Additional Information


DEFERRED EXCHANGES

 

For eighty years, the Internal Revenue Code and related Treasury Regulations have provided that taxpayers can exchange business or investment property, and no taxable gain will be recognized if the properties are of "like kind". "Like kind" 1031 Exchange refers to the nature or character of property, rather than to grade or quality. Therefore, for example, any type of real property interest can be exchanged for any other type of real property interest, regardless of the use or service of the property, with no taxable gain.

In 1984, section 1031 of the Internal Revenue Code was amended to provide that a sale of property can be treated as a tax-free exchange, if "replacement property" of like kind is identified within 45 days and purchased within 180 days. In 1991, Treasury Regulations provided detailed guidance for "deferred" tax free exchanges. These Regulations provide the following structure for a deferred exchange, typically called a "Starker" transaction:

  • Exchangor enters contract for sale of original property ("relinquished property")
  • Exchangor enters written exchange agreement with qualified intermediary
  • At or before closing, exchanger assigns sale contract to qualified intermediary, and written notice of that assignment is provided to buyer
  • At closing, relinquished property is transferred directly from exchanger to buyer
  • At closing, proceeds of sale are transferred directly to qualified intermediary; exchanger must not receive actual or constructive receipt of sales proceeds
  • Exchange funds are held and invested by qualified intermediary in qualified escrow account; exchanger may receive all interest upon completion of the exchange 
  • Exchangor must identify replacement property in writing within 45 days 
  • Replacement property must be purchased within 180 days
  • Exchangor enters contract for purchase of replacement property
  • At or before closing, exchanger assigns purchase contract to qualified intermediary, and written notice of that assignment is provided to seller
  • At closing, exchange funds are transferred directly to seller or closing agent
  • At closing, replacement property is transferred directly from seller to Exchangor

Following a section 1031 tax-free exchange, the basis of the relinquished property is transferred to the replacement property. Therefore, the taxable gain in the relinquished property is deferred until the sale of the replacement property.

For the exchange to be entirely tax-free, all cash proceeds from the relinquished property must be reinvested in the replacement property, and the value of the replacement property must equal or exceed the value of the relinquished property.

 


 

PLANNING ISSUES

 

The following issues are frequently encountered in tax-free exchanges. For these issues, careful planning is necessary to maximize tax savings and minimize IRS audit risks.

1031 Exchange

Reverse Exchanges - The exchanger may need to purchase the replacement property before the sale of the relinquished property. For these transactions, the qualified intermediary or a special purpose entity must acquire title to the replacement property in order to facilitate the exchange. Although not specifically authorized by Treasury Regulations, some legal authority exists for the reverse exchange.

"Build-to-Suit" Exchanges - The exchanger may need to use exchange funds to construct improvements to the replacement property. For these transactions, the qualified intermediary or a special purpose entity must hold title to the replacement property during the period of construction. For construction projects that cannot be completed within 180 days, the exchange must be structured as a reverse exchange.

Exchanges of Multiple Properties - For exchanges involving multiple types of properties, such as real estate and various items of equipment, the assets must be classified into exchange groups by matching properties of a like kind or like class. The tax result of the exchange is then determined for each individual exchange group.

Entity Issues - The IRS has consistently taken the position that the same taxpayer entity that has held the relinquished property for business or investment must obtain the replacement property with the intention of holding it for business or investment. This IRS position creates planning challenges when taxpayers seek to remove exchange property from a partnership or corporation prior `to an exchange, or transfer exchange property to a new partnership or corporation following an exchange.

Related Party Transactions - Taxpayers often seek to exchange property with related parties (certain family members and controlled partnerships or corporations). Section 1031 provides that if either related party sells exchange property within two years following an exchange, then both related parties must recognize the previously-deferred gain in the year of the sale. For deferred exchanges, a taxpayer should not purchase replacement property from a related party; and relinquished property sold to a related party should not be re-sold within two years following the exchange. However, there are several exceptions to these rules that we can assist in determining.

 


 

SERVICES AND FEES

 

We provide comprehensive services related to section 1031 tax-free exchanges, including services as qualified intermediary. To provide qualified intermediary services, 1031 Services Corporation, a Texas corporation was established.

Exchange funds for each transaction are held in a separate qualified escrow account as provided by section 1. 103 1 (k)- 1 (g)(3) of Treasury Regulations. Exchange funds are held as depository; and no disbursements are made from the escrow account without written authorization from the qualified intermediary at the instruction of the Exchanger. The Exchanger will receive all interest earned on exchange funds upon completion of the exchange transaction. This arrangement provides maximum security and maximum investment return for exchange funds.

We provide all legal documents necessary to implement a section 1031 tax-deferred exchange, and we coordinate the exchange aspects of the property closings.  We charge a basic fee which includes the sale of one relinquished property and the purchase of one replacement property. If the exchange involves more than one property, then additional fees will be charged.

For simultaneous, reverse, "build-to-suit", multiple property, or non-routine deferred exchanges, we will quote a fixed or flexible fee based on the nature of the transaction. Fixed fees include all services and expenses for the exchange transaction. We also provide consultation and research with fees based on time and expenses. Please call us for information regarding the fee for a specific transaction.