1031 Like Kind Exchanges: Pursuing 1031 Like Kind Exchanges: - - PowerPoint PPT Presentation

Presenting a live 90‐minute webinar with interactive Q&A

1031 Like‐Kind Exchanges: Pursuing 1031 Like Kind Exchanges: Pursuing Opportunities in a Rebounding Market

Mastering Complex Tax Rules and Leveraging the New Net Investment Income Tax

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNES DAY, AUGUS T 28, 2013

Today’s faculty features:

John (Trey) Webb, S hareholder, Bennett Thrasher, Atlanta Ricky Novak, Strategic 1031 Exchange Advisors, Atlanta

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Tax law changes and IRC 1031 Tax law changes and IRC 1031

August 28, 2013

Trey Webb TWebb@btcpa net TWebb@btcpa.net

Circular 230 Disclosure To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax advice contained in this communication is not intended or written to be contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code th li bl t l (ii) ti k ti

• r any other applicable tax law or (ii) promoting, marketing, or

recommending to another party any transaction, arrangement, or

• ther matter.

PAGE 6

Why like kind exchanges should regain momentum…  They defer income taxes!

• American Taxpayer Relief Act of 2012
• Net Investment Income Taxes under PPACA
• Depreciation recapture under bonus depreciation rules

PAGE 7

American Taxpayer Relief Act of 2012  Law passed in Senate on January 1, 2013, signed by President Obama on January 2nd  F lfill P id t’ l d t i t lthi t  Fulfills President’s pledge to raise taxes on wealthiest Americans  Top ordinary tax rate increases from 35% to 39.6%  Top capital gains rate increases from 15% to 20%  Single $400 000; Married filing joint $450 000  Single $400,000; Married filing joint $450,000  Itemized deductions and personal exemptions phase out  Single $250,000; Married filing joint $300,000

PAGE 8

Net Investment Income under PPACA  Law was passed in 2010 but taxes delayed until 2013  Net investment income over $250,000 subject to 3.8% t surtax  IRS issued proposed regulations December 2012

PAGE 9

Net Investment Income under PPACA Background  Investment income includes:  Investment income includes:  Gross income from interest, dividends, annuities, royalties and rents, other than such w hich is derived in the ordinary course of a trade or derived in the ordinary course of a trade or business except… (IRC §1411(c)(1)(A)(i))  Net gain attributable to the disposition of property other than property held in a trade

• r business except… (IRC §1411(c)(1)(A)(iii))

p

( ( )( )( )( ))

PAGE 10

Net Investment Income under PPACA Background  Tax applies to trades or businesses which are  Tax applies to trades or businesses which are  Passive activities (IRC §1411(c)(2)(A))  In the trade or business of trading financial instruments or commodities (IRC §1411(c)(2)(B))

PAGE 11

Net Investment Income under PPACA Background  Income not recognized for regular income tax will  Income not recognized for regular income tax will not be recognized for net investment income tax (see

Preamble to Proposed Regulations)

 Planning opportunities for :  Planning opportunities for :  1031 Like kind exchanges  Installment sales  Involuntary conversions excluded under IRC §1033

PAGE 12

Net Investment Income under PPACA Challenges  Our guidance comes from  Our guidance comes from  Internal Revenue Code Section §1411  Proposed Regulations  Draft Form 8960 issued in August 7, 2013 (without instructions)

PAGE 13

Net Investment Income under PPACA Challenges  Definition of Rental Trade or Business  Definition of Rental Trade or Business  Proposed regulations take the approach that two criteria must be met for rental income to be excepted from tax (

( ))

excepted from tax (Prop. Reg. §1.1411-5(a))  Must be trade or business within the meaning

• f IRC §162

 Must be non-passive under IRC §469

PAGE 14

Net Investment Income under PPACA Challenges  Definition of Trade or Business  There is no definition of trade or business under  There is no definition of trade or business under IRC §162  From 1987 US Supreme Court Case Commissioner v. R b t P G t i 87 1 U S T C P 9191 (F b 24 Robert P. Groetzinger 87-1 U.S.T.C. Par 9191 (Feb 24, 1987) –

“The phrase “trade or business” has been in §162(a) and in that section's predecessors for man ears Indeed the phrase is common section's predecessors for many years. Indeed, the phrase is common in the Code, for it appears in over 50 sections and 800 subsections and in hundreds of places in proposed and final income tax

• regulations. The slightly longer phrases, “carrying on a trade or

business” and “engaging in a trade or business,” themselves are used no less than 60 times in the Code. The concept thus has a well-known and almost constant presence on our tax-law terrain. Despite this, the Code has never contained a definition of the words “trade or business”

PAGE 15

Code has never contained a definition of the words trade or business for general application, and no regulation has been issued expounding its meaning for all purposes”

Net Investment Income under PPACA Challenges  Definition of Trade or Business  Definition of Trade or Business  We have not needed it for rental property  Rental expenses are deductible under Code Section §212

PAGE 16

Net Investment Income under PPACA Challenges  Definition of Trade or Business  Definition of Trade or Business  Must look to case law

 Edwin R. Curphey v. Commissioner (1980) 73 TC 766 Favorable Favorable  Byron K. Anderson and Carolyn Anderson v. Commissioner (1982) TC Memo 1982-576 Unfavorable  Amir H. Jafarpour, et ux. v. Commissioner (2012) TC p , ( ) Memo 2012-165 Unfavorable  Patrick L. O’Donnell and LaDona S. O’Donnell v. Commissioner (1974) 62 TC 781,785 Unfavorable

PAGE 17

Net Investment Income under PPACA Challenges  Definition of Trade or Business  Definition of Trade or Business  It appears that IRS may take a narrow view of what rental properties will qualify as a trade or business business  From Prop. Reg. §1.1411-5(b)(2) Example 1. Rental activity. A, an unmarried individual, rents y a commercial building to B for $50,000 in Year 1. A's rental activity does not involve the conduct of a section 162 trade or business

PAGE 18

Net Investment Income under PPACA Challenges

“Rents could escape the tax under the proposed regulations if a taxpayer Rents could escape the tax under the proposed regulations if a taxpayer qualifies as a ‘real estate professional’ under Section 469(c)(7) and if the particular rental activity is not a passive activity, but determining at what level a taxpayer can be considered such a professional can be difficult, one of IRS's primary drafters of the proposed rules, David Kirk, said in January. There are 11 types of previous real estate professional trades or businesses under Section 469(c)(7)(c), that could fall along a spectrum of material participation Kirk an attorney with the IRS Office of Associate Chief Counsel participation, Kirk, an attorney with the IRS Office of Associate Chief Counsel, Passthroughs and Special Industries, said. ‘We've gotten many comments so far, formal and informal, to say ‘please define trade or business of rental real estate,' and I'm not sure anyone can. It's sort of like ‘you'll know it when you see it,' ‘ Kirk said” From Inclusion of Net Loss of Draft NII Tax Form Could Benefit Taxpayers, Practitioners Say by Lydia Beyoud in Bloomberg BNA Daily Tax Report August 9 2013 9, 2013

PAGE 19

Net Investment Income under PPACA Scenario One  Gain on sale of non-rental real property  Gain on sale of non rental real property  Examples

 Raw land  Second homes  Second homes  Personal residence if gain is taxable  Ownership and use test not met  Gain greater than exemption amount  Gain greater than exemption amount

PAGE 20

Net Investment Income under PPACA Scenario One  Gain is subject to tax since it is not held in a trade or  Gain is subject to tax since it is not held in a trade or business (IRC §1411(c)(1)(A)(iii))  Planning for investment property

 1031 h  1031 exchanges  Be careful that property qualifies as held for investment  Be careful with property placed in service between  Be careful with property placed in service between 1981 and 1986  Installment sales – spread gain over multiple years to stay below income threshold amount for tax to apply  Be careful with property placed in service between 1981 and 1986

PAGE 21

Net Investment Income under PPACA Scenario Two  Gain on sale of non-rental property held in a trade or  Gain on sale of non rental property held in a trade or business  Examples

 F t b ildi  Factory building  Hotel  Hospital

PAGE 22

Net Investment Income under PPACA Scenario Two  Gain is not subject to tax if three criteria are met  Gain is not subject to tax if three criteria are met

 Cannot be gain derived from investment of working capital (i.e. property must be used in the trade or business) (Prop.

• Reg. §1.1411-6(a))

 The trade or business cannot be trading of financial instruments or commodities (IRC §1411(c)(2)(B))  The trade or business cannot be a passive activity in regards to the taxpayer (IRC §1411(c)(2)(A)) to the taxpayer (IRC §1411(c)(2)(A))  Same material participation tests as under IRC §469  Grouping of activities is allowed for material participation  Rental activity exceptions under IRC §469 apply i e  Rental activity exceptions under IRC §469 apply i.e. hotels

PAGE 23

Net Investment Income under PPACA Scenario Three  Gain from sale of rental property  Gain from sale of rental property  Examples

 Office buildings  Rental homes  Rental homes  Apartment complexes  Vacation homes

PAGE 24

Net Investment Income under PPACA Scenario Three  Gain is possibly excepted from tax but two key  Gain is possibly excepted from tax but two key hurdles  Does your rental of the property qualify as a trade or business? trade or business?  Do you materially participate in the trade or business?

PAGE 25

Net Investment Income under PPACA Scenario Three  Does the activity meet the definition of a trade or  Does the activity meet the definition of a trade or business under IRC § 162?  Discussed previously

PAGE 26

Net Investment Income under PPACA Scenario Three  Material participation  Material participation

 Rental activities are per se passive (IRC §469(c)(2))  Rental activities do not include: (Reg. §1.469-1T(e)(3)(ii))  Average period of use is seven days or less  Average period of use is seven days or less  Average period of use is 30 days and significant personal services provided  Extraordinary personal services provided  Rental of property is incidental to non-rental activity of the taxpayer  Property is customarily made available during defined b i h f l i b business hours for non-exclusive use by customers  The provision of the property for use in an activity conducted by a partnership, S corporation, or joint venture in which the taxpayer

• wns an interest is not a rental activity under paragraph (e)(3)(vii)

PAGE 27

• wns an interest is not a rental activity under paragraph (e)(3)(vii)
• f this section.

Net Investment Income under PPACA Scenario Three  Real Estate Professional (IRC §469(c)(7)(B)  Real Estate Professional (IRC §469(c)(7)(B)  Must perform services in real property trades or businesses for more than half of total personal service hours during year and for more than 750 service hours during year and for more than 750 hours  Real estate professionals can make an all or nothing grouping election for rental properties to meet material participation tests on individual properties

PAGE 28

Net Investment Income under PPACA Scenario Three  Real Estate Professional  Real Estate Professional  Often litigated in court  Common errors include  Inability to prove hours in real property trades

• r businesses/ unreasonable hours claimed by

taxpayer  Failure to prove that more than half of hours in real property trades or businesses  Inclusion of non qualifying hours (investor  Inclusion of non-qualifying hours (investor type hours)  Failure to make proper grouping election

PAGE 29

Net Investment Income under PPACA Scenario Four  Sale of property held in a separate entity that is  Sale of property held in a separate entity that is rented to your operating trade or business  Be careful – Can you consider the property separately a trade or business? separately a trade or business?  IRS appears to be expecting a broad inclusion of income in the calculation of net investment income

PAGE 30

Net Investment Income under PPACA Scenario Four  Comment from David H Kirk IRS Office of  Comment from David H. Kirk, IRS Office of Associate Chief Counsel (Passthroughs and Special Industries) “If the rent paid out is not subject to the SECA “If the rent paid out is not subject to the SECA tax and is also exempt for section 1411 purposes, ‘we are perpetuating the base erosion for M di ’” Medicare’”

From Speakers Say NII Tax Regs Could Be Simplified and Recommend Exemptions by Shamik Trivedi Tax Notes Today April 3, 2012

PAGE 31

Net Investment Income under PPACA Scenario Four  Planning:  Planning:  Do not take drastic action immediately  We are still working with proposed regulations  In the future, you may need to consider  Restructuring your business organization  1031 exchanges to defer gain on sale of  1031 exchanges to defer gain on sale of property

PAGE 32

Depreciation recapture  Real estate generally depreciated on a straight line basis  Exception for bonus depreciation  Bonus depreciation allows immediate expenses of certain assets  First introduced 2001-2004, reintroduced 2008-2013 ,  Applies to land improvements  And leasehold improvements since 10/ 22/ 2004

PAGE 33

Depreciation recapture  Taxpayers must recapture depreciation deductions at higher tax rate when property is sold  B f l th t h d t i “lik ki d”  Be careful that exchanged property is “like-kind”  Real property rules

• Straight line recapture – up to 25%

g p p

• Accelerated recapture – up to 39.6%
• May be subject to Net Investment Income tax as well

PAGE 34

Tax Tax-

• Deferred Exchange Strategies:

Deferred Exchange Strategies: Beyond the Basics Beyond the Basics

Ricky B. Novak, Esq.

Qualified to be more than just your Intermediary…….

Disclaimer Disclaimer

IRS Circular 230 Disclosure: Unless explicitly stated to the contrary, this outline, the presentation to which it relates and any other documents or attachments are not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the I t l R C d (ii) ti k ti di t th Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. Qualified to be more than just your Intermediary…….

36

1031 Exchange Fundamentals

Qualified to be more than just your Intermediary…….

37

1031 Exchange Basics 1031 Exchange Basics

• Internal Revenue Code §1031 allows for the deferral of capital gains tax on

the sale of like-kind property either held for investment or productively used in a t d b i trade or business

• Also allows for the deferral of depreciation recapture and deferral of state

taxes (where applicable)

• Deferral can be indefinite, as the taxpayer will not recognize capital gain until

the replacement property is sold without the use of an exchange

• Estate planning opportunities include leaving the assets to one’s heirs,

p g pp g , whereby at the taxpayer’s death, heirs receive the assets at a stepped-up basis (e.g. current fair market value)

• Essentially, the taxpayer deferred payment of capital gains tax and the heirs
• Essentially, the taxpayer deferred payment of capital gains tax and the heirs

are only taxed if and when they sell the inherited asset at a value that exceeds the stepped-up basis Qualified to be more than just your Intermediary…….

38

1031 Exchange Basics 1031 Exchange Basics

• Taxpayer has 45 days from the date of the relinquished property sale to

identify potential replacement property and 180 days to close on this property identify potential replacement property, and 180 days to close on this property

• Identification Rules include the 3 Property Rule, 200% Rule and the 95% Rule
• Like-Kind is broadly defined for real property exchanges, allowing the taxpayer
• Like Kind is broadly defined for real property exchanges, allowing the taxpayer

to trade between: raw land, retail, office, warehouse/industrial, residential rental, and other property types.

• Like-Kind is very narrowly defined for personal property and often requires the
• Like Kind is very narrowly defined for personal property, and often requires the

taxpayer to exchange assets within the same general asset or product class. Personal property assets can include: aircraft, watercraft, collectibles, art, FF&E, certain intangible rights, etc. Qualified to be more than just your Intermediary…….

39

1031 Exchange Basics 1031 Exchange Basics

• Requirements for complete tax deferral:

− Taxpayer must acquire replacement property that equals or exceeds in value the property which was relinquished property which was relinquished − Taxpayer must roll relinquished sale proceeds (referred to as “cash boot”) forward into the replacement property, and replace any debt that was extinguished at the relinquished sale (referred to as “mortgage boot”) with either new debt, new cash or relinquished sale (referred to as mortgage boot ) with either new debt, new cash or any combination of the two

• Should the taxpayer fail to acquire replacement property that equals or

exceeds the value of the relinquished property, taxpayer may still complete a q p p y, p y y p partial exchange

− Replacement property value must exceed the adjusted basis of the relinquished property in order for taxpayer to defer taxation

• Exchanges require involvement by a third-party known as a Qualified

Intermediary (“QI”) Qualified to be more than just your Intermediary…….

40

1031 Exchange Basics 1031 Exchange Basics

• Exchange Tax Deferral Example:

− Taxpayer purchases income producing commercial property for $1 million in 2004 Taxpayer purchases income producing commercial property for $1 million in 2004 (using $250,000 in cash and a $750,000 interest only loan to acquire the property), and enters into a contract to sell the property in 2013 for $1.4 million. − From 2004-2013, Taxpayer takes depreciation on the property in the amount of $250,000 and performs capital improvements to the property in the amount of $100,000. Therefore the adjusted basis of the property is $850,000 (sum of $1 million purchase price, minus $250,000 in depreciation, plus $100,000 in capital improvements). − Taxpayer’s potential taxable gain is $550,000 (sum of $1.4 million sales price, minus $850,000 adjusted basis). − In order to defer all potential taxable gain, the Taxpayer will need to acquire p g , p y q replacement property that equals or exceed the relinquished property sales price ($1.4 million) AND must roll all $650,000 in cash boot ($1.4 million sale price, minus $750,000 mortgage boot) into the replacement property).

Qualified to be more than just your Intermediary…….

41

Understanding the Math Understanding the Math

$100,000 Taxable Gain Taxable Gain Deferred Gain $500,000 Deferred Capital Gain $600,000 Capital Gain Basis Capital Gain $400,000 Basis $400,000 Basis

$1 000 000 $900 000 Qualified to be more than just your Intermediary……. $1,000,000 Relinquished Sale $900,000 Replacement Purchase

42

Complex 1031 Transactions

Qualified to be more than just your Intermediary…….

43

Complex Exchange Options Complex Exchange Options

• There are several creative exchange options that allow taxpayers to buy

replacement property before they sell relinquished property, build replacement t l d d b ild l t t i t l d th property on new land, and build replacement property improvements on land they already own

• These exchanges require the intermediary to engage an Accommodating

Titleholder (“AT”), whereby a single-member LLC that is owned by an entity affiliated with the intermediary is used to acquire the eventual replacement property on the taxpayer’s behalf (known as “parking” property)

• These transactions require significant preplanning, as any third-party lending is

typically affected by the use of the AT Qualified to be more than just your Intermediary…….

44

Reverse Exchanges Reverse Exchanges

• IRS provided safe harbor guidance for reverse exchanges in Revenue

Procedure 2000-37

• Two types of reverse exchanges:
• Reverse exchange first (used when lender will not agree to lend to AT in order to

acquire replacement property; difficult to structure due to strict debt/equity requirements) requirements)

• Reverse exchange last (most commonly used reverse structure)
• Reverse Exchange Last: AT acquires the parked property on behalf of the

taxpayer, and then sells the property to the taxpayer as replacement property taxpayer, and then sells the property to the taxpayer as replacement property after the relinquished property has been sold

• Rev. Proc. 2000-37 requires transaction to be completed within 180 days in
• rder for taxpayer to obtain safe harbor benefit

p y Qualified to be more than just your Intermediary…….

45

Construction Exchanges Construction Exchanges

• Utilized when taxpayer wishes to acquire land and construct ideal replacement

property

• AT is used to park the property and cause improvements to be completed;
• nce construction has been completed, property is transferred to the taxpayer as

the replacement property

• R

l t l i l l t d b ddi th t f th l d d t f ll

• Replacement value is calculated by adding the cost of the land and cost of all

improvements completed within the 180 days; property need not receive Certificate of Occupancy

• Can also be performed as a Reverse Construction exchange whereby AT
• Can also be performed as a Reverse Construction exchange, whereby AT

parks the land and initiates improvements before relinquished property has been sold Qualified to be more than just your Intermediary…….

46

Construction Leasehold Construction Leasehold Exchanges Exchanges

• Utilized when taxpayer wishes to improve property that taxpayer already owns
• Transaction specifically outlined in Rev Proc 2004-51; IRS specified that the
• Transaction specifically outlined in Rev. Proc. 2004 51; IRS specified that the

exchanger should not own both the property that is being relinquished and the property that is to be improved, however, property to be improved can be owned by a related party

• AT enters into a 30+ year ground lease with the owner of fee title and causes

improvements to be constructed; within 180 days the ground lease and leasehold improvements are transferred to the exchanger as the replacement property (typically via transfer of the membership interest in the AT) (typically via transfer of the membership interest in the AT)

• Lease must continue to be respected for at least 2 years in order for

transaction to be accepted by the IRS

• C

l b f d R C t ti L h ld h

• Can also be performed as a Reverse Construction Leasehold exchange

Qualified to be more than just your Intermediary…….

47

Non Non-

• Safe Harbor Exchanges

Safe Harbor Exchanges

• Rev.Proc. 2000-37 considered exchanges that did not follow the safe harbor

guidance, which was memorialized in its “no inference” language

• PLR 200111025 granted deferral to a taxpayer who took nearly 19 months to

complete a reverse exchange

• Transactional structure changes were minimal
• Transactional structure changes were minimal
• Is this PLR still valid today?
• Current industry standards (consensus of Big Four) require “burdens and
• Current industry standards (consensus of Big Four) require

burdens and benefits” of ownership to be on the AT

• Requires AT to have “skin in the game”; 5-10% equity contribution
• Exchange must reflect “real world” transactional structuring

Exchange must reflect real world transactional structuring

Qualified to be more than just your Intermediary…….

48

Current Issues for 1031 Transactions

Qualified to be more than just your Intermediary…….

49

Qualifying the Intermediary Qualifying the Intermediary

• Over

the past few years, there have been numerous instances

• f

intermediaries filing bankruptcy or misappropriating client funds. Examples include:

• Southwest Exchange Corp.
• 1031 Tax Group
• LandAmerica 1031 Exchange Services Company
• Real Estate Exchange Services (REES)

Real Estate Exchange Services (REES)

• Top areas to focus on when considering a QI:
• Disinterested – QI must be a disinterested third party and not have acted in any

agency capacity for the prior two years

• Knowledge – Do they understand complex exchange issues, and truly appreciate how

these issues affect the taxpayer’s short & long term tax, real estate, and other

• bjectives?
• Security – How are funds invested, is this a transparent process that allows input from

the taxpayer, and what security measures are in place to protect principal and ensure liquidity?

• Service – Do you have direct access to the person with 1031 expertise at all times, or

do you get handed off to a less qualified back office paper processor with “9-5” hours?

Qualified to be more than just your Intermediary…….

50

Seller Financing Seller Financing

• While the credit markets have loosened, there continues to be a substantial

amount of seller financing being offered by sellers

• Seller financing is an attractive option for both buyers and sellers looking to

consummate a real estate transaction when debt financing is difficult to obtain

• Replacement Property acquisition: seller financing is treated no differently than

traditional third-party bank financing

• Relinquished Property sale: seller financing has significant impact on the 1031
• Relinquished Property sale: seller financing has significant impact on the 1031

exchange transaction Qualified to be more than just your Intermediary…….

51

Seller Financing: Seller Financing: Relinquished Property Relinquished Property

• If the note term will exceed the 180 day exchange period, various options may

be considered:

1. Cash Loan to Buyer at Closing 2. Sale of the Note by the Intermediary to the Taxpayer or Related Party for Full Value 3 Use the Note as Partial Payment for Replacement Property 3. Use the Note as Partial Payment for Replacement Property 4. Sale of Note to Third Party at Less Than Face Value

• Seller financed note may be structured as a wrap note

Qualified to be more than just your Intermediary…….

52

Cash-Out Options for 1031 Transactions

Qualified to be more than just your Intermediary…….

53

Cash Cash-

• Out Options

Out Options

• Taxpayers may perform a partial exchange whereby cash is taken at closing
• Cash is taxed as it is deemed to be paid from the gain portion of the

t ti thi l li t f d f i iti l it i t t transaction; this also applies to any refund of initial equity investments

• Note that debt repayment for amounts legitimately loaned to an entity (LLC, S-

Corp, C-Corp, Partnership) are not characterized as cash out

• Solution to achieve 100% tax deferral: taxpayer does not take cash at closing,

but instead performs a post-closing cash-out refinance Qualified to be more than just your Intermediary…….

54

Rules for Cash Rules for Cash-

• Out

Out Refinancing Refinancing

• Pre-Relinquished Property Sale Cash-Out
• Generally, this is acceptable if it occurs at least 6 months before closing, and prior to

y, p g, p the property being under contract

• 6-month guideline should not be required if cash is reinvested in the relinquished

property (i.e. cash is used to repair the property as a condition to sale) or cash is used as earnest money for replacement property

• Post-Replacement Property Acquisition Cash-Out
• Industry has mixed emotions over this activity, and general thought process has

Industry has mixed emotions over this activity, and general thought process has changed numerous times over the past 3 years

• Current belief by “Big Four” accounting firms is that cash-out refinance can occur

immediately after closing, with no risk to the taxpayer’s 1031 exchange success

• More conservative approach is to wait at least 6 months before performing the cash-
• ut refinance, unless equity is being reinvested in the replacement property (repairs,

improvements, etc.)

Qualified to be more than just your Intermediary…….

55

More on Cash More on Cash-

• Out

Out Refinancing Refinancing

• There is much uncertainty over the ability of a taxpayer to perform a cash-out

refinance immediately before the relinquished property closing or immediately after the replacement property closing

• Main IRS concern is that equity is preserved in the transaction and taxpayer

does not circumvent the “spirit” of the 1031 rules, but there is no statutorily driven p y guidance

• Lenders typically do not allow a refinance once a property is listed for sale,

which may also limit cash-out refinance possibility which may also limit cash out refinance possibility Qualified to be more than just your Intermediary…….

56

Title & Partnership Issues for Title & Partnership Issues for 1031 Transactions

Qualified to be more than just your Intermediary…….

57

Title / Entity Issues Title / Entity Issues

• The 1031 rules require that title is taken to replacement property by the same

taxpayer who relinquished title

• Title should not be changed immediately before or immediately after an

exchange transaction

• Definition of “immediately” varies since there is no statutorily driven requirement

y y q

• Tax professionals find a varying degree of risk associated with this issue, especially

when considering Drop & Swap structuring

• Husband & Wife are an exception to the “immediate” rule as the IRS does not
• Husband & Wife are an exception to the immediate rule, as the IRS does not

perceive any potential abuse Qualified to be more than just your Intermediary…….

58

Partnership Issues Partnership Issues

• Options for partners who wish to perform an exchange but also want to

discontinue the partnership relationship when selling real estate & S “

• Drop & Swap: Property is deeded out, or “dropped” to each partner in advance
• f closing, and individual partners then perform their own exchange
• Requires significant preplanning; most tax professionals recommend the “drop” occur

before the property is under contract and long before closing (~one year?) before the property is under contract, and long before closing (~one year?)

• There are potential Lender issues to consider if property is leveraged with third-party

debt with a due-on sale clause

• Dissolution of partnership is also recommended

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More Partnership Issues More Partnership Issues

• Swap & Drop: In the event there is not sufficient time to properly execute the

Drop & Swap, the partnership can perform the exchange and then perform the drop in the future drop in the future

• Partnership typically sets-up a new single-member LLC for each partner and each

LLC acquires replacement property according to each partner’s need Id tifi ti i t b id d

• Identification issues must be considered
• Each partner manages their respective LLC of interest, and after sufficient time has

passed (~one year?), the partnership is liquidated and each partner receives their respective LLC in the liquidating distribution respective LLC in the liquidating distribution

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Exchanges of Exchanges of Vacation Homes/Second Homes

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Vacation Homes & Vacation Homes & Second Homes Second Homes

• A taxpayer wishing to exchange these types of property must be certain that

they have established a held for investment intent and must avoid significant personal use of the property personal use of the property

• Personal use property does not qualify for exchange treatment
• Regardless of the existence of an “investment intent” by the taxpayer, personal
• Regardless of the existence of an investment intent by the taxpayer, personal

use will typically trump this intent

• Moore v. Commissioner, T.C. memo. 2007-134

IRS d d C t d th t th i t f i t t i t t i d f

• IRS argued, and Court agreed that the existence of an investment intent, in and of

itself, is not sufficient

• Must look at totality of circumstance

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Vacation Homes & Vacation Homes & Second Homes Second Homes

• IRS issued safe-harbor guidelines for residential properties in Rev Proc 2008-

16, 2008-10 IRB; note that this is only a safe-harbor

• IRS will not challenge whether a dwelling unit satisfies the intent test if:
• The taxpayer owns both the Relinquished Property and Replacement Property for at

least 24 months which is deemed long enough to establish a qualifying use ; AND least 24 months, which is deemed long enough to establish a qualifying use ; AND

• In each of the two 12-month periods immediately preceding and following the

exchange, (i) the taxpayer rents the dwelling unit to another person(s) at a fair market rental for 14 days or more, and (ii) the period of the taxpayer’s personal use of the dwelling unit doe not exceed the greater of 14 days or 15 percent of the number of days during the 12-month period that the dwelling

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Related-Party Concerns for Related-Party Concerns for 1031 Transactions

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Related Related-

• Party Concerns

Party Concerns

• Who is a Related-Party? The term related-party means any party bearing a

relationship to the taxpayer described in Section 267(b) or 707(b)(1) of the Code, including but not limited to: including, but not limited to:

• Family members, such as siblings, spouses, ancestors, and lineal descendants;
• Individual and corporation, where more than 50% in value of the stock is owned

directly or indirectly by or for such individual; y y y ;

• A fiduciary and a beneficiary of the same trust;
• A grantor and a fiduciary of the same trust;
• 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; and

• Two partnerships in which the same persons own, directly or indirectly, more than

50% of the capital interest or profits interest. p p

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Related Related-

• Party Concerns

Party Concerns

• Selling to a Related-Party
• A taxpayer may sell his or her Relinquished Property to a related-party as long as

th l t d t h ld th t f t l t 2 ft i i it f th the related-party holds the property for at least 2 years after acquiring it from the taxpayer

• Note that there are certain exceptions to this 2 year rule, such as death of the

taxpayer or related-party & involuntary conversion.

• Buying from a Related-Party
• Generally, a taxpayer may only purchase the Replacement Property from a related

party if either:

(1) that related-party is also performing an exchange; or (2) that related-party recognizes tax liability that exceeds the liability the taxpayer would have recognized had he or she not performed the exchange (i.e., no basis-shifting occurs; See Teruya Bros, Ltd 124 T.C. 45)

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Personal Property Exchanges Personal Property Exchanges

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Personal Property Exchanges Personal Property Exchanges

• The like-kind element for personal property assets that are used in a trade or

business or held for investment is much more narrowly defined as compared to real property assets real property assets

• In certain situations the taxpayer must acquire Replacement Property that is

within the same General Asset or Product Class, with an added element of lifi ti i l i th l ti i hi h t i d i tl h d qualification involving the location in which asset is predominantly housed or used

• State and/or local sales and use tax concerns must be also addressed when

selling personal property assets, especially if there are multijurisdictional issues; this can become even more complex when structuring a Reverse Personal Property exchange Qualified to be more than just your Intermediary…….

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Types of Personal Property Types of Personal Property

• Typical personal property assets include:
• Depreciable Tangible Personal Property
• Requires the property to be of like product or general asset class
• FF&E, aircraft, watercraft, railroad cars, autos, trucks, etc.
• Non-Depreciable Tangible Personal Property

Non Depreciable Tangible Personal Property

• Art, collectibles, livestock, etc.
• Intangible Personal Property
• Requires analysis of the nature or character of the rights involved and the nature and the

character of the underlying property to which the intangible relates

• Patents, software, designs and drawings, trade secrets and know-how, etc.

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Multi-Asset Exchanges Multi-Asset Exchanges

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Understanding Understanding Multi Multi-

• Asset Exchanges

Asset Exchanges

• When taxpayers sell a business, they have the alternative to perform a stock

sale or an asset sale

• Prior to finalizing any sales agreement, the taxpayer should consider the

various financial and tax concerns associated with each of these alternatives

• It is recommended that the taxpayer consider sales proceeds allocations prior

to entering into any sales agreements, as this may ultimately influence the manner in which they structure their business sale

• Asset sales have the ability to be structured as a 1031 exchange, with values

being allocated to real property, personal property and goodwill/going concern Qualified to be more than just your Intermediary…….

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Understanding Understanding Multi Multi-

• Asset Exchanges

Asset Exchanges

• Within the realm of justifiable economic feasibility, the taxpayer should attempt

to allocate values of Relinquished Property based on the taxpayer’s intended R l t P t b th t th ll d b h ld t th Replacement Property; remember that the seller and buyer should agree to these allocations and file a Form 8594

• As an example, should that taxpayer plan to only purchase income producing

real estate as Replacement Property, then value should maximized in allocations to the real property which is being relinquished, as opposed to the personal property and goodwill/going concern Qualified to be more than just your Intermediary…….

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The International Perspective

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International 1031 Exchanges International 1031 Exchanges

• US Taxpayer (resident alien, naturalized citizen, etc.) with non-US real

property holdings

• Exchange must be foreign to foreign or US to US (whereby US is defined as the 50
• Exchange must be foreign to foreign or US to US (whereby US is defined as the 50

States plus US protectorates)

• Currency issues
• Treatment of how real estate is held in foreign jurisdictions
• Foreign person who holds US property
• FIRPTA (Foreign Investment in Real Property Tax Act) Withholding
• On or after January 1, 1985
• Any person who acquires US real property from a foreign seller (person or corporation)
• 10% of sales price mandatory withholding by purchaser, regardless of cash involved or basis of

foreign seller

• These funds are treated outside the 1031 exchange and result in gain to the foreign seller

(unless apply & receive a withholding certificate)

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Tax Credit & Deduction Strategies

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Tax Mitigation for Tax Mitigation for Non Non-

• Exchanged Property

Exchanged Property

• Taxpayers who choose to perform a partial exchange or who incur tax liability
• n the sale of the non-exchanged assets (such as Inventory, Goodwill / Going-

Concern Personal Property etc ) should consider investing in other tax Concern, Personal Property, etc.) should consider investing in other tax mitigation strategies.

• These tax benefits may mitigate state or federal tax liability, and are typically

purchased in the form of certificates or require investing in partnerships that can purchased in the form of certificates or require investing in partnerships that can allocate these credits or deductions to the taxpayer

• These tax mitigation strategies may also be implemented as a way to increase

free cash-flow for companies that want to improve their balance sheet in preparation for a future sale Qualified to be more than just your Intermediary…….

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Credit & Deduction Credit & Deduction Alternatives Alternatives

• Common Federal Tax Deductions and/or Credits

– Conservation Easement Tax Deductions Conservation Easement Tax Deductions – Renewable Energy Tax Credits / Deductions

• Various State Tax Deductions and/or Credits
• Various State Tax Deductions and/or Credits

– Conservation Easement Tax Credits / Deductions – Film Tax Credits – Historic Tax Credits – Historic Tax Credits – Low Income Housing Tax Credits – Renewable Energy Tax Credits /Deductions

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Firm Contact Information Firm Contact Information

Ricky B. Novak direct: 678.522.8801 1.888.800.1031 www.sea1031.com email: rbnovak@sea1031.com Qualified to be more than just your Intermediary……. www.sea1031.com

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