Category: 1031 Exchange General

When setting out to conduct a 1031 like-kind exchange, it’s important to know the rules associated with Section 1031 of the tax code. The following rules are key:

Identification of any and all replacement properties by day 45 of the exchange
Acquisition of the identified replacement properties by day 180 of the exchange
Prohibitions on personal use of the investment property for more than 14 days in either of the first two years of ownership
Rental of investment property for at least 14 days in each of the first two years of ownership

How will the IRS know?
Owners of investment property must understand that there is no gray area related to any of the above issues, and while most investors get that, some want to push the boundaries of the law.  These more aggressive investors will typically ask the following questions:

How will the IRS know if I make changes after day 45?
I may not be able to close by day 180, but can’t I just report that I did?
How will the IRS know if I use the property for more than 14 days each year?
Will the IRS know if I don’t rent the property for at least 14 days each year?

 The overarching theme of these questions is, “How will the IRS know?” 
The IRS has many methods to collect and audit data, but a somewhat new approach involves collecting data from our cell phones.  That’s right, the tool we use to be more productive also makes the IRS more productive.  These phones we carry are storing evidence that could be used against overly aggressive property owners in tax court.
A Picture is Worth Thousands of Dollars
In one case, a taxpayer told the IRS they constructed and purchased a new property by day 180 of their like-kind exchange.  During the audit, the IRS reviewed the photos saved on the taxpayer’s smartphone.  The pictures showed the various phases of the new construction at the job site, and each picture bore a date stamp.  The IRS found specific pictures of the job site with date stamps after day 180 of the exchange, revealing that the property in question was far from complete on day 180.  Only the foundation had been poured! This left the taxpayer with some explaining to do.
Location, Location, Location
In another case, a taxpayer reported that they were renting a property and not using it for personal reasons.  This property was located in a different state from the taxpayer’s primary residence.  During an audit, the IRS was able to review the taxpayer’s smartphone activity and discovered that the phone was communicating with a cell tower located very close to the taxpayer’s “rental.”  The phone’s communication process with this tower occurred for at least two months during one year.  This information helped the IRS prove that the taxpayer was actually using the “rental” for personal purposes, beyond what is allowed by law.
The IRS Likes You on Facebook
It’s been reported that the IRS is tracking taxpayer activity on social media sites like Facebook and eBay in its quest to minimize the amount of revenue lost to tax evasion each year, an estimated $300 billion.
Big Data: Not Just a Buzzword
Taxpayers need to be fully aware of the risks when venturing outside Section 1031’s regulations.  That’s why it’s important to involve the right team of experienced professionals – an experienced tax advisor and an experienced qualified intermediary – who can highlight important issues and help structure a like-kind exchange without violating the rules.  Big data is more than a buzzword; it’s a reality with a staggering amount of individual data points being collected on each of us. How exactly the IRS will know is unclear, but that they will is certain.
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No matter where you stand politically, there are certain things we can all agree upon, including the benefits of Section 1031 of the tax code.  Section 1031 like-kind exchanges (LKEs) have been around since 1921, and, at their core, encourage continuity of investment – allowing asset owners to defer taxable gains into replacement assets rather than cashing out. From a planning and growth perspective, that’s particularly powerful as Section 1031 allows investors to follow opportunity – by moving their investments anywhere across the United States – without income tax penalty.
Who benefits from Section 1031?
Yes, ”The Donald” does benefit from 1031s, but so do ordinary American taxpayers, including rental property owners, farmers, collectors, rental car companies, construction contractors, and leasing companies.  LKEs can be utilized by any taxpayer in any tax bracket and can significantly increase their cash flow.  This increased cash is an effective economic stimulant, allowing asset owners to keep their money working in their businesses.
We need more jobs.
Both sides of the political spectrum say we need to create more jobs.  Taken as a whole, the 1031 exchange process is job creation on steroids.  Below is an example of Donald Trump saying “You’re hired” not “You’re fired” to an army of professionals.
Let’s say Trump receives an offer to buy one of his commercial real estate properties.  Upon accepting the offer, a waterfall of events will take place: 

CPAs and attorneys will review the purchase and sale contract. 
Inspectors will arrive to verify the property’s condition.
Settlement agents and attorneys will be engaged.
Improvements to the property will likely be made requiring contractors and materials.
Financing might be sought, requiring lenders and appraisers to be brought in. 

In this case, Trump’s interested in a like-kind exchange and will need to hire a qualified intermediary.  The qualified intermediary will invest the funds at a bank and Mr. Trump will hire another broker to assist him in finding one or more replacement properties, triggering another team of professionals to facilitate the purchase.  Finally, a team of accountants will be hired to file the final tax returns showing the positive impact of the LKE.
Why would the government want to take away 1031?
Some politicians believe that by taking away this section of the tax code, more tax dollars will be captured without impacting the investment/job creation process described above.  Frankly, they are wrong and taking away this powerful tax deferment tool will discourage investment in American assets and in American workers.  Why would Congress endanger the American economic environment during this fragile period?
What can I do to save 1031?
Please visit http://www.1031taxreform.com”>www.1031taxreform.comhttps://www.votervoice.net/FEA/campaigns/36117/respond”>contact

No matter where you stand politically, there are certain things we can all agree upon, including the benefits of Section 1031 of the tax code.  Section 1031 like-kind exchanges (LKEs) have been around since 1921, and, at their core, encourage continuity of investment – allowing asset owners to defer taxable gains into replacement assets rather than cashing out. From a planning and growth perspective, that’s particularly powerful as Section 1031 allows investors to follow opportunity – by moving their investments anywhere across the United States – without income tax penalty.
Who benefits from Section 1031?
Yes, ”The Donald” does benefit from 1031s, but so do ordinary American taxpayers, including rental property owners, farmers, collectors, rental car companies, construction contractors, and leasing companies.  LKEs can be utilized by any taxpayer in any tax bracket and can significantly increase their cash flow.  This increased cash is an effective economic stimulant, allowing asset owners to keep their money working in their businesses.
We need more jobs.
Both sides of the political spectrum say we need to create more jobs.  Taken as a whole, the 1031 exchange process is job creation on steroids.  Below is an example of Donald Trump saying “You’re hired” not “You’re fired” to an army of professionals.
Let’s say Trump receives an offer to buy one of his commercial real estate properties.  Upon accepting the offer, a waterfall of events will take place: 

CPAs and attorneys will review the purchase and sale contract. 
Inspectors will arrive to verify the property’s condition.
Settlement agents and attorneys will be engaged.
Improvements to the property will likely be made requiring contractors and materials.
Financing might be sought, requiring lenders and appraisers to be brought in. 

In this case, Trump’s interested in a like-kind exchange and will need to hire a qualified intermediary.  The qualified intermediary will invest the funds at a bank and Mr. Trump will hire another broker to assist him in finding one or more replacement properties, triggering another team of professionals to facilitate the purchase.  Finally, a team of accountants will be hired to file the final tax returns showing the positive impact of the LKE.
Why would the government want to take away 1031?
Some politicians believe that by taking away this section of the tax code, more tax dollars will be captured without impacting the investment/job creation process described above.  Frankly, they are wrong and taking away this powerful tax deferment tool will discourage investment in American assets and in American workers.  Why would Congress endanger the American economic environment during this fragile period?
What can I do to save 1031?
Please visit http://www.1031taxreform.com”>www.1031taxreform.comhttps://www.votervoice.net/FEA/campaigns/36117/respond”>contact

No matter where you stand politically, there are certain things we can all agree upon, including the benefits of Section 1031 of the tax code.  Section 1031 like-kind exchanges (LKEs) have been around since 1921, and, at their core, encourage continuity of investment – allowing asset owners to defer taxable gains into replacement assets rather than cashing out. From a planning and growth perspective, that’s particularly powerful as Section 1031 allows investors to follow opportunity – by moving their investments anywhere across the United States – without income tax penalty.
Who benefits from Section 1031?
Yes, ”The Donald” does benefit from 1031s, but so do ordinary American taxpayers, including rental property owners, farmers, collectors, rental car companies, construction contractors, and leasing companies.  LKEs can be utilized by any taxpayer in any tax bracket and can significantly increase their cash flow.  This increased cash is an effective economic stimulant, allowing asset owners to keep their money working in their businesses.
We need more jobs.
Both sides of the political spectrum say we need to create more jobs.  Taken as a whole, the 1031 exchange process is job creation on steroids.  Below is an example of Donald Trump saying “You’re hired” not “You’re fired” to an army of professionals.
Let’s say Trump receives an offer to buy one of his commercial real estate properties.  Upon accepting the offer, a waterfall of events will take place: 

CPAs and attorneys will review the purchase and sale contract. 
Inspectors will arrive to verify the property’s condition.
Settlement agents and attorneys will be engaged.
Improvements to the property will likely be made requiring contractors and materials.
Financing might be sought, requiring lenders and appraisers to be brought in. 

In this case, Trump’s interested in a like-kind exchange and will need to hire a qualified intermediary.  The qualified intermediary will invest the funds at a bank and Mr. Trump will hire another broker to assist him in finding one or more replacement properties, triggering another team of professionals to facilitate the purchase.  Finally, a team of accountants will be hired to file the final tax returns showing the positive impact of the LKE.
Why would the government want to take away 1031?
Some politicians believe that by taking away this section of the tax code, more tax dollars will be captured without impacting the investment/job creation process described above.  Frankly, they are wrong and taking away this powerful tax deferment tool will discourage investment in American assets and in American workers.  Why would Congress endanger the American economic environment during this fragile period?
What can I do to save 1031?
Please visit http://www.1031taxreform.com”>www.1031taxreform.comhttps://www.votervoice.net/FEA/campaigns/36117/respond”>contact

A successful like-kind exchange (LKE) requires that there be both relinquished and replacement property.  As such, equipment owners must actually sell old equipment and purchase new or used units as like-kind replacements.  Another LKE requirement states the proceeds generated from the sale of the old (relinquished) assets must be subject to specific restrictions.  These monetary restrictions are usually satisfied through employing a qualified intermediary (QI), whose responsibilities include safeguarding the sale proceeds until the replacement property is acquired.  Found within Section 1031’s underlying restrictions and often referred to as the “g(6) restrictions,” these rules forbid the equipment owner from having any right to receive, pledge, borrow, or otherwise obtain the benefits from the sale proceeds residing in their like-kind exchange account.
Immediately after the sale transaction, the QI will typically receive the proceeds directly from the buyer.  This deposit is usually net of various items, such as:

Broker fees
Auctioneer costs
Debt payoffs/pay downs

Generally, if the equipment owner were to receive any of the sale proceeds, or use it to pay off or pay down debt unrelated to the equipment being sold, the receipt could trigger a violation of the g(6) restrictions and possibly ruin the like-kind exchange. 
For owner/operators, most equipment transactions are fairly simple and do not involve anything beyond pay offs or pay downs of debt related to the relinquished property.  When the sale triggers a debt payment, it is a matter of instructing the broker, auctioneer, or buyer to send a portion of the purchase funds to the lender with any remaining amounts to be delivered to the qualified intermediary.  However, there are cases where lenders (or lienholders) do not wish to receive payment related to the sale of the property.  Instead, they seek to take hold of the proceeds or arrange for some sort of pledge against the funds held in the exchange account.  While it’s understandable the lienholder would want to secure their interest in a traditional manner, these traditional arrangements would likely violate the terms of the g(6) restrictions and potentially taint the equipment owner’s like-kind exchange.
What’s a Lender/Lienholder to do?
In cases where the lienholder wishes to retain their secured interest, from sale of the relinquished property through the acquisition of the replacement property, there are three recommended techniques:

The Standing Disbursement Instruction
The Irrevocable Right to Approve
A Pledge of Interest in a New Subsidiary

Each technique may be done through adding specific language directly to the like-kind exchange agreement with your QI, or through a separate agreement. 
Standing Disbursement Instruction
The standing disbursement instruction simply states that at the end of the exchange, any remaining exchange funds shall be paid to the lienholder, rather than back to the equipment owner.  
The Irrevocable Right to Approve
The irrevocable right to approve method inserts the lienholder into the process for:

Identifying replacement property and,
disbursing exchange funds for the acquisition of the replacement property. 

This method requires the lienholder physically sign any LKE identification forms and disbursement requests made of the quailified intermediary.
A Pledge of Interest in a New Subsidiary
A pledge of interest in a new subsidiary requires that the equipment owner, prior to the sale, transfer the relinquished property into a single member limited liability company (LLC).  The lienholder then takes a pledge of this new LLC’s interests as security.  After the sale of the old property the lienholder retains a secured interest in the LLC, with the LLC’s primary asset being the amount held by the Qualified Intermediary.
Summary
All three of the above methods may be used separately, or together to mitigate the lienholder’s security risks.  After the acquisition of the replacement property, the lienholder may make standard arrangements to directly attach a lien on the replacement property.  It is advisable that all parties seek the advice of an experienced tax attorney.  Failure to address security concerns can be risky for the secured party, and failure to address these concerns correctly can be potentially invalidate the equipment owner’s like-kind exchange.

A successful like-kind exchange (LKE) requires that there be both relinquished and replacement property.  As such, equipment owners must actually sell old equipment and purchase new or used units as like-kind replacements.  Another LKE requirement states the proceeds generated from the sale of the old (relinquished) assets must be subject to specific restrictions.  These monetary restrictions are usually satisfied through employing a qualified intermediary (QI), whose responsibilities include safeguarding the sale proceeds until the replacement property is acquired.  Found within Section 1031’s underlying restrictions and often referred to as the “g(6) restrictions,” these rules forbid the equipment owner from having any right to receive, pledge, borrow, or otherwise obtain the benefits from the sale proceeds residing in their like-kind exchange account.
Immediately after the sale transaction, the QI will typically receive the proceeds directly from the buyer.  This deposit is usually net of various items, such as:

Broker fees
Auctioneer costs
Debt payoffs/pay downs

Generally, if the equipment owner were to receive any of the sale proceeds, or use it to pay off or pay down debt unrelated to the equipment being sold, the receipt could trigger a violation of the g(6) restrictions and possibly ruin the like-kind exchange. 
For owner/operators, most equipment transactions are fairly simple and do not involve anything beyond pay offs or pay downs of debt related to the relinquished property.  When the sale triggers a debt payment, it is a matter of instructing the broker, auctioneer, or buyer to send a portion of the purchase funds to the lender with any remaining amounts to be delivered to the qualified intermediary.  However, there are cases where lenders (or lienholders) do not wish to receive payment related to the sale of the property.  Instead, they seek to take hold of the proceeds or arrange for some sort of pledge against the funds held in the exchange account.  While it’s understandable the lienholder would want to secure their interest in a traditional manner, these traditional arrangements would likely violate the terms of the g(6) restrictions and potentially taint the equipment owner’s like-kind exchange.
What’s a Lender/Lienholder to do?
In cases where the lienholder wishes to retain their secured interest, from sale of the relinquished property through the acquisition of the replacement property, there are three recommended techniques:

The Standing Disbursement Instruction
The Irrevocable Right to Approve
A Pledge of Interest in a New Subsidiary

Each technique may be done through adding specific language directly to the like-kind exchange agreement with your QI, or through a separate agreement. 
Standing Disbursement Instruction
The standing disbursement instruction simply states that at the end of the exchange, any remaining exchange funds shall be paid to the lienholder, rather than back to the equipment owner.  
The Irrevocable Right to Approve
The irrevocable right to approve method inserts the lienholder into the process for:

Identifying replacement property and,
disbursing exchange funds for the acquisition of the replacement property. 

This method requires the lienholder physically sign any LKE identification forms and disbursement requests made of the quailified intermediary.
A Pledge of Interest in a New Subsidiary
A pledge of interest in a new subsidiary requires that the equipment owner, prior to the sale, transfer the relinquished property into a single member limited liability company (LLC).  The lienholder then takes a pledge of this new LLC’s interests as security.  After the sale of the old property the lienholder retains a secured interest in the LLC, with the LLC’s primary asset being the amount held by the Qualified Intermediary.
Summary
All three of the above methods may be used separately, or together to mitigate the lienholder’s security risks.  After the acquisition of the replacement property, the lienholder may make standard arrangements to directly attach a lien on the replacement property.  It is advisable that all parties seek the advice of an experienced tax attorney.  Failure to address security concerns can be risky for the secured party, and failure to address these concerns correctly can be potentially invalidate the equipment owner’s like-kind exchange.

A successful like-kind exchange (LKE) requires that there be both relinquished and replacement property.  As such, equipment owners must actually sell old equipment and purchase new or used units as like-kind replacements.  Another LKE requirement states the proceeds generated from the sale of the old (relinquished) assets must be subject to specific restrictions.  These monetary restrictions are usually satisfied through employing a qualified intermediary (QI), whose responsibilities include safeguarding the sale proceeds until the replacement property is acquired.  Found within Section 1031’s underlying restrictions and often referred to as the “g(6) restrictions,” these rules forbid the equipment owner from having any right to receive, pledge, borrow, or otherwise obtain the benefits from the sale proceeds residing in their like-kind exchange account.
Immediately after the sale transaction, the QI will typically receive the proceeds directly from the buyer.  This deposit is usually net of various items, such as:

Broker fees
Auctioneer costs
Debt payoffs/pay downs

Generally, if the equipment owner were to receive any of the sale proceeds, or use it to pay off or pay down debt unrelated to the equipment being sold, the receipt could trigger a violation of the g(6) restrictions and possibly ruin the like-kind exchange. 
For owner/operators, most equipment transactions are fairly simple and do not involve anything beyond pay offs or pay downs of debt related to the relinquished property.  When the sale triggers a debt payment, it is a matter of instructing the broker, auctioneer, or buyer to send a portion of the purchase funds to the lender with any remaining amounts to be delivered to the qualified intermediary.  However, there are cases where lenders (or lienholders) do not wish to receive payment related to the sale of the property.  Instead, they seek to take hold of the proceeds or arrange for some sort of pledge against the funds held in the exchange account.  While it’s understandable the lienholder would want to secure their interest in a traditional manner, these traditional arrangements would likely violate the terms of the g(6) restrictions and potentially taint the equipment owner’s like-kind exchange.
What’s a Lender/Lienholder to do?
In cases where the lienholder wishes to retain their secured interest, from sale of the relinquished property through the acquisition of the replacement property, there are three recommended techniques:

The Standing Disbursement Instruction
The Irrevocable Right to Approve
A Pledge of Interest in a New Subsidiary

Each technique may be done through adding specific language directly to the like-kind exchange agreement with your QI, or through a separate agreement. 
Standing Disbursement Instruction
The standing disbursement instruction simply states that at the end of the exchange, any remaining exchange funds shall be paid to the lienholder, rather than back to the equipment owner.  
The Irrevocable Right to Approve
The irrevocable right to approve method inserts the lienholder into the process for:

Identifying replacement property and,
disbursing exchange funds for the acquisition of the replacement property. 

This method requires the lienholder physically sign any LKE identification forms and disbursement requests made of the quailified intermediary.
A Pledge of Interest in a New Subsidiary
A pledge of interest in a new subsidiary requires that the equipment owner, prior to the sale, transfer the relinquished property into a single member limited liability company (LLC).  The lienholder then takes a pledge of this new LLC’s interests as security.  After the sale of the old property the lienholder retains a secured interest in the LLC, with the LLC’s primary asset being the amount held by the Qualified Intermediary.
Summary
All three of the above methods may be used separately, or together to mitigate the lienholder’s security risks.  After the acquisition of the replacement property, the lienholder may make standard arrangements to directly attach a lien on the replacement property.  It is advisable that all parties seek the advice of an experienced tax attorney.  Failure to address security concerns can be risky for the secured party, and failure to address these concerns correctly can be potentially invalidate the equipment owner’s like-kind exchange.