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  • Qualia FORES22 Debut of Exchange Manager Pro(SM)

    Exchange Manager ProSM by Accruit had the pleasure of not only attending, but co-sponsoring the recent Qualia Future of Real Estate Summit 2022 (FORES22). FORES22, Building a Connected Tomorrow, was designed to bring together title & escrow, mortgage, and property tech companies to explore technology, processes, and business models to unite all segments for an improved client experience. Exchange Manager ProSM was right at home, introducing its white label 1031 exchange solution, Managed Service, to companies in attendance from across the US.
    What is Managed Service?
    Managed Service through Exchange Manager ProSM provides a value add for title companies and others that are interested in offering 1031 exchange services. The white-labeled 1031 exchange technology solution allows the company, referred to as exchange facilitator, to maintain the relationship with their client while Exchange Manager ProSM provides all of the documentation and banking services of the Qualified Intermediary (QI) behind the scenes, providing a turnkey 1031 exchange experience for all parties.
    Managed Service not only provides an improved customer experience for the exchange facilitator’s client, but it also eliminates the need for companies to turn away clients or worse, recommend a competitor for the 1031 exchange. Lastly, it creates a new income source for exchange facilitators through a revenue share.
    How does Managed Service Work? 
    Implementing our white-labeled QI, Managed Service, is seamless for all involved. Once a Managed Service agreement is in place, there are a few simple steps for the exchange facilitator to follow in order to offer in-house 1031 exchange services to their existing clients:

    Qualify the client for a 1031 Exchange: Is the client interested in doing a 1031 exchange on their real estate transaction? Utilize a provided guide to confirm the client and their transaction qualify for a 1031 exchange.
     
    Collect client information and documents: Through our cloud-based intake form, submit client info and documentation pertinent to the 1031 exchange. All information required is likely already on-hand due to the work your company is already completing on behalf of the client.>
     
    Once all information is provided, the remaining 1031 exchange processes will be facilitated through Exchange Manager ProSM including document creation and execution, deadline reminders, wiring of funds, etc.

    Through Managed Service, companies can facilitate 1031 exchanges for their clients and ultimately retain future business by keeping everything under one roof.
    Benefits of Managed Service
    While there are numerous benefits of implementing Managed Service, some of the more notable benefits that will directly impact your company’s bottom line include:

    Retain 1031 Exchange Business: When your client requests a 1031 Exchange, instead of referring them to another company that services 1031 exchanges and potentially losing future business with that client, you will be able to facilitate the 1031 exchange in-house and preserve future business.
     
    Offer 1031 Exchanges as a Disqualified Party: Per IRC §1031 you may be a disqualified party and unable to facilitate the 1031 exchange; however, through Managed Service you could still offer 1031 exchange services.
     
    Drive Income Through NEW Revenue Share: With minimal effort and manpower on your end, you will drive income through a new, favorable revenue share while retaining your current clients – win, win!

    Learn more about Managed Service.

  • Qualia FORES22 Debut of Exchange Manager Pro(SM)

    Exchange Manager ProSM by Accruit had the pleasure of not only attending, but co-sponsoring the recent Qualia Future of Real Estate Summit 2022 (FORES22). FORES22, Building a Connected Tomorrow, was designed to bring together title & escrow, mortgage, and property tech companies to explore technology, processes, and business models to unite all segments for an improved client experience. Exchange Manager ProSM was right at home, introducing its white label 1031 exchange solution, Managed Service, to companies in attendance from across the US.
    What is Managed Service?
    Managed Service through Exchange Manager ProSM provides a value add for title companies and others that are interested in offering 1031 exchange services. The white-labeled 1031 exchange technology solution allows the company, referred to as exchange facilitator, to maintain the relationship with their client while Exchange Manager ProSM provides all of the documentation and banking services of the Qualified Intermediary (QI) behind the scenes, providing a turnkey 1031 exchange experience for all parties.
    Managed Service not only provides an improved customer experience for the exchange facilitator’s client, but it also eliminates the need for companies to turn away clients or worse, recommend a competitor for the 1031 exchange. Lastly, it creates a new income source for exchange facilitators through a revenue share.
    How does Managed Service Work? 
    Implementing our white-labeled QI, Managed Service, is seamless for all involved. Once a Managed Service agreement is in place, there are a few simple steps for the exchange facilitator to follow in order to offer in-house 1031 exchange services to their existing clients:

    Qualify the client for a 1031 Exchange: Is the client interested in doing a 1031 exchange on their real estate transaction? Utilize a provided guide to confirm the client and their transaction qualify for a 1031 exchange.
     
    Collect client information and documents: Through our cloud-based intake form, submit client info and documentation pertinent to the 1031 exchange. All information required is likely already on-hand due to the work your company is already completing on behalf of the client.>
     
    Once all information is provided, the remaining 1031 exchange processes will be facilitated through Exchange Manager ProSM including document creation and execution, deadline reminders, wiring of funds, etc.

    Through Managed Service, companies can facilitate 1031 exchanges for their clients and ultimately retain future business by keeping everything under one roof.
    Benefits of Managed Service
    While there are numerous benefits of implementing Managed Service, some of the more notable benefits that will directly impact your company’s bottom line include:

    Retain 1031 Exchange Business: When your client requests a 1031 Exchange, instead of referring them to another company that services 1031 exchanges and potentially losing future business with that client, you will be able to facilitate the 1031 exchange in-house and preserve future business.
     
    Offer 1031 Exchanges as a Disqualified Party: Per IRC §1031 you may be a disqualified party and unable to facilitate the 1031 exchange; however, through Managed Service you could still offer 1031 exchange services.
     
    Drive Income Through NEW Revenue Share: With minimal effort and manpower on your end, you will drive income through a new, favorable revenue share while retaining your current clients – win, win!

    Learn more about Managed Service.

  • IRC Section 1031 Exchange Qualified Use Requirements

    We recently examined the duration a taxpayer must hold a relinquished and replacement property to satisfy the requirement that exchanged assets must be held for investment or used in a business or trade.  The conclusion was that there is no specific time limit for an asset to be deemed to having been held, rather it is a facts and circumstances test.  In this post, we will look into the issue of “qualified use” as another key element in a successful tax deferred exchange.
    IRC Section 1031(a)(1) provides “In general no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment”. 
    Let’s look at some examples where the productive or qualified use requirement may, or may not, apply in a 1031 exchange.
    Vacation Homes and Qualified Use
    A taxpayer’s vacation home or second residence can be eligible for a 1031 exchange if specific requirements are met. The property must have been held for investment for at least 24 months prior to the exchange. Additionally, the property must have been rented out at fair market value for a minimum of 14 days within each of the 12 months and the taxpayer cannot have used the property personally for more than 14 days, or 10% of the days the property was rented, within each of the 12 month periods. 
    Taxpayer Occupied Multi-Family Property and Qualified Use
    A multifamily property such as a two flat or three flat, where the owner lives in one unit and rents out the other unit(s) can be the subject of an exchange of the investment portion.  The sale would be split where the taxpayer could receive directly the net proceeds pertaining to the personal use unit and could cause the net proceeds pertaining to the investment unit(s) to go to fund the exchange account. In most cases, the gain associated with the owner occupied unit could also be deferred under IRC Section 121, the Code section dealing with the sale of a personal residence. 
    Keep in mind that the assignment of contract rights under the relinquished property agreement must be modified to show what percentage interest of the whole property will be the subject of the assignment to the qualified intermediary.
    Taxpayer Occupied Farm Land and Qualified Use
    Similarly, exchanges of farmland are very common.  Often the personal residence of the owner sits on the farmland.  Again, as in the other examples, the percentage of the land that is used for farming can be exchanged and the percentage used for the dwelling can be sheltered under IRC Section 121.
    Mixed Use Personal Residences and Qualified Use
    There are taxpayers who have mixed use of their personal residence.  An example of this might be a psychologist who uses a room in the home as the office to meet with clients.  If the square footage of this room is 10% of the entire residence than a 10% interest in the relinquished property could be sold as part of an exchange. 
    Death of a Taxpayer and Qualified Use
    As the saying goes, the only sure things in life are death and taxes.  We have covered taxes above, so let’s look at the effect of the death of the taxpayer on the issue of qualified use.  If a taxpayer dies prior to the anticipated sale of relinquished property, the heirs get the property with a stepped up basis and would not have a need for tax deferral.  However in the event a taxpayer dies after the start of an exchange and the sale of the relinquished property, the gain would be due without an acquisition of replacement property.  Despite the estate not having qualified use of the property itself, there are various favorable IRS rulings allowing the estate to acquire the replacement property and defer the gain recognition.
    Summary
    The exchange rules require that the relinquished and replacement properties be ones that are held for productive use in a business or trade or as an investment. This “productive use,” often referred to ‘qualified use” can sometimes cause confusion where there is both a personal use of a property and also a qualified use of part of the same property.  In most cases, the qualified use portion of the property can be separated and be the subject of a §1031 exchange.
     
    Updated 4/12/2022.

  • IRC Section 1031 Exchange Qualified Use Requirements

    We recently examined the duration a taxpayer must hold a relinquished and replacement property to satisfy the requirement that exchanged assets must be held for investment or used in a business or trade.  The conclusion was that there is no specific time limit for an asset to be deemed to having been held, rather it is a facts and circumstances test.  In this post, we will look into the issue of “qualified use” as another key element in a successful tax deferred exchange.
    IRC Section 1031(a)(1) provides “In general no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment”. 
    Let’s look at some examples where the productive or qualified use requirement may, or may not, apply in a 1031 exchange.
    Vacation Homes and Qualified Use
    A taxpayer’s vacation home or second residence can be eligible for a 1031 exchange if specific requirements are met. The property must have been held for investment for at least 24 months prior to the exchange. Additionally, the property must have been rented out at fair market value for a minimum of 14 days within each of the 12 months and the taxpayer cannot have used the property personally for more than 14 days, or 10% of the days the property was rented, within each of the 12 month periods. 
    Taxpayer Occupied Multi-Family Property and Qualified Use
    A multifamily property such as a two flat or three flat, where the owner lives in one unit and rents out the other unit(s) can be the subject of an exchange of the investment portion.  The sale would be split where the taxpayer could receive directly the net proceeds pertaining to the personal use unit and could cause the net proceeds pertaining to the investment unit(s) to go to fund the exchange account. In most cases, the gain associated with the owner occupied unit could also be deferred under IRC Section 121, the Code section dealing with the sale of a personal residence. 
    Keep in mind that the assignment of contract rights under the relinquished property agreement must be modified to show what percentage interest of the whole property will be the subject of the assignment to the qualified intermediary.
    Taxpayer Occupied Farm Land and Qualified Use
    Similarly, exchanges of farmland are very common.  Often the personal residence of the owner sits on the farmland.  Again, as in the other examples, the percentage of the land that is used for farming can be exchanged and the percentage used for the dwelling can be sheltered under IRC Section 121.
    Mixed Use Personal Residences and Qualified Use
    There are taxpayers who have mixed use of their personal residence.  An example of this might be a psychologist who uses a room in the home as the office to meet with clients.  If the square footage of this room is 10% of the entire residence than a 10% interest in the relinquished property could be sold as part of an exchange. 
    Death of a Taxpayer and Qualified Use
    As the saying goes, the only sure things in life are death and taxes.  We have covered taxes above, so let’s look at the effect of the death of the taxpayer on the issue of qualified use.  If a taxpayer dies prior to the anticipated sale of relinquished property, the heirs get the property with a stepped up basis and would not have a need for tax deferral.  However in the event a taxpayer dies after the start of an exchange and the sale of the relinquished property, the gain would be due without an acquisition of replacement property.  Despite the estate not having qualified use of the property itself, there are various favorable IRS rulings allowing the estate to acquire the replacement property and defer the gain recognition.
    Summary
    The exchange rules require that the relinquished and replacement properties be ones that are held for productive use in a business or trade or as an investment. This “productive use,” often referred to ‘qualified use” can sometimes cause confusion where there is both a personal use of a property and also a qualified use of part of the same property.  In most cases, the qualified use portion of the property can be separated and be the subject of a §1031 exchange.
     
    Updated 4/12/2022.

  • IRC Section 1031 Exchange Qualified Use Requirements

    We recently examined the duration a taxpayer must hold a relinquished and replacement property to satisfy the requirement that exchanged assets must be held for investment or used in a business or trade.  The conclusion was that there is no specific time limit for an asset to be deemed to having been held, rather it is a facts and circumstances test.  In this post, we will look into the issue of “qualified use” as another key element in a successful tax deferred exchange.
    IRC Section 1031(a)(1) provides “In general no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment”. 
    Let’s look at some examples where the productive or qualified use requirement may, or may not, apply in a 1031 exchange.
    Vacation Homes and Qualified Use
    A taxpayer’s vacation home or second residence can be eligible for a 1031 exchange if specific requirements are met. The property must have been held for investment for at least 24 months prior to the exchange. Additionally, the property must have been rented out at fair market value for a minimum of 14 days within each of the 12 months and the taxpayer cannot have used the property personally for more than 14 days, or 10% of the days the property was rented, within each of the 12 month periods. 
    Taxpayer Occupied Multi-Family Property and Qualified Use
    A multifamily property such as a two flat or three flat, where the owner lives in one unit and rents out the other unit(s) can be the subject of an exchange of the investment portion.  The sale would be split where the taxpayer could receive directly the net proceeds pertaining to the personal use unit and could cause the net proceeds pertaining to the investment unit(s) to go to fund the exchange account. In most cases, the gain associated with the owner occupied unit could also be deferred under IRC Section 121, the Code section dealing with the sale of a personal residence. 
    Keep in mind that the assignment of contract rights under the relinquished property agreement must be modified to show what percentage interest of the whole property will be the subject of the assignment to the qualified intermediary.
    Taxpayer Occupied Farm Land and Qualified Use
    Similarly, exchanges of farmland are very common.  Often the personal residence of the owner sits on the farmland.  Again, as in the other examples, the percentage of the land that is used for farming can be exchanged and the percentage used for the dwelling can be sheltered under IRC Section 121.
    Mixed Use Personal Residences and Qualified Use
    There are taxpayers who have mixed use of their personal residence.  An example of this might be a psychologist who uses a room in the home as the office to meet with clients.  If the square footage of this room is 10% of the entire residence than a 10% interest in the relinquished property could be sold as part of an exchange. 
    Death of a Taxpayer and Qualified Use
    As the saying goes, the only sure things in life are death and taxes.  We have covered taxes above, so let’s look at the effect of the death of the taxpayer on the issue of qualified use.  If a taxpayer dies prior to the anticipated sale of relinquished property, the heirs get the property with a stepped up basis and would not have a need for tax deferral.  However in the event a taxpayer dies after the start of an exchange and the sale of the relinquished property, the gain would be due without an acquisition of replacement property.  Despite the estate not having qualified use of the property itself, there are various favorable IRS rulings allowing the estate to acquire the replacement property and defer the gain recognition.
    Summary
    The exchange rules require that the relinquished and replacement properties be ones that are held for productive use in a business or trade or as an investment. This “productive use,” often referred to ‘qualified use” can sometimes cause confusion where there is both a personal use of a property and also a qualified use of part of the same property.  In most cases, the qualified use portion of the property can be separated and be the subject of a §1031 exchange.
     
    Updated 4/12/2022.

  • 1031 Drop and Swap out of a Partnership or LLC

    Can a partner or member trade their share of a property interest upon sale?
    One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself.  The section generally provides
    “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.
    However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership.”  As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members. 
    While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share.  The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”
    How is a 1031 drop and swap done?
    A 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”
    To date the IRS has not adopted this position.  If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.
    IRS Form 1065 U.S. Return of Partnership Income
    In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to http://www.irs.gov/pub/irs-pdf/f1065.pdf”>Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property.”  Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis. 
    As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange.  Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.
    Underlying Loan Considerations
    When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member.  As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member.  In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.
    Almost all loans secured by property contain “due on transfer” clauses.  So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents.  This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.
    Deemed Partnership
    There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership.  This would negate a drop and swap.  Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs.  The least amount of management by the co-owners is helpful to avoid partnership characterization.  Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property. 
    For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship.  The terms of such an agreement comes from IRS guidance in the form of http://www.irs.gov/pub/irs-drop/rp-02-22.pdf”>Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership.   It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible.  Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.
    Summary
    The possibility of structuring of a

  • 1031 Drop and Swap out of a Partnership or LLC

    Can a partner or member trade their share of a property interest upon sale?
    One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself.  The section generally provides
    “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.
    However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership.”  As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members. 
    While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share.  The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”
    How is a 1031 drop and swap done?
    A 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”
    To date the IRS has not adopted this position.  If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.
    IRS Form 1065 U.S. Return of Partnership Income
    In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to http://www.irs.gov/pub/irs-pdf/f1065.pdf”>Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property.”  Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis. 
    As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange.  Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.
    Underlying Loan Considerations
    When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member.  As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member.  In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.
    Almost all loans secured by property contain “due on transfer” clauses.  So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents.  This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.
    Deemed Partnership
    There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership.  This would negate a drop and swap.  Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs.  The least amount of management by the co-owners is helpful to avoid partnership characterization.  Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property. 
    For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship.  The terms of such an agreement comes from IRS guidance in the form of http://www.irs.gov/pub/irs-drop/rp-02-22.pdf”>Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership.   It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible.  Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.
    Summary
    The possibility of structuring of a

  • 1031 Drop and Swap out of a Partnership or LLC

    Can a partner or member trade their share of a property interest upon sale?
    One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself.  The section generally provides
    “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.
    However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership.”  As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members. 
    While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share.  The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”
    How is a 1031 drop and swap done?
    A 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”
    To date the IRS has not adopted this position.  If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.
    IRS Form 1065 U.S. Return of Partnership Income
    In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to http://www.irs.gov/pub/irs-pdf/f1065.pdf”>Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property.”  Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis. 
    As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange.  Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.
    Underlying Loan Considerations
    When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member.  As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member.  In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.
    Almost all loans secured by property contain “due on transfer” clauses.  So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents.  This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.
    Deemed Partnership
    There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership.  This would negate a drop and swap.  Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs.  The least amount of management by the co-owners is helpful to avoid partnership characterization.  Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property. 
    For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship.  The terms of such an agreement comes from IRS guidance in the form of http://www.irs.gov/pub/irs-drop/rp-02-22.pdf”>Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership.   It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible.  Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.
    Summary
    The possibility of structuring of a

  • 1031 Drop and Swap out of a Partnership or LLC

    Can a partner or member trade their share of a property interest upon sale?
    One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself.  The section generally provides
    “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.
    However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership.”  As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members. 
    While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share.  The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”
    How is a 1031 drop and swap done?
    A 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”
    To date the IRS has not adopted this position.  If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.
    IRS Form 1065 U.S. Return of Partnership Income
    In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to http://www.irs.gov/pub/irs-pdf/f1065.pdf”>Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property.”  Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis. 
    As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange.  Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.
    Underlying Loan Considerations
    When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member.  As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member.  In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.
    Almost all loans secured by property contain “due on transfer” clauses.  So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents.  This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.
    Deemed Partnership
    There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership.  This would negate a drop and swap.  Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs.  The least amount of management by the co-owners is helpful to avoid partnership characterization.  Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property. 
    For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship.  The terms of such an agreement comes from IRS guidance in the form of http://www.irs.gov/pub/irs-drop/rp-02-22.pdf”>Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership.   It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible.  Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.
    Summary
    The possibility of structuring of a

  • 1031 Drop and Swap out of a Partnership or LLC

    Can a partner or member trade their share of a property interest upon sale?
    One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself.  The section generally provides
    “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.
    However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership.”  As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members. 
    While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share.  The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”
    How is a 1031 drop and swap done?
    A 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”
    To date the IRS has not adopted this position.  If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.
    IRS Form 1065 U.S. Return of Partnership Income
    In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to http://www.irs.gov/pub/irs-pdf/f1065.pdf”>Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property.”  Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis. 
    As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange.  Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.
    Underlying Loan Considerations
    When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member.  As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member.  In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.
    Almost all loans secured by property contain “due on transfer” clauses.  So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents.  This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.
    Deemed Partnership
    There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership.  This would negate a drop and swap.  Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs.  The least amount of management by the co-owners is helpful to avoid partnership characterization.  Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property. 
    For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship.  The terms of such an agreement comes from IRS guidance in the form of http://www.irs.gov/pub/irs-drop/rp-02-22.pdf”>Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership.   It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible.  Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.
    Summary
    The possibility of structuring of a