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).
+ 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
Boot: Any non like-kind property received by Exchangor during the exchange.
Build To Suit Exchange: A 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 deferral. Bloomington 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.
Capitalization Rate: A rate of return used to produce the capital value of an income stream.
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.
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: A 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.
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.
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, artwork, farm equipment, breeding stock, aircrafts,telecommunications equipment, heavy 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: A 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 Exchange: A 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.
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: A 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
- 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.
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.