Description
1031 Exchange
- Why Exchange?
- Exchange Timelines & Rules
- Types of Exchanges
- 1031 Exchange Recent Developments
- The Role of the Qualified Intermediary
Like —-Kind Exchanges — The Basics
- Tax Code
- Property Qualifications
- Rules
1031 Exchange — Tax Code
- No gain or loss shall be recognized on theexchange of property held for productive
use in atrade or business or for investment if such property is exchanged solely for
property of like-kind, which is to be held for productive use in a trade or business or forinvestment.
OR in Layman’s terms:
- A Section 1031 Exchange allows an owner of investment property to exchange
property and defer paying federal capital gains tax, depreciation recapture tax and
state income taxes if they purchase “like-kind” property following rules and regulations
of the IRC.
Why Exchange?
Tax Deferral
- 20% Federal Capital Gain Tax for assets held >1 year
- 25% Federal Depreciation Recapture Tax
- State Income Taxes (if applicable)
- 3.8% Medicare Tax on net investment income
- Other Advantages of Exchanging
- Diversification
- Consolidation
- Greater cash flow
- Estate planning
QUALIFYING PROPERTIES
- Property held for investment, income, or a trade or business, and not primarily for Sale:
- Rentals homes/condos/coops
- Raw land
- Retail
- Industrial/Warehouse
- Office
- Agricultural
- 30 Year Leases
- Easements
- NNN & DST’s
- Properties that DO Qualify
- Properties that DO NOT Qualify
- Stock in trade or other property held primarily for sale
- Stocks, bonds, notes
- Other securities or evidences of indebtedness or interest
- Certificates of trust or beneficial interests
- Choses in action
- Partnership Interests
- Primary Residence
Qualifying for a 1031 Exchange
Qualifying Properties
Exchanges that NEVER Qualify
- Real property for personal property
- Livestock of different sex
- Real property in the US for foreign real property and vice-versa
Personal Property Exchanges
- Collectibles — IRC 408(m)(2) lists: artwork, rugs, antiques, metals, gems, stamps, coins
- Taxed at a maximum rate of 28% IRC 1(h)(5)
- Can you meet the Qualified Use Test?
- TP has burden of proof that investment intent outweighed personal enjoyment
- Artwork: PLR 8127089— context of 1033
Calculating Gain
Facts:
$1,000,000 purchase price
$100,000 depreciation
$50,000 capital improvements
$2,000,000 sales price
Adjusted Basis
Purchase Price $1,000,000
(Depreciation) $100,000
+Capital Improvements $ 50,000
Adjusted Basis $950,000
1031 Exchange Rules
NAPKIN RULE
- All cash proceeds from the sale of the Relinquished Property must be reinvested in the Replacement Property (or pay tax on the difference)
- The purchase price of the Replacement Property must be at least as much as the sales price of the Relinquished Property (or pay tax on the difference)
- The purchaser of the Replacement Property must be the same as the seller of the Relinquished Property, or be a “Disregarded Entity”
- For safe harbor protection, exchange funds should be held by a Qualified Intermediary
1031 Exchange Time Periods
The 1031 Exchange time frame begins the day after escrow closes on the relinquished
property.
From this point, the 180 day count down begins.
1031 Exchange —Identification Rules
- Property Rule Without regard to FMV
- 200% Rule Aggregate FMV not to exceed 200% of RP
- 95% Rule
- Acquire 95% of FMV of identified property
Identification Rules – continued
Replacement Property must be designated as such in written document signed by
taxpayer and hand delivered, mailed, telecopied, or otherwise sent before the end of
the identification period to either:
(1) person obligated to transfer Replacement Property to the taxpayer regardless of
whether that person is disqualified; or
(2) any other person involved in theexchange other than the taxpayer or disqualified
person
Negligence penalty and/or fraud penalty under IRC 6663; criminal charges for delivery
of false documents (backdated letter)
Release of exchange funds – (6) limits rights to receive, pledge, borrow or otherwise
obtain benefits of money orother property before end of the exchange period
Types of Exchanges
- Construction Exchanges
- Reverse Exchanges
- Related Parties
- Vacation Homes
- Split Treatment Exchanges
- DSTs
Securitized Replacement Property Strategy
Interests in entity owning one ormore properties offered to multiple investors in an
offering of securities
TICS —Rev Proc 2002-22 sets guidelines
Lender underwrites each owner of TIC interest
Investor must sign carve-out guarantees
SMLLC
No more than 35 investors
Unanimous consent of investors for major decisions
DST’s- Rev Proc 2004-86 sets guidelines
Rights and obligations governed by DST’s trust agreement
Limited voting rights over ownership and operation
Lender makes 1 loan to borrower
Trust agreement prevents creditors of Exchangor from reaching DST property — therefore making it bankruptcy remote
DST shields Exchangor from liability with respect to the property
Up to 2,000 investors
DST’s continued
Exchangor has no operational control over management of DST or its property
Therefore lender has no need to perform due diligence on Exchangor
Not required to sign any indemnification orguarantees
DST’s continued
“7 Deadly Sins” – Prohibitions on the power of the trustee as described in 2004-86
No capital contributions may be made by new or existing beneficiaries after the offering is fully subscribed
DST cannot renegotiate its existing mortgage debt or enter into new or replacement mortgage debt unless a property tenant is bankrupt or insolvent
DST cannot renegotiate its existing leases or enter into new leases or lease extensions unless a property tenant is bankrupt or insolvent
Trustee cannot reinvest proceeds of thesale of its real estate
Capital expenditures can only be made for normal repair and maintenance or
improvements as required by law
Any cash held between distributions may only be invested in short term debt
obligations
All cash, other than reserves, must be distributed on a current basis
1031 Mixing Pot of Issues
Rev. Proc. 2013-17: same sex married persons are now “spouses” for Federal tax
purposes
California Reporting: Rev & Tax code 18032 & 24953 effective 1/1/14, if CA RQ exchanged for out of state RP, TP must file annual reporting form with FTB
Seller Financing
Closing Costs
Qualified Intermediary Role – Initiating an Exchange
Security
“Security should be a client’s most important concern. Select a Qualified Intermediary
that can be trusted with client funds
Service
Clients need to work closely with theQI. Make sure they provide top customer service
Experience
A client depends on the QI to properly document and facilitate the 1031 Exchange
Price
Be sure to look at the amount of the exchange fee, including all hidden costs
