section 1031

What Happens if a 1031 Exchange Spans Two Tax Years?

Anonymous — Fri, 29 Dec 2023 11:47:59 +0000

What Happens if a 1031 Exchange Spans Two Tax Years?

Anonymous (not verified) Fri, 12/29/2023 - 11:47

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What Happens if a 1031 Exchange Spans Two Tax Years?

Most taxpayers who are considering a Section 1031 exchange are familiar with the 45-day Identification period, and the 180-day Exchange period. As a reminder, the taxpayer must identify the Replacement Property (or Properties) to be acquired within 45 days after the sale of the Relinquished Property. Section 1031(a)(3)(b) says that taxpayers must complete their 1031 exchanges within 180 days after the sale of their Relinquished Property, or the due date of their tax return, whichever is earlier. For most taxpayers, and in most years, the tax return due date is April 15 of the following year.

But for taxpayers who sell investment real estate in the fourth quarter as part of a 1031 exchange, it is imperative to pay particularly close attention to the exchange deadlines, specifically the rules and regulations around the 180 day exchange period.

Realize Full Exchange Timeline by Filing for an Extension on Taxes

For example, if you sold your relinquished property after October 17, 2023, you must complete your 1031 exchange by April 15, 2024, or you must file for an extension on your 2023 taxes. This means that if you sold your investment property on November 30, 2023, for example, you would have an exchange deadline of April 15, 2024 – which is only 136 days later. To have the benefit of the full 180-day exchange period, you would have to file for an extension.

Filing for an extension on your tax return requires submission of Form 4868 and will provide you with a six-month extension on your income taxes. This does not, however, provide you with an additional six months to complete your 1031 exchange, but rather, the balance of your 180 days, which in November 30 example above, moves the deadline to May 29, 2024.

Convert Failed 1031 Exchange to Installment Sale

Alternatively, you could opt to let your exchange fail. Our November 30 example above has a 45-day identification deadline of January 14, 2024, and a 180-day exchange deadline of May 29, 2024. Whether the 1031 exchange fails by non-identification or by failure to acquire replacement property, you are not entitled to obtain the exchange proceeds until the subsequent tax year. In this example, the IRS allows you to either report the gain in the year of the sale, or in the year the proceeds were received under Section 453 installment sale rules. Choosing the installment sale rules would require you to file Form 6252, but effectively provides a one-year deferral on the gains from the sale of the property. Deciding to convert from a failed 1031 exchange to an installment sale does not result in any IRS penalties, and provides you with additional flexibility. Indeed, the default reporting of an unsuccessful exchange that crosses tax years is the installment sale method unless you affirmatively choose to report it in the prior year.

Keep in mind that the rules for Section 453 installment sales are quite specific. Installment sales do not necessarily apply to all sales, and do not defer any gain that was attributable to debt relief. Taxpayers are strongly encouraged to discuss the concepts covered here with their tax and/or legal advisors.

Implications of a Partial Exchange

There is yet another possible scenario. Assume that you sold your relinquished property on November 30, 2023 for $500,000 as part of a properly structured 1031 exchange. Your 45-day identification deadline is January 14, 2024 and your 180-day acquisition deadline is May 28, 2024. You properly identify one target replacement property before the deadline, and ultimately acquire that property on January 30, 2024 for $450,000. This results in “boot” – taxable event – of $50,000. Whether this $50,000 is attributable to depreciation recapture or capital gains, the results are the same, you could elect to recognize the taxable event on your 2023 tax return, or you could elect installment sale treatment as discussed above.

Whether you should recognize the taxable event in 2023 or 2024 is a taxpayer specific inquiry that is best resolved by consulting your tax and legal advisors.

*Updated 12/29/2023.

The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

Anonymous — Tue, 26 Apr 2022 19:54:13 +0000

The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

Anonymous (not verified) Tue, 04/26/2022 - 19:54

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The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?

In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property. Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property. The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.

In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property. If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property. So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.

When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title. It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership. Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.

Can a Taxpayer Change the Ownership but Maintain the Tax Identity?

Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property. So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

Hold title in taxpayer’s own name
Hold title under a single member limited liability company (LLC)
Hold title as the trustee of a Revocable Living Trust
Hold title as beneficiary of an Illinois type land trust
Hold title as a Tenant in Common (TIC)
Hold title under a Delaware Statutory Trust (DST)

Holding Title in the Taxpayer’s Own Name

Using the taxpayer’s own name is the most common form or ownership. This ownership can be as an individual, LLC, partnership, etc. There is always a tax identification number associated with this ownership.

Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC

Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust. A TIC is also deemed to be owned by the owner of that Tenant in Common share. The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.

Holding Title under a Delaware Statutory Trust

DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust. As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name. In 2004, the IRS issued a ruling confirming that the use of a DST for the purchase of replacement property was permissible with certain restrictions.

Holding Title as Beneficiary of an Illinois Type Land Trust

The Illinois land trust is similar to the DST in that the owner of the trust interest is considered to be holding the beneficial interest in the trust that holds title to the property. Since an exchange of a “beneficial interest” was not allowed under Section 1031 in the past, many sellers of property within a land trust faced a lot of uncertainty as to how to proceed. Eventually the IRS issued Private Letter Ruling 92-105 confirming that due to the unique nature of an Illinois land trust, the beneficiary causing sale of land trust property would qualify for a real estate exchange and was not subject to the beneficial interest prohibition.

The Same Taxpayer Rule and Spouses

There are times when only one spouse is on title to the relinquished property and the taxpayer would like to add the spouse to the title to the replacement property. This is not encouraged since the other spouse was not the same taxpayer who sold the relinquished property. When a taxpayer does want to bring the spouse on title, advisors usually suggest waiting until the “exchange is old and cold.” Waiting several years should be sufficient.

Other times, only one spouse will be on title to property but the lender in connection with the replacement property financing will require the additional spouse to go on title as a condition of the loan. If this is a written request from the lender, rather than the taxpayer’s election, it is unlikely that the IRS would find it objectionable. Should someone wish to use an abundance of caution, a document could be drawn up confirming that the additional spouse is holding the interest “in trust” on behalf of the original spouse.

Spouses in Community Property States

In cases where only one spouse is on title to the relinquished property there is an exception to the requirement that only that spouse may be on title to the replacement property. This exception can be found in community property states where if the spouses live in one such state both spouses are deemed to own the property regardless of only one of the spouse holds legal title. While this will apply to most real estate ownership in these states, there are a few exceptions such as the real estate being the subject of a gift or inheritance of one spouse.

These states include:

Arizona
California
Idaho
Louisiana
Nevada
New Mexico
Texas
Washington
Wisconsin

Death of a Taxpayer during a 1031 Exchange

There are instances in which a taxpayer passes away at a point in time after the sale of the relinquished property and before the purchase of replacement property. In the absence of continuation of the exchange in these instances, the estate would be taxed on the gain from the sale. However, in spite of the fact that a (deceased) individual and his estate are not the same taxpayer, the regulations do allow the estate to continue the exchange transaction and receive deferral.

Summary

The theory behind like-kind exchange tax deferral is based upon continuity of a taxpayer’s investment. Implicit with this is that if the taxpayer changes between the disposition of an asset and the acquisition, there cannot be continuation of the taxpayer’s investment. However, there are various types of property-holding arrangements, many of which are disregarded for tax purposes, that allow for a taxpayer to hold relinquished property in a different name while meeting the same taxpayer requirement.

Updated 4/26/2022.

1031 Drop and Swap out of a Partnership or LLC

Anonymous — Mon, 04 Apr 2022 21:36:49 +0000

1031 Drop and Swap out of a Partnership or LLC

Anonymous (not verified) Mon, 04/04/2022 - 21:36

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1031 Drop and Swap out of a Partnership or LLC

Can a partner or member trade their share of a property interest upon sale?

One of the most common questions asked of a qualified intermediary involves the situation in which one or more members or partners in a limited liability company (LLC) or partnership wish to do a 1031 exchange and others simply wish to cash out. There are several practical difficulties in this regard starting with Section 1031 itself. The section generally provides

“No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged for property of like kind which is held for productive use in trade or business or for investment”.

However the section also provides for several exclusions to the ability to trade any qualified use asset and one of those exclusions states “This subsection shall not apply to any exchange of interests in a partnership." As a result, the challenge here is to allow members to go their separate ways while not deeming them attempting to trade in their capacities as members.

While there are multiple ways to structure transactions allowing various members to effectively trade their interest, by far the most common technique is for the outgoing member to have the LLC redeem the member’s interest and to convey by deed the applicable percentage interest in the property equivalent to the member’s former share. The transfer to the member and the subsequent trade by that person is generally referred to as a “drop and swap.”

How is a 1031 drop and swap done?

A 1031 tax exchange drop and swap can take place in several different ways. As mentioned above, when the majority of members wish to cash out, the taxpayer can transfer his membership interest back to the LLC in consideration of his receipt of a deed for a percentage fee interest in the property equivalent to his former membership interest. The taxpayer would then own a tenant in common (TIC) interest in the relinquished property together with the LLC. At closing each would provide their deed to the buyer and the former member can direct his share of the net proceeds to a qualified intermediary.

At times, the majority of members will wish to complete an exchange and one or more minority members will wish to simply cash out. The drop and swap can be used in this instance also by dropping applicable percentages of the property to the exiting members while the limited liability company completes an exchange at the LLC level and the former members cash out and pay the taxes due.

Meeting the “Held For” Requirement in a Drop and Swap

As indicated above, in order for property to be exchanged, it must have been held by the taxpayer for use in a business or for investment. So, if on the eve of the closing on the sale of the relinquished property a fee interest is conveyed to the exiting member, that member would be hard pressed to claim that she personally had held the property for any real period of time. However, when outgoing members wish to cash out, the “held for” requirement is less of an issue since the exchange is done at the LLC level and the LLC has clearly held the property for a qualified use for a significant length of time. It does not matter that the outgoing members will not have satisfied the holding period requirement since they are not seeking exchange status.

For quite some time there have been recommendations from different groups to the IRS to allow outgoing members to be able to tack on their holding period as members to their individually-held ownership interest prior to an exchange. The Joint Committee of Taxation, which every several years comes up with suggested tax-related recommendations, has stated:

“For purposes of determining whether property satisfies the holding requirement under Section 1031 like kind exchange rules, a taxpayer’s holding period and use of property should include the holding period of and use of the property by the transferor, in the case of property….distributed by a partnership to a partner…”

To date the IRS has not adopted this position. If anything, over time the drop and swap appears to be increasingly disfavored by the IRS.

IRS Form 1065 U.S. Return of Partnership Income

In 2008, as part of the IRS’ attempt to limit drop and swap transactions, Schedule B 14 was added to Form 1065. Schedule B 14 asks “At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property." Prior to the inclusion of this check-the-box requirement, drop and swaps were frequently done on a “don’t ask, don’t tell” basis.

As a result of this reporting requirement, it is far better, when planning on a member exchange, to distribute out to the member(s) in a tax year prior to the year in which the sale of the property takes place. This enhances the holding period requirement and separates the drop to a prior tax year from the year in which the former member is completing an exchange. Most Section 1031 experts also strongly suggest making any of these changes prior to entering into a contract for sale.

Underlying Loan Considerations

When a deed of conveyance to a fractional interest in the real estate is given to the outgoing member, that deed is subject to whatever debt is on the property, however the debt is an obligation of the LLC and not that of the member. As a result, the conveyance does not, by itself, act to transfer a pro-rata amount of debt to that member. In order to avoid all the debt remaining against the LLC, the Operating Agreement or the Partnership Agreement needs to be amended to allow for a special debt allocation to flow through to the member as part of his receiving a deed to the fractional interest.

Almost all loans secured by property contain “due on transfer” clauses. So conveying an interest in the property to one or more members may constitute a technical violation under the loan documents. This is often overlooked since the loan payments are kept current and the property would likely be sold before a lender took notice of any transfer.

Deemed Partnership

There is a long history of case law in which the IRS has successfully argued that if a TIC holding has the attributes of a partnership, the co-ownership relationship will be deemed a partnership. This would negate a drop and swap. Although there are many factors that go into determining whether a co-ownership constitutes a de facto partnership, the single largest factor is the degree in which the property is managed by the TICs. The least amount of management by the co-owners is helpful to avoid partnership characterization. Often in an attempt to deal with this consideration, the co-owners will appoint a single co-owner as management agent for the group or will have an outside management company manage the property.

For other various reasons, co-ownership groups will sometimes enter into a tenant in common agreement setting forth their respective rights and relationship. The terms of such an agreement comes from IRS guidance in the form of Rev. Proc. 2002-22. These agreements are often used by lawyers advising clients in order to rebut the argument of a deemed partnership. It is generally understood in the legal community that it is almost impossible for a co-ownership structure to adhere to each and every requirement set forth in the Rev. Proc., but many people try to pattern a tenant in common arrangement to include as many of the provisions as possible. Caution should be taken to avoid the situation where a TIC agreement is entered into, but its terms are ignored in whole or in part by the co-owners.

Summary

The possibility of structuring of a 1031 tax exchange by a subsection of the partners in a partnership or members in an LLC, is one of the most common questions asked by taxpayers to their exchange facilitator or their advisers. While at one time this was done regularly and with apparent impunity, over time the IRS has taken steps to limit this deferral opportunity when the taxpayer has failed to hold the property for an amount of time. The technique of “dropping” an interest to a partner in the form of a tenant in common ownership of title to the property and then “swapping” that interest is very popular. The same can be true when a member wishes to cash out where the LLC seeks to do an exchange. There are some planning steps that can be taken in order to provide the exchange transaction the best chance to pass IRS muster.

Updated 4/4/2022.

#Revolutionize1031 at FEA 2021

Anonymous — Mon, 27 Sep 2021 14:59:09 +0000

#Revolutionize1031 at FEA 2021

Anonymous (not verified) Mon, 09/27/2021 - 14:59

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#Revolutionize1031 at FEA 2021

Last week, several members of Accruit joined other industry colleagues at the annual FEA conference in Chicago to hear about the latest updates regarding tax reform and the potential impact to 1031s. Through the efforts of the 1031 Coalition, the 1031 industry was successful in ensuring capping 1031s were not part of the revenue offsets presented by the House of Representatives earlier this month. This is a positive outcome as we typically see the Senate follow the lead on tax offsets from the House. Furthermore, on the Senate floor last month, Senator Kennedy (LA) submitted an amendment during a “vote-a-rama” to retain 1031s in their current state. Per the request of Senate Finance Chairman Wyden (OR) the vote was taken as a voice-vote and received unanimous support from all Senators.

This week, Brent Abrahm, Accruit President & CEO, participated in three significant virtual calls with Senators to further underscore the importance of retaining 1031s as an effective stimulus for our country. Along with other members of the 1031 Coalition, critical points were made regarding the positive impact of 1031s. A few key supporting facts were highlighted in each call; 1031 like-kind exchanges allow the country to repurpose inefficient commercial properties, 1031s actually produce a positive economic benefit, increase income taxes, and create additional jobs by stimulating our economy, and any attempts to cap the 1031 provision is equivalent to repeal. Senators Bennet (CO), Tester (MT) and Kennedy (LA) all showed wide support and understanding of our data and points of impact.

The efforts are not over and work still needs to be done. Accruit will participate in additional Hill meetings in the coming weeks. We still ask that anyone who may be impacted by a change in the 1031 code, please ACT NOW and share your support.

1031 Exchange Timeline Overview and Considerations

Anonymous — Thu, 19 Aug 2021 17:23:52 +0000

1031 Exchange Timeline Overview and Considerations

Anonymous (not verified) Thu, 08/19/2021 - 17:23

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1031 Exchange Timeline Overview and Considerations

IRC Section 1031 has been around for more than 100 years. Although the overall concept and purpose of 1031 like-kind exchanges have largely remained the same, the regulations and sequence of events an exchange must comply with have evolved. Legislation has sought to address and prevent potential wrongdoings or misinterpretation, as was done in the landmark legal ruling in the Starker vs US case. To fully benefit from the tax deferral, the requirements to exchange are as follows:

An exchange must be facilitated through a Qualified Intermediary (QI)
Property must be held for investment or business purposes
There must be no constructive or actual receipt of exchange funds
Taxpayer must adhere to the time limits set out in the tax code
Property must be "like-kind"
The property exchanged into must be equal or up in value

The requirement that investors tend to feel is the most restrictive once they deem their property eligible for exchange is the strict timeline they must follow.

Forward Exchange

In a typical forward exchange, the taxpayer will hire a Qualified Intermediary (QI) to help transact their exchange. The taxpayer will list their property, and once it sells, the QI will hold the proceeds from the sale of the relinquished property for later use in purchasing the identified replacement property(s). Once the relinquished property sells, the taxpayer has 45 days to identify replacement property(s) and 135 days after that to finalize their exchange for a total of 180 days.

Reverse Exchange

The Internal Revenue Service (IRS) does not allow a taxpayer to hold the replacement property and the relinquished property simultaneously. This restriction can present challenges to investors who would like to purchase their replacement property before selling their relinquished property when a reverse exchange is required. The timeline of a reverse 1031 exchange, sometimes called a parking exchange, is the same as a forward exchange. The main difference is that instead of the QI holding funds, they hold a property. After hiring the qualified intermediary, the taxpayer and QI will open an LLC that will act as the Exchange Accommodation Titleholder (EAT), which will hold the replacement property as the taxpayer sells the relinquished property. Once the EAT has taken the title of the new property, the exchanger has 45 days to identify the property they will be selling. After the initial 45 days, the taxpayer has the remaining 135 days of the total 180 to sell the property they identified and finalize the exchange.

Build-to-Suit or Improvement Exchange

There are times when a taxpayer would like to sell a property and exchange it for a property they would like to develop or improve. Build-to-suit exchanges refer to exchanges in which improvements are made on the property acquired. In a build-to-suit or improvement exchange, the taxpayer can sell their property to purchase and improve a new property or purchase the replacement property first and then use the funds from the sale of the relinquished property to pay back loans used to fund the initial purchase and improvements. In both cases, the taxpayer has 180 days to use the balance of funds to improve the property. Any funds that have not been used during the parking period are considered real estate “boot” and are subject to capital gain tax. The 180-day time limit begins when the EAT, set up with the QI before the exchange, assumes title of the property.

1031 Exchange Timeline Considerations

Following the timeline on a 1031 exchange is not always as easy as it sounds. A taxpayer may not be able to identify a suitable property to buy in the 45-day identification period. A taxpayer may not be able to sell their property within 180 days. Improvements on a property may take longer than 180 days. Once a safe harbor provision is not met, the exchange is no longer eligible for tax deferment.
Here are a few ways of setting yourself up for a successful exchange:

If you want to begin a forward exchange, start looking for your replacement property as early as possible
You can stretch out this extra period by delaying the close date on your relinquished property, preventing your 45-day countdown from starting
If you have already identified a property you would like to purchase but have not been able to sell your current property, consider a reverse exchange. That way, you will ensure your purchase and have 180 days to sell the old property
To avoid unwanted delays that may cut your 1031 exchange timeline short, ensure that your financing is in order before entering into an exchange agreement

Exchanging Equal or up in Value

Anonymous — Thu, 22 Jul 2021 16:23:19 +0000

Exchanging Equal or up in Value

Anonymous (not verified) Thu, 07/22/2021 - 16:23

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Exchanging Equal or up in Value

Since 1921, the rules for qualifying and completing 1031 exchanges have gradually broadened and become less restrictive. Even so, there are do's and don’ts and several gray areas of which taxpayers should be aware. Here at Accruit, we are accustomed to dealing with all types of complex exchanges, and we want to make sure that the complexity of exchange doesn't deter you from considering one. We'll help you put the pieces together for a successful exchange. For the taxable gain to be deferred, specific key requirements must be satisfied:

Properties Must Be Exchanged, Rather than Sold and then Purchased
There Must Be No Constructive or Actual Receipt of Exchange Funds
Properties Must be "Like-Kind"
Must Follow Exchange Time Limit & Identification Requirement
Properties Must Be Held for Business or Investment Purposes
Exchange Must Be Equal or Up in Value:
- To potentially defer all of the taxable gain, a property owner must first reinvest all of the equity in the relinquished property into the replacement property. Second, the purchase price of the property acquired must equal or exceed the sale price of the relinquished property. Typically, this requires debt on the new property to equal or exceed the debt that is paid off on the relinquished property.

Identification Rules: The 3-Property Rule

The 3-property rule states that the replacement property identification can be made for up to three properties, meaning that an exchanger may identify more than one alternate property to be received in an exchange. The taxpayer can identify and purchase up to three replacement properties after relinquishing their initial property to the qualified intermediary, like Accruit. The amount totaled at the end of the identification is not relevant to the requirements of section 1031, as long as it is not more than three properties. A majority of taxpayers will utilize this rule. Here is an example of the utilization of the 3-property rule: Ms. Garcia begins a 1031 exchange in Minnesota with Accruit, with a lot valued at $325,000. Before identifying her new replacement properties, Ms. Garcia confirmed to Accruit that she has identified three potential properties and intends to acquire only one. Within 45 days Ms. Garcia unambiguously identifies three new properties valued at $325,000, $350,000, and $370,000, respectively. As long as Ms. Garcia receives one of these properties within the replacement period, she has satisfied the 3-property rule.

Identification Rules: The 200% Rule

The 200% rule states that 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 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. Here is an example of the 200% percent rule: Ms. Garcia is exchanging her lot valued at $300,000. She identifies four new properties, each priced at 100,000. Although Ms. Garcia identified more than three properties, their combined value does not equal more than 200% of the value of her relinquished property. Therefore, it has satisfied the identification rules.

Identification Rules: 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 difficult to adhere to. It provides that should the taxpayer have overidentified for 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, suppose a taxpayer identified four properties or more whose market value exceeds 200% of the relinquished property value, to the extent that the taxpayer received 95% of what was identified the identification is deemed proper. In the real world, it is difficult to imagine this rule being relied upon by a taxpayer. Let's use Ms. Garcia as an example again, she is exchanging her $300,000 lot in Minnesota, and she overidentifies a total of 21 lots, each priced at $35,000. Ms. Garcia identified more than three properties and exceeded 200% of the value of her relinquished property. However, she can still keep her exchange valid if she purchases at least 95% of the value of those 21 lots she identified. If Ms. Garcia instructs her intermediary to convey at least 20 of those lots during the replacement period, she has satisfied the identification rules because she is purchasing at least 95% of the $735,000 she identified, and her exchange is still valid.

Conclusion

The relinquishment and replacement of properties are vital components of 1031 exchanges. Navigating the regulations in a 1031 exchange can seem daunting, and there are many questions throughout the process. Can you buy two properties in a 1031 exchange? What are the 1031 exchange rules in Florida or Kentucky? It is strongly recommended that you discuss your exchange with your tax and legal advisors along with a qualified intermediary. Accruit's leadership team has over 200 years of combined experience working with taxpayers and their advisors in structuring successful 1031 exchanges.

At Accruit, we handle all types of complex exchanges. Have a situation you'd like to speak to an expert about? No problem. We're happy to have a free, no-obligation consultation with you.

Preserve Your Agricultural Assets with 1031 Exchange

Anonymous — Mon, 07 Jun 2021 16:21:59 +0000

Preserve Your Agricultural Assets with 1031 Exchange

Anonymous (not verified) Mon, 06/07/2021 - 16:21

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Preserve Your Agricultural Assets with 1031 Exchange

Like-kind exchanges provide benefits to sellers of agricultural property under Internal Revenue Code Section 1031. Section 1031 helps preserve the sellers’ agricultural assets, such as farmland and ranches, utilized for productive use in a trade, investment, or business purposes, when the seller exchanges their property for a “like-kind” property. “Like-Kind” property can be defined as any real property used for trade, investment, or business purposes. In broadest terms, Section 1031 gives sellers the right to exchange business or investment real estate to purchase other business or investment real estate. There is often misunderstanding when it comes to “Like-kind” property as “like-kind” does not mean the same type of property as the property being sold.

This common misconception people have when selling agricultural property is that you must buy agricultural property in a 1031 like-kind exchange. The fact is you can buy any real property such as farm, ranch, apartment complex, commercial building, or rental home used for trade, investment, or businesses purposes. These rules allow agricultural property owners to diversify their investments and grow a wider range of assets. Without 1031 tax deferred exchange, agricultural property owners will be held responsible for paying taxes on the property being sold, even if they reinvest and purchase new property.

What can Agricultural Property Owners Exchange with 1031?

Agricultural property owners can exchange labor, chemical, and water intensive land into less management intensive property such as residential or office condominiums. Or they can exchange conservation easements on their ranch land to acquire new property.

For example:

Recently a client sold two easements on his agricultural land. One of the easements restricted his ability to use the wells on his land. This helps keep water in the underground aquifers and permits more water to flow further downstream for other users. The second easement restricted his ability to use chemical fertilizers on his land. The societal benefit here is that fewer chemicals being applied to the land mean fewer chemicals running into the streams, polluted the water, and killing the fish. The cash generated by the sale of the easements was used to acquire a few single-family homes nearby, which will be used as VRBO/Airbnb type rentals.

Time is of the essence when it comes to Selling and Obtaining Real Property

Timing is crucial when it comes to selling and acquiring real property in a 1031 tax deferred exchange. As property owner, you will need to contact a qualified intermediary, like Accruit, to process a 1031 tax deferred exchange. Without doing so, you may miss out on an opportunity to invest while you are waiting on your current property to sell. Section 1031 gives the seller 180-days to replace their property when exchanging into another real property.

Why am I doing a 1031 tax deferred exchange?

Diversify your portfolio
- Rather than having all of your funds locked into one large property, you can reinvest into multiple properties of different asset classes (residential, commercial, retail, etc.).
- Rather than having all of your funds locked into one location, you can reinvest across town, or across the country, to take advantage of stronger opportunities.
- Spread assets into smaller investments as party of an estate plan.
Upgrade or consolidate your portfolio
- Rather than having your investments scattered across the county, consolidate into fewer, larger properties.

For more information, contact Accruit and subscribe to our blog to learn more about 1031!

Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

Anonymous — Thu, 06 May 2021 16:59:51 +0000

Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

Anonymous (not verified) Thu, 05/06/2021 - 16:59

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Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

When President Biden released his American Family Plan last week, under which Internal Revenue Code Section 1031 like-kind exchanges would be severely limited, the true negative impact this would have on America began to sink in. Not the impact to the corporations or the high-net worth individuals that so routinely and inappropriately are pegged as the sole beneficiaries of Section 1031, but to the American public – everyday working-class citizens who rely on real estate to provide services, rental homes, work-force housing, medical assistance, retirement communities, and schools, just to name a few. Should 1031 exchanges be impacted, many Americans will experience either lack of services or dramatic increases in costs to receive similar benefits.

Because owners and investors of real estate have been leveraging Section 1031 for over 100 years, America’s economy and people reap the benefits of this time proven tax strategy. When certain sectors of U.S. real estate are not providing their most useful and economic utilization to owners, neighborhoods, and cities, that real estate should be repurposed. By providing a deferral of the gain –not an avoidance –through a 1031 exchange, the owner of the property is able to reinvest the proceeds back into the U.S. economy and place them into a more productive property benefiting the investor, the recipients who utilize the property, and the communities where these properties are located.

Today, 1031 exchange real estate investors are choosing more and more to invest in social impact projects benefiting neighborhoods, communities, and our country. In recent years, up to 70% of targeted project funding needs were benefited by 1031 exchange proceeds. These included a Special Needs School in Minnesota in 2019, a Goodwill Store in Florida last year, and a Fertility Clinic in Illinois this year. Other examples include numerous Dollar General thrift stores, DaVita Kidney Care centers, CVS Pharmacies, Fresenius Medical Care dialysis centers, and Walmart's. Since these projects are larger investment opportunities overall, aggregating multiple real estate investors’ exchange proceeds is necessary to ensure these impactful projects are completed. For the builders focused on making a social impact, 1031 exchange monies are cheaper, less risky, and faster to deploy than typical funding sources. Absent 1031 exchanges, these projects, if they even get funded, would require a higher cost of after-tax capital, including more debt, causing the increased cost to be pushed to the ultimate residents of the property in the form of higher rents.

Investments into single family rentals (SFRs) are another example of 1031 exchange proceeds supporting social impact. Across the U.S., investors are recognizing the investment opportunities and the importance of securing rental properties to provide housing other than multi-family properties. During the COVID-19 pandemic, and for years to come, families will continue to seek a home as opposed to dense community living. For SFR companies that eventually sell the homes to their renters, using 1031 exchanges keeps their cost of capital low due to the deferral, which allows them to pass that on through lower rents and lower sale prices to the eventual tenant and buyer

So, for skeptics out there, first understand the rules around Internal Revenue Code Section 1031 and stop the rhetoric that ‘only the rich benefit from 1031 exchanges.’ Section 1031 is not simply checking the box, or filing an IRS form, or even hiring enough attorneys to avoid paying gains. No, facilitating a proper 1031 like-kind exchange requires planning, coordination with buyers and sellers, prohibiting both these and access to the funds through agreements with a qualified intermediary. Section 1031 exchanges benefit everyone –as long as everyone follows the rules. And if you really want to understand the impact of 1031 exchanges, look around your neighborhood, your community, and your city. 1031 exchanges help build and service America.

(Photo credit: Dollar General creates worry in small towns | | bismarcktribune.com)

The Myth of the 1031 Exchange Cooperation Clause

Anonymous — Mon, 19 Oct 2020 15:08:19 +0000

The Myth of the 1031 Exchange Cooperation Clause

Anonymous (not verified) Mon, 10/19/2020 - 15:08

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The Myth of the 1031 Exchange Cooperation Clause

In this post, we will take a brief look into the evolution of Section 1031 to show why it was critical along the way to make use of an “Exchange Cooperation Clause” and why, as the rules changed over time, such use is no longer necessary.

The Starker case

Section 1031 made its way into the Tax Code in 1921, nearly a hundred years ago. At that time, until the mid-1980s, the sale and purchase were thought to need to take place “simultaneously”, after all, isn’t that the commonsense definition of a trade between two people? Apparently not. Beginning in the late 1970s and continuing into the mid-1980s, in the landmark case of Starker vs. U.S., it was determined by a Federal District Court in California that there did not appear to be any requirement in the plain language of Section 1031 of simultaneity.

“No gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of a like kind to be held either for productive use in a trade or business or for investment”.

This seemingly innocuous ruling opened up a Pandora’s Box of opportunity, not to mention confusion. The period of time for completing the trade with his buyer in the Starker case was five years. In 1986, shortly after the decision came out, Congress chose a legislative fix. It agreed that Section 1031 did not require the exchange of the properties to take place at the same time but decided to limit the open ended duration to complete the trade of the one for the other to 180 days. Essentially that limited time period still allowed the two transactions to be close enough in time to be considered to be tied to one another. But anything of a longer period simply broke the link between the sale and the purchase into unrelated (for tax purposes) transactions.

Identification and purchase period to qualify for 1031 exchange

As for the opportunity presented, taxpayers had 45 days to identify potential properties and 180 days to close on one or more of the properties designated. This was much easier than trying to pull together a sale and a purchase at the same time. Instead of being a somewhat little used provision to defer tax, exchanges began to flourish as a result of the extended window to complete the exchange.

But practical problems abounded. One of the biggest problems was what to do with the buyer’s funds during the interim period between the sale and purchase? Section 1031 still required an actual exchange between the taxpayer and the buyer. If the seller took the funds and applied them within 180 days, that was not sufficient. The moment the taxpayer received the funds, the matter became a taxable sale whether or not new property was acquired within the time limits. It was not akin to the old rules where you could get deferral on the sale of a personal residence if you bought a new one within two years. One solution was to allow the buyer to retain the funds with the contractual obligation to use them to buy the new property once the seller was ready to do so. That has so much obvious risk that it doesn’t have to be explained.

Creative lawyers at the time came up with an effective solution. Keep the exchange relationship open between the taxpayer and buyer but place the buyer’s purchase price into a trust account with a third party to keep it out of the taxpayer’s receipt. This also had the benefit of keeping it out of the buyer’s possession or control. A name quickly followed for this procedure and it was affectionately called a Starker Trust!

Now we are getting close to the point of this blog. Starker Trusts could be fifteen pages long and filled with legalese. From the buyer’s standpoint, he or she saw the property listed for sale and negotiated a deal. The buyer came to closing with the applicable funds. However, in the case of a seller doing an exchange, at closing the seller (or seller’s lawyer) would ask the buyer to enter into the Starker Trust for the seller’s benefit. But the buyer would often balk. Sometimes there was simply bad blood between the parties by the time of closing. Other times buyers were reluctant generally to get involved in a tax matter that did not otherwise involve them. It was not unusual for the buyer to agree only if the buyer’s lawyer read and approved it and the seller agreed to pay the attorney fees.

What is an Exchange Cooperation Clause?

The only way the seller could obligate the buyer to sign the necessary agreement was to provide for that buyer’s obligation in the body of the purchase/sale agreement. Hence a clause began appearing in contracts for this purpose requiring the buyer to execute the Starker Trust agreement. That became know as the Exchange Cooperation Clause and it was good policy at the time.

In regard to the Pandora’s Box mentioned above, many unresolved issues arose pertaining what could, and could not, be done for a seller to attain exchange status. These included such issues as:

Who could retain the benefit of the interest accrued on the Starker Trust deposit
Who was eligible to hold the funds in the Starker Trust
Were there other ways to secure the buyer’s obligation to provide replacement property to the taxpayer
If the taxpayer picked out new property for the buyer to acquire to trade back to the taxpayer, did the buyer have to come into the chain of title

Where does the Qualified Intermediary come in?

In response to these questions and many more, in 1991, the 1031 Treasury Regulations were issued to provide some guidance. At the heart of the Regulations was the introduction of a new player within the exchange, namely the Intermediary. Certain persons in an agency relationship with the taxpayer were “disqualified” from acting as the intermediary but anyone else was deemed “qualified”. Hence the term Qualified Intermediary (QI) came into being. This is what gave rise to the many exchange companies, such as Accruit, that exist today.

The main function of the QI was to stand in the shoes of the buyer as a party with whom the taxpayer could effectuate an exchange. Through a series of steps set forth in the regulations, for tax purposes, the taxpayer was selling to the QI (who caused the property to go the buyer) and the QI acquired replacement property from the seller and transferred it to the taxpayer. As a result, an exchange was deemed to have taken place between the taxpayer and the QI. So, the buyer was not a party to the seller’s exchange transaction and had no need to cooperate. The regulations also set up several options in regard to holding the funds during the transaction including letting the QI hold them. This is what is typically done in an exchange today.

Is an Exchange Cooperation Clause necessary?

So, for nearly thirty years, there has been no requirement for the buyer to cooperate in the seller’s tax transaction, but old habits die hard. In today’s world, due to the series of steps referred to above, the seller does have to assign the rights under the sale contract to the QI and notify the fact of this limited assignment to the parties to the contract. The parties receiving the written notice (mainly the buyer and later the seller) are not required to agree, cooperate or even to sign acknowledging receipt. They often sign receipt as a courtesy, but it is not required by the regulations. The same thing must be done with regard to the replacement property contract. This assignment in not tantamount to an outright assignment of the whole contract to a third party, rather it is just the assignment of the seller’s rights (but not the obligations) in the contract for purpose of getting tax deferral. As a matter of general law, if a contract has no restriction against assignment, and most don’t, the person has the legal right to make an assignment. However, if a contract, or state law, included a restriction on assignment, even just of the “rights” to treat it as an exchange, a counterparty in the sale or purchase agreement might be able to thwart this as a technicality. As a result, in today’s contracts, even when there is no restriction against assignment, just to be safe, a clause is usually found in the preprinted contracts or added, along the lines as follows:

“Each of the parties hereto may assign its rights (but not its obligations) to a Qualified Intermediary as defined in the IRC Code Section 1031 Treasury Regulations. Said exchange will be closed without cost, liability or delay to the non-exchange party.”

In summary, as the rules evolved under IRC Section 1031 since its inception, at one time it was very important to have a clause in the sale contract requiring the buyer to “cooperate” in the seller’s exchange transaction. One of the primary changes to the need for the buyer to participate was in the heart of the 1991 Treasury Regulations substituting in a third party, namely the Qualified Intermediary to remove the buyer from any need to cooperate. As a result, an “exchange cooperation clause” because irrelevant. To this day people tend to put emphasis on this clause because it was necessary so many years ago. In the modern era, post-1991, the only requirement for a taxpayer in this regard is to assign the rights under the contract and provide written notice of the fact. There is no requirement for the buyer to cooperate in any way.

Real Estate Transaction Basics

Anonymous — Tue, 17 Apr 2018 19:05:02 +0000

Real Estate Transaction Basics

Anonymous (not verified) Tue, 04/17/2018 - 19:05

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Real Estate Transaction Basics

No useful reason exists to think of or treat a closing like litigation although it does happen. Everyone involved needs to work together in a cooperative way to consummate the deal. Real estate law is a function of locality and custom in many respects; however, we will generally review some commonalities in the closing of a real estate transaction.

Most real estate transactions begin with a written contract and end with a closing. The following parties are typically involved in negotiating, performing and closing on the contract:

Seller
Buyer
Real estate agents
Attorneys (depending on locality and complexity)
Lender (if not a cash deal or other financing arrangement)
Title company

All agreements for the purchase and sale of real estate must be in writing. The contract sets forth the conditions under which the seller agrees to transfer and the buyer agrees to purchase the property. The contract may be lengthy or pithy, complex or straightforward, but its ultimate purpose is to convey ownership of the property to the buyer under mutually agreed upon terms.

Occasionally, a real estate transaction may involve an IRC Section 1031 tax-deferred exchange. The tax code and treasury regulations also provide certain rules that address conveying real estate in a tax deferred exchange. A qualified intermediary (QI) is generally required and is a person or entity that is not a “disqualified person” as defined under the tax code. For the most part, a disqualified person is someone who is under the control, or an agent, of the taxpayer. The QI enters into a written exchange agreement with the taxpayer pursuant to which the QI agrees to acquire and transfer both the relinquished (old) and replacement (new) properties to the taxpayer. For exchange purposes, these transfers to and from the QI can be accomplished if the party’s rights are assigned to the QI and all parties to the contract are notified in writing of the assignment on or before the closing date (see: Case Study: A Forward Exchange of Real Estate).

On the date set forth in the contract, the parties will gather at a title company office to close the transaction. One of the seller’s most basic contractual duties is to convey the marketable title to the buyer. Title is “marketable” if it covers the entire property that the seller is purporting to convey to the buyer and is free of encumbrances that a reasonable buyer would not accept. In other words, it needs to be demonstrated that the seller actually owns the real estate and has a right to transfer ownership to the buyer free from unacceptable title defects.

The seller will prove the title is marketable by way of a title commitment or title report issued by a title insurance company. A title commitment is prepared by the title company (or attorney depending on locality) based upon a title search of the public records to see which documents have been recorded against the property. It is the seller’s obligation to remove or otherwise satisfy any unacceptable conditions not agreed to in the contract that may be set forth in the title commitment. Examples of unpermitted or unacceptable title exceptions may include mortgage, tax, mechanics’ liens, encroachments or other such encumbrances.

At closing, the seller will deliver properly executed and notarized conveyance documents and other documents to the buyer and title company. Examples of such closing deliverables may include the deed, bill of sale, plat of survey, and settlement statement. Possession of the real estate is usually surrendered to the buyer at the closing.

The buyer’s principal obligation at the closing is to pay the purchase price to the seller in consideration for the property. Unless it’s a cash deal, the buyer will typically procure a mortgage loan from a lender for purposes of financing all or portion of the purchase. The buyer’s lender will have its own documents and requirements that will need to be satisfied on or before the closing in order for the buyer to obtain the loan.

Lastly, the title insurance company plays an important part in a real estate closing on behalf of all the parties. The title company will waive, insure over, or otherwise resolve all matters set forth on the title commitment. If the buyer is utilizing a lender, the title company will review the loan documents, ensure they are accurate as well as properly executed, and obtain any required information or documentation from the parties. The title company also acts as the disbursing agent for the seller and buyer. At closing, the title company will collect the purchase proceeds from the buyer and its lender (if any) and disburse the funds as set forth in the final settlement statement. After the closing has occurred, the title company will issue an owners’ policy (and loan policy if applicable) in addition to sending certain documents of record, such as the deed and mortgage, to be recorded in the County Recorder of Deeds Office where the real estate is situated.

In sum, it is advantageous to know the parties and possess a knowledge of established procedures for purposes of effectively navigating the real estate closing process. The foregoing is especially important if the transaction qualifies for a tax deferred exchange under Section 1031.

section 1031

What Happens if a 1031 Exchange Spans Two Tax Years?

What Happens if a 1031 Exchange Spans Two Tax Years?

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What Happens if a 1031 Exchange Spans Two Tax Years?

Realize Full Exchange Timeline by Filing for an Extension on Taxes

Convert Failed 1031 Exchange to Installment Sale

Implications of a Partial Exchange

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The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

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The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?

Can a Taxpayer Change the Ownership but Maintain the Tax Identity?

Holding Title in the Taxpayer’s Own Name

Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC

Holding Title under a Delaware Statutory Trust

Holding Title as Beneficiary of an Illinois Type Land Trust

The Same Taxpayer Rule and Spouses

Spouses in Community Property States

Death of a Taxpayer during a 1031 Exchange

Summary

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1031 Drop and Swap out of a Partnership or LLC

1031 Drop and Swap out of a Partnership or LLC

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1031 Drop and Swap out of a Partnership or LLC

Can a partner or member trade their share of a property interest upon sale?

How is a 1031 drop and swap done?

Meeting the “Held For” Requirement in a Drop and Swap

IRS Form 1065 U.S. Return of Partnership Income

Underlying Loan Considerations

Deemed Partnership

Summary

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#Revolutionize1031 at FEA 2021

#Revolutionize1031 at FEA 2021

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#Revolutionize1031 at FEA 2021

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1031 Exchange Timeline Overview and Considerations

1031 Exchange Timeline Overview and Considerations

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1031 Exchange Timeline Overview and Considerations

Forward Exchange

Reverse Exchange

Build-to-Suit or Improvement Exchange

1031 Exchange Timeline Considerations

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Exchanging Equal or up in Value

Exchanging Equal or up in Value

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Exchanging Equal or up in Value

Identification Rules: The 3-Property Rule

Identification Rules: The 200% Rule

Identification Rules: The 95% Rule

Conclusion

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Preserve Your Agricultural Assets with 1031 Exchange

Preserve Your Agricultural Assets with 1031 Exchange

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Preserve Your Agricultural Assets with 1031 Exchange

What can Agricultural Property Owners Exchange with 1031?

Time is of the essence when it comes to Selling and Obtaining Real Property

Why am I doing a 1031 tax deferred exchange?

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Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

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Stop the Rhetoric - Understanding the Social Impact of 1031 Exchanges on America

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The Myth of the 1031 Exchange Cooperation Clause

The Myth of the 1031 Exchange Cooperation Clause

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The Myth of the 1031 Exchange Cooperation Clause

The Starker case

Identification and purchase period to qualify for 1031 exchange

What is an Exchange Cooperation Clause?

Where does the Qualified Intermediary come in?