1. 1 Welcome Tax Deferred 1031 Real Property Exchanges

2. 2 As a courtesy to others... Please turn off phones and pagers

3. 3 Course Goal  Recognize and evaluate when a 1031 tax-deferred exchangecould be advantageous  Explain the tax saving benefits  Work with the client and a team of experts to structure the transaction

4. 4 Objectives  Gain an understanding of how the rules governing 1031 tax-deferred real property exchanges are applied and how transactions are put together  Explain the tax deferral benefits of a 1031 exchange

5. 5 Objectives  Recognize and evaluate situations in which a 1031 tax deferred exchange could be to the client’s advantage  Involve and work with intermediaries and other experts to structure the transaction

6. 6 Day One  The Fundamentals Safe Harbors and Intermediaries

7. 7 Day Two...  Practicum – Case Studies  Putting the Deal Together  Completion Exam

8. 8 Two Positive Economic Outcomes...  Deferral of capital gain taxes  Preservation of equity

9. 9 When……  Business reasons should always be the driving factor  When the potential tax liability outweighs both taxes and costs

10. 10 Real Estate Professional’s Role..  Help the client think through the pros and cons  Identify exchangeable properties  Interface with the team of professional advisors

11. 11 Basic Concept...  Continue an investment without adverse tax consequences  Solution to the “tax-locked property” dilemma

12. 12 Basic Concept... Value of Real Estate Holdings Time Purchase Exchange Purchase Exchange Sale

13. 13 Eligibility...  Property must be held for investment or productive use in trade or business - AND -  Exchanged for like-kind property

14. 14 Business Objectives...  Diversify or consolidate  Business needs  Financial strategy  Estate planning  Change of lifestyle  Avoid cost recapture  Relocation (depreciation)

15. 15 Advantages...  Capital gains tax deferred  Heirs receive a stepped-up basis and tax on accumulated capital gain is forgiven  Tax-locked property is freed up  Money available for reinvestment instead of taxes

16. 16 Disadvantages...  Future tax rates could be higher  Carryover of basis to replacement property  Complex and expensive transactions  Losses cannot be recognized  Proceeds must be reinvested in real estate  Time limits must be strictly adhered to

17. 17 Capital Gains & Income Tax Top Rates...

18. 18 Four Basic Rules... 1. Property must be held for investment or productive use in trade or business 2. Like kind property must be exchanged for like kind 3. Replacement properties must be identified within 45 days 4. Exchange must be completed within 180 days or tax due date

19. 19 Rule 1... Held for investment or productive use in trade or business  Personal residences cannot be exchanged  Classification:  relinquished property when transferred  replacement property when received  If owner occupies a unit as a personal residence, the rental portion can be an exchange, personal use portion receives capital gain tax treatment

20. 20 Rule 1... Held for investment or productive use in trade or business Vacation Properties...  Exchanges can be problematic if any personal use of it–hard to document occupancy  Considered personal residence if owner occupied more than (greater of) 14 days, or 10% of the total days rented

21. 21 Rule 1... Held for investment or productive use in trade or business  Dealer property specifically excluded for 1031 exchange  Dealer property: primarily for sale in ordinary course of business  Real estate brokers/agents are not automatically dealers

22. 22 Qualified property determined by owner’s intent... Not Qualified Qualified Home Sweet Home Personal Residence For Sale Dealer Property Keep Out Vacant Land (1221) & Investment Property For Rent Used in Trade or Business (1231)

23. 23 Rule 1... Held for investment or productive use in trade or business Unqualified Property...  Personal residence  Dealer property  Stock, bonds, notes  Choses in action  Certificates of trust or beneficial interests  Securities or evidences of indebtedness  Interests in a partnership

24. 24 Rule 2... Like kind exchanged for like kind  All real estate held for investment or productive use in trade or business is like-kind  Property included in exchange that is not like-kind is taxable boot  Property located outside the U. S. (50 states & DC) not like kind  Exception, U.S. Virgin Islands

25. 25 Rule 2... Like kind exchanged for like kind Real Estate Trade or Business, Investment $ Personal Property Like Kind Exchange

26. 26 Rule 3... 45 Days to Identify Replacement Property  Identification period starts on the day that the title to the relinquished property is transferred  If multiple properties relinquished, date of first transfer starts 45-day period

27. 27 Rule 4... 180 days or by tax due date to complete exchange  The replacement property must be transferred before the EARLIER of 180 days after the date of transfer of the relinquished property, OR the due date, including extensions, of the tax return for the tax year of the exchange

28. 28 Rule 4... 180 days or by tax due date to complete exchange.  Count the days  180 days does not equal 6 months * * May file for an extension, but exchange must be completed with 180 days.

29. 29 Foreign Taxpayers  Foreign Investment in Real Property Tax Act of 1980 (FIRPTA)  Applies when the transferor (seller) is a non-U.S. taxpayer (individual or organization) and the property is a U.S. real property interest (USRPI).  Withholding agent (may be the real estate agent) must withhold 10% of the amount realized (not gain) and remit the it to the IRS within 20 days of transaction.

30. 30 Taxpayer Identification Number (TIN)  For an individual who cannot or does not qualify to receive a Social Security number.  Non-U.S. persons must provide a TIN when they buy or sell U.S. real property.

31. 31 Boot in 1031 Exchanges...  Cash or unlike property received in the exchange  Taxable gain  Fair market value is recognized

32. 32 Rule 2... Like kind exchanged for like kind Unqualified Property Personal residence Dealer Property Mortgage Relief Cash Unqualified Property in an Exchange = Taxable Boot

33. 33 Boot in 1031 Exchanges...  Compare the fair market value of boot with the gain that would result from selling the property  Taxable gain is the lesser of these two amounts

34. 34 Boot in 1031 Exchanges... Example 2.1... Real estate with an adjusted basis of $30,000 is exchanged for other real estate with a fair market value of $100,000, plus $35,000 boot. Total consideration received$135,000 Less - Adjusted basis$30,000 Total realized gain$105,000 GAIN Total boot received$35,000 Taxable gain is the smaller of the two $35,000

35. 35 Boot in 1031 Exchanges...  If either party assumes any of debts or liabilities of the other as part of the exchange, the amount of liability is treated as cash boot

36. 36 Boot in 1031 Exchanges... Example 2.2... Allen exchanged real estate with an adjusted basis of $30,000 for other real estate with a fair market value of $100,000. In addition, he received $35,000 cash and the other party assumed a mortgage of $25,000.

37. 37 Boot in 1031 Exchanges... Step 1 - Total Gain Realized FMV of like-kind property Allen received$100,000 Cash boot received$35,000 Mortgage assumed by other party $25,000 Total consideration Allen received $160,000 Less basis of property given up $30,000 Total gain realized$130,000 Step 2 - Total Boot Received Mortgage assumed by other party $25,000 Cash received$35,000 Total boot received$60,000 Taxable gain is lesser amount... $60,000

38. 38 Boot in 1031 Exchanges... Netting the Liabilities...  Mortgage on relinquished property is boot received  Mortgage assumed may be offset against this boot

39. 39 Boot in 1031 Exchanges... Example 2.3... Christine exchanged land with a mortgage of $10,000 for land with a mortgage of $15,000. In addition, she received cash boot of $6,000. After offsetting the mortgages, she has paid $5,000 mortgage boot, but is not allowed to deduct this boot paid from the cash boot received. Her taxable boot received is $6,000.

40. 40 Boot in 1031 Exchanges...  Transaction costs reduce both recognized and realized gain on the sale side and increase basis on the purchase side  Includes: brokerage commissions and closing costs such as title policy, escrow, and recording fees

41. 41 Boot in 1031 Exchanges... Example 2.4... Dave owned property with an adjusted basis of $30,000 and exchanged it for like- kind property with a fair market value of $100,000 plus $35,000 cash. He paid a $9,000 commission to his real estate broker. Dave’s taxable gain is limited to the net boot he received—$26,000. A "loss" is not deductible.

42. 42 Boot in 1031 Exchanges...  Cash boot paid offsets boot received  Mortgage boot paid offsets mortgage boot received  Mortgage paid, if more than mortgage assumed, may not offset cash or unlike property  Other boot paid may be treated as the purchase price for non-like kind property received  Selling expenses may offset boot received or net mortgage relief if no cash or unlike property is received  Recognized gain may be offset by suspended losses

43. 43 Basis...  Cost of a property for tax purposes  If purchased outright, basis is the price paid for the property plus acquisition costs

44. 44 Basis...  Capital improvements increase basis  Items that provide a tax benefit decrease basis, e.g. cost recovery (depreciation)

45. 45 Basis... Time 39 Years Property Sold Property Purchased Market Value Cost Recovery Original Basis Capital Gain Cost Recovery Recapture 15% tax 25% tax Cost recovery decreases basis; recaptured at sale, taxed at 25%. No cost recovery on land.

46. 46 Basis... Very Important... Basis in the relinquished property is carried over to the replacement property, regardless of the cost of either of the properties

47. 47 Increases in Basis...  Cash paid in to balance equities  Liabilities/debts assumed on the replacement property  Improvements to the property  Acquisition costs

48. 48 Decreases in Basis...  Depreciation  Cash or nonqualified property received  Debt relief on the relinquished property  Reimbursement from an insurance policy for casualty or theft loss

49. 49 Equity... $400,000 Mortgage Balance $550,000 Equity $ 50,000 selling costs Property A $1 Million $1,450,000 New Mortgage* $550,000 Equity Property B $2 Million Transfer of Equity * Could finance $1.5 Million and take out $50,000 cash (taxable). Relinquished Property Replacement Property

50. 50 Basis... $500,000 adjusted basis $450,000 deferred gain $ 50,000 selling costs Property A $1 Million $1,550,000 substitute basis $450,000 deferred gain Property B $2 Million Transfer of Basis Relinquished Property Replacement Property

51. 51 Exchange with Installment...  The installment sale gross profit (recognized gain) is reduced by gain not recognized in the exchange

52. 52 Exchange with Installment... Example 2.5... Frank owned, free and clear, an investment property with a FMV of $100,000 and a basis of $30,000. If he made a cash sale, he would be taxed on $70,000. Frank decided to make a like-kind exchange for an investment property owned by George. The FMV of George’s property is $75,000. Frank receives George’s property in the exchange and agrees to accept an installment note for $25,000 to balance the equities. Frank receives no payments of principal in the year of sale.

53. 53 Exchange with Installment... Example... Frank’s gross profit percentage is 100%— the gross profit of $25,000 divided by contract price of $25,000. Since he did not collect any payments in the year of sale, he has no recognized gain in the year of the exchange. Each year following, 100% of the principal collected that year will be recognized as taxable capital gain

54. 54 Identifying Properties...  No limit on the number/value of properties to be relinquished  Limits on number/value of replacement properties identified

55. 55 Identifying Properties... Three Property Rule... Maximum number of replacement properties that may be identified is three without regard to the FMV of the properties

56. 56 Identifying Properties... 200 Percent Rule... Any number of properties if aggregate FMV is not more than 200% of the aggregate FMV of all the relinquished properties

57. 57 Identifying Properties... 95 Percent Rule... Any number of properties if by end of exchange period (180 days) aggregate value of replacement property acquired is minimum 95% of aggregate FMV of all identified property.

58. 58 Incidental Property...  Not separate from larger item of property  Typically transferred together  Aggregate FMV is not more than 15% of FMV of the larger item of property

59. 59 Identifying Properties... In Writing...  Delivered, mailed, or telecopied (faxed), on/before end 45-day identification period to the other person involved in the exchange  Or part of written agreement signed by all parties–includes the real estate agent

60. 60 Revoking Identification...  May be made at any time before the end of the 45-day identification period  Written document signed by taxpayer

61. 61 Property to be Produced... Property to be Produced /Built to Suit  Qualifies as replacement property  Estimated at FMV as of the date it is expected to be received or would have if construction had been completed

62. 62 Property to be Produced...  Additional production on replacement property after received does not qualify for like-kind exchange  Caution: exchange for services

63. 63 Holding Period... The holding period of the relinquished property for capital gain tax treatment is carried over to the replacement property

64. 64 Holding Period... Related Parties Minimum two-year holding period...  If related parties involved in exchange – relinquished or replacement property  Additional reporting – Form 8824 for two more years

65. 65 Related Parties...  Family members (siblings, spouse, ancestors, and lineal descendants)  Corporate relationships  Partnerships  Trusts  Estates  Organizational relationships

66. 66 Holding Period... Residence Received in Exchange Minimum five-year ownership period...  Property received in exchange and converted to personal residence must be held 5 years in order to qualify for $250,000 exclusion of gain on sale of personal residence.

67. 67 State Laws...  E xamine for both the state of the relinquished property and replacement property

68. 68 Documenting Intent to Exchange...  Listing Agreement... 1031 exchange contingency if dependent on completion of a tax-deferred exchange  Exchange Agreement... Document relationship between taxpayer & safe harbor

69. 69 Documenting Intent to Exchange...  Sales Contract...notice of assignment of rights if a qualified intermediary involved  Purchase Agreement... 1031 exchange contingency establishes intent

70. 70 Documenting Intent to Exchange...  Escrow Instructions.. direct how the proceeds should be received and disbursed  These documents... not required to be included with filing, should be in place to prove intent

71. 71 Reporting the Exchange... IRS Forms...  1099-S Proceeds From Real Estate Transactions  Form 8824 Like-Kind Exchanges  Form 4797 Sales of Business Property

72. 72 Types of Exchanges... Simultaneous Exchange... On the agreed day, the parties meet at the closing table to swap deeds for the properties

73. 73 Types of Exchanges... Deferred “Starker” Exchange  T.J. Starker v. United States... Exchanges do not have to be simultaneous to qualify  Landmark 1979 Federal Court case

74. 74 Types of Exchanges...  Deferred “Starker”: Relinquished property transferred before replacement property acquired  Reverse “Starker”: Replacement property acquired before relinquished property transferred

75. 75 Types of Exchanges...  Actual receipt... cash proceeds or property are in the taxpayer’s possession  Constructive receipt... cash proceeds or property can be drawn or are in taxpayer’s control

76. 76 Types of Exchanges... Deferred “Starker” Exchanges...  Key to successful transaction – avoiding actual or constructive receipt  Actual or constructive receipt by an agent is actual or constructive receipt by the taxpayer

77. 77 Types of Exchanges...  Qualified Exchange Accommodation Arrangement (QEAA)  Qualified Exchange Accommodations Titleholder (QEAT) takes and holds title to the replacement property  “Parks” title with QEAT until replacement property identified & exchange completed

78. 78 Types of Exchanges... Reverse Exchange...  Taxpayer must complete agreement with QEAT within 5 days of accommodator acquiring replacement property

79. 79 Reverse Exchange Safe- Harbor Guidelines...  Complete within 180-days or the property held by the QEAT is deeded to the taxpayer  Identify relinquished property within 45 days  Intermediary can hold title to replacement or relinquished property  Qualified Exchange Accommodations Agreement (QEAA) completed within 5 days

80. 80 Types of Exchanges... Reverse Exchange...  Replacement property held in a QEAA may not be owned by the taxpayer within the 180- day period preceding the date of transfer of the property to the Exchange Accommodation Titleholder. Rev. Proc. 2004-51

81. 81 Types of Exchanges... Delayed Closing or Deferred Exchange?  Don’t confuse  Delayed closing: relinquished property "sale" does not close until an agreed date

82. 82 Types of Exchanges... Edward (exchanger) Susan (seller) Central Court Silver City Example 2.6: Two Way Exchange

83. 83 Types of Exchanges... Three Way Exchange...  Solves the dilemma of a two-way swap  Why? Other owner seldom wants the offered property, but would accept another one, or prefers to sell the property and take the cash proceeds

84. 84 Types of Exchanges... Edward (exchanger ) Susan (seller) Example 2.7 Three Individual Transfers Bob (buyer)

85. 85 Types of Exchanges... Edward (exchanger) Susan (seller) Example 2.8 Exchange with Purchaser Bob (buyer) 1 2

86. 86 Types of Exchanges... Edward (exchanger ) Susan (seller) Example 2.9 Exchange with Seller Bob (buyer) 2. 1.

87. 87 Types of Exchanges... Edward (exchanger) Susan (seller) Example 2.10 Escrow Holder as Accommodator Bob (buyer) Escrow

88. 88 Types of Exchanges... Edward (exchanger) Susan (seller) Bob (buyer) Intermediary Example 2.11 Exchange with an Intermediary

89. 89 Tenants in Common...  Enables small investor ownership participation in premium commercial & investment property  Like-kind property for 1031 exchange

90. 90 Tenants in Common...  What it is not... a joint venture, partnership, or limited partnership  What it is... each investor owns an undivided, fractional, interest

91. 91 Tenants in Common... Advantages...  Avoid involvement in day-to-management  Investment in high quality properties  Comply quickly with 45-day identification time limit  Exchange a specific amount of value  Upgrade and diversity a portfolio

92. 92 Tenants in Common... Advantages...  Sponsors (specialized firms) research properties, package investments, and monitor performance  Large, institutional-grade properties

93. 93 Tenants in Common... Caution...  SEC regulations bar a commission or referral fee unless the real estate professional is a licensed security dealer  Agent may be compensated for counseling services  Can be paid from funds held by the QI, not the sponsor

94. 94 Four Safe Harbors... Purpose... avoid actual or constructive receipt of proceeds 1. Security or guarantee arrangements 2. Qualified escrow accounts and trusts 3. Interest and growth factors 4. Qualified intermediaries

95. 95 Four Safe Harbors... Security or Guarantee Arrangements  Mortgage, deed of trust, or other security interest in property (other than cash or a cash equivalent)  Standby letter of credit  Guarantee of a third party

96. 96 Four Safe Harbors... Qualified Escrow Accounts & Trusts... Escrow may not be held by the exchanger or a related party, and the exchanger’s rights to receive, pledge, borrow, or otherwise obtain the benefits of the escrow account must be limited

97. 97 Four Safe Harbors... Escrow Account or trust funds may pay transactional items if...  Related to disposition or acquisition of property, and  Typically listed as the responsibility of a buyer or seller on the closing statement

98. 98 Four Safe Harbors...  Exchanger may receive money or other property directly from another party to the transaction – not from a qualified escrow, trust, or intermediary  Why? Disqualifies safe harbor

99. 99 Four Safe Harbors... Interest and Growth Factors...  Interest earned while the sale proceeds are held by the QI may be paid into escrow  Received by the exchanger as earned income upon completion of transaction

100. 100 Four Safe Harbors... Qualified Intermediary... A person (or company) who facilitates the exchange by making an agreement for the exchange of properties

101. 101 Four Safe Harbors... Qualified Intermediary  Transfers titles to properties  Agreement with a person (other than the exchanger) to transfer relinquished property  Agreement with the replacement property owner to transfer that property

102. 102 Four Safe Harbors...  Direct deeding: intermediary acquires rights to transfer deeds to the properties  Sequential deeding: intermediary acquires deed to relinquished and replacement properties and transfers deeds

103. 103 Four Safe Harbors... Edward (exchanger) Susan (seller) Example 3.1A Direct deeding by a Qualified Intermediary Bob (buyer) Qualified Intermediary

104. 104 Four Safe Harbors... Example 3.1B Direct deeding by Exchanger and Seller Edward (exchanger) Susan (seller) Bob (buyer) Qualified Intermediary $1 million $1 million property $1 million cash $900,000 property $100,000 $1,000,000 $900,000

105. 105 BeforeAfter Edward owns Central Court Apartments valued at $1,000,000 Edward owns Silver City Apartments valued at $900,000 and has $100,000 cash Bob has $1,000,000 CashBob owns Central Court Apartments valued at $1,000,000 Susan owns Silver City Apartments valued at $900,000 Susan has $900,000 cash

106. 106 Four Safe Harbors... Disqualification... Intermediary may not be:  Taxpayer  Related person  Agent of the taxpayer  Person related to agent of taxpayer “Person” also means corporate entities

107. 107 Four Safe Harbors... Disqualification... Agent of the exchanger:  Employee  Attorney  Accountant  Investment banker or broker  Real estate agent or broker Within two-year period ending on the date of the transfer of the first of the relinquished properties

108. 108 Four Safe Harbors... Disqualification... Exceptions  Performance of services that are solely with respect to exchanges of real estate  Performance of routine financial, title insurance, escrow, trust services by a financial institution, title insurance company, or escrow company

109. 109 How Are Real Estate Agents Paid?... Safe harbor arrangements allow the real estate professional’s commission to be paid on behalf of the taxpayer as a “transactional item”

110. 110 How Are Real Estate Agents Paid?... Caution: When tenants-in-common ownership interest in involved in the exchange  SEC views the ownership interest as a security, bars payment of a commission or referral fee unless the real estate professional is a licensed security representative  Exchanger may compensate a real estate agent for counseling services

111. 111 Putting It All Together... Evaluating exchange situations  Assess the overall situation  Experience and comfort level  Change of mindset  Even swap or value gain ?

112. 112 Putting It All Together... Finding a qualified intermediary  Member of the Federation of Exchange Accommodators  CES designation  Bonded by insurance company  Professional background, CPA? Attorney?

113. 113 Putting It All Together... Finding a qualified intermediary  Responsibility for losses  Interest on the escrow account  Accessible to your client and you

114. 114 Putting It All Together... Finding a qualified intermediary  Other experts involved  Adequate paper trail  Accustomed to type/size of transaction  Specialty  Licensed securities representative

115. 115 Putting It All Together... Watch out for…..  Complying with time limits  Lack of preparation  Negotiating for only “Plan A” property  Other obstacles that intervene  Unscrupulous parties

116. 116 Thank You... Tax Deferred 1031 Real Property Exchanges