1031 Exchange
*The information below is not
guaranteed/implied to be accurate. Always consult with your accountant, lawyer,
bookkeeper or 1031 exchange expert

Introduction To 1031 Exchanges
A 1031 Exchange (Tax-Deferred Exchange) Is One Of The Most
Powerful Tax Deferral Strategies Remaining Available For Taxpayers. Anyone
involved with advising or counseling real estate investors should know about
tax-deferred exchanges, including Realtors, lawyers, accountants, financial
planners, tax advisors, escrow and closing agents, and lenders. Taxpayers should
never have to pay income taxes on the sale of property if they intend to
reinvest the proceeds in similar or like-kind property.The Advantage
of a 1031 Exchange is the ability of a taxpayer to sell income, investment
or business property and replace with like-kind replacement property
without having to pay federal income taxes on the transaction. A sale of
property and subsequent purchase of a replacement property doesn't work, there
must be an Exchange. Section 1031 of the Internal Revenue Code is the
basis for tax-deferred exchanges. The IRS issued "safe-harbor" Regulations in
1991 which established approved procedures for exchanges under Code Section
1031. Prior to the issuance of these Regulations, exchanges were subject to
challenge under examination on a variety of issues. Since issuance of the 1991
Regulations, tax-deferred exchanges are easier, less expensive and safer than
ever before.
The Disadvantages of a Section 1031 Exchange include
a reduced basis for depreciation in the replacement property. The tax basis
of replacement property is essentially the purchase price of the replacement
property minus the gain which was deferred on the sale of the exchange property
as a result of the exchange.
Exchange Techniques. There is more than one way to
structure a tax-deferred exchange" under Section 1031 of the Internal Revenue
Code. However, the 1991 Regulations established safe harbor procedures which
include the use of an Intermediary, direct deeding, the use of qualified escrow
accounts for temporary holding of "exchange funds" and other procedures which
now have the official blessing of the IRS. Therefore, it is desirable to
structure exchanges so that they can be in harmony with the 1991 Regulations. As
a result, exchanges commonly employ the services of an Intermediary with direct
deeding.
Exchanges can also occur without the services of an
Intermediary when parties to an exchange are willing to exchange deeds or if
they are willing to enter into an Exchange Agreement with each other. However,
two-party exchanges are rare since in the typical Section 1031 transaction, the
seller of the replacement property is not the buyer of the taxpayer's exchange
property.

The Basic Rules For A 1031 Exchange
The Exchange Property Must Be Qualifying Property.
Qualifying property is property (or equipment) held for investment purposes
or used in a taxpayer's trade or business. Investment property includes real
estate, improved or unimproved, held for investment or income producing
purposes. Property used in a taxpayer's trade or business includes his office
facilities or place of doing business, as well as equipment used in his trade or
business.
Property Which Does Not Qualify For A 1031 Exchange includes ?

A personal residence
Land under development
Construction or fix/flips for resale
Property purchased for resale
Inventory property

Corporation common stock
Bonds
Notes
Partnership interests
 

As explained below, common stock may (or may not) include ditch stock which
is sold with farm land.
Replacement Property Title Must Be Taken In The Same Names As
The Exchange Property Was Titled.
The Replacement Property Must Be Like-Kind. For real estate
exchanges, like-kind replacement property means any improved or unimproved real
estate held for income, investment or business use. Improved real estate can be
replaced with unimproved real estate. Unimproved real estate can be replaced
with improved real estate. A 100% interest can be exchanged for an undivided
percentage interest with multiple owners and vice-versa. One property can be
exchanged for two or more properties. Two or more properties can be exchanged
for one replacement property. A duplex can be exchanged for a four-plex.
Investment property can be exchanged for business property and vice versa.
However, as referenced above, a taxpayer's personal residence cannot be
exchanged for income property, and income or investment property cannot be
exchanged for a personal residence, which the taxpayer will reside in.
Any Boot Received In Addition To Like Kind Replacement Property
Will Be Taxable (to the extent of gain realized on the exchange). This is
okay when a seller desires some cash or debt reduction and is willing to pay
some taxes. Otherwise, boot should be avoided in order for a 1031 Exchange to be
completely tax-free.
The term "boot" is not used in the Internal Revenue Code or the
Regulations, but is commonly used in discussing the tax consequences of a
Section 1031 tax-deferred exchange. Boot received is the money or the fair
market value of "other property" received by the taxpayer in an exchange. Money
includes all cash equivalents plus liabilities of the taxpayer assumed by the
other party, or liabilities to which the property exchanged by the taxpayer is
subject. "Other property" is property that is non-like-kind, such as personal
property received in an exchange of real property, property used for personal
purposes, or "non-qualified property." "Other property" also includes such
things as a promissory note received from a buyer (Seller Financing).
A Rule Of Thumb for avoiding "boot" is to always replace with
property of equal or greater value than the Exchange Property. Never "trade
down." Trading down always results in boot received, either cash, debt reduction
or both. Boot received is mitigated by exchange expenses paid. See The Rules
Of Boot In A Section 1031 Exchange for a detailed explanation of these
rules.
 

The Basic Types Of Exchanges
A Simultaneous Exchangeis an exchange in which the closing
of the Exchange Property and the Replacement Property occur on the same day,
usually back - to - back. There is no interval of time between the two closings.
This type of exchange is covered by the Safe Harbor Regulations.
A Delayed Exchange is an exchange where the Replacement
Property is closed on at a later date than the closing of the Exchange Property.
The exchange is not simultaneous or on the same day. This type of exchange is
sometimes referred to as a "Starker Exchange" after the well known Supreme Court
case in which ruled in the taxpayer's favor for a delayed exchange before the
Internal Revenue Code provided for such exchanges. There are strict time frames
established by the Code and Regulations for completion of a delayed exchange,
namely the 45-Day Clock and the 180-Day Clock (see detailed explanation below).
Delayed exchanges are covered by the Safe Harbor Regulations.
A Reverse Exchange(Title-Holding Exchange) is an exchange
in which the Replacement Property is purchased and closed on before the Exchange
Property is sold. Usually the Intermediary takes title to the Replacement
Property and holds title until the taxpayer can find a buyer for his Exchange
Property and close on the sale under an Exchange Agreement with the
Intermediary. Subsequent to the closing of the Exchange Property (or
simultaneous with this closing), the Intermediary conveys title to the
Replacement Property to the taxpayer. The IRS has issued new safe-harbor
guidance on Reverse Exchanges.
An Improvement Exchange (Title-Holding Exchange) is an
exchange in which a taxpayer desires to acquire a property and arrange for
construction of improvements on the property before it is received as
Replacement Property. The improvements are usually a building on an unimproved
lot, but also include enhancements made to an already improved property in order
to create adequate value to close on the Exchange with no boot occurring. The
Code and Regulations do not permit a taxpayer to construct improvements on a
property as part of a 1031 Exchange after he has taken title to property as
Replacement Property in an exchange. Therefore, it is necessary for the
Intermediary to close on, take title and hold title to the property until the
improvements are constructed and then convey title to the improved property to
the taxpayer as Replacement Property. Improvement Exchanges are done in the
context of both Delayed Exchanges and Reverse Exchanges, depending on the
circumstances. The IRS has issued new safe-harbor guidance on Reverse Exchanges
(including title-holding exchanges for construction or
improvement)

Delayed Exchanges - The Exchange Process And Time Clocks

A taxpayer desiring to do a 1031 Exchange lists and/or markets
his property for sale in the normal manner without regard to the contemplated
1031 Exchange. A buyer is found and a contract to sell the property is executed.
Accommodation language is usually placed in the contract securing the
cooperation of the buyer to the seller's intended 1031 Exchange, but such
accommodation language is not mandatory.
When contingencies are satisfied and the contract is scheduled
for a closing, the services of an Intermediary are arranged for. The taxpayer
enters into an Exchange Agreement with the Intermediary which permits the
Intermediary to become the "substitute seller" in accordance with the
requirements of the Code and Regulations.
The Exchange Agreement usually provides for:
·An assignment of the seller's Contract to Buy and Sell Real Estate to the
Intermediary.
·A closing where the Intermediary receives the proceeds due the seller at
closing.
·Direct deeding is used. The Exchange Agreement will comply
with the requirements of the Code and Regulations wherein the taxpayer can have
no rights to the funds being held by the Intermediary until the exchange is
completed or the Exchange Agreements terminates. The taxpayer "cannot touch" the
funds.
·An interval of time where the seller proceeds to locate
suitable replacement property and enter into a contract to purchase the
property. The interval of time is subject to the 45-Day and 180-Day rules.
·An assignment of the contract to purchase replacement property to the
Intermediary.
·A closing where the Intermediary uses the exchange funds in his possession
and direct deeding to acquire the replacement property for the seller.
The 45-Day Rule for Identification. The first timing
restriction for a delayed Section 1031 exchange is for the taxpayer to either
close on Replacement Property or to identify the potential Replacement Property
within 45 days from the date of transfer of the exchanged property. The 45-Day
Rule is satisfied if replacement property is received before 45 days has
expired. Otherwise, the identification must be by written document (the
identification notice) signed by the taxpayer and hand-delivered, mailed, faxed,
or otherwise sent to the Intermediary. The identification notice must contain an
unambiguous description of the replacement property. This includes, in the case
of real property, the legal description, street address or a distinguishable
name.
After 45 days, limitations are imposed on the number of
potential Replacement Properties which can be received as Replacement
Properties. More than one potential replacement property can be identified under
one of the following three conditions:
The Three-Property Rule - Any three properties regardless of their
market values.
The 200% Rule - Any number of properties as long as
the aggregate fair market value of the replacement properties does not exceed
200% of the aggregate FMV of all of the exchanged properties as of the initial
transfer date.
The 95% Rule - Any number of replacement properties
if the fair market value of the properties actually received by the end of the
exchange period is at least 95% of the aggregate FMV of all the potential
replacement properties identified.
Although the Regulations only require written notification
within 45 days, it is recommended practice for a solid contract to be in place
by the end of the 45-day period. Otherwise, a taxpayer may find himself unable
to close on any of the properties which are identified under the 45-day letter.
After 45 days have expired, it is not possible to close on any other property
which was not identified in the 45-day letter. Failure to submit the 45-Day
Letter causes the Exchange Agreement to terminate and the Intermediary will
disburse all unused funds in his possession to the taxpayer.
The 180-Day Rule for Receipt of Replacement Property. The
replacement property must be received and Exchange completed no later than the
earlier of 180 days after the transfer of the exchanged property or the due date
(with extensions) of the income tax return for the tax year in which the
exchanged property was transferred. The replacement property received must be
substantially the same as the property which was identified under the 45-day
rule described above. There is no provision for extension of the 180 days for
any circumstance or hardship.
As noted above, the 180-Day Rule is shortened to the due date
of a tax return if the tax return is not put on extension. For instance, if an
Exchange commences late in the tax year, the 180 days can be later than the
April 15 filing date of the return. If the Exchange is not complete by the time
for filing the return, the return must be put on extension. Failure to put the
return on extension can cause the replacement period for the Exchange to end on
the due date of the return. This can be a trap for the unwary.
Reverse Exchanges - The Exchange Process And Time Clocks
After promising to do so since 1991, the IRS issued safe-harbor
guidance and recognition for Reverse Exchanges on September 15, 2000. Rev. Proc.
2000-37 officially sanctions Reverse Exchanges that are structured to comply
with the procedures outlined in the Revenue Procedure. The new safe-harbors are
effective for Reverse Exchanges occurring on or after September 15, 2000.
Reverse Exchanges occur when a taxpayer arranges for a Exchange
Accommodation Titleholder (EAT) (usually the Intermediary) to take and hold
title to Replacement Property before a taxpayer finds a buyer for his Exchange
Property. Sometimes the exchange accommodation titleholder will take and hold
title to the Exchange Property until a buyer can be found for it. Reverse
Exchanges have been common and have been preferred in circumstances where a
taxpayer has been compelled to close on Replacement Property before an Exchange
Property could be sold and closed or where the taxpayer desired ample time to
search for suitable Replacement Property before selling an Exchange Property
which started the well-known 45 and 180-day clocks for Delayed
Exchanges.Reverse Exchanges have also been common where a taxpayer
wanted to acquire a property and construct improvements on it before taking
title to the property as Replacement Property for an exchange. The Reverse
Exchange gave the taxpayer extra time to get the improvements constructed in
addition to the 180-day clock referred to above.The new safe-harbor
procedures impose compliance requirements on Reverse Exchanges that are new and
require analysis for impact and planning that can be summarized as follows ?
·The 5-Day Rule. A "Qualified Exchange Accommodation
Agreement" must be entered into between the taxpayer and the exchange
accommodation titleholder (qualified intermediary in most cases) within five
business days after title to property is taken by the exchange accommodation
titleholder in anticipation of a Reverse Exchange.
·The 45-Day Rule. The property to be "relinquished"
(the exchange property) must be identified within 45-days. More than one
potential property to be sold can be identified in a manner similar to the rules
of delayed exchanges (i.e., the three-property rule, the 200% rule, etc.)
·The 180-Day Rule. The Reverse Exchange must be
completed within 180-days of taking title by the exchange accommodation
titleholder.
The 180-Day Clock ? As with Delayed Exchanges where the
exchange must be completed within 180-days, Reverse Exchanges now must be closed
under the new procedures within 180-days. This is a new requirement. In the
past, since there has been no statutory limitation of time in which to be in
title, it has been common for the Exchange Accommodation Titleholder to be in
title on the parked property for a year or more during which the taxpayer would
find a buyer for his Exchange Property or during which time the taxpayer would
have improvements constructed on the property being held by the Titleholder.
180-days may be a suitable time for a buyer to be found for the Exchange
Property. But, 180-days is a problem with respect to construction/improvement
exchanges. The 180-day time limit within which to complete a safe-harbor Reverse
Exchange is probably insufficient for most large "build to suit"
exchanges.
What if the taxpayer has not yet found a buyer for his Exchange
Property by the end of 180-days? In this case, the taxpayer can discontinue
his attempt to accomplish a Reverse Exchange and take deed to the Replacement
Property. Or the taxpayer may decide to extend his Reverse Exchange outside of
the protection of the safe-harbor procedures. The safe-harbor guidance issued by
the IRS is optional, not mandatory. Reverse Exchanges that do not comply with
the requirements of Rev. Proc. 2000-37 stand or fall on their own merits and
should be considered risky now that guidelines have been issued for safe-harbor
exchanges.
Rev. Proc. 2000-37 imposes new responsibilities and burdens on
the Exchange Accommodator Titleholder. The Accommodator is now required to
report for federal income tax purposes the "tax attributes" of ownership of the
property it is in title on. It is possible that the Accommodator will be
required to depreciate the property just as a true owner would be required to
do. Rents and expenses attributed to ownership of the property may have to be
reported by the Accommodator. There has been no specific requirement requiring
Accommodators to do this prior to Rev. Proc. 2000-37. Failure to comply
with these new reporting requirements by the Accommodator could invalidate the
safe-harbor protection to the client. In addition to these new responsibilities,
Accommodators will now have to track the new "time clocks" that apply to Safe
Harbor Reverse Exchanges.
Compliance with these new requirements and responsibilities will impose new
administrative burdens and responsibilities on the Accommodator and may
contribute to increased fees for this service.
Reverse Exchanges may very well become the preferred way to
manage and transact 1031 Exchanges as a result of this new official blessing
by the IRS. The 45-Day identification period of Delayed Exchanges and related
pressure to find suitable replacement property are often so burdensome that
taxpayers are unable to successfully take advantage of the tax-deferral
potential of a delayed 1031 exchange. The risks of Reverse Exchanges have been
mitigated into reasonable commercial risks with the new safe-harbor
guidelines.

The Role Of The Qualified Intermediary
The role of the Qualified Intermediary is essential to
completing a successful and valid delayed exchange. The Qualified Intermediary
is the glue that puts the buyer and seller of property together into the form of
a 1031 Exchange. Where such an intermediary (often called an exchange
facilitator) is used, the intermediary will not be considered the agent of the
taxpayer for constructive receipt purposes notwithstanding the fact that he may
be an agent under state law and the taxpayer may gain immediate possession of
the money or property under the laws of agency.
In order to take advantage of the qualified intermediary "safe
harbor" there must be a written agreement between the taxpayer and intermediary
expressly limiting the taxpayer's rights to receive, pledge, borrow or otherwise
obtain the benefits of the money or property held by the intermediary.
A qualified intermediary is formally defined as a person who is
not the taxpayer or a disqualified person who enters into a written agreement
(the "exchange agreement") with the taxpayer and, as required by the exchange
agreement, acquires the relinquished property from the taxpayer, transfers the
relinquished property, acquires the replacement property, and transfers the
replacement property to the taxpayer. The qualified intermediary does not
actually have to receive and transfer title as long as the legal fiction is
maintained.
The intermediary can act with respect to the property as the
agent of any party to the transaction and further, an intermediary is treated as
entering into an agreement if the rights of a party to the agreement are
assigned to the intermediary and all parties to the agreement are notified in
writing of the assignment on or before the date of the relevant transfer of
property. This provision allows a taxpayer to enter into an agreement for the
transfer of the relinquished property (i.e., a contract of sale on the property)
and thereafter to assign his rights in that agreement to the intermediary.
Providing all parties to the agreement are notified in writing of the assignment
on or before the date of the transfer of the relinquished property, the
intermediary is treated as having entered into the agreement and, upon
completion of the transfer, as having acquired and transferred the relinquished
property.
There are no licensing requirements for Intermediaries. They
need merely be not an unqualified person as defined by the Internal Revenue Code
in order to be qualified. The Code prohibits certain "agents" of the taxpayer
from being qualified. Accountants, attorneys and realtors who have served
taxpayers in their professional capacities within the prior two years are
disqualified from serving as a Qualified Intermediary for a taxpayer in an
exchange.

The Rules of "Boot" in a Section 1031 Exchange
A Taxpayer Must Not Receive "Boot" from an exchange
in order for a Section 1031 exchange to be completely tax-free. Any boot
received is taxable (to the extent of gain realized on the exchange). This is
okay when a seller desires some cash and is willing to pay some taxes.
Otherwise, boot should be avoided in order for a 1031 Exchange to be tax
free.
The term "boot" is not used in the Internal Revenue Code or
the Regulations, but is commonly used in discussing the tax consequences of a
Section 1031 tax-deferred exchange. Boot received is the money or the fair
market value of "other property" received by the taxpayer in an exchange. Money
includes all cash equivalents plus liabilities of the taxpayer assumed by the
other party, or liabilities to which the property exchanged by the taxpayer is
subject. "Other property" is property that is non-like-kind, such as personal
property received in an exchange of real property, property used for personal
purposes, or "non-qualified property." "Other property" also includes such
things as a promissory note received from a buyer (Seller Financing).
Boot can result from a variety of factors. It is important
for a taxpayer to understand what can result in boot if taxable income is to be
avoided. The most common sources of boot include the following:
Cash boot taken from the exchange. This will usually
be in the form of "net cash received", or the difference between cash received
from the sale of the exchange property and cash paid to acquire the replacement
property or properties. Net cash received can result when a taxpayer is "trading
down" in the exchange so that the replacement property does not cost as much as
the exchange property sold for.
Debt reduction boot which occurs when a taxpayer´s debt on
replacement property is less than the debt which was on the exchange property.
As with cash boot, debt reduction boot can occur when a taxpayer is "trading
down" in the exchange.
Sale proceeds being used to service costs at closing which
are not closing expenses. If proceeds of sale are used to service
non-transaction costs at closing, the result is the same as if the taxpayer
received cash from the exchange, and then used the cash to pay these costs.
Taxpayers are encouraged to bring cash to the closing of the sale of their
property to pay for the following non-transaction costs:
·Rent prorations.
·Utility escrow charges.
·Tenant damage deposits transferred to the buyer.
·Any other charges unrelated to the closing.
Excess borrowing to acquire replacement property. Borrowing
more money than is necessary to close on replacement property will cause cash
being held by an Intermediary to be excessive for the closing. Excess cash held
by an Intermediary is distributed to the taxpayer, resulting in cash boot to the
taxpayer. Taxpayers must use all cash being held by an Intermediary for
replacement property. Additional financing must be no more than what is
necessary, in addition to the cash, to close on the property.
Loan acquisition costs with respect to the replacement
property which are serviced from exchange funds being brought to the closing.
Loan acquisition costs include origination fees and other fees related to
acquiring the loan. Taxpayers usually take the position that loan acquisition
costs are being serviced from the proceeds of the loan. However, the IRS may
take a position that these costs are being serviced from Exchange Funds. This
position is usually the position of the financing institution also. There is no
guidance in the form of Treasury Regulations on this issue at the present time
which is helpful.
Non-like-kind property which is received from the exchange,
in addition to like-kind property (real estate). Non-like-kind property could
include the following:
·Seller financing, promissory note.
·Sprinkler equipment acquired with farm land.
·Ditch stock in a mutual irrigation ditch company acquired with farm land
(possible issue).
·Big T Water acquired with farm land (possible issue).
Acquisition of ditch stock or Big T water is a possible issue
with the IRS. Most taxpayers report their exchanges of farm land by taking the
position that water on the farm land is indistinguishable from, and the same
thing as real estate. The IRS has been known to have a different view.
Boot Offset Rules - Only the net boot received by a
taxpayer is taxed. In determining the amount of net boot received by the
taxpayer, certain offsets are allowed and others are not, as follows:
·Cash boot paid (replacement property) always offsets
cash boot received (exchange property).
·Debt boot paid (replacement property) always offsets
debt-reduction boot received (exchange property).
·Cash boot paid always offsets debt -reduction boot received.
·Debt boot paid never offsets cash boot received (net
cash boot received is always taxable).
·Exchange expenses (transaction and closing costs) paid (exchange property
and replacement property closings) always offset net cash boot received.

Rules of Thumb:
·Always trade "across" or up. Never trade down. Trading down
always results in boot received, either cash, debt reduction or both. The
boot received can be mitigated by exchange expenses paid.
·Bring cash to the closing of the Exchange Property to cover
charges which are not transaction costs (see above).
·Do not receive property which is not like-kind.
·Do not over-finance replacement property. Financing should be
limited to the amount of money necessary to close on the replacement property in
addition to exchange funds which will be brought to the replacement property
closing.

Seller Carrybacks and Dispositions
A Seller Financed Sale is usually incompatible with a
desire to do a Section 1031 Exchange of real estate. The reason is that a
promissory note is property received which does not meet the requirement that
real estate be exchanged solely for other like-kind property (real estate). If
seller financing is necessary due to circumstances, and if a delayed exchange
with the use of an Intermediary is employed, it is possible to salvage Section
1031 Exchange treatment by one of the following procedures:
·The Intermediary can take and hold the promissory note as
part of the exchange proceeds and hold the note until a disposition occurs. At
the closing of the Replacement Property, the Intermediary conveys ownership of
the note to the taxpayer and the taxpayer brings a like amount of money to the
closing table in exchange for the note. This is equivalent to "buying" the note
from the Intermediary. Otherwise, it is a distribution of "boot" to the taxpayer
by the Intermediary which is offset by "boot" paid by the taxpayer at the
Replacement Property closing table. Under the Rules of Boot, cash boot paid by a
taxpayer offsets cash boot received, and hence, under the boot netting rules,
there is no net boot received by the taxpayer.
·The seller could loan the buyer money prior to the real estate closing and
then take a deed of trust on the property at closing.
·The Intermediary could sell the promissory note to a
financial institution or investor and use cash received to acquire qualifying
replacement real estate for the seller under the Exchange Agreement.
·The Intermediary could use the promissory note in his
possession as consideration for the acquisition of replacement property. A
problem with this is that in the hands of the seller of the replacement
property, the note is a third-party note not eligible for installment sale
reporting under IRC §453. Accordingly, there is disincentive for the seller to
take the note as part of the consideration to be received from the sale of his
property. This problem is compounded if the seller is also trying to do a 1031
Exchange of his property.
These dispositions are not covered by the 1991 Regulations and
are not protected by the safe-harbor provisions. Therefore, potential tax issues
are always possible under an examination by the IRS.

Related Party Exchanges (Two-Year Holding Period
Requirement)
There is a special rule for exchanges between related parties
(§1031(f)), which provides that related taxpayers who directly or indirectly
exchange property must hold the exchanged property for at least two years after
the exchange for the exchange to qualify for nonrecognition treatment. If either
party disposes of the property received in the exchange before the running of
the two-year period, any gain or loss that would have been recognized on the
original exchange must be taken into account on the date that the disqualifying
disposition occurs.
Often, a taxpayer will sell to a related party but receive
Replacement Property from an unrelated party. Tax and Exchange Professionals do
not perceive this type of transaction to be a "related party exchange."
Also, a taxpayer will often desire to sell to an unrelated
party and receive Replacement Property from a related party. This type of
related party transaction does not work according to the IRS. The IRS issued a
Technical Advice Memorandum (TAM 9748006) in 1997 that says that this type of
related party transaction is equivalent to conveying the Exchange Property to
the related party with a deemed subsequent resale by the related party to the
unrelated party (a disqualifying disposition). Rev. Rul. 2002-83 issued in 2002
confirmed this position by the IRS. Accordingly, taxpayers should not receive
Replacement Property from a related party.
Related parties under the rules are the following -
·Members of a family, including only brothers, sisters,
half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.),
and lineal descendants (children, grandchildren, etc.);
·An individual and a corporation when the individual owns,
directly or indirectly, more than 50% in value of the outstanding stock of the
corporation;
·Two corporations that are members of the same controlled
group as defined in §1563(a), except that "more than 50%" is substituted for
"at least 80%" in that definition;
·A trust fiduciary and a corporation when the trust or the
grantor of the trust owns, directly or indirectly, more than 50% in value of the
outstanding stock of the corporation;
·A grantor and fiduciary, and the fiduciary and beneficiary, of any trust;

·Fiduciaries of two different trusts, and the fiduciary and
beneficiary of two different trusts, if the same person is the grantor of both
trusts;
·A tax-exempt educational or charitable organization and a
person who, directly or indirectly, controls such an organization, or a member
of that person's family;
·A corporation and a partnership if the same persons own more
than 50% in value of the outstanding stock of the corporation and more than 50%
of the capital interest, or profits interest, in the partnership;
·Two S corporations if the same persons own more than 50% in
value of the outstanding stock of each corporation;
·Two corporations, one of which is an S corporation, if the
same persons own more than 50% in value of the outstanding stock of each
corporation; or
·An executor of an estate and a beneficiary of such estate,
except in the case of a sale or exchange in satisfaction of a pecuniary bequest.

·Two partnerships if the same persons own directly, or
indirectly, more than 50% of the capital interests or profits in both
partnerships, or
·A person and a partnership when the person owns, directly or
indirectly, more than 50% of the capital interest or profits interest in the
partnership.
A disqualifying disposition does not include dispositions by
reason of the death of either party, the compulsory or involuntary conversion of
the exchanged property if the exchange occurred before the threat or imminence
of the conversion, or dispositions where it is established to the satisfaction
of the IRS that neither the exchange nor the disposition had as one of their
principal purposes the avoidance of federal income
tax.

Multiple-Asset Exchanges And Personal Residences
A Multiple-Asset Exchange occurs when a taxpayer is
selling/exchanging a property which includes more than one type of asset. A
Common example is a farm property including a personal residence, farm land and
farm equipment.
The Treasury Department has issued Regulations which govern how
multiple-asset exchanges are to be reported. The Regulations establish "exchange
groups" which are separately analyzed for compliance with the like-kind
replacement requirements and rules of boot. Farm land must be replaced with
qualifying like-kind real property. Farm equipment must be replaced with
qualifying like-kind equipment. A personal residence is not 1031 property and is
accounted for under the rules applicable to the sale of a personal
residence.
The Multiple-Asset Regulations are ambiguous concerning how the
personal residence portion of a multiple-asset exchange should be accounted for.
However, it is common practice for the closing on the Exchange Property to be
bifurcated into two separate closings; one for the personal residence and the
other for the remainder of the property. The proceeds applicable to the sale of
the personal residence are usually disbursed to the taxpayer and not retained by
the Intermediary in the exchange escrow. The balance of the proceeds is
disbursed to the Intermediary for use in acquiring like-kind replacement
property under the Exchange Agreement.
Another common example of multiple-asset exchanges is a real
property sale that includes personal property (i.e. furniture and appliances).
Rental properties including this type of personal property are multiple-asset
exchanges. Hotel properties are a good example of a multiple-asset exchange
including real and personal property.
Even a sale/exchange of a rental property includes a
combination of real and personal property. In practice, the value of the
personal property that is transferred with a rental property is commonly
disregarded for calculation and income tax reporting purposes. However, there is
no de minimis rule which permits a taxpayer to disregard the value of personal
property, even if it is nominal.
The Multiple-Asset Regulations are complex and require the
services of a tax professional for analysis purposes and income tax reporting.
The tax professional is essential and will help in determining values,
allocations of sale price and purchase prices to the elements of the
transaction. Exchanges that include personal property of significant value
should reference the personal property in the exchange agreement and be
completed in a manner that complies with all of the exchange rules concerning
identification, etc.

Personal Property Exchanges(In A Nutshell)
As explained above, exchanges frequently include personal
property. However, personal property exchanges are just as common as real
property exchanges. Personal property exchanges commonly occur with respect to
corporate or business aircraft and ships, construction equipment, farm
equipment, and even livestock.
The like-kind rules are more challenging for personal property
than for real property. The like-kind provisions contained in the Regulations
establish safe-harbor definitions of like-kind replacement personal property if
the replacement property is within the same "General Asset Class" or within the
same "Product Class."
The General Asset Classes are found in the Regulations
(§1.1031(a)-2(b)(2)) and can be summarized as follows -
·Office Furniture, Fixtures, And Equipment
·Information systems (computers and peripheral equipment)
·Data Handling Equipment, Except Computers
·Airplanes (airframes and engines), except those used in
commercial or contract carrying of passengers or freight, and all helicopters
(airframes and engines)
·Automobiles, Taxis
·Buses
·Light General Purpose Trucks
·Heavy General Purpose Trucks
·Railroad cars and locomotives, except those owned by railroad
transportation companies
·Tractor Units For Use Over-the-road
·Trailers And Trailer-mounted Containers
·Vessels, barges, tugs, and similar water-transportation
equipment, except those used in marine construction, and
·Industrial steam and electric generation and/or distribution systems
The Product Classes are found in Division D (Manufacturing) of
the government publication Standard Industrial Classification Manual
1987.
Property within a Product Class consists of depreciable
personal property that is listed in a 4-digit Product Class within Division D of
the Standard Industrial Classification Codes. Division D of the SIC Manual
contains a listing of manufactured products and equipment. However, any 4-digit
Product Class ending in a "9" (i.e., a miscellaneous category) will not be
considered a Product Class. The classes are broad for classes of equipment
such as farm equipment, office equipment and hotel furnishings. Vehicles must be
replaced with similar types of vehicles.
The services of a tax-professional are essential for successful
personal property exchanges and related compliance with the like-kind
replacement property rules.

Partnership And Co-Ownership Issues
Investment real estate is commonly owned by co-owners in a
partnership containing two or more partners, or by co-owners as tenants in
common. An exchange of a tenant in common interest in real estate poses no
problems and is eligible for 1031 Exchange treatment. However, an exchange of an
interest in a partnership is not permitted under the Code and Regulations.
If a partnership owns property and desires to sale/exchange the
property, then the partnership is the entity that is the Exchanger and party to
the Exchange Agreement. The partnership will take title to the Replacement
Property.
Frequently, individual partners in a partnership desire to take
their share of the proceeds of sale of the partnership property, replace with
qualifying 1031 replacement property in their own names and end their
relationship with the partnership. This presents problems that require careful
planning and is not without tax risk.
If a two-partner partnership wishes to discontinue the
partnership, sell the property and go their separate ways with either the cash
or a 1031 Exchange, it is necessary for the individual partners to receive deed
to the property from the partnership in advance of the sale of the property.
This is done in the context of a distribution of property from the partnership
to its partners. The individual partners are then generally required to hold the
property as tenants in common for an unspecified period of time (decent interval
of time) in order to comply with the "holding" requirement of 1031 Exchanges
that requires a taxpayer to have "held" qualifying property for business or
investment purposes prior to the exchange.
If a partnership with multiple partners wishes to exchange
property but some of the partners want to "cash-out" or go separate ways, it is
common for the partnership to do a "split-off." The partnership distributes
tenancy in common title to a portion of the partnership property to those
individual partners who wish to proceed in separate directions, and the
partnership (and its remaining partners) proceed with an exchange in the name of
the partnership.
The services of a tax professional are essential for tax
planning and structuring for successful exchanges of partnership and
co-ownership interests in real
estate.

What Realtors Should Know About1031 Exchanges
Realtors are Often the First to Recognize the Potential
Benefits of a Section 1031 Exchange to a seller of real estate. When a
seller is going to replace qualifying real estate with other replacement real
estate, a Section 1031 Exchange should be suggested. It is possible for a seller
to employ the services of an Exchange Intermediary at any time after a contract
is executed up to the day of closing on the contract. It is too late after the
closing has occurred.
Accommodation Language in the Contract. Accommodation
language is usually placed in Contracts to Buy and Sell Real Estate wherein the
other party to the contract is informed and agrees to cooperate with the 1031
exchange. Typical accommodation language might read as follows:
For a Seller - "A material part of the consideration to the
seller for selling is that the seller has the option to qualify this transaction
as a tax deferred exchange under Section 1031 of the Internal Revenue Code.
Purchaser agrees to cooperate in the exchange provided purchaser incurs no
additional liability, cost or expense" or
For a Buyer - "This offer is conditional upon the seller's
cooperation at no cost to allow the purchaser to participate in an exchange
under Section 1031 of the Internal Revenue Code at no additional liability, cost
or expense. Seller hereby grants buyer permission to assign this Contract to an
Intermediary not withstanding any other language to the contrary in this
Contract".
Accommodation language is not mandatory but can be useful.
However, accommodation language can drive buyers to their attorneys for
consultation and if this is the case, it can be eliminated from the
contract.
Assignment of Contracts. If a Realtor knows that a buyer
intends to assign the contract to an Intermediary in connection with an
exchange, it is helpful to reference the buyer as "John Doe or Assigns" on the
contract.
The standard form Contract to Buy and Sell Real Estate used by
Colorado Realtors contains a provision wherein the contract is not assignable by
a buyer without the seller's permission. The standard form Contract does not
limit a seller's right to assign the contract.
When a Realtor is assisting a buyer with a contract which is
going to be assigned to an Intermediary in connection with a 1031 Exchange, this
paragraph should be eliminated so that the buyer can proceed with an assignment
with no contract restrictions. If the "not assignable" paragraph is not
eliminated, then an addendum to the contract is usually prepared by the
Intermediary which makes the contract assignable by the buyer.
Accommodation language which gives a buyer the right to assign
the Contract is another way in which the Contract can be made to be assignable
by a buyer; see previous section.
An Exchange Addendum To Contract To Buy And Sell Real Estate
issued by the Colorado Real Estate Commission containing all necessary
accommodation language is also available. Use of this Addendum makes contract
accommodation language unnecessary and automatically provides for assignability
of a contract by the buyer in an exchange transaction.
Settlement Statements. Section 1031 of the Internal Revenue
Code imposes no requirements and provides no guidance with respect to
preparation of Settlement Statements for an exchange of property. The law
governing the preparation of settlement statements is Colorado Real Estate Law
and requirements which apply to title companies under insurance regulations. The
Colorado Real Estate Commission has no special requirements concerning exchanges
involving an Intermediary.
A common (but unnecessary) practice in Coloradois for the
title company closing on the transaction to prepare a second set of settlement
statements in which the Intermediary is shown as a buyer and seller. The
Intermediary's set of statements usually "mirror" each other as to debits and
credits. The thinking here is that the settlement statements should reflect a
"chain of title."
Our recommendation is to prepare one set of settlement
statements in the normal manner which total to zero proceeds due to or from
the Exchanger. The settlement statements should be made to total to zero
proceeds due to or from the Exchanger by showing a debit or credit for "Exchange
Funds - 1031 Corporation" as a transaction item "above the bottom line". The
amount of "Exchange Funds" is the amount of funds being transferred to or from
the Intermediary in connection with the
closing.