately, the Internal Revenue Code does not allow an individual member or partner to do an exchange; it can only be done at the entity level. In order to get around this restriction, it was somewhat common to cause the LLC or partnership to deed a fractional interest in the property to the individual immediately before the sale so that she would not be selling in her capacity of a member or partner. The interest was “dropped” to her so she could “swap” it as part of an exchange. These are known as Drop & Swap techniques. Because a proper exchange requires a period of “holding” the property before the sale, this technique is frowned upon by the IRS unless the “drop” takes place well in advance of the sale and ideally in advance of the property going under contract.
If multiple properties are being sold by one seller under one contract, they are considered one property for the purpose of the three-property rule
Probably not. If there are contiguous lots and multiple permanent index numbers, an argument can be made that they cannot be sold separately and therefor only constitute one property. However if they are not contiguous and/or are capable of being sold separately (despite the seller’s preference not to) they are likely considered separate properties for purpose of this rule. Taxpayers commonly identify Delaware Statutory Trust (DST) investments. A single investment might be comprised of a fractional share in a portfolio of properties. This is an example of each property being considered a separate property for purposes of the three-property rule (although it may still work under the separate 200% rule).
Summary
If you have questions about any of these points or want to get clear on other questions about how 1031 exchanges work, please contact us. We will be happy to provide more information.
 
 
 
 
 
 
 
 

1031 tax-deferred exchanges were established as part of United States tax law in 1921, yet there are still misconceptions about like-kind exchanges and how they work. Let’s clear up a few in this post.
I can receive tax deferral by rolling over my gain into new property
No, this is not the case. In order to receive full deferral, the value of the property must be replaced, net of the closing costs. In other words, the net proceeds from the sale of the relinquished property must be rolled over and new debt must be on the new property in an amount equal or greater than the amount of debt paid off in the sale of the relinquished property. The first dollars not rolled over will be considered return of the gain, not return of the capital investment nor prorated between the gain and capital investment.
If I trade up or even in value, I am deferring all my gain.
Yes and no. More specifically, a taxpayer has to use up all the net cash and have equal or greater debt than was paid off upon sale of the relinquished property. And while excess cash can be added to replacement property to replace debt retired, the corollary is not true; excess debt on replacement property will not offset cash received upon the sale of the relinquished property.
If I or my attorney holds the buyer’s earnest money, my exchange will fail due to the receipt of funds.
While it is true that actual receipt, in which you hold the buyer’s earnest money, or constructive receipt, in which your attorney or agent holds the buyer’s earnest money, will violate the rule that a taxpayer can have no right to “receive, pledge or otherwise obtain the benefits of money,” technically these rules do not come into being until the time of the exchange event, i.e. the sale of the relinquished property. As such, holding the funds prior to that time is not a problem so long as the funds are turned over to the qualified intermediary directly or through the settlement agent at the time of closing.
If I elect to terminate the exchange and pay full taxes owed, I can receive my exchange funds at any time.
The exchange regulations appear to be contrary to this common sense position. The regulations allow return of funds only upon the failure to identify replacement property within 45 days of the sale of relinquished property or upon taxpayer’s receipt of all identified property which the taxpayer is entitled to acquire or upon the expiration of the 180 day exchange period. In the year 2000, the IRS issued a Private Letter Ruling underscoring these rules. Even if a taxpayer is not concerned about a violation of these rules in the event of a failed exchange, the qualified intermediary abides by the rules in order to establish a course of conduct consistent with the rules.
I cannot effectuate an exchange if my contract fails to contain an Exchange Cooperation Clause.
Not so. Early in the history of exchanges, a buyer had to actively participate in the exchange in order for the taxpayer to be able to complete an exchange. Modern day rules only require that the buyer of the old property and the seller of the new property receive written notice that the taxpayer has assigned the rights (but not the liabilities or obligations) to the qualified intermediary. No signature nor other affirmative action is required by the other parties. So unless the property is in one of the few states, like New York, where assignments are not permitted without a provision in the contract, they are otherwise freely assignable.
So long as written notice of the assignment of rights is given to the buyer of the relinquished property and the seller of the replacement property, I have conformed to the requirements under the regulations.
In most cases this is true. However the regulations state that all parties to the contract must be given written notice of the assignment. So in the case of multiple sellers or multiple buyers on the taxpayer’s side of a transaction, all co-sellers or co-buyers must also receive written notice for compliance. In one recent instance being handled by our office, the escrow agent was named as a party to the contract and the client’s attorney was instructed to ensure that the agent also received written notice of the assignment.
Identification of replacement property has to be made to the qualified intermediary.
Although it is most common to make the 45-day identification to the qualified intermediary, the regulations actually allow the identification to be made to the seller or “any other person involved in the exchange other than the taxpayer or a disqualified person.” Examples provided in the regulations include the buyer of the relinquished property, the intermediary, the title company and the escrow agent. So a valid indication can be made to these parties and not necessarily to the intermediary. For example, a provision in the replacement property contract could indicate that the buyer is identifying the property as his replacement property for his exchange.
A taxpayer can direct the qualified intermediary to pay legal or accounting fees from the exchange account.
Perhaps. Certain transactional costs can come from the exchange account however the expense must (i) pertain only to the exchange transaction and (ii) would be an expense that would “appear under local standards in the typical closing statement as the responsibility of a buyer or seller.” Attorney’s fees may typically appear on a closing statement in certain locales, but one would not expect to see accountant’s fees on a closing statement. Payment for transactional costs should be done with care and only if they fall within the above two prong test. Examples appearing in the regulations include real estate commissions, prorate taxes, recording or transfer taxes and title company fees.
A taxpayer can pay loan-related costs for the replacement property from the exchange account.
No. Not every cost associated with the acquisition of replacement property can be paid out of exchange funds. Remember, these are like-kind exchanges. Real estate is exchanged for real estate, not for loan costs. So such items as loan commitment fees, points, appraisal and credit reports should be paid from separate funds.
A limited liability company member or a partner in a partnership can do their own exchange upon sale of property owned by the LLC or partnership.
This is the most common question or misconception seen by qualified intermediaries. Unfortunately, the Internal Revenue Code does not allow an individual member or partner to do an exchange; it can only be done at the entity level. In order to get around this restriction, it was somewhat common to cause the LLC or partnership to deed a fractional interest in the property to the individual immediately before the sale so that she would not be selling in her capacity of a member or partner. The interest was “dropped” to her so she could “swap” it as part of an exchange. These are known as Drop & Swap techniques. Because a proper exchange requires a period of “holding” the property before the sale, this technique is frowned upon by the IRS unless the “drop” takes place well in advance of the sale and ideally in advance of the property going under contract.
If multiple properties are being sold by one seller under one contract, they are considered one property for the purpose of the three-property rule
Probably not. If there are contiguous lots and multiple permanent index numbers, an argument can be made that they cannot be sold separately and therefor only constitute one property. However if they are not contiguous and/or are capable of being sold separately (despite the seller’s preference not to) they are likely considered separate properties for purpose of this rule. Taxpayers commonly identify Delaware Statutory Trust (DST) investments. A single investment might be comprised of a fractional share in a portfolio of properties. This is an example of each property being considered a separate property for purposes of the three-property rule (although it may still work under the separate 200% rule).
Summary
If you have questions about any of these points or want to get clear on other questions about how 1031 exchanges work, please contact us. We will be happy to provide more information.