Tag: section 1031

United States tax code sections 1031 and 1033 are sometimes confused by taxpayers as they are similar, not only in section number, but in that they were both created to provide for tax deferral of depreciation recapture and capital gains on the sale of property, but that’s where their similarity ends. 1031 exchange and 1033 exchange differ materially in:

Types of transactions they address
Type of property that can be acquired
Timeline requirements

Section 1033: Involuntary Conversion
Section 1033 of the tax code provides for the deferral of gain that is realized from an “involuntary conversion.” Such a conversion includes property that is destroyed in a casualty, property that is lost due to theft and property that is transferred as the result of condemnation or the threat of condemnation.
Section 1033: Direct and Indirect Conversions
With a conversion into replacement property in a 1033 exchange, any gain related to the involuntary conversion is deferred if the conversion involves property considered similar in related service or use. That is, the use of the replacement property must be substantially similar to that of the relinquished property. This is considered a direct conversion. With a condemned property, the replacement property must be considered like-kind, a standard similar to that of Section 1031.
A 1033 conversion may also be indirect – with gain triggered on the amount converted into cash or dissimilar property. Partial deferral of gain in an indirect conversion is elective, and the taxpayer must take certain steps and meet certain criteria in order to defer gain in an indirect conversion. Most importantly, the cost of the qualifying replacement property must be equal to or greater than the amount realized at conversion. Falling short of the replacement cost will trigger gain recognition to the extent of the underinvested portion. Acquisitions from related parties can also trigger gain recognition.
Section 1033: Timelines
Generally, replacement property in a 1033 conversion must be acquired within two years of the end of the tax year in which the gain was realized, though some conversions can result in three, four and five-year replacement periods.
1031 Like-Kind Exchanges
Unlike 1033, tax code Section 1031 is specific to the voluntary reinvestment of gain from the sale of investment or business use property. In the case of a 1031 exchange, any gain related to the disposition of property is deferred if the replacement property is considered similar in nature and character. The quality or grade of the replacement property is of no consequence in a 1031 like-kind exchange, only that the property is of the same nature, character, or class. In fact, most real estate is considered like-kind to other real estate.
Gain recognition is triggered in a 1031 like-kind exchange if the cost of replacement property is less than the amount of gain from property that is relinquished. Gain recognition would also be triggered in the event that the taxpayer receives property that is not like-kind to the relinquished property. Finally, as in the case of a 1033 conversion, acquisitions from related parties can trigger gain recognition. Learn more about this in “1031 Tax Deferred Exchanges between Related Parties.”
Section 1031: Timelines
In order to defer gain in a 1031 exchange, the taxpayer must acquire like-kind replacement property by the earlier of 180 calendar days or the due date of the taxpayer’s next income tax return.
Summary Tax Code Sections 1031 and 1033
Section 1031 and 1033 are both powerful tax deferral strategies, but they differ substantially in their usage. Section 1033 is tax deferral specific to the loss of property by a taxpayer and is therefore is referred to as an involuntary conversion. Section 1031 is the voluntary replacement of real property in an exchange of business or investment assets. Finally, while Section 1031 generally requires the use of a qualified intermediary, Section 1033 does not.

United States tax code sections 1031 and 1033 are sometimes confused by taxpayers as they are similar, not only in section number, but in that they were both created to provide for tax deferral of depreciation recapture and capital gains on the sale of property, but that’s where their similarity ends. 1031 exchange and 1033 exchange differ materially in:

Types of transactions they address
Type of property that can be acquired
Timeline requirements

Section 1033: Involuntary Conversion
Section 1033 of the tax code provides for the deferral of gain that is realized from an “involuntary conversion.” Such a conversion includes property that is destroyed in a casualty, property that is lost due to theft and property that is transferred as the result of condemnation or the threat of condemnation.
Section 1033: Direct and Indirect Conversions
With a conversion into replacement property in a 1033 exchange, any gain related to the involuntary conversion is deferred if the conversion involves property considered similar in related service or use. That is, the use of the replacement property must be substantially similar to that of the relinquished property. This is considered a direct conversion. With a condemned property, the replacement property must be considered like-kind, a standard similar to that of Section 1031.
A 1033 conversion may also be indirect – with gain triggered on the amount converted into cash or dissimilar property. Partial deferral of gain in an indirect conversion is elective, and the taxpayer must take certain steps and meet certain criteria in order to defer gain in an indirect conversion. Most importantly, the cost of the qualifying replacement property must be equal to or greater than the amount realized at conversion. Falling short of the replacement cost will trigger gain recognition to the extent of the underinvested portion. Acquisitions from related parties can also trigger gain recognition.
Section 1033: Timelines
Generally, replacement property in a 1033 conversion must be acquired within two years of the end of the tax year in which the gain was realized, though some conversions can result in three, four and five-year replacement periods.
1031 Like-Kind Exchanges
Unlike 1033, tax code Section 1031 is specific to the voluntary reinvestment of gain from the sale of investment or business use property. In the case of a 1031 exchange, any gain related to the disposition of property is deferred if the replacement property is considered similar in nature and character. The quality or grade of the replacement property is of no consequence in a 1031 like-kind exchange, only that the property is of the same nature, character, or class. In fact, most real estate is considered like-kind to other real estate.
Gain recognition is triggered in a 1031 like-kind exchange if the cost of replacement property is less than the amount of gain from property that is relinquished. Gain recognition would also be triggered in the event that the taxpayer receives property that is not like-kind to the relinquished property. Finally, as in the case of a 1033 conversion, acquisitions from related parties can trigger gain recognition. Learn more about this in “1031 Tax Deferred Exchanges between Related Parties.”
Section 1031: Timelines
In order to defer gain in a 1031 exchange, the taxpayer must acquire like-kind replacement property by the earlier of 180 calendar days or the due date of the taxpayer’s next income tax return.
Summary Tax Code Sections 1031 and 1033
Section 1031 and 1033 are both powerful tax deferral strategies, but they differ substantially in their usage. Section 1033 is tax deferral specific to the loss of property by a taxpayer and is therefore is referred to as an involuntary conversion. Section 1031 is the voluntary replacement of real property in an exchange of business or investment assets. Finally, while Section 1031 generally requires the use of a qualified intermediary, Section 1033 does not.

United States tax code sections 1031 and 1033 are sometimes confused by taxpayers as they are similar, not only in section number, but in that they were both created to provide for tax deferral of depreciation recapture and capital gains on the sale of property, but that’s where their similarity ends. 1031 exchange and 1033 exchange differ materially in:

Types of transactions they address
Type of property that can be acquired
Timeline requirements

Section 1033: Involuntary Conversion
Section 1033 of the tax code provides for the deferral of gain that is realized from an “involuntary conversion.” Such a conversion includes property that is destroyed in a casualty, property that is lost due to theft and property that is transferred as the result of condemnation or the threat of condemnation.
Section 1033: Direct and Indirect Conversions
With a conversion into replacement property in a 1033 exchange, any gain related to the involuntary conversion is deferred if the conversion involves property considered similar in related service or use. That is, the use of the replacement property must be substantially similar to that of the relinquished property. This is considered a direct conversion. With a condemned property, the replacement property must be considered like-kind, a standard similar to that of Section 1031.
A 1033 conversion may also be indirect – with gain triggered on the amount converted into cash or dissimilar property. Partial deferral of gain in an indirect conversion is elective, and the taxpayer must take certain steps and meet certain criteria in order to defer gain in an indirect conversion. Most importantly, the cost of the qualifying replacement property must be equal to or greater than the amount realized at conversion. Falling short of the replacement cost will trigger gain recognition to the extent of the underinvested portion. Acquisitions from related parties can also trigger gain recognition.
Section 1033: Timelines
Generally, replacement property in a 1033 conversion must be acquired within two years of the end of the tax year in which the gain was realized, though some conversions can result in three, four and five-year replacement periods.
1031 Like-Kind Exchanges
Unlike 1033, tax code Section 1031 is specific to the voluntary reinvestment of gain from the sale of investment or business use property. In the case of a 1031 exchange, any gain related to the disposition of property is deferred if the replacement property is considered similar in nature and character. The quality or grade of the replacement property is of no consequence in a 1031 like-kind exchange, only that the property is of the same nature, character, or class. In fact, most real estate is considered like-kind to other real estate.
Gain recognition is triggered in a 1031 like-kind exchange if the cost of replacement property is less than the amount of gain from property that is relinquished. Gain recognition would also be triggered in the event that the taxpayer receives property that is not like-kind to the relinquished property. Finally, as in the case of a 1033 conversion, acquisitions from related parties can trigger gain recognition. Learn more about this in “1031 Tax Deferred Exchanges between Related Parties.”
Section 1031: Timelines
In order to defer gain in a 1031 exchange, the taxpayer must acquire like-kind replacement property by the earlier of 180 calendar days or the due date of the taxpayer’s next income tax return.
Summary Tax Code Sections 1031 and 1033
Section 1031 and 1033 are both powerful tax deferral strategies, but they differ substantially in their usage. Section 1033 is tax deferral specific to the loss of property by a taxpayer and is therefore is referred to as an involuntary conversion. Section 1031 is the voluntary replacement of real property in an exchange of business or investment assets. Finally, while Section 1031 generally requires the use of a qualified intermediary, Section 1033 does not.

Utilizing a long term ground lease on real estate owned by a party related to the taxpayer can enable a taxpayer to invest proceeds into making improvements on that property. In a recent blog post we discussed build-to-suit and property improvement exchanges.  As that post made clear, a taxpayer cannot do improvements on property that is already owned by the taxpayer. Another post pertaining to exchange transactions between related parties underscored the admonition against a taxpayer acquiring replacement property from a related party.  Merging these two issues provides an opportunity for us to discuss the potential of a taxpayer using exchange proceeds to improve a property owned by a related party.
This type of transaction is made possible by introducing a long term lease for the property into the ownership structure of the land.  For 1031 exchange purposes, a long term lease is defined as a lease with 30 years or more to run, including renewal options.  As an example, a ten year ground lease with two ten year options would be a sufficient interest in the land to constitute an ownership of the “leasehold estate” by the lessee which is legally recognizable as a separate and distinct ownership from that of the underlying land itself.  This long term interest is considered like-kind to a direct (“fee”) interest in land.  Consequently if improvements are built upon the land those improvements belong to the ground lessee and conversely, the land owner, the related party, has no ownership rights in those improvements.    
Looking back to the rules disallowing a taxpayer to build on property it already owns, this issue can be resolved by having an Exchange Accommodation Titleholder (“EAT”) become the ground lessee and for the EAT to build the improvements per the plans and specifications required by the taxpayer (This was the gist of the first blog referenced above).  Further, if the interest in a long term ground lease, including improvements upon the property, is recognized as a separate and distinct real property interest, then the taxpayer’s receipt of these leasehold improvements should not be deemed to be received from the underlying related party land owner.
This structure was the subject of a 2002 Private Letter Ruling. In that fact pattern the related party was not the land owner but rather a lessee itself of the property under a long term lease.  As stated above, a long term lease interest for 1031 exchange purposes is the same as a fee interest and, as such, the ground lease was subleased to an EAT for purposes of constructing upon the property.  This structure was approved.
A short time later PLR 200329021 was issued.  In this case too, the related party had a lease in excess of thirty years.  The leasehold interest was assigned to an EAT for purposes of constructing taxpayer desired improvements.  This structure got a favorable ruling from the IRS.
The most recent ruling on this structure was PLR 201408019. In this case a part of the property leased to the related party was subleased to an EAT with a lease term in excess of thirty years.  Similar to the findings in the prior Private Letter Rulings, the IRS ruled that the sublease and the improvements were like kind to the taxpayer’s fee interest in the relinquished property.
There were a couple of common threads to these rulings which someone structuring such a transaction should keep in mind. 

First, a fair market rental payment was paid by the EAT to the lessor/sublessor. Sometimes in practice the start of those payments is deferred for the first 180 days of the sublease in order to avoid having the EAT getting involved with the rent payment. 
Second, the lease/sublease should have 30 or more years to run as of the time the EAT leases the property. 
Lastly, the rulings all had language suggesting that neither the related party nor the taxpayer should dispose of its interest for at least two years, which is a requirement of one of the exceptions to the related party rules. 

Regarding this last item, one could argue that had the related party been the land owner, the two year holding requirement would not be needed since the taxpayer would receive nothing from the related party throughout the transaction.  The fact that the EAT is leasing the property from the related party should not be relevant. The situation in the Private Letter Rulings involved the EAT taking an assignment of the ground lease from the related party and the ground lease was ultimately transferred to the taxpayer. Nevertheless, it is not usually necessary in these transactions for a party to dispose of either property within two years, so it is not a burdensome requirement in any event. Also, most advisors agree that the lease relationship can be terminated after a time in excess of two years when the exchange transaction is considered “old and cold.”
So, quite often a taxpayer – whether an individual, partnership or limited liability company – has the desire to use exchange proceeds towards building upon land owned by a related person or entity.  The taxpayer can take advantage of the legal fiction that improvements to property under a long term ground lease do not constitute building upon the underlying land owned by a related party and therefore they can use exchange proceeds to fund the improvements. They are acquiring the improvements from the EAT and not the related party.
Documents for a build-to-suit under a ground lease on property owned by a related party include:

Qualified Exchange Accommodation Agreement
Ground Lease
Build-to-Suit Agreement between Taxpayer and EAT
Agreement between Contractor and Owner
Evidence of Liability Insurance, including Builder’s Risk coverage
Environmental Indemnity

Utilizing a long term ground lease on real estate owned by a party related to the taxpayer can enable a taxpayer to invest proceeds into making improvements on that property. In a recent blog post we discussed build-to-suit and property improvement exchanges.  As that post made clear, a taxpayer cannot do improvements on property that is already owned by the taxpayer. Another post pertaining to exchange transactions between related parties underscored the admonition against a taxpayer acquiring replacement property from a related party.  Merging these two issues provides an opportunity for us to discuss the potential of a taxpayer using exchange proceeds to improve a property owned by a related party.
This type of transaction is made possible by introducing a long term lease for the property into the ownership structure of the land.  For 1031 exchange purposes, a long term lease is defined as a lease with 30 years or more to run, including renewal options.  As an example, a ten year ground lease with two ten year options would be a sufficient interest in the land to constitute an ownership of the “leasehold estate” by the lessee which is legally recognizable as a separate and distinct ownership from that of the underlying land itself.  This long term interest is considered like-kind to a direct (“fee”) interest in land.  Consequently if improvements are built upon the land those improvements belong to the ground lessee and conversely, the land owner, the related party, has no ownership rights in those improvements.    
Looking back to the rules disallowing a taxpayer to build on property it already owns, this issue can be resolved by having an Exchange Accommodation Titleholder (“EAT”) become the ground lessee and for the EAT to build the improvements per the plans and specifications required by the taxpayer (This was the gist of the first blog referenced above).  Further, if the interest in a long term ground lease, including improvements upon the property, is recognized as a separate and distinct real property interest, then the taxpayer’s receipt of these leasehold improvements should not be deemed to be received from the underlying related party land owner.
This structure was the subject of a 2002 Private Letter Ruling. In that fact pattern the related party was not the land owner but rather a lessee itself of the property under a long term lease.  As stated above, a long term lease interest for 1031 exchange purposes is the same as a fee interest and, as such, the ground lease was subleased to an EAT for purposes of constructing upon the property.  This structure was approved.
A short time later PLR 200329021 was issued.  In this case too, the related party had a lease in excess of thirty years.  The leasehold interest was assigned to an EAT for purposes of constructing taxpayer desired improvements.  This structure got a favorable ruling from the IRS.
The most recent ruling on this structure was PLR 201408019. In this case a part of the property leased to the related party was subleased to an EAT with a lease term in excess of thirty years.  Similar to the findings in the prior Private Letter Rulings, the IRS ruled that the sublease and the improvements were like kind to the taxpayer’s fee interest in the relinquished property.
There were a couple of common threads to these rulings which someone structuring such a transaction should keep in mind. 

First, a fair market rental payment was paid by the EAT to the lessor/sublessor. Sometimes in practice the start of those payments is deferred for the first 180 days of the sublease in order to avoid having the EAT getting involved with the rent payment. 
Second, the lease/sublease should have 30 or more years to run as of the time the EAT leases the property. 
Lastly, the rulings all had language suggesting that neither the related party nor the taxpayer should dispose of its interest for at least two years, which is a requirement of one of the exceptions to the related party rules. 

Regarding this last item, one could argue that had the related party been the land owner, the two year holding requirement would not be needed since the taxpayer would receive nothing from the related party throughout the transaction.  The fact that the EAT is leasing the property from the related party should not be relevant. The situation in the Private Letter Rulings involved the EAT taking an assignment of the ground lease from the related party and the ground lease was ultimately transferred to the taxpayer. Nevertheless, it is not usually necessary in these transactions for a party to dispose of either property within two years, so it is not a burdensome requirement in any event. Also, most advisors agree that the lease relationship can be terminated after a time in excess of two years when the exchange transaction is considered “old and cold.”
So, quite often a taxpayer – whether an individual, partnership or limited liability company – has the desire to use exchange proceeds towards building upon land owned by a related person or entity.  The taxpayer can take advantage of the legal fiction that improvements to property under a long term ground lease do not constitute building upon the underlying land owned by a related party and therefore they can use exchange proceeds to fund the improvements. They are acquiring the improvements from the EAT and not the related party.
Documents for a build-to-suit under a ground lease on property owned by a related party include:

Qualified Exchange Accommodation Agreement
Ground Lease
Build-to-Suit Agreement between Taxpayer and EAT
Agreement between Contractor and Owner
Evidence of Liability Insurance, including Builder’s Risk coverage
Environmental Indemnity

Utilizing a long term ground lease on real estate owned by a party related to the taxpayer can enable a taxpayer to invest proceeds into making improvements on that property. In a recent blog post we discussed build-to-suit and property improvement exchanges.  As that post made clear, a taxpayer cannot do improvements on property that is already owned by the taxpayer. Another post pertaining to exchange transactions between related parties underscored the admonition against a taxpayer acquiring replacement property from a related party.  Merging these two issues provides an opportunity for us to discuss the potential of a taxpayer using exchange proceeds to improve a property owned by a related party.
This type of transaction is made possible by introducing a long term lease for the property into the ownership structure of the land.  For 1031 exchange purposes, a long term lease is defined as a lease with 30 years or more to run, including renewal options.  As an example, a ten year ground lease with two ten year options would be a sufficient interest in the land to constitute an ownership of the “leasehold estate” by the lessee which is legally recognizable as a separate and distinct ownership from that of the underlying land itself.  This long term interest is considered like-kind to a direct (“fee”) interest in land.  Consequently if improvements are built upon the land those improvements belong to the ground lessee and conversely, the land owner, the related party, has no ownership rights in those improvements.    
Looking back to the rules disallowing a taxpayer to build on property it already owns, this issue can be resolved by having an Exchange Accommodation Titleholder (“EAT”) become the ground lessee and for the EAT to build the improvements per the plans and specifications required by the taxpayer (This was the gist of the first blog referenced above).  Further, if the interest in a long term ground lease, including improvements upon the property, is recognized as a separate and distinct real property interest, then the taxpayer’s receipt of these leasehold improvements should not be deemed to be received from the underlying related party land owner.
This structure was the subject of a 2002 Private Letter Ruling. In that fact pattern the related party was not the land owner but rather a lessee itself of the property under a long term lease.  As stated above, a long term lease interest for 1031 exchange purposes is the same as a fee interest and, as such, the ground lease was subleased to an EAT for purposes of constructing upon the property.  This structure was approved.
A short time later PLR 200329021 was issued.  In this case too, the related party had a lease in excess of thirty years.  The leasehold interest was assigned to an EAT for purposes of constructing taxpayer desired improvements.  This structure got a favorable ruling from the IRS.
The most recent ruling on this structure was PLR 201408019. In this case a part of the property leased to the related party was subleased to an EAT with a lease term in excess of thirty years.  Similar to the findings in the prior Private Letter Rulings, the IRS ruled that the sublease and the improvements were like kind to the taxpayer’s fee interest in the relinquished property.
There were a couple of common threads to these rulings which someone structuring such a transaction should keep in mind. 

First, a fair market rental payment was paid by the EAT to the lessor/sublessor. Sometimes in practice the start of those payments is deferred for the first 180 days of the sublease in order to avoid having the EAT getting involved with the rent payment. 
Second, the lease/sublease should have 30 or more years to run as of the time the EAT leases the property. 
Lastly, the rulings all had language suggesting that neither the related party nor the taxpayer should dispose of its interest for at least two years, which is a requirement of one of the exceptions to the related party rules. 

Regarding this last item, one could argue that had the related party been the land owner, the two year holding requirement would not be needed since the taxpayer would receive nothing from the related party throughout the transaction.  The fact that the EAT is leasing the property from the related party should not be relevant. The situation in the Private Letter Rulings involved the EAT taking an assignment of the ground lease from the related party and the ground lease was ultimately transferred to the taxpayer. Nevertheless, it is not usually necessary in these transactions for a party to dispose of either property within two years, so it is not a burdensome requirement in any event. Also, most advisors agree that the lease relationship can be terminated after a time in excess of two years when the exchange transaction is considered “old and cold.”
So, quite often a taxpayer – whether an individual, partnership or limited liability company – has the desire to use exchange proceeds towards building upon land owned by a related person or entity.  The taxpayer can take advantage of the legal fiction that improvements to property under a long term ground lease do not constitute building upon the underlying land owned by a related party and therefore they can use exchange proceeds to fund the improvements. They are acquiring the improvements from the EAT and not the related party.
Documents for a build-to-suit under a ground lease on property owned by a related party include:

Qualified Exchange Accommodation Agreement
Ground Lease
Build-to-Suit Agreement between Taxpayer and EAT
Agreement between Contractor and Owner
Evidence of Liability Insurance, including Builder’s Risk coverage
Environmental Indemnity