Tax Terms

1031 Exchange Requirements: A 1031 tax-deferred exchange is an approved technique for selling property that has been used for investment or use in a trade or business, and purchasing another like-kind property of greater or equal value without having to pay capital gains taxes. Section 1031 of the Internal Revenue Code states that no gain or loss shall be recognized on the exchange of property that is held for productive use in a trade or business, or for investment purposes (i.e. qualified purpose) if it is exchanged for like kind property that is also held for productive use in a trade or business, or for investment purposes (i.e. qualified purpose).

3 Property Rule: 1031 Exchangor may identify three or fewer replacement properties.  The most common identification rule utilized.
200% Rule: 1031 Exchangor may identify any number of replacements; however, the total value of those properties identified may not exceed 200% of the value of Exchangor’s relinquished property.
95% Rule: 1031 Exchangor may identify any number of replacements as long as Exchangor receives at least 95% of the value of all properties identified.  Note: This rule is not used very often.
14 Day Rental Rule: the IRS rule for determining whether a vacation home is a personal residence or a rental property for allocating deductible expenses.
Abatements: Abatements reduce the amount of tax by providing a reduction. The City has several abatement programs: the J-51 housing rehabilitation, the Senior Citizen Rent Increase Exemption, the Lower Manhattan Revitalization and the Cooperative and Condominium abatement. (See also exemptions)
Active Participation: For tax purposes, minimum 10% ownership of a rental property and management level decision making.
Actual Assessed Value: The assessment established for all tax classes without regard to the five year phase-in requirements.
Adjusted Basis: Adjusted Basis is the net cost of an asset after adjusting for various tax-related items. Adjusted basis is calculated by adding up an asset’s original cost basis, and then making adjustments for additional expenditures for improvements and certain reductions for depreciation and losses.Adjusted basis is calculated as follows:

Cost Basis+ Purchase costs (title & escrow fees, broker commissions, shipping, sales tax, etc.)

+ Improvements (rehabilitation expenses & substantial repairs)

+ Legal fees (to defend or to perfect title to the property, zoning costs, etc.)

+ Selling costs (title & escrow fees, broker commissions, shipping, transfer fees, etc.)

– Accumulated depreciation, depletion, or amortization

– Casualty or theft Loss

– Other decreases to basis

= Adjusted Basis

Ad Valorem: According to value.
Assessed Value: The property value given for tax purposes. Finance determines a property’s  assessed value by multiplying its estimated full market value by the assessment ratio for the property’s tax class. In New York City, property may have three assessed values – actual assessed value, transitional assessed value, and billable assessed value.
Assessment Ratio: The ratio of assessment value to market value. The assessment ratio is also called the uniform percentage of value and the assessment rate. The assessment ratio for Class 1 is 6 percent and for the other tax classes, the assessment ratio is 45 percent.
Assessment Roll: A list of the assessed value of all properties in a jurisdiction. The tentative and final assessments for every property in the City of New York are published by Finance in January and May. The tentative roll lists the same estimated market value, assessed value, and exemption information contained in the annual Notice of Property Value.
Basis: The value of taxpayer’s investment in property.
Billable Assessed Value: The assessed value on which the tax liability for all classes is based. The billable assessed value for Class 2 or 4 properties is the lower of the actual or transitional assessed value.

Boot: Any non like-kind property received by Exchangor during the exchange.

Build To Suit Exchange: Build to Suit Exchange (construction improvement exchange) is when the Exchangor wants to construct improvements on the replacement property before the title to the property is transferred to them. The general rule is that you can not construct improvements on property that you already own. Once the Exchangor has title to the replacement property, additional improvements or materials delivered but not constructed are ineligible for 1031 tax deferralBloomington Coca-Cola Bottling Co. v. Commissioner, 189 F.2d 14 [40 AFTR 648] (7th Cir. 1951) Often the Exchangor will want to make improvements so that they receive finished property that is of equal or higher value than the relinquished property.

Capital Asset: Any asset held by a taxpayer (regardless of its business use) except certain property excluded under IRC Section 1221.  Capital Asset is often held for long-term period and are often tangible property which cannot easily be converted into cash and which is usually held for a long period, including real estate, buildings, machinery, fixtures, furniture and equipment.
Capital Gain: Calculation of the difference between the sales price of the Relinquished Property less selling expenses and less the adjusted basis of the Relinquished Property.
Capital Gains Tax: Tax imposed is a gain from the sale or disposition of a capital asset. The tax is collected on the gain made selling  (personal property, real property, shares of stock, etc). Capital gains are typically taxed at a lower rate than other income.
Capitalization: The process by which anticipated future income and benefits are converted to a present value.

Capitalization Rate:
A rate of return used to produce the capital value of an income stream.
Carryover Basis: The basis of property transferred by gift (§1012, §102 or §1041) or in trust, equaling the transferor’s basis.
Cash Boot: Any cash, note or seller carry back received (or not reinvested) by Exchangor during an exchange period
Chattel: Personal property (in contrast to real property) – including tangible movable property (telecommunications equipment, aircraft, trucks, drilling rigs, artwork or farm animals or a heavy equipment etc). Real property is typically fixed to the earth while personal property is moveable.

Chose in Action: An intangible claim or right to sue at law. An ownership interest in or right in intangible property which is not in one’s possession, but which is enforceable through legal process. A personal right of property which can only be claimed or enforced in a court of law, as distinguished from one which is enforceable by the taking of physical possession. Example: A claimant�s right of action in breach of contract proceeding.

Comparable Sales Method: The process of estimating a property’s market value based on the sales prices of similar properties. The Method is also known as market approach.

Constructive Receipt: Violation of the G(6) limitation wherein the Exchanger obtains direct or indirect control over the exchange proceeds through an agent or employer or other person during the exchange period.

Cooperation Clause: A Cooperation Clause is a provision in a purchase agreement that states that either the buyer or seller wants to conduct a 1031 exchange and reserves the right to assign it’s interest in the purchase agreement to a qualified intermediary. A Cooperation Clausealso typically elicits the other parties (buyer or seller) to assist in signing 1031 documents. If your purchase agreement does not include this Cooperation Clause, the contract can be amended at closing, provided the other parties (buyer or seller) does not object.

Cost Basis: Taxpayer’s cost of acquiring the property. (§1012) Everything you give to get it.

Deferred Exchange:Deferred Exchange is typically what people mean when referring to a 1031 exchange, Starker exchange, like-kind exchange, etc. This is A 1031 exchange conducted under the safe harbor 1994 Treasury Regulations wherein the Replacement Property is received up to 180 days after the disposition of the Relinquished Property.

Depreciation Deductions: The tax deduction for writing off the cost of theoretical wear and tear of your property and business-assets over an IRS-specified number of years. Residential rental property is typically depreciated over 27.5 years whereas commercial real estate is typically depreciated over 39 years.

Depreciation Recapture: This is really just capital gains tax applied at a higher rate (maximum 25%) rather than normal appreciation gains (maximum 15%). The federal capital gain rate is currently capped at 15%, the federal depreciation recapture rate is capped at 25%.

Disqualified Person: Section 1.1031(k)-1(k) defines a disqualified person to include an agent of the taxpayer at the time of the transaction. An agent includes a person that has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within two years of the taxpayer’s transfer of relinquished property.

However, in determining whether a person is a disqualified person, services provided by such person for the taxpayer with respect to section 1031 exchanges of property and routine financial, title insurance, escrow, or trust services provided to the taxpayer by a financial institution, title insurance company, or escrow company are not taken into account. Under §1.1031(k)-1(k)(4), a person that is related to a disqualified person, determined by using the attribution rules of sections 267(b) and 707(b), but substituting 10 percent for 50 percent, is also considered a disqualified person.

Direct Deeding: At the direction of the Qualified Intermediary, title passes directly to the ultimate owners without the Qualified Intermediary being in the actual chain of title.

Exchange Accommodation Title Holder: Also referred to as an “EAT”, is typically a special purpose, limited-liability company that is used to own the legal title to property that is being parked as part of a reverse exchange. An exchange accommodation title holder may not be a person who a disqualified person.

Exchange Fees:
To set up an exchange it is usually necessary to hire a Qualified Intermediary. However, the cost of conducting the exchange can be collected on the closing statement – so that the fee is actually paid for with the proceeds of the relinquished property.Exchange fees include preparation of the exchange-documentation, coordination, and communication with the title-company/law-firm that is closing the transaction. The fees for your exchange will range in cost depending on the size and complexity of your transaction.Read More

Exchange Period: Interim time between the disposition of the relinquished property and the earlier of the following:

(i) acquisition of all replacement properties by the Exchangor;

(ii) after the 45 day identification period if an identification has not been made or any identified properties have been previously received by Exchangor or revoked as identified properties;

(iii) after the 180th day following the disposition of the relinquished property;

(iv) after the Exchangors deadline for filing its federal income tax return for the year in which the Relinquished Property was disposed in (including extensions).

Note: The exchange period includes all weekends and holidays. There are no extensions if the exchange period ends on Saturdays, Sundays, or holidays.

Exchangor (Taxpayer): Person intending to conduct a 1031 tax deferred exchange, who transfers a Relinquished Property and thereafter receives a Replacement Property.

Exemptions: Exemptions provide tax relief by reducing a property’s taxable assessed value, that is, the base amount to which the tax rate is applied. A property may be fully or partially exempt. (Also see Abatements)
Exempt Value: The amount or percentage of assessed value that is not subject to tax.
FIRPTA: FIRPTA was enacted in 1981, its goal was to assure that appropriate taxes were paid when a non-US person sold US real property. The FIRPTA requirements apply to both residential and commercial/investment property. The general rules require buyers to withhold 10% of the proceeds when there is a non-US seller unless certain exceptions apply.
G(6) Limitation: Section 1.1031(k)-1(g)(6) provides that an agreement with an escrow holder, trustee or qualified intermediary must expressly limit the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property held in the qualified escrow or trust or by the qualified intermediary.
General Asset Class Property: Refers to property described in classes set out in Revenue Procedure 87-56 for depreciable tangible personal property.
Fair Market Value: Reasonable amount for which a property can be sold to a willing buyer
Fiscal Year: A 12-month period used for financial reporting. The City’s fiscal year runs from July 1 to June 30.
Identification: Section 1031(a)(3) and Section 1.1031(k)-1(c) provides that a written unambiguous description of the intended replacement property or properties, signed by the Exchangor must be  sent to the qualified intermediary or other person who is a party to the exchange and who is not a disqualified person.
Identification Period: Any Replacements received within the 45 day Identification period are deemed to have been identified.  Replacements received after the 45th day must have been properly identified in writing during the 45 day Identification period. This period runs from the day after the close of the Relinquished Property to the 45th day thereafter.
Income Capitalization Approach: A method of valuing property by leaving out the net operating income to arrive at a present worth estimate.
Investment Property: property not occupied by the owner and purchased for the purpose of generating profit through rental income and/or value appreciation.
Like-kind Property: Exchange must be of “like” property (i.e U.S. real property for U.S. real property OR i.e. light-duty truck for a light-duty truck). Like-kind property is determined by the nature of the property the Exchangor relinquishes and receives in the exchange.
Market Value: The likely price a property should command in a competitive and open market.
Material Participation: Substantive involvement in operations on a regular and continuous basis. Work done only as an investor  is generally not considered material participation.
Mortgage boot: Results when an Exchangor is discharged of a debt obligation with the transfer of the relinquished property and this debt is not offset by either: (i) new debt (assumed or purchase money) of equal or greater amount incurred in conjunction with the closing of the replacement property; (ii) additional cash contributed for the acquisition of the Replacement Property equal to the amount of Exchangor’s debt relief.
Non-Qualifying Property: Property excluded from exchange treatment under IRC §1031(a)(2), such as inventory or property held primarily for sale; beneficial interests in or an ownership in a trust; interests in a partnership; and securities or evidences of indebtedness

Notice of Property Value:
The annual notice mailed to New York City property owners in January that shows how their property’s market value is estimated.  It also shows any exemptions that have been granted for the upcoming tax year.
Operating Expenses: Includes all expenses necessary to maintain a property and/or its income excluding debt service. Property taxes are omitted for assessment purposes.
Partial Tax Exchange: An exchange in which the Exchangor receives some like-kind property and recognizes some gain due to: (i) failure to receive adequately valued Replacement Property; (ii) mortgage boot; or cash boot.
Passive Activity: for tax purposes an activity in which the tax payer does not materially participate; income for passive activity is deemed passive income.
Personal Property: All things other than real estate which have value such as cars, trucks, motorcycles, campers, motor homes, marine equipment, aircraft, and items used in a business such as furniture, fixtures and equipment are taxed yearly. These taxes are based on ownership December 31st of the previous year.

Personal Property Exchange: A transfer of personal property (or “chattel” as apposed to real-property) as part of a tax-deferred exchange transaction involving personal property held for trade, business, or investment. This type of exchange can be used to dispose of older property such as; collector cars, artworkfarm equipmentbreeding stockaircrafts,telecommunications equipmentheavy equipment, etc. – and replace it with newer like-kind equipment.

Product Class Property: This refers to property set out in the North American Product Classification System (NAPCS) manual in sectors 31, 32 and 33 relating to manufacturing industries.

Qualified Intermediary:Qualified Intermediary (or Q.I.) is person acting to facilitate an exchange under section 1031 and the regulations. This person may not be the taxpayer or a disqualified person.  Section 1.1031(k)-1(g)(4)(iii) requires that, for an intermediary to be a qualified intermediary, the intermediary must enter into a written “exchange” agreement with the taxpayer and, as required by the exchange agreement, acquire the relinquished property from the taxpayer, transfer the relinquished property, acquire the replacement property, and transfer the replacement property to the taxpayer.

Qualified 1031 Property: Both the Relinquished Property and the Replacement Property must be held by an Exchangor for a “productive use in Trade or Business or for Investment purposes”.

Real Estate Professional: (IRS definition) individuals who spend more than 50% of their time in real estate and materially participate in real estate business more than 750 hours per year.

Realization: The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

Real Property : All land and the buildings, structures or improvements on that land and mobile homes are billed as real property. The Auditor does not appraise real property. Real property is taxed each year based on ownership December 31st of the previous year.

Real Property Exchange: real estate exchange (as opposed to chattel or personal property) as part of a tax-deferred exchange transaction involving real estate held for trade, business, or investment. Real Property 1031 Exchanges may involve transfers of land buildings and structures including but not limited to: Office Buildings, Industrial Warehouses, Retail Stores, Multi-family Apartment Buildings, Farms, Raw Undeveloped Land, Factories, Shopping Centers, Leasehold interest of 30 years including options to renew, and certain Tenant in Common Investments.

Recapture Tax: Rather then tax your entire recognized gain at the current 15% rate for long-term capital gains, the taxman figures that depreciation (cost recovery) has already given you tax relief during the holding period of the asset and therefore should be taxed at the higher cost recovery recapture rate of 25%. Consequently, thanks to the recapture tax, you pay more taxes when you dispose of your income property

Received: Typically when title is transferred and the benefits and burdens of ownership are shifted. For example, when the risk of loss (if the property is damaged) is shifted to the new-owner. Another example would be when the obligation to pay property taxes is shifted to new buyer. A final exampled would be when a new buyer is entitled to possession of the property.

NOTE: Generally, just signing a standard purchase-agreement to acquire your replacement property, will NOT be adequate to complete your 1031 exchange because the benefits and burdens of ownership have not sufficiently shifted.

Relinquished Property: Property or properties given up or conveyed by Exchangor as part of a 1031 exchange.

Replacement Property: Property or properties properly received by Exchangor as part of a 1031 exchange.

Replacement Cost: The cost to construct, at current prices, an improvement equivalent in utility to an existing structure, using modern building materials and according to current standards and building requirements.
Reproduction Cost: The cost to replicate an existing structure, using the same materials, standards, quality, design, etc. as the original structure.

Recognition of Gain: Unless there is an exception in the code such as section 1031, the entire amount of the a realized gain or loss, on the sale or exchange of property must be recognized.

Reverse Exchange:Reverse Exchange is typically conducted under the safe harbor established in Rev Proc 2000-37.  These are “parking arrangement” where either:

(i) a property is purchased and “parked” as a potential replacement property for the benefit of a specific Taxpayer by an exchange accommodation title holder until such time as the taxpayer arranges for the transfer of the relinquished property to the ultimate transferee in a simultaneous or deferred exchange; or

(ii) a taxpayer transfers the relinquished property to be “parked” by an exchange accommodation title holder in exchange for immediately receiving the replacement property, and the exchange accommodation title holder later transfers the relinquished property to the ultimate transferee

Simultaneous Exchange: A concurrent exchange wherein the Exchangor disposes of the Relinquished Property and immediately receives the Replacement Property. Often conducted as a direct swap between two parties exchanging similar properties.
Stepped-Up Basis: The basis of property transferred by inheritance (§1014) wherein the basis equals the fair market value of property on the date of the decedent’s death (or on the alternate valuation date).
Stepped-Down Basis: The basis of property transferred by Gift (§102) wherein the basis equals the fair market value of property on the date transfer from Donor because the FMV of the gifted property has decrease below the Donor’s basis
Substituted Basis: The basis of property transferred in a tax-free exchanges (1031). The FMV of the new replacement property LESS the amount gain that was deferred.
Tax Class: Four groupings (Classes 1, 2, 3, and 4), to which every property in the City is assigned, based on the use and size of the property.
  • Class 1: Includes most residential property of up to three units (family homes and  small stores or offices with one or two apartments attached), vacant land zoned for residential use in boroughs other than Manhattan, and most condominiums that are not more than three stories.
  • Class 2: Includes all other property that is primarily residential, such as cooperatives and condominiums.
  • Class 3: Includes property with equipment owned by a gas, telephone or electric company.
  • Class 4: Includes all commercial and industrial property, such as office, factory buildings and vacant land other than in Tax Class 1.
Tax Rate: The amount, usually expressed in dollars per hundred of assessed value, applied to the tax base to determine tax liability. In New York City, the City Council and Mayor set an annual tax rate for each tax class.
Taxable Assessed Value: This is the assessed value minus any exemptions and limitations.
Taxable Status Date: The date the assessed value, taxable status and, if applicable, tax class are fixed for all properties in a taxing jurisdiction.

Tenancy/Tennant In Common:
(TIC) A fractional or partial ownership interest in a parcel of property, rather than owning the entire piece of property. Typically this is an undivided interest that has not be physically partitioned or separated apart from the interests of the other co-owners.
Transitional Value: Represents the assessed value of a property during the five year phase-in of equalization changes. Applicable to all Class 4 properties and Class 2 cooperatives, condominiums and rental buildings with more than 10 units. Increases in market value for Class 4 properties must be phased in over a period of five years because State law limits assessment increases other than those based on physical changes to the property. For example, on residential properties with ten or fewer units, assessments may not increase more than 6 percent over one year and 20 percent over five years. If market value rises quickly, it must be phased in, and the assessment for a particular year may not accurately reflect true market value for that year. For this reason, during the years when true value is being phased-in, the assessment is based on “transitional value.”
Vacation Home : The U.S. Census Bureau defines a second home or vacation home as a seasonal, recreational, and occasional use property.