Development

Blog

  • Case Study: A Reverse Exchange of Real Estate – Parking the Replacement Property

    Download the free step-by-step guide, https://info.accruit.com/reverse-exchange-whitepaper”>Parking the Replacement Property in a Reverse Exchange.
    The Facts
    On May 7, 2014, an attorney from central Illinois contacted us on behalf of his client, Mr. Lodo, who wished to do 1031 Exchange. Mr. Lodo needed to acquire, or risk losing, his desired replacement property, however, he did not have a buyer in place for the sale of his relinquished property. The purchase price for the replacement property was $1,512,000 and the closing was scheduled for June 6, 2014. In a typical tax deferred exchange, the taxpayer sells the relinquished property first and uses the exchange proceeds to acquire the replacement property. When the situation requires the taxpayer to take ownership of the new property prior to the sale of the old property, in a reverse fashion of a standard 1031 Exchange, this is referred to as a Reverse Exchange.
    The Problem
    Mr. Lodo wanted to do an exchange of his old property for the new property but was unable to find a buyer for his old property prior to the scheduled closing of the new property. Unfortunately, the IRS does not recognize the validity of a “pure reverse exchange” where the taxpayer acquires the new property before the sale of the old property.
    The Solution
    This is a common conundrum – the inability to sell the old property prior to the date of acquisition of the new property. To address this situation, the IRS issued Revenue Procedure 2000-37 to effectively enable taxpayers to buy before selling. There are several approved solutions, the most common being to arrange for the exchange company to hold title to the new property on behalf of the taxpayer. When the exchange company services a routine exchange, it acts as a Qualified Intermediary (QI); when an exchange company services a reverse exchange, in which it has to take title to a property, it is referred to as an Exchange Accommodation Titleholder (EAT).
    The EAT takes title to the new property and “parks,” or holds, that title until the taxpayer sells the relinquished property as part of a conventional forward exchange. In this type of reverse exchange, the taxpayer will ultimately acquire the replacement property from the EAT, who acquired it from the original seller.
    In Mr. Lodo’s transaction, a financial institution made a loan of $1,100,000 towards the acquisition price of the new property. The loan was made to a new LLC, established specifically to take title to the new property, with the EAT as its sole member. This loan was documented by a note and secured by a mortgage on the property. Mr. Lodo, rather than the EAT, was asked to guaranty the loan. In addition, Mr. Lodo made his own loan to the LLC in the approximate amount of $412,000 to help finance the EAT’s acquisition of the replacement property. The loan was documented with a note and secured with a pledge of the EAT’s membership interest in the LLC. The acquisition of the new property was closed on June 6, 2014 resulting in a maximum safe harbor deadline to complete the Reverse Exchange as of December 2, 2014.
    While the replacement property was held by the EAT, Mr. Lodo entered into a contract to sell the relinquished property with a closing date of October 31, 2014. The sale price was $1,425,000. The debt on the old property was $700,000 and that loan was paid directly from the closing, so the net equity amounted to roughly $725,000.  Upon closing, the remaining sale proceeds were deposited directly into Mr. Lodo’s Forward Exchange account.  Mr. Lodo then directed the QI to transfer the funds from the exchange account to the EAT in order to pay down the two loans that were originally made to the EAT to acquire the new property. The EAT paid off the $412,000 loan from Mr. Lodo and paid down the loan from the financial institution with the remainder of the funds in the exchange account. Mr. Lodo then took ownership of the replacement property subject to the remaining debt.
    The Result
    Mr. Lodo used the Reverse Exchange safe harbor to manage the purchase of the replacement property before the sale of the relinquished property, deferring taxes on the sale of his relinquished property.
    Reverse Exchanges, such as Mr. Lodo’s transaction detailed above, are typically documented by the following:

        An exchanger information form
        A qualified exchange accommodation agreement (the reverse exchange agreement)
        Assignment to the EAT of the purchase agreement between the client and the seller to buy the replacement property
        Limited liability company sale agreement to sell the EAT’s membership interest to the client
        Non-recourse promissory note documenting taxpayer’s loan to the EAT to purchase the replacement property
        Pledge of the exchange company’s membership interest in the title-holding LLC as security for the note
        Master lease allowing for the client to enter into tenant leases directly with the tenants
        Environmental indemnity agreement

     
    Updated 2/28/2022.

  • Case Study: A Reverse Exchange of Real Estate – Parking the Replacement Property

    Download the free step-by-step guide, https://info.accruit.com/reverse-exchange-whitepaper”>Parking the Replacement Property in a Reverse Exchange.
    The Facts
    On May 7, 2014, an attorney from central Illinois contacted us on behalf of his client, Mr. Lodo, who wished to do 1031 Exchange. Mr. Lodo needed to acquire, or risk losing, his desired replacement property, however, he did not have a buyer in place for the sale of his relinquished property. The purchase price for the replacement property was $1,512,000 and the closing was scheduled for June 6, 2014. In a typical tax deferred exchange, the taxpayer sells the relinquished property first and uses the exchange proceeds to acquire the replacement property. When the situation requires the taxpayer to take ownership of the new property prior to the sale of the old property, in a reverse fashion of a standard 1031 Exchange, this is referred to as a Reverse Exchange.
    The Problem
    Mr. Lodo wanted to do an exchange of his old property for the new property but was unable to find a buyer for his old property prior to the scheduled closing of the new property. Unfortunately, the IRS does not recognize the validity of a “pure reverse exchange” where the taxpayer acquires the new property before the sale of the old property.
    The Solution
    This is a common conundrum – the inability to sell the old property prior to the date of acquisition of the new property. To address this situation, the IRS issued Revenue Procedure 2000-37 to effectively enable taxpayers to buy before selling. There are several approved solutions, the most common being to arrange for the exchange company to hold title to the new property on behalf of the taxpayer. When the exchange company services a routine exchange, it acts as a Qualified Intermediary (QI); when an exchange company services a reverse exchange, in which it has to take title to a property, it is referred to as an Exchange Accommodation Titleholder (EAT).
    The EAT takes title to the new property and “parks,” or holds, that title until the taxpayer sells the relinquished property as part of a conventional forward exchange. In this type of reverse exchange, the taxpayer will ultimately acquire the replacement property from the EAT, who acquired it from the original seller.
    In Mr. Lodo’s transaction, a financial institution made a loan of $1,100,000 towards the acquisition price of the new property. The loan was made to a new LLC, established specifically to take title to the new property, with the EAT as its sole member. This loan was documented by a note and secured by a mortgage on the property. Mr. Lodo, rather than the EAT, was asked to guaranty the loan. In addition, Mr. Lodo made his own loan to the LLC in the approximate amount of $412,000 to help finance the EAT’s acquisition of the replacement property. The loan was documented with a note and secured with a pledge of the EAT’s membership interest in the LLC. The acquisition of the new property was closed on June 6, 2014 resulting in a maximum safe harbor deadline to complete the Reverse Exchange as of December 2, 2014.
    While the replacement property was held by the EAT, Mr. Lodo entered into a contract to sell the relinquished property with a closing date of October 31, 2014. The sale price was $1,425,000. The debt on the old property was $700,000 and that loan was paid directly from the closing, so the net equity amounted to roughly $725,000.  Upon closing, the remaining sale proceeds were deposited directly into Mr. Lodo’s Forward Exchange account.  Mr. Lodo then directed the QI to transfer the funds from the exchange account to the EAT in order to pay down the two loans that were originally made to the EAT to acquire the new property. The EAT paid off the $412,000 loan from Mr. Lodo and paid down the loan from the financial institution with the remainder of the funds in the exchange account. Mr. Lodo then took ownership of the replacement property subject to the remaining debt.
    The Result
    Mr. Lodo used the Reverse Exchange safe harbor to manage the purchase of the replacement property before the sale of the relinquished property, deferring taxes on the sale of his relinquished property.
    Reverse Exchanges, such as Mr. Lodo’s transaction detailed above, are typically documented by the following:

        An exchanger information form
        A qualified exchange accommodation agreement (the reverse exchange agreement)
        Assignment to the EAT of the purchase agreement between the client and the seller to buy the replacement property
        Limited liability company sale agreement to sell the EAT’s membership interest to the client
        Non-recourse promissory note documenting taxpayer’s loan to the EAT to purchase the replacement property
        Pledge of the exchange company’s membership interest in the title-holding LLC as security for the note
        Master lease allowing for the client to enter into tenant leases directly with the tenants
        Environmental indemnity agreement

     
    Updated 2/28/2022.

  • Case Study: A Forward Exchange of Real Estate

    The Facts
    A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
    The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
    The Problem
    They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

    20% capital gain on the appreciation ($250,000 x 20%)
    25% recapture of depreciation taken ($150,000 x 25%)
    Affordable Care Act tax ($250,000 x 3.8%)
    Approximate effective rate of California capital gain ($250,000 x 9%)

    The Solution: A 1031 Exchange
    A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

    Exchanger information form
    Tax deferred exchange agreement
    Qualified escrow agreement for the deposit and holding of the exchange funds
    Assignment of rights in the relinquished property contract
    Copy of the sale contract pertaining to the assignment
    W-9 in connection with the interest to be earned on the deposit of the exchange funds
    Copies of their drivers’ licenses

    For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
    The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

    Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
    Assignment of rights in the replacement property contract
    Copy of the purchase contract pertaining to the assignment
    Disbursement instructions to the QI and the escrow agent for the replacement property purchase

    On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
    The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
    The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
    The Result
    With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
    Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
     
    Updated 2/24/2022.

  • Case Study: A Forward Exchange of Real Estate

    The Facts
    A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
    The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
    The Problem
    They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

    20% capital gain on the appreciation ($250,000 x 20%)
    25% recapture of depreciation taken ($150,000 x 25%)
    Affordable Care Act tax ($250,000 x 3.8%)
    Approximate effective rate of California capital gain ($250,000 x 9%)

    The Solution: A 1031 Exchange
    A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

    Exchanger information form
    Tax deferred exchange agreement
    Qualified escrow agreement for the deposit and holding of the exchange funds
    Assignment of rights in the relinquished property contract
    Copy of the sale contract pertaining to the assignment
    W-9 in connection with the interest to be earned on the deposit of the exchange funds
    Copies of their drivers’ licenses

    For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
    The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

    Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
    Assignment of rights in the replacement property contract
    Copy of the purchase contract pertaining to the assignment
    Disbursement instructions to the QI and the escrow agent for the replacement property purchase

    On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
    The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
    The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
    The Result
    With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
    Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
     
    Updated 2/24/2022.

  • Case Study: A Forward Exchange of Real Estate

    The Facts
    A qualified intermediary (QI) company, Accruit, received an inquiry from some taxpayers, who we will call Mr. and Mrs. Pike, regarding facilitating a real estate exchange.  The clients got in touch with Accruit on July 14, 2014.
    The Pikes had entered into a contract to sell their ½ interest in a multi-family investment property located in San Francisco, California.  The contract called for a closing on August 15, 2014.  The sale price was $1,000,000.  At this point in time, the Pikes did not know what they might be acquiring as replacement property. 
    The Problem
    They did not want to incur any tax in connection with the sale.  Although QIs cannot give tax advice, and we did not, let’s assume their basis in the property being sold, the relinquished property, was $600,000 and their joint income was above $250,000 per year.  The basis in property is determined by the original purchase price of the property plus the cost of any improvements they added to the property and minus any depreciation they took on the property during their period of ownership.  Let’s assume they bought the property for $700,000, added $50,000 in improvements and took $150,000 in depreciation to arrive at the basis in the property.  Without an exchange they would be looking at taxes as follows:

    20% capital gain on the appreciation ($250,000 x 20%)
    25% recapture of depreciation taken ($150,000 x 25%)
    Affordable Care Act tax ($250,000 x 3.8%)
    Approximate effective rate of California capital gain ($250,000 x 9%)

    The Solution: A 1031 Exchange
    A tax deferred exchange, in which the Pikes would trade up or even in value and have at least the same new mortgage liability as they had on the relinquished property, would negate the payment of any tax.  The applicable forward exchange docs were prepared for the Pikes.  They executed and returned these documents consisting of the following:

    Exchanger information form
    Tax deferred exchange agreement
    Qualified escrow agreement for the deposit and holding of the exchange funds
    Assignment of rights in the relinquished property contract
    Copy of the sale contract pertaining to the assignment
    W-9 in connection with the interest to be earned on the deposit of the exchange funds
    Copies of their drivers’ licenses

    For a non-1031 exchange transaction in California, the settlement agent may have to hold back some of the sale proceeds to cover the state’s capital gains liability.  However when California taxpayers are selling relinquished property as the first step towards an exchange of property, the client will complete a form 593-C known as a “Real Estate Withholding Certificate” in order to obtain an exemption from the withholding.  The QI is then responsible for withholding should the taxpayer not utilize all the funds in the exchange account when they acquire their replacement property.
    The Pikes closed on the sale of their property on July 31, 2014, and the amount of $821,377 was wire transferred to their exchange account.  Once the relinquished property sale was complete they needed to provide the following forms in order to complete their acquisition of the replacement property:

    Designation notice within 45 days of the sale identifying up to three potential replacement properties (read more about the requirements for identifying replacement property)
    Assignment of rights in the replacement property contract
    Copy of the purchase contract pertaining to the assignment
    Disbursement instructions to the QI and the escrow agent for the replacement property purchase

    On August 26, 2014, the Pikes signed and returned the designation notice identifying a property in San Mateo, California as their only replacement property.  On September 3, 2014, they assigned their rights under the replacement property contract and directed the QI to put down earnest money of $23,250 in connection with the purchase of the new property.  On September 11, 2014, the QI was directed to wire transfer the additional sum of $776,414 to the settlement agent and the Pikes acquired the property at that time.
    The client’s exchange account held an additional $21,176 of non-reinvested proceeds and the Pikes sought a return of that sum.  Due to California’s withholding requirement, North Star completed a California Real Estate Withholding Tax Statement (Form 593) requiring a hold back and direct payment to the State of 3.33%, or $723. North Star remitted the balance to the Pikes.
    The Pike’s will file an IRS form 8824 at the end of the tax year to report their exchange transaction.
    The Result
    With the exception of the small amount of tax pertaining to the funds not needed in the acquisition of the replacement property, the Pikes achieved tax deferral on the sale of their relinquished property  – approximately a $112,000 savings which was reinvested in their replacement property. 
    Download the https://info.accruit.com/forward-exchange-whitepaper”>1031 Forward Exchange Procedural Outline of the step-by-step processes involved in completing a tax deferred exchange, which you may review with your tax advisor.
     
    Updated 2/24/2022.

  • What are the Rules for Identification and Receipt of Replacement Property in an IRC §1031 Tax Deferred Exchange?

    Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
    Why is it Necessary to Identify Replacement Property?
    In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
    These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
    What are the Identification and Receipt Rules?
    The identification rules in a 1031 exchange include the following:

    The 45-day requirement to designate replacement property
    The 3-property rule
    The 200-percent rule
    The 95-percent rule
    The incidental property rule
    Description of Replacement Property
    Property to be produced

    The 45-day Identification Rule
    The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
    The 3-Property Rule
    This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
    The 200% Percent Rule
    The 200-percent rule states the taxpayer may identify: 

    “Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

    Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
    The 95% Rule
    The 95-percent rule is defined as follows: 

    “Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

    As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
    The Incidental Property Rule in Section 1031
    The incidental property rule is defined as follows: 

    “Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

    In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
    To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
    Description of Replacement Property in IRS 1031 Exchange
    The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

    Replacement property is identified only if it is unambiguously described in the written document or agreement.
    Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
    Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

    1031 Exchange Property to Be Improved or Produced
    Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
    Summary
    The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
     

    Updated 2/23/2022.

  • What are the Rules for Identification and Receipt of Replacement Property in an IRC §1031 Tax Deferred Exchange?

    Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
    Why is it Necessary to Identify Replacement Property?
    In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
    These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
    What are the Identification and Receipt Rules?
    The identification rules in a 1031 exchange include the following:

    The 45-day requirement to designate replacement property
    The 3-property rule
    The 200-percent rule
    The 95-percent rule
    The incidental property rule
    Description of Replacement Property
    Property to be produced

    The 45-day Identification Rule
    The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
    The 3-Property Rule
    This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
    The 200% Percent Rule
    The 200-percent rule states the taxpayer may identify: 

    “Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

    Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
    The 95% Rule
    The 95-percent rule is defined as follows: 

    “Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

    As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
    The Incidental Property Rule in Section 1031
    The incidental property rule is defined as follows: 

    “Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

    In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
    To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
    Description of Replacement Property in IRS 1031 Exchange
    The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

    Replacement property is identified only if it is unambiguously described in the written document or agreement.
    Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
    Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

    1031 Exchange Property to Be Improved or Produced
    Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
    Summary
    The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
     

    Updated 2/23/2022.

  • What are the Rules for Identification and Receipt of Replacement Property in an IRC §1031 Tax Deferred Exchange?

    Understanding the rules for identification in regards to a 1031 Exchange are essential for ensuring you are on track for a valid 1031 Exchange. The rules were established as part of the Tax Reform Act of 1984 and have remained unchanged to date. Let’s review the article below which covers the specific rules for identification, as well as receipt of replacement property.
    Why is it Necessary to Identify Replacement Property?
    In a typical Internal Revenue Code (IRC) §1031 delayed exchange, commonly known as a 1031 exchange or tax deferred exchange, a taxpayer has 45 days from the date of sale of the relinquished property to identify potential replacement property.  This 45-day window is known as the identification period.  The taxpayer has 180 days (shorter in some circumstances) to acquire one or more of the identified properties, which is known as the exchange period. Property(ies) actually acquired within the 45-day identification period do not have to be specifically identified, however they do count toward the 3-property and 200 percent rules discussed below.
    These rules are a direct result of the Starker case where for the first time a taxpayer was found to be able to sell relinquished property on one day and acquire replacement property at a different point in time.  In fact, the Starker case involved a five-year gap between the sale and purchase.  Prior to the decision in the Starker case, it was believed that an exchange had to be simultaneous.  As a result of the open-endedness of this decision, as part of the Tax Reform Act of 1984, Congress added the 45/180 day limitation to the delayed exchange.  These time limitations were a compromise between allowing an exchange to be non-simultaneous while at the same time having some temporal continuity between the sale and the purchase.
    What are the Identification and Receipt Rules?
    The identification rules in a 1031 exchange include the following:

    The 45-day requirement to designate replacement property
    The 3-property rule
    The 200-percent rule
    The 95-percent rule
    The incidental property rule
    Description of Replacement Property
    Property to be produced

    The 45-day Identification Rule
    The exchange regulations provide “The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.”  The identification must (i) appear in a written document, (ii) signed by the taxpayer and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange.  The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.  The restriction against providing the notice to a disqualified person is that such a person may be likely to bend the rules a bit based upon the person’s close relation to the taxpayer.  Disqualified persons generally are those who have an agency relationship with the taxpayer.  They include the taxpayer’s employee, attorney, accountant, investment banker and real estate agent if any of those parties provided services during the two-year period prior to the transfer of the relinquished property.  Property identifications made within the 45-day period can be revoked and replaced with new identifications, but only if done so within that the identification period.
    The 3-Property Rule
    This rule simply states that the replacement property identification can be made for up to “three properties without regard to the fair market values of the properties.”  At one time in the history of §1031 exchanges, there was a requirement to prioritize identified properties.  At those times, if a taxpayer wished to acquire a second identified property, they could not do so unless the first identified property fell through due to circumstances beyond the taxpayer’s control.   Presumably this harsh requirement played a role in the 1991 Treasury Regulations where the 3-Property Rule is found.  By far and away, most taxpayers utilize this rule.
    The 200% Percent Rule
    The 200-percent rule states the taxpayer may identify: 

    “Any number of properties as long as their aggregate fair market value as of the end of the identification period does not exceed 200 percent of the aggregate fair market value of all the relinquished properties as of the date the relinquished properties were transferred by the taxpayer.” 

    Another way to state this is that the taxpayer can identify any number of properties and actually close on any number of them if the sum of the market value of all of them does not exceed twice the market value of the relinquished property.  There is some uncertainty of how the market value of these properties is determined.  The listing price? The amount the seller is willing to accept?  The amount that the taxpayer agrees to pay?  The answer is unclear but using the listing price would surely be a safe choice.
    The 95% Rule
    The 95-percent rule is defined as follows: 

    “Any replacement property identified before the end of the identification period and received before the end of the exchange period, but only if the taxpayer receives before the end of the exchange period identified replacement property the fair market value of which is at least 95 percent of the aggregate fair market value of all identified replacement properties.”

    As a practical matter, this rule is very hard to adhere to.  Basically, it provides that should the taxpayer have over identified for purpose of the first two rules, the identification can still be considered valid if the taxpayer receives at least 95% in value of what was identified.  For example, if a taxpayer identified four properties or more whose market value exceeds 200% of the value of the relinquished property, to the extent that the taxpayer received 95% of what was “over” identified then the identification is deemed proper.  In the real world it is difficult to imagine this rule being relied upon by a taxpayer.
    The Incidental Property Rule in Section 1031
    The incidental property rule is defined as follows: 

    “Solely for purposes of applying this paragraph (c), property that is incidental to a larger item of property is not treated as property that is separate from the larger item of property. Property is incidental to a larger item of property if – (A) In standard commercial transactions, the property is typically transferred together with the larger item of property, and (B) The aggregate fair market value of all of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property.” 

    In other words, if there is some incidental property that typically passes to a buyer in standard commercial transactions for this kind of property sale, to the extent that the value of any such property is less than 15%  of the primary property, the incidental property does not have to be separately identified.
    To illustrate this rule the exchange regulations use the example of an apartment building to be acquired for $1,000,000 which includes furniture, laundry machines and other miscellaneous items of personal property whose aggregate value does not exceed $150,000.  In this example, those various items of personal property are not required to be separately identified nor does that property count against the 3-Property Rule.  Be aware however that this rule only applies to identification and not to making sure that replacement property must still be like-kind to the relinquished property.  For example, if the relinquished property was real estate with a value of $1,000,000 and the replacement property was real estate with a value of $850,000 plus incidental property of $150,000, the taxpayer will still have tax to pay (known as “ boot”) because the incidental personal property was not like-kind to the relinquished property.
    Description of Replacement Property in IRS 1031 Exchange
    The description of replacement property must be unambiguous and specific.  For instance, the identification of “a condominium unit at 123 Main Street, Chicago, IL” would fail due to the specific unit not having been identified.  The actual rules are as follows:

    Replacement property is identified only if it is unambiguously described in the written document or agreement.
    Real property generally is unambiguously described if it is described by a legal description, street address, or distinguishable name (e.g., the Mayfair Apartment Building).
    Personal property generally is unambiguously described if it is described by a specific description of the particular type of property. For example, a truck generally is unambiguously described if it is described by a specific make and model.

    1031 Exchange Property to Be Improved or Produced
    Oftentimes, the property intended to be acquired by the taxpayer will be in a different physical state at the time it is identified than it will be upon receipt by the taxpayer.  The regulations account for this by requiring the identification for real estate to include the address or legal description of the property plus as much detail as practical about the intended improvements.  In connection with the receipt of property to be improved, even if the described improvements are not completed at the time it is received by the taxpayer, the exchange is valid so long as the actual property received does not differ from what was identified by the taxpayer except for the degree of improvements that have been completed. Personal property is a bit different in this regard and the “production” (improvements) needs to be completed within the 180-day term.
    Summary
    The ability to defer taxes through a §1031 exchange is a very valuable benefit to taxpayers.  However, to receive this benefit, all the exchange rules must be strictly adhered to.  The rules pertaining to identification and receipt of replacement property must be understood and met in order to comply with the technical requirements of this IRC section.  In fact, the property identification rules are so germane to a proper exchange that there is a question asked of the taxpayer on the exchange reporting form 8824 about compliance with these rules.
     

    Updated 2/23/2022.

  • Exchange Authority Successfully Implements Exchange Manager Pro(SM)

    DENVER, CO, February 15, 2022 – Exchange Authority, a subsidiary of Fidelity Bank in Leominster, MA, became the first Qualified Intermediary (QI) to implement Exchange Manager ProSM to facilitate their 1031 exchange business. Exchange Manager ProSM, a patented SaaS offering, hosted on Microsoft Azure, provides 24/7 secure, online access to all 1031 exchange data, documents, and reports. It allows for single-entry data to auto-generate required exchange agreements, assignments, and notifications.
    Exchange Authority’s President and CEO, John Peculis, confirmed that Exchange Manager ProSM has offered his team a one-stop-shop for 1031 exchanges, from document creation, automated communication, calendar reminders, and status tracking throughout the entire exchange process. “Exchange Manager ProSM is a solution made for QIs, by a QI that truly understands the technical side of 1031 Exchanges and therefore provides a true solution,” stated John.
    Exchange Authority is seeing a significant reduction in the calls and emails their specialists must manage daily due to Exchange Manager ProSM providing their team a real-time dashboard of the exchange status and automated updates to the client. “After internal analysis, we expect to decrease the time spent on tedious, back-and-forth communication by 30-50% with Exchange Manager ProSM,” adds John.
    “Exchange Manager ProSM is an out-of-the-box solution for all Qualified Intermediaries that are looking to increase efficiencies, security, and volume, without increasing staff,” said Brent Abrahm, Accruit’s President and CEO. “We are excited about the impact this technology is having on the entire real estate industry.  Automating routine, repetitive processes through Exchange Manager ProSM is allowing QIs to focus on creating a much greater customer experience.” 
     
    About Exchange Manager Pro SM
    Exchange Manager ProSM by Accruit is a proprietary, online software application that makes administering 1031 exchanges safe, secure, and simple. Exchange Manager ProSM was designed to ease the administrative burdens related to like-kind exchanges and automate routine functions of Qualified Intermediaries including: online client onboarding, document creation and distribution, and automatic deadline reminders and notifications.
    About Exchange Authority
    Exchange Authority has been assisting clients and their professional advisors throughout the United States on exchange matters and acting as a Qualified Intermediary since Congress adopted the exchange safe harbor regulations in 1991. As a Qualified Intermediary,  Exchange Authority advises and educates their clients on the process, creates all required documents, coordinates the exchange of funds, and provides full reports at the end of the exchange. In 2008, Exchange Authority was acquired by Fidelity Cooperative Bank, making it a wholly-owned subsidiary of the bank. Learn more about

  • Exchange Authority Successfully Implements Exchange Manager Pro(SM)

    DENVER, CO, February 15, 2022 – Exchange Authority, a subsidiary of Fidelity Bank in Leominster, MA, became the first Qualified Intermediary (QI) to implement Exchange Manager ProSM to facilitate their 1031 exchange business. Exchange Manager ProSM, a patented SaaS offering, hosted on Microsoft Azure, provides 24/7 secure, online access to all 1031 exchange data, documents, and reports. It allows for single-entry data to auto-generate required exchange agreements, assignments, and notifications.
    Exchange Authority’s President and CEO, John Peculis, confirmed that Exchange Manager ProSM has offered his team a one-stop-shop for 1031 exchanges, from document creation, automated communication, calendar reminders, and status tracking throughout the entire exchange process. “Exchange Manager ProSM is a solution made for QIs, by a QI that truly understands the technical side of 1031 Exchanges and therefore provides a true solution,” stated John.
    Exchange Authority is seeing a significant reduction in the calls and emails their specialists must manage daily due to Exchange Manager ProSM providing their team a real-time dashboard of the exchange status and automated updates to the client. “After internal analysis, we expect to decrease the time spent on tedious, back-and-forth communication by 30-50% with Exchange Manager ProSM,” adds John.
    “Exchange Manager ProSM is an out-of-the-box solution for all Qualified Intermediaries that are looking to increase efficiencies, security, and volume, without increasing staff,” said Brent Abrahm, Accruit’s President and CEO. “We are excited about the impact this technology is having on the entire real estate industry.  Automating routine, repetitive processes through Exchange Manager ProSM is allowing QIs to focus on creating a much greater customer experience.” 
     
    About Exchange Manager Pro SM
    Exchange Manager ProSM by Accruit is a proprietary, online software application that makes administering 1031 exchanges safe, secure, and simple. Exchange Manager ProSM was designed to ease the administrative burdens related to like-kind exchanges and automate routine functions of Qualified Intermediaries including: online client onboarding, document creation and distribution, and automatic deadline reminders and notifications.
    About Exchange Authority
    Exchange Authority has been assisting clients and their professional advisors throughout the United States on exchange matters and acting as a Qualified Intermediary since Congress adopted the exchange safe harbor regulations in 1991. As a Qualified Intermediary,  Exchange Authority advises and educates their clients on the process, creates all required documents, coordinates the exchange of funds, and provides full reports at the end of the exchange. In 2008, Exchange Authority was acquired by Fidelity Cooperative Bank, making it a wholly-owned subsidiary of the bank. Learn more about