1031 Exchange Blog

RULES AND REGULATIONS

Practical Application of Identification Rules in a 1031 Exchange

08/15/24

The identification phase in a 1031 Exchange is a critical step that needs careful consideration to maximize investment possibilities and guarantee ...

Authored by: meredithb@accruit.com

Authored on: Thu, 08/15/2024 - 15:03

Rules and Regulations

The identification phase in a 1031 Exchange is a critical step that involves identifying potential Replacement Property(ies) within a strict 45-day timeline, making it essential to understand the rules and strategize effectively. Our case study discusses how and why an Exchanger might use each of the three Identification Rules based on their reinvestment goals. By putting these rules into action, we can examine potential challenges and provide valuable insights for investors aiming to navigate the complexities of a 1031 Exchange successfully.

<h2 aria-level="1" paraeid="{26581a98-dedb-490d-a4db-aed279beed95}{209}" paraid="2014018441" role="heading">What are Identification Rules? </h2>

In a 1031 Exchange, an Exchanger has 45 days from the date of sale of a Relinquished Property to identify potential Replacement Property(ies). This period is known as the identification period and entails adherence to specific requirements to ensure the validity of the exchange. There are three distinct Identification Rules that an Exchanger can utilize when identifying Replacement Property in a 1031 Exchange, including the 3-property rule, 200% rule, and 95% rule. These rules were put into place as a part of the <a href="https://www.accruit.com/resources/internal-revenue-service-regulations-… Treasury Regulations</a> to provide clarity and instruction on the timing and identification of Replacement Property(ies) in 1031 Exchanges. Prior the 1991 Regulations, Exchangers were still required to identify potential Replacement Property(ies), but did not have restrictions on the number they could identify. However, Exchangers were obligated to rank properties and were only allowed to acquire properties further down their list if the sale of the prior property fell through for reasons outside of their control. The 1991 Regulations offered more flexibility and guidance in the identification process of 1031 Exchanges.

<h3 aria-level="2" paraeid="{b2e2ce19-8ccd-4587-8523-6950611853d1}{85}" paraid="755483835" role="heading">The 3-Property Rule: </h3>

The most commonly used rule is the 3-property rule. This rule permits the identification of up to three Replacement Properties regardless of their fair market values. When Section 1031 was amended in 1984 to impose the 45-day identification period, Congress was concerned that too much flexibility in varying the Replacement Property(ies) would make the transaction appear to be more of a sale than an exchange. This concern influenced the 1991 Treasury Regulations, where the 3-Property Rule was established.

The 200% rule allows Exchangers to identify any number of properties, so long as their total fair market value at the end of the identification period does not exceed 200% of the aggregate fair market value of the Relinquished Property(ies) at the time they were transferred. Simply put, Exchangers can identify any number of properties if their combined market value does not exceed twice the market value of the Relinquished Property(ies). There is some uncertainty regarding how the market value is determined - whether it's based on the listing price, the seller's acceptable price, or the agreed-upon purchase price. Using the listing price is generally considered a safe choice.

The final identification rule, which is seldom utilized due to the complexity of meeting the requirements, is the 95% rule. The 95% rule allows Exchangers to identify any number of Replacement Property(ies) regardless of fair market value in relation to the Relinquished Property values, but they must acquire at minimum 95% of the fair market value of all identified properties.  Essentially, if an Exchanger has over-identified properties for the first two rules, the identification can still be considered valid if the Exchanger receives at least 95% of the total value of all of the identified properties. For instance, if an Exchanger sold one property for $100,000 and identified five properties of various values totaling $300,000, they would need to acquire at least $285,000 of identified value. In practice, this usually means that the Exchanger must buy all of the identified property. In practice, this rule is very challenging to adhere to and carries the most risk of the Exchanger being unable to satisfy the identification requirement potentially resulting in a nullified Exchange and taxable event.

<h2 aria-level="2" paraeid="{b2e2ce19-8ccd-4587-8523-6950611853d1}{217}" paraid="129312130" role="heading">Identification Rules Employed in a 1031 Exchange </h2>

We will now look at a hypothetical case study of an Exchanger in the identification phase of their exchange, testing different identification strategies to figure out which is the right fit for their exchange.

Our Exchanger is a real estate investor looking to defer capital gains taxes by utilizing a 1031 Exchange. They engaged Accruit as the Qualified Intermediary for their 1031 Exchange prior to the sale of their multi-family rental property for $1,000,000. Now, they need to identify potential Replacement Property(ies) within 45 days. We will review how they might use each of the identification rules: the 3-Property Rule, 200% rule, and 95% Rule in their 1031 Exchange.

<h3 aria-level="2" paraeid="{b2e2ce19-8ccd-4587-8523-6950611853d1}{247}" paraid="2068806564" role="heading">The 3-Property Rule Attempt: </h3>

Our Exchanger aims to leverage the 3-Property Rule, which allows them to identify up to three potential Replacement Property(ies) without considering their total value relative to the Relinquished Property.

The Exchanger identifies the following properties:

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="2" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property B: A retail space valued at $1,300,000. 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="3" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property C: A mixed-use property valued at $1,200,000. 
</li>
</ul>

The Exchanger successfully identifies these three properties within the 45-day identification period and has the option to acquire one or more of the three properties for a successful exchange.

For the sake of demonstration, let’s say our Exchanger wants to identify not three individual properties, but one individual property and then a <a href="https://www.accruit.com/blog/delaware-statutory-trusts-1031-exchange-in… Statutory Trust (DST)</a> portfolio of properties. If more than three properties are to be identified, our Exchanger is unable to use the 3-Property Rule and therefore the Exchanger must look to the 200% rule instead.

<h3 aria-level="2" paraeid="{11656b2d-be35-43e0-a23b-2621400c464f}{77}" paraid="1785927276" role="heading">The 200% Rule Attempt: </h3>

Our Exchanger will try to utilize the 200% Rule, which allows them to identify any number of properties (greater than three) so long as their combined fair market value does not exceed 200% of the value of the Relinquished Property. In this example, the allowed combined market value of the identified properties would be $2,000,000 since the Relinquished Property sold for $1,000,000.

Identification:

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="4" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property A: An apartment building valued at $1,000,000. 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="5" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property D: A DST portfolio of 6 properties including multi-family and retail properties valued at $1,000,000 
</li>
</ul>

Total value of identified properties: $2,000,000, satisfying the 200% rule requirements.

For illustrative purposes, let’s say our Exchanger wants to identify all three properties in our example - Property A, Property B, and Property C, in addition to Property D, the DST portfolio.

The Exchanger identifies the following properties:

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="6" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property A: An apartment building valued at $1,000,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="7" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property B: A retail space valued at $1,300,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="8" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property C: A mixed-use property valued at $1,200,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="9" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="3" role="listitem">
Property D: A DST Portfolio valued at $1,000,000 
</li>
</ul>

The total fair market value of the identified properties of $4,500,000 exceeds 200% of the Relinquished Property value, and therefore the 200% rule cannot be utilized, and the Exchanger must seek to comply with the 95% rule.

<h3 aria-level="2" paraeid="{a56f3a86-643f-4523-8eb7-c01aa8bd208c}{184}" paraid="1416682837" role="heading">The 95% Rule Attempt: </h3>

Our Exchanger identifies three Replacement Property(ies) within the 45-day identification period:

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="2" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="10" role="listitem">
Property B: A retail space valued at $1,300,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="3" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="10" role="listitem">
Property C: A mixed-use property valued at $1,200,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="4" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="10" role="listitem">
Property D: A DST portfolio valued at $1,000,000 
</li>
</ul>

The total fair market value of the identified Replacement Property(ies) is $4,500,000.

The Exchanger plans to use the 95% Rule, which requires them to acquire at least 95% of the total fair market value of all identified properties. This means they must acquire properties worth at least $4,275,000 (95% of $4,500,000) by the end of the 180-day exchange period.

It should not go without note that this rule is difficult to successfully adhere to and is rarely used as a result.  Our Exchanger is now in the position where they must actually acquire all four of these identified properties for their identification to remain valid and the 1031 Exchange to be successful.

Another example may help to clarify this requirement. Our same Exchanger sold the same $1,000,000 property, but has now identified the following four properties:

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="2" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="8" role="listitem">
Property B for $750,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="3" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="8" role="listitem">
Property C for $125,000 
</li>
</ul>

<ul role="list">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="4" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559683":0,"335559684":-2,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"hybridMultilevel"}" data-listid="8" role="listitem">
Property D for $1,000,000 
</li>
</ul>

These four potential Replacement Properties also total $4,000,000 in aggregate fair market value. For the exchange to be successful, our Exchanger must complete the acquisition of at least $2,375,000. If they acquire Property A, Property B, and Property D ($625,000 + $750,000, + $1,000,000 = $2,375,000), their exchange will succeed.

<h2 aria-level="2" paraeid="{528f06e7-a1bd-4275-81e9-8c765f2c09d1}{49}" paraid="1540118842" role="heading">How to Determine the Proper ID Rule in a 1031 Exchange </h2>

For a 1031 Exchange, the determination of which of the identification rules to utilize really comes down to the goals of the Exchanger and which identification rule will help them achieve that goal.

For example, if an Exchanger’s goal is to sell one property in one real estate market and acquire a single Replacement Property in a different real estate market, the 3-property rule would likely suffice. However, if the Exchanger wants to diversify their real estate portfolio and dispose of one, large asset and reinvest into multiple lower value assets, they will likely be looking to invest in more than three properties and therefore would need to utilize the 200% rule. The 95% rule is generally used if the Exchanger sells one very large asset and seeks to diversify into many smaller assets while increasing their debt-to-equity ratio along the way. In practice, when an Exchanger relies on the 95% rule, they almost always buy everything on their identification list.

In a 1031 Exchange, it is critical to choose the appropriate identification rule based on individual circumstances, such as financial constraints and market dynamics, to maximize the benefits of a 1031 Exchange. By understanding the nuances of each rule, Exchangers can maximize the benefits of an exchange, avoid potential pitfalls such as boot, and successfully defer capital gains (and potentially other) taxes. Strategic planning and a thorough understanding of the 1031 Exchange identification rules with the assistance of a Qualified Intermediary (QI) are essential for real estate investors looking to optimize their investments and ensure compliance.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Thu, 08/15/2024 - 15:44

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What is the 75% Rule or “Substantially the Same” Rule in a 1031 Exchange?

06/26/24

This article dives into a lesser-known rule involving the acquisition of identified Replacement Property under the Regulations being substantially the ...

Authored by: meredithb@accruit.com

Authored on: Wed, 06/26/2024 - 17:29

Rules and Regulations

Under the 1031 Regulations, unless Replacement Property is acquired within 45 days from the date of sale of the Relinquished Property, the intended Replacement Property must be identified in accordance with <a href="/blog/what-are-rules-identification-and-receipt-replacement-property-irc-%C2%A71031-tax-deferred-exchange" rel="noreferrer noopener" target="_blank" title="Identification Rules">several specific provisions</a>. In addition, consistent with the identification, it is required that “the Replacement Property received is substantially the same property as identified”. The question often arises is to what extent deviations in the property actually received, or acquired, can still constitute as “substantially the same property”. In the context of a <a href="https://www.accruit.com/blog/passive-real-estate-investments-reits-and-…; rel="noreferrer noopener" target="_blank">Delaware Statutory Trust investment</a> or receipt of conventional property, the amount or extent of the interest received sometimes varies from what is identified, which bring into play the 75% Rule.

In general terms, the 75% Rule applies to acquiring at least 75% of the Replacement Property that was identified, and if additional considerations are met, that 75% acquired is deemed as “substantially the same property as identified” and therefore the IRS considers it substantially the same as what was identified.

Exchange companies and others who are frequently involved with 1031 exchanges sometimes refer to this rule as “the 25% rule”, “Substantially the Same”, or the “75% safe harbor”. Since the term “safe harbor” is specifically referenced in the Regulations, but not in this context, the latter statement is not recommended, although is still used by some.

<h2 aria-level="2" paraeid="{4215e782-fdf8-483c-a2d7-de76cd48faec}{157}" paraid="1240355217" role="heading">Examples of the 75% Rule within a 1031 Exchange </h2>

For a better understanding of the 75% Rule, the Regulations provide some guidance, as well as example of the acceptable application of the 75% Rule. Essentially the examples suggest that “nature and character” of the real estate must remain constant, as well as the amount or extent of the property received.

In one example the property identified consists of a barn and some acreage. The property ultimately received consisted of the barn and a lesser amount of acreage. Due to receiving a lesser amount of land, the payment for the Replacement Property was 75% of the value of the original, full property identified. However, the example provides that “the barn and underlying land differ in nature or character from real property [Q] as a whole” and concludes that it is not the same as the property identified, and therefore is not considered substantially the same.

An additional example that appears in the Regulations changes the facts above just slightly and addresses value discrepancy. It simply poses a situation where the Exchanger identifies a certain real property, with no barn or improvements, and ends up purchasing less than all of it with a payment of 75% of the value of the originally identified property. Here, the Regulations conclude that the nature or character of the real property did not differ and the “75% of the fair market value” … “is considered to have received substantially the same property as identified”.

<h2 aria-level="2" paraeid="{c8ae1cd0-bcc9-4763-88bf-9579a02fa291}{57}" paraid="550145028" role="heading">Considerations and Misconceptions of the 75% Rule </h2>

As with many of the nuances around 1031 Exchanges, there are misconceptions around the 75% Rule which need to be addressed. One potential misconception is believing that the above example provides comfort in receiving Replacement Property within a margin of 25% lower or higher than what was identified. At a glance, logic might suggest that if someone identifies a specific property and receives 75% of it or 125% of it, both of those are equivalent, however the latter has not been explicitly confirmed by the IRS. Sometime after the <a href="/resources/internal-revenue-service-regulations-irc-ss1031" rel="noreferrer noopener" target="_blank">1031 Exchange Regulations</a> were published in 1991, the Taxation Section of the American Bar Association issued a set of comments on open issues the section members felt would benefit from additional clarity by the Treasury Department. The group raised these issues and also set forth suggested answers that the group believed would constitute an appropriate clarification. Question 11 from the ABA Taxation Section pertained to “substantially the same property as identified” and, in part, the Answer proposed “(B) the fair market value of the Replacement Property on the date of receipt should be no less than 75%, nor more than 125%, of the fair market value of the identified property.” Unfortunately, the IRS did not elect to act in response to this issue or the others covered by the submission. However, it might have furthered the thought that a deviation could be both less or more not exceeding a 25% variance. It should also be kept in mind that when an Exchanger identifies 100% and receives at least 75%, whatever property received was covered by the full identification. However, when 100% is identified up front but 125% is received, by definition the extra 25% was not included in the original 100% designation.

Another consideration is that the 25% variance applies to the percentage of property identified, which is particularly relevant to the identification of a fractional real estate interest like a DST or tenancy-in-common interest. For example, if the Exchanger identified 3% of DST ABC than the 75% rule applies to only a variance of .75%, which is 25% of 3%. Therefore, to be in accordance with the 75% Rule the Exchanger would still need to acquire at minimum 2.25% of DST ABC to have received “substantially the same property as identified.”

In summary, the 1031 Regulations provide specific rules in regard to the identification of Replacement Property including the receipt of such property. In regard to the receipt, the property has to be “substantially the same property” as identified. Use of the word “substantially” suggests some flexibility, but at the same time provides ambiguity. The examples mentioned above from the Regulations shed some light on the subject. Specifically, the example involving a property whose “nature or character” has not changed, and at least 75% of such identified property was received, was said to be in compliance with the rules. It is tempting to extrapolate from this example that receiving property that is no more or less than 25%, to the low side or high side, from what was identified is within bounds, but doing so may be making a leap without actual support.

For those seeking reliable information and premier assistance with a 1031 Exchange, utilizing a national Qualified Intermediary like Accruit can be invaluable. Leveraging the expertise of a trusted Qualified Intermediary as well as our website resources can help you navigate the complexities of 1031 Exchanges with ease.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Wed, 06/26/2024 - 19:06

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1031 Exchanges Involving Foreign Property

05/31/24

Are 1031 Exchanges only available to domestic real property within the United States? Can a United States taxpayer that owns real ...

Authored by: meredithb@accruit.com

Authored on: Fri, 05/31/2024 - 16:53

Rules and Regulations

1031 Exchanges enable Exchangers to defer Capital Gains taxes by reinvesting the proceeds from selling an investment or business use property into another. It's important to understand the distinct rules for domestic and foreign properties: you can exchange a U.S. property for another U.S. property or a foreign property for another foreign property, but you cannot exchange a U.S. property for a foreign property, or visa versa. Exchangers should carefully plan and educate themselves on the rules and regulations of 1031 Exchanges to ensure they will retain tax deferral benefits.

<h2 paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Do US Taxes Apply to Foreign Real Estate?</h2>

Prior to discussing the considerations for 1031 Exchanges involving foreign property, it is important to understand how United States taxes apply to foreign property. If a US taxpayer, or taxpaying entity, owes property outside of the United States, the property or income generated from the property is treated largely the same as domestic property, including:

<ul>
<li paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Profits from the sale of property for a profit those proceeds would be subject to taxation</li>
<li paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Income generated from the ownership or operation of foreign real estate is taxable income </li>
<li paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Property owners can deduct qualifying expenses for foreign properties to lower their taxable income</li>
<li paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Property is eligible for depreciation, although foreign commercial property is depreciated over 40 years and foreign residential property is depreciated over 30 years, versus the 39 years and 27.5 years respectively for domestic properties</li>
</ul>

In summary, foreign property owned by a taxpaying citizen of the United States is essentially treated the same as domestic property in regard to annual taxes.

<h2 paraeid="{f66967bf-b3ea-48ac-b77f-cb88de2561f4}{233}" paraid="607981180">Do 1031 Exchanges Apply to Property Outside the United States? </h2>

In a 1031 Exchange, both the Relinquished and Replacement Properties must be like-kind. <a href="https://www.accruit.com/blog/understanding-like-kind-requirement-1031-e…; rel="noreferrer noopener" target="_blank">Like-kind</a> means that any real estate property held for use in a trade or business or for investment is like-kind to any other real estate property held for use in a trade or business or for investment, i.e. they do not need to be same kind. For example, a multi-family property can be exchanged for an office building. The historical reference to like-kind was much more relevant prior to 2018 when various types of personal and intangible property was often exchanged.  Since that time, only real property can be exchanged.

This requirement establishes that properties located within the continental United States are considered like-kind other continental U.S. properties.  For example, properties in Puerto Rico are considered outside of the U.S. However, properties located in the Virgin Islands may be treated as like-kind to domestic property under certain circumstances. There is also some authority that properties in Guam or the Northern Mariana Islands may qualify for a 1031 exchange for U.S. property. What is clear within the Regulations is that foreign property is considered like-kind to other foreign property.

Relinquished and Replacement Properties in a 1031 Exchange involved must be domestic or foreign, there cannot be a mix. In the United States, properties can only be exchanged for others within the United States. Foreign properties can be exchanged for other properties in any country, as they are all foreign. Exchanges between different foreign countries are valid, as the qualifying consideration is that they are both foreign to the U.S.

Therefore, Exchangers can exchange foreign property for other foreign property because it is like-kind. Foreign property is not like-kind to domestic property, so a 1031 Exchange is not permissible between domestic and foreign properties.

<h2 paraeid="{f4cc4ab0-2e79-4042-ba9e-656ef2931fe7}{113}" paraid="1738044409">1031 Exchange Scenarios</h2>

When considering a 1031 Exchange, it is important to keep in mind specific rules regarding foreign and domestic properties:

<ol role="list" start="1">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="1" data-font="Calibri Light" data-leveltext="%1." data-list-defn-props="{"335552541":0,"335559685":720,"335559991":360,"469769242":[65533,0],"469777803":"left","469777804":"%1.","469777815":"multilevel"}" data-listid="1" role="listitem">
U.S. Property to U.S. Property: An investor can conduct a like-kind exchange of a U.S. property for another U.S. property. For instance, selling a multi-family rental property in San Francisco, California and exchanging it for an office building in Nashville, Tennessee qualifies for a 1031 exchange. 
</li>
</ol>

<ol role="list" start="2">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="2" data-font="Calibri Light" data-leveltext="%1." data-list-defn-props="{"335552541":0,"335559685":720,"335559991":360,"469769242":[65533,0],"469777803":"left","469777804":"%1.","469777815":"multilevel"}" data-listid="1" role="listitem">
Foreign Property to Foreign Property: An investor can exchange a foreign property for another foreign property. With this, both properties must be located outside the U.S. to be considered like-kind.  
</li>
</ol>

<ol role="list" start="3">
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="3" data-font="Calibri Light" data-leveltext="%1." data-list-defn-props="{"335552541":0,"335559685":720,"335559991":360,"469769242":[65533,0],"469777803":"left","469777804":"%1.","469777815":"multilevel"}" data-listid="1" role="listitem">
U.S. Property to Foreign Property: Exchanging a U.S. property for a foreign property is not permissible under Section 1031 of the Internal Revenue Code. If an investor attempts this, their 1031 Exchange would likely be nullified and they could have to pay associated taxes on the real estate transaction. 
</li>
</ol>

<h2 paraeid="{f4cc4ab0-2e79-4042-ba9e-656ef2931fe7}{198}" paraid="505097873">Does a 1031 Exchange Make Sense for Foreign Property? </h2>

Any sale of foreign property held for investment should undergo the same evaluation as a domestic property being sold. A 1031 exchange of one foreign property for another would result in tax deferral for U.S. tax reporting purposes. Hence, a 1031 Exchange for foreign property would still be beneficial for a property owner even if the country in which the property is not located does not impose its own taxation.

If the foreign country does impose its’ own taxes on the sale, an investor might be afforded some tax liability protection from a duplicate tax levy by the U.S. Foreign Tax Credit. In some cases, an owner of foreign property can take credit on their tax return for some taxes paid in the foreign country and use it to offset United States taxes.

A 1031 Exchange can be as beneficial for owners of foreign real estate as those owning US property. It is important to remember that US real property and foreign real estate are not like-kind to one another for 1031 Exchange purposes. As always, when contemplating a 1031 Exchange it is crucial to involve a Qualified Intermediary (QI) skilled to facilitate all types of 1031 exchanges, including those for foreign real estate holdings.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Wed, 06/05/2024 - 22:07

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Recent Private Letter Ruling Allows Minimal Qualified Use Period for Distribution from Trust to TIC Owners and Subsequent Sale

05/22/24

The IRS issued a recent Private Letter Ruling on April 19th, 2024 regarding property held within a Testamentary Trust distributed as ...

Authored by: meredithb@accruit.com

Authored on: Wed, 05/22/2024 - 15:06

Rules and Regulations

The IRS Private Letter Ruling (PLR) 202416012 issued on April 19, 2024, addresses the potential issues in a 1031 Exchange of a trust beneficiary’s Tenancy in Common (TIC) interest in an asset that had formerly been owned by the trust. This PLR involves a testamentary Trust (a trust established by the will of a deceased person) that continued to hold property long after the death of the creator of the Trust to presumably assure the Trust property would devolve to specific beneficiaries. When it became apparent the conditions for termination of the Trust had occurred, the trustees of the Trust petitioned the probate court to approve the sale of the Trust real property.

As part of the termination of the Trust, the Trustees initially considered the sale by the Trust and a 1031 exchange into replacement property. However, certain beneficiaries, including the beneficiary Exchanger requesting the PLR, advised the Trustees and the probate court they wished to effect individual 1031 exchanges of their respective TIC interests in the real property into what would be their individual Replacement Properties. The Trustees and exchanging Beneficiaries, including the Exchanger, agreed as part of the Trust Termination Plan to distribute tenancy in common (TIC) interests in the trust property to separate single member LLCs created by each of the exchanging beneficiaries. Upon approval of the Termination Plan by the Probate Court, each of the LLC’s will complete 1031 exchanges of their TIC interests into Replacement Property.

The IRS ruled that the distribution from the Trust to Exchanger of the TIC interest will not preclude such interest from being deemed “held for investment or for productive use in a trade or business” within the meaning of § 1031(a) of the Code. In issuing the PLR, the IRS distinguished this transaction from similar transactions described in Rev. Rul. 75-292, 1975-2 C.B. 333 and Rev. Rul. 77-337, 1977-2 C.B. 305 where the IRS ruled that distributions of real property out of a business entity with a short-term hold disqualified the real property as being held for investment/business use. The IRS distinguished those scenarios due in large part to the fact that the distributions were voluntary and pre-planned.

The facts provided in this PLR which seem to favor the Exchanger are as follows:

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The Trust was a testamentary trust subject to a predetermined termination event beyond the control of the exchanging beneficiaries. 
</li>
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="2" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"multilevel"}" data-listid="1" role="listitem">
The holding period by the Trust was very lengthy. 
</li>
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="3" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"multilevel"}" data-listid="1" role="listitem">
The Trust always held the subject property for investment/business use. 
</li>
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="4" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"multilevel"}" data-listid="1" role="listitem">
The Termination Plan was part of a court-ordered disposition. 
</li>
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="5" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"multilevel"}" data-listid="1" role="listitem">
The Exchanger/beneficiary is going to acquire and hold qualifying like-kind property and therefore there is a continuity of investment. 
</li>
<li aria-setsize="-1" data-aria-level="1" data-aria-posinset="6" data-font="Symbol" data-leveltext="" data-list-defn-props="{"335552541":1,"335559685":720,"335559991":360,"469769226":"Symbol","469769242":[8226],"469777803":"left","469777804":"","469777815":"multilevel"}" data-listid="1" role="listitem">
The Exchanger’s LLC is a Single Member LLC and therefore a disregarded entity. 
</li>
</ul>

We’re left with the question of whether this PLR is a harbinger of a softer stance by the IRS in the area of “drop and swap” transactions incident to a 1031 Exchange. Keep in mind that private letter rulings are not the same as a legal precedent and any reliance is only warranted by the Exchanger seeking the ruling and compliance with the facts set forth in the ruling. Though this ruling may not constitute carte blanche approval of “Drops and Swaps”, it may provide comfort for those Exchangers involved in involuntary distributions which otherwise comport with a substantial amount of the facts in this PLR.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Fri, 05/24/2024 - 16:19

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Amplify Returns by Utilizing 1031 Exchanges

04/03/24

This article explores the potential for a greater return on investment property owners can reap when utilizing a 1031 Exchange on ...

Authored by: meredithb@accruit.com

Authored on: Wed, 04/03/2024 - 16:03

Rules and Regulations

Real estate investors understand the importance of strategic decisions to enhance their portfolios and maximize returns, but the owner of one business property or family-owned land might not be as familiar with these practices. One powerful tool at a property owner’ s disposal is a 1031 exchange, a provision in the Internal Revenue Code that allows you to defer capital gains taxes, depreciation recapture, state tax, and net investment income tax when selling an investment or business property and reinvesting the proceeds into qualified replacement property. In this article, we'll look at different scenarios of selling a property held for investment or business use and utilizing a 1031 exchange to reinvest in various property asset classes, including a rental house, an industrial warehouse, and a Delaware Statutory Trust (DST).

<h2 aria-level="2" paraeid="{fadaaa7e-5975-4ad7-83d5-95394795dd62}{27}" paraid="1663958951" role="heading">Understanding a 1031 Exchange </h2>

Before we dive into the specifics of each asset class, it's crucial to understand the fundamentals of a 1031 exchange. This tax deferral strategy enables investors to defer taxes that would otherwise be associated with the sale of the property, by reinvesting the sale proceeds into qualified replacement property within a specified time frame. To qualify for a 1031 exchange, the Relinquished Property and the Replacement Property must both be held for productive use in a trade or business or for investment and held by the same tax entity.

<h3 aria-level="3" paraeid="{fadaaa7e-5975-4ad7-83d5-95394795dd62}{43}" paraid="776916789" role="heading">Key Requirements for a 1031 Exchange: </h3>

Like-Kind Property: The Replacement Property must be of like-kind to the Relinquished Property, but this does not necessarily mean identical. For example, you can exchange a commercial property for a residential property. For purposes of a 1031 exchange, all business or investment property is like-kind.

Identification Period: Within 45 days of selling the Relinquished Property, you must identify potential Replacement Property(ies) in writing, following one of the three available <a href="https://www.accruit.com/blog/what-are-rules-identification-and-receipt-… rules</a>.

Closing Period: The Replacement Property must be acquired, and the exchange completed, within 180 days from the sale of the Relinquished Property.

Now, let's explore the potential of reinvesting in different asset classes as Replacement Property in a 1031 exchange.

<h2 aria-level="2" paraeid="{fadaaa7e-5975-4ad7-83d5-95394795dd62}{150}" paraid="1949574642" role="heading">Potential 1031 Exchange Reinvestment Scenarios </h2>

Before we dive into examples of reinvestment options through a 1031 Exchange, let’s look at investment scenarios that do not involve a 1031 Exchange.

Let’s assume a property owner inherited family land and has personally owned, or held, the land for 20 years. Due to urban expansion, the property owner has been offered $2 million by a developer to sell the land. The value of land when inherited was $1.2 million, so upon the sale of land, roughly $230,000 would be owed in Capital Gains Tax, State Tax, and Net Investment Income Tax without a 1031 Exchange. The property owner has reinvestment options that do not involve like-kind property. Some of the most common avenues include, stocks and bonds, mutual funds, and Exchange-Traded Funds (ETFs).

Let’s look at the estimated annual returns for each of these avenues. Note, the total reinvestment into these avenues is roughly $1,770,000 due to the taxable event without a 1031 Exchange.

Stocks and Bonds:

Average Return: Stocks historically yield an average annual return of 7-10%, while bonds offer a more conservative but stable return ranging from 2-5%.

Total Annual Return: Based on the above averages total annual returns could be expected from $35,400-$177,000 annually.

Mutual Funds:

Average Return: Historical average annual returns for mutual funds typically range between 5-8%.

Total Annual Return: Based on the above averages total annual returns could be expected from $88,500-$141,600 annually.

Exchange-Traded Funds (ETFs):

Average Return: Historical average annual returns for well-diversified ETF portfolios tend to align with stock market performance, around 7-10%.

Total Annual Return: Based on the above averages total annual returns could be expected from $123,900-$177,000 annually.

<h2 aria-level="2" paraeid="{34703980-e088-489d-87eb-c104e79d3ab6}{115}" paraid="1585139260" role="heading">Potential 1031 Exchange Reinvestment Scenarios </h2>

Now, let's explore the potential returns of reinvesting in different asset classes as Replacement Property in a 1031 Exchange. By utilizing a 1031 Exchange for the real estate transaction the reinvestment requirement for full tax deferral is the $2 million sale price.

Rental House Investment:

One of the most common choices for investors utilizing a 1031 exchange is the acquisition of a rental house. Residential real estate offers stability, potential for appreciation, and a consistent income stream through rental payments.

Potential Annual Returns:

Appreciation: Historically, residential real estate has shown steady appreciation. On average, the annual appreciation rate for single-family homes in the United States has hovered around 3-5%.

Rental Income: The rental market's performance varies by location, but a well-chosen property in a desirable area can provide a steady rental income. A conservative estimate for annual rental yield is between 4-6% of the property's value.

Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 7% - 11% annual returns could be expected, equating to $140,000-$220,000 annually.

Tax Benefits: Besides deferring capital gains taxes, rental property owners can benefit from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses.

Industrial Warehouse:

Investing in industrial real estate, particularly storage warehouses, offers unique advantages. The growing demand for e-commerce and logistics has increased the appeal of this asset class, providing investors with the potential for both appreciation and robust rental income.

Potential Annual Returns:

Appreciation: Industrial real estate has witnessed strong appreciation in recent years due to the increasing reliance on online shopping and the need for efficient logistics. Annual appreciation rates can range from 6-8%.

Rental Income: Industrial storage warehouses can generate substantial rental income, especially in prime locations. Rental yields may range from 6-8%, depending on the specific market and property characteristics.

Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 12% - 16% annual returns could be expected, equating to $240,000-$320,000 annually.

Long-Term Leases: Industrial tenants often sign long-term leases, providing stability and a consistent cash flow for investors.

Tax Benefits: Similar to a rental home, an industrial warehouse would also provide benefits from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses.

Delaware Statutory Trust (DST):

For investors seeking a passive approach to real estate ownership, Delaware Statutory Trusts (DSTs) offer an intriguing option. A DST is a legal entity that holds title to real estate assets, allowing investors to own a fractional interest in a larger, higher quality property than they could purchase on their own, without the day-to-day management responsibilities.

Potential Annual Returns:

Appreciation: Historically, institutional-grade properties including apartment complexes, retail centers, and commercial buildings of properties have shown average annual appreciation rates ranging from 3% to 5% in stable markets over the long term.

Annual Return: DSTs typically focus on income-producing properties, such as apartment complexes, commercial buildings, or retail centers. Investors on average can expect between a 4-9% annual rate of return.

Total Annual Return: Based on the above averages for Appreciation and annual return income, a total between 7% - 14% annual returns could be expected, equating to $140,000-$280,000 annually.

Tax Benefits: DST investors generally receive an annual statement from the Sponsor allocating the investors share of depreciation, mortgage interest, property taxes, and other tax benefits.

Diversification: DSTs provide diversification by allowing investors to own a portion of multiple properties within a single investment. This diversification can mitigate risks associated with a single property or market.

<h2 aria-level="2" paraeid="{b6f45eac-3420-4a1c-9b60-0c6b5c23e8a6}{100}" paraid="1260724357" role="heading"> 
1031 Exchanges Impact on Return on Investment </h2>

In conclusion, utilizing a 1031 Exchange to transition from one property to another is a strategic move for property owners or investors looking to optimize their real estate investments. By carefully considering the potential returns and characteristics of traditional investments compared to like-kind real estate investments, investors can increase their reinvestment and tailor their real estate investments to align with their financial goals and risk tolerance.

Before embarking on a 1031 Exchange, it is crucial to consult with tax professionals, legal advisors, and real estate experts to ensure compliance with regulations and to make informed decisions. Additionally, market conditions and investment landscapes can change, so staying informed about current trends and conducting thorough due diligence is essential for long-term success in real estate investing.

A well-executed 1031 Exchange can not only defer four levels of tax but also serve as a catalyst for diversification, capital growth, and enhanced income streams within a carefully curated real estate portfolio.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Tue, 10/22/2024 - 17:15

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Reverse and Property Improvement Exchanges Outside the Safe Harbor

03/27/24

The article covers the historical evolution and regulations of Section 1031 of the Tax Code, focusing on Reverse Exchanges and Property ...

Authored by: meredithb@accruit.com

Authored on: Wed, 03/27/2024 - 16:23

Rules and Regulations

<h2 aria-level="1" paraeid="{f9d25216-1388-4fb4-b80a-f2e651cca622}{193}" paraid="635633104" role="heading">Evolution </h2>

The idea that an exchange of a like kind property for another should not subject a Taxpayer, or Exchanger, to a tax payment so long as they did not “cash out” formed the basis for Section 1031 to become part of the Tax Code in 1921. At one time almost all asset types could be exchanged, but in the present era, only real estate can be exchanged. The rationale for this tax deferral was based on the fact that the Exchanger maintained a “continuity of investment” in the asset, and it would be unfair to assess a tax under the circumstances of maintaining the investment in the “like kind” property. Then, as well as now, applicable taxes were deferred until some final cash out disposition, if any.

There were additions to the Code section over time but there were still a lot of open questions as the use of §1031 gathered steam over the years. In 1991, the IRS sought to provide more certainty on what could or could not be done and promulgated some regulations to provide a safe harbor that people could follow when entering into a tax deferred exchange. The 1991<a href="/sites/default/files/Internal%20Revenue%20Service%20Regulations%20IRC%20Section.pdf"> regulations</a> included distinct safe harbors:

During a comment period before the 1991 rules came into effect, many people wrote in to the Internal Revenue Service (IRS) asking if the final rules could provide some guidance when circumstances dictated that the Replacement Property needed to be acquired before the sale of the Relinquished Property, commonly referred to as a Reverse Exchange, or when a portion of the Relinquished Property sale proceeds needed to be allocated to construction or improvement on the new property, a Construction or Improvement exchange. The IRS replied to these comments by declining to include such guidance but indicated that it would continue to study the issue and provide rules on it in the future. It took some time, but in the year 2000, that guidance was published in <a href="/sites/default/files/Rev%20Proc%202000-37_0.pdf" title="Revenue Procedure 200-37 pertaining to 1031 Exchanges">Revenue Procedure 2000-37</a>.

<h2 paraeid="{530cbd30-0de9-4362-ad54-a65f651a2107}{18}" paraid="853233036">Safe Harbor for Reverse and Improvement Exchanges </h2>

Like the Forward Exchange Rules before it, IRS Rev. Proc. 2000-37 provided a new safe harbor for Reverse and Construction/Improvement Exchanges. Among other things, the rules required having a third party, referred to as an Exchange Accommodation Titleholder, park title to the subject property as part of the necessary structure. Also, it was a condition of the safe harbor that the transaction, including the title parking arrangement, could go on no longer than 180 days.

<h2 paraeid="{530cbd30-0de9-4362-ad54-a65f651a2107}{30}" paraid="547767587">Traditional Structuring for Reverse and Improvement Exchange Prior to the Safe Harbor </h2>

Prior to the issuance of this Rev. Proc. in 2000, there was some case law on Reverse and Property Improvement Exchanges. The gist of which was that it could be done via a title parking arrangement, but it was necessary for the third-party parking Accommodator to have true “benefits and burdens” of ownership. This was a very high bar to reach and required such things as:

<ul role="list">
<li aria-setsize="-1" data-aria-level="2" data-aria-posinset="1" data-font="Arial" data-leveltext="•" data-list-defn-props="{"335552541":1,"335559685":1440,"335559991":360,"469769226":"Arial","469769242":[9675],"469777803":"left","469777804":"•","469777815":"hybridMultilevel"}" data-listid="2" role="listitem">
Risk of gain or loss required should the market value change over the term of the parking arrangement 
</li>
<li aria-setsize="-1" data-aria-level="2" data-aria-posinset="2" data-font="Arial" data-leveltext="•" data-list-defn-props="{"335552541":1,"335559685":1440,"335559991":360,"469769226":"Arial","469769242":[9675],"469777803":"left","469777804":"•","469777815":"hybridMultilevel"}" data-listid="2" role="listitem">
“Skin in the game” from the Accommodator, often thought to be a minimum of 5% of the equity 
</li>
<li aria-setsize="-1" data-aria-level="2" data-aria-posinset="3" data-font="Arial" data-leveltext="•" data-list-defn-props="{"335552541":1,"335559685":1440,"335559991":360,"469769226":"Arial","469769242":[9675],"469777803":"left","469777804":"•","469777815":"hybridMultilevel"}" data-listid="2" role="listitem">
Lease of the property back to the Exchanger during the parking term with true economics and arm’s length dealing 
</li>
<li aria-setsize="-1" data-aria-level="2" data-aria-posinset="4" data-font="Arial" data-leveltext="•" data-list-defn-props="{"335552541":1,"335559685":1440,"335559991":360,"469769226":"Arial","469769242":[9675],"469777803":"left","469777804":"•","469777815":"hybridMultilevel"}" data-listid="2" role="listitem">
Exchanger could not be the agent of the accommodator 
</li>
<li aria-setsize="-1" data-aria-level="2" data-aria-posinset="5" data-font="Arial" data-leveltext="•" data-list-defn-props="{"335552541":1,"335559685":1440,"335559991":360,"469769226":"Arial","469769242":[9675],"469777803":"left","469777804":"•","469777815":"hybridMultilevel"}" data-listid="2" role="listitem">
Exchanger could not simply provide a blanket guarantee on any bank loan made to the Accommodator for the purchase price and/or cost of improvements 
</li>
</ul>

As can be imagined, meeting these criteria suggested by the case law was hard to do. The 2000 regulations changed most of this and for all intents and purposes just required the Accommodator to be in legal title during the 180 term of the transaction. Simplifying the requirements provided many Exchangers the ability to enter into these parking arrangements without tax risk.

<h2 paraeid="{530cbd30-0de9-4362-ad54-a65f651a2107}{115}" paraid="554584921">Rev. Proc. Position on Structuring Outside the Safe Harbor </h2>

The regulations recognized that it was not always possible to have a parking transaction be concluded within 180 days. For example, in the case of new construction or property improvements, it takes time to get architect plans, permits, deal with inclement weather conditions, etc. Taking this into consideration, the Regs included a paragraph suggesting that “no (adverse) inference” was to be made for deals structured outside the safe harbor, specifically it states:

“No inference is intended with respect to the federal income tax treatment of arrangements similar to those described in this revenue procedure that were entered into prior to the effective date of this revenue procedure. Further, the Service recognizes that "parking" transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of "parking" transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.”

This language was meant to leave the window open for matters that required more than 180 days to accomplish a completed exchange. For transactions that could only be done for a period in excess of 180 days, the only practical way was to resort to the benefits and burdens approach referred to above and, as before, that was difficult to adhere to.

<h2 paraeid="{530cbd30-0de9-4362-ad54-a65f651a2107}{203}" paraid="1349343978">The Case of Estate of George H. Bartell, Jr. v. Commissioner, 147 T.C. No. 5 (2016) </h2>

As so many times before, the landscape for these transactions changed once again with the ruling in the Bartell case that was issued in 2016. That case pertained to a taxpayer who structured an exchange involving new construction with a corresponding parking arrangement for 24 months. The actual period ended up being 17 months. Unlike traditional deals outside the safe harbor, it did not have benefits and burdens built in, rather it merely had a third-party Accommodator, referred to by the Court as a “warehousing” entity, hold title during the parking term. Predictably, the IRS challenged the tax reporting since it did not comply with historical requirements for a structure outside the safe harbor. However, the Federal District Court examined some cases on the subject and reached the conclusion that the case law primarily required a third party to be in title to the property during the period of construction.

This finding by the Court was a radical departure from what practitioners expected and opened up the door to many more parking transactions to be structured following the Bartell model. While the IRS was bound by the decision, it expressed its continuing disagreement with the holding by filing a “non-acquiesce” to the decision, meaning that it did not agree to be bound by it in other cases. This meant that persons in other Federal Districts could not necessarily rely on the case holding as applicable law.

However, gradually since 2016 real estate investors and business owners have been structuring deals requiring more than 180 days in conformity with the Bartell decision. At this time in 2024, such a matter being done outside the safe harbor is somewhat commonplace and certainly the IRS is aware that it happens. A lot of time has elapsed since the case holding and there is no evidence that the IRS has disallowed this structure since then so it would seem that a parking arrangement that uses an Accommodator but does not require benefits and burdens to that party, is indeed possible.

Like all tax related matters that are not the equivalent of a published safe harbor, it is always recommended to seek advice from your professional advisers to ensure that any perceived tax risk is properly assessed.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Thu, 04/11/2024 - 20:12

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RULES AND REGULATIONS

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