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1031 Exchanges David Gorenberg

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  • 1. 1031 Exchanges –The Art & Science of Capital PreservationPresented by:Citibank, N.A. – 1031 Exchange ServiceDavid M. Gorenberg, EsquireCertified Exchange Specialist®Presented to:
  • 2. Please Turn Cell Phones and Pagers to Silent or Off.Thank you.2 1031 Exchanges: The Art & Science of Capital Preservation
  • 3. Important Disclosures This presentation does not constitute legal or tax advice. Citibank and its employees do not provide tax or legal advice and are not responsible for advising customers on the laws or regulations pertaining to any 1031 exchange transaction. Citibank and its employees will not make any representations regarding the tax consequences of any 1031 exchange transaction. It is the customer’s responsibility to seek tax and legal advisors in connection with any 1031 exchange transaction. IRS Circular 230 Disclosure: To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Citibank, N.A., Member FDIC. Citibank and Arc Design is a registered trademark of Citigroup Inc.3 1031 Exchanges: The Art & Science of Capital Preservation
  • 4. Overview of the Statute and Regulations4 1031 Exchanges: The Art & Science of Capital Preservation
  • 5. Taxation 101• Generally, all income is taxable, unless specifically exempted by law.• Even illegal income, such as stolen or embezzled funds, must be reported on Line 21 of Form 1040. Source: Department of Treasury, Internal Revenue Service, Publication 525.5 1031 Exchanges: The Art & Science of Capital Preservation
  • 6. IRC Section 1031• “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held for productive use in a trade or business or for investment.”• §1031 provides for deferral of taxes, not complete elimination.6 1031 Exchanges: The Art & Science of Capital Preservation
  • 7. Like-kind Property Foreign real property is not like-kind to U.S. real property.7 1031 Exchanges: The Art & Science of Capital Preservation
  • 8. Business or Investment Use • There are five tax classes of property: 1) property used in taxpayer’s trade or business; 2) property held primarily for sale to customers; 3) property which is used as your principal residence; 4) property held for investment; and 5) property used as a vacation home • Section 1031 applies to the first and fourth categories (and perhaps the fifth)8 1031 Exchanges: The Art & Science of Capital Preservation
  • 9. Less than Fee Interests in Real Property that Qualify forExchanges• Leases with at least 30 years remaining, including renewal options• Vendee’s interest in a land sale contract; not the vendor’s interest• Undivided interest in one property for an undivided or 100% interest in another property• Remainder interest in real property• Timber rights, riparian rights, mineral rights – As determined by state law9 1031 Exchanges: The Art & Science of Capital Preservation
  • 10. Like Kind Personal Property• Under the regulations, personal depreciable property used in business or held for investment is exchanged with like-kind property if exchanged either for property of a like kind or like class• Properties are of like class if they are in the same: – General Asset Class – Rev. Proc. 87-56, or – Product Class – SIC Manual (4 digits)• Personal property is like kind if identical10 1031 Exchanges: The Art & Science of Capital Preservation
  • 11. Like Kind Personal Property• Livestock of the same sex• Automobiles for automobiles• Buses for buses• Manufacturing equipment for manufacturing equipment• 13 general asset classes; OMB Standard Industrial Classification (SIC) Manual identifies 4-digit product classes; New North American Industry Classification System (NAICS) is 1400 pages – Exchanges within product class11 1031 Exchanges: The Art & Science of Capital Preservation
  • 12. Common Personal Property Exchanges• Aircraft• Artwork• Collectibles• Equipment• Fleet Vehicles• Intellectual Property – Licenses, Franchises, Patents, Trademarks• Others12 1031 Exchanges: The Art & Science of Capital Preservation
  • 13. §1031 in a Nutshell• To obtain complete deferral of capital gains taxes, the taxpayer should: – Purchase replacement property that is equal or greater in value to the relinquished property – Have equal or greater equity in the replacement property – Have equal or greater debt on the replacement property – Receive nothing except like-kind property – Avoid constructive receipt of exchange proceeds – Use a qualified intermediary13 1031 Exchanges: The Art & Science of Capital Preservation
  • 14. Why Exchange?14 1031 Exchanges: The Art & Science of Capital Preservation
  • 15. Delayed Exchanges- Statutory Requirements• 1984 Congress amends Section 1031 – 45 day identification period – 180 day exchange period runs concurrent • Or due date of tax return, whichever is earlier – Calendar days, not business days – No extensions – Exchange starts on date of recording, or when burdens and benefits of ownership of relinquished property are transferred, whichever is first15 1031 Exchanges: The Art & Science of Capital Preservation
  • 16. Identification Requirements• Signed, and in writing• Delivered – QI or seller of replacement property• Unambiguously described – Legal description – Street address – Distinguishable name (e.g., Mayfair Apartment Building)• May be revoked or amended, with same formality as above16 1031 Exchanges: The Art & Science of Capital Preservation
  • 17. Identification Rules• 3 Property Rule – up to 3 properties, without regard to FMV; or• 200% Rule – any number of properties, so long as aggregate FMV does not exceed 200% of FMV of relinquished properties; but• 95% Exception – if first two rules violated, must acquire 95% of FMV of all identified properties17 1031 Exchanges: The Art & Science of Capital Preservation
  • 18. Time Restrictions Identification Period Exchange Period Day 0 Day 45 Day 180 NOTE: The total exchange period cannot exceed 180 days, under any circumstances. 1031 Exchanges: The Art & Science of Capital Preservation18
  • 19. Regulations: 1.1031- safe harbors• 1.1031(k)-1(g) – (2) Security or Guarantee Arrangements • Determination of whether the taxpayer is in actual or constructive receipt of the exchange funds is made without regard to existence of mortgage, standby letter of credit, third party guarantee, etc. – (3) Qualified Escrow Accounts and Qualified Trusts • Determination of whether the taxpayer is in actual or constructive receipt of the exchange funds is made without regard to whether the funds are held in a Qualified Escrow Account or Qualified Trust – QEA – Escrow holder is not a disqualified person; escrow agreement contains “(g)(6)” limitations – QT – Trustee is not a disqualified person; trust agreement contains “(g)(6)” limitations – (4) Qualified Intermediary – QI is not considered an agent of the taxpayer; is not a disqualified person; QI enters into “exchange agreement” that contains the “(g)(6)” limitations – (5) Interest and Growth Factors • Determination of whether the taxpayer is in actual or constructive receipt of exchange funds is made without regard to the fact that the taxpayer is or may be entitled to receive any interest or growth factor with respect to the deferred exchange. 1031 Exchanges: The Art & Science of Capital Preservation19
  • 20. Regulations: 1.1031- (g)(6) Limitations• (i) An agreement limits a taxpayers rights as provided in this paragraph (g)(6) only if the agreement provides that the taxpayer has no rights, except as provided in paragraphs (g)(6)(ii) and (g)(6)(iii) of this section, to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.• (ii) The agreement may provide that if the taxpayer has not identified replacement property by the end of the identification period, the taxpayer may have rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property at any time after the end of the identification period.• (iii) The agreement may provide that if the taxpayer has identified replacement property, the taxpayer may have rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property upon or after – (A) The receipt by the taxpayer of all of the replacement property to which the taxpayer is entitled under the exchange agreement, or – (B) The occurrence after the end of the identification period of a material and substantial contingency that – • (1) Relates to the deferred exchange, • (2) Is provided for in writing, and • (3) Is beyond the control of the taxpayer and of any disqualified person (as defined in paragraph (k) of this section), other than the person obligated to transfer the replacement property to the taxpayer. 1031 Exchanges: The Art & Science of Capital Preservation20
  • 21. Treasury Inspector General for Tax Administration21 1031 Exchanges: The Art & Science of Capital Preservation
  • 22. Treasury Inspector General for Tax Administration• Reference 2008-30-154; August 27, 2008 – “Guidance Could Be Enhanced for Deciding to Use a Qualified Intermediary in Like-Kind Exchanges” • “This report presents the results of our review of qualified intermediary regulations and qualification requirements. The objectives of this review were to examine transactions subject to Internal Revenue Code Section 1031, assess the qualification requirements for qualified intermediaries, and determine the legal protections available to taxpayers. We conducted this review in response to a request by the Chairman of the United States House of Representatives Committee on Financial Services.” 1031 Exchanges: The Art & Science of Capital Preservation22
  • 23. Regulations under Sections 468B and 787223 1031 Exchanges: The Art & Science of Capital Preservation
  • 24. Treasury decision 9413- Regulations Update• Designated settlement funds – escrow accounts, trusts, and funds used in deferred like-kind exchanges; loans to exchange facilitators.• “468-B” Regulations – The regulations provide rules regarding the taxation of income earned on escrow accounts, trusts, and other funds used during deferred like-kind exchanges of property• “7872” Regulations - regarding below-market loans to facilitators of these exchanges.• Effective for all transactions commenced on or after October 8, 2008. 1031 Exchanges: The Art & Science of Capital Preservation24
  • 25. 468-B Regulations• IF: – The exchange funds are $2,000,000 or greater; OR – The exchange funds remain with the QI for 6 months or longer• THEN: – All interest earned on the exchange funds must be paid to the taxpayer • Applicable Federal Rate • 91-day (13-week) T-Bill rate 1031 Exchanges: The Art & Science of Capital Preservation25
  • 26. Effect of Bankruptcy of Large National Qualified Intermediaries 1031 Exchanges: The Art & Science of Capital Preservation26
  • 27. QI Bankruptcy- A Tale of Two Cities• Southwest Exchange – Henderson, NV; Donald K. McGhan and others in his family – 2007; 130+ clients; $97.5MM+ – Funds used to acquire breast implant company, 19-passenger jet, lavish meals, etc.27 1031 Exchanges: The Art & Science of Capital Preservation
  • 28. QI Bankruptcy- A Tale of Two Cities• 1031 Tax Group – Richmond, VA; Edward H. Okun and others in his business – 2007; 300 +/- open exchanges; $151MM+ – Funds used to acquire jewelry, sports cars, helicopters, shopping malls and other “toys”28 1031 Exchanges: The Art & Science of Capital Preservation
  • 29. QI Bankruptcy- The LandAmerica saga• Millard refrigerated Services v. LandAmerica – http://www.les1031creditorcommittee.com/76_3147.pdf – DeGroot v. Exchanged Titles • 159 B.R. 303 (1993) – Cook v. Garcia • 110 F.3d 67 , 1997 WL 143827 (1997) – In re San Diego Realty Exchange Co., Inc. • 24 F.3d 249, 1994 WL 161646 (1994) – Cook v. 1031 Exchange Corp. • 29 Va. Cir. 302, Not Reported in S.E.2d, 1992 WL 885015 (1992) – In re. Sale Guaranty Corp. • 220 B.R. 660 (1998) – Rechtzigel v. Fidelity National • 748 N.W. 2d 312 (2008) 1031 Exchanges: The Art & Science of Capital Preservation29
  • 30. State Regulation of Qualified Intermediaries• Enacted • Pending – California – Arizona – Colorado – Maine – Idaho – Oklahoma – Nevada – Oregon – Virginia – Texas – Washington 1031 Exchanges: The Art & Science of Capital Preservation30
  • 31. Other Considerations 1031 Exchanges: The Art & Science of Capital Preservation31
  • 32. Choosing a Qualified Intermediary• Phone Book? • Qualifications – When was firm established• Internet? – Primary business, or sideline• Referrals – How many transactions completed – Financial stability – Security of exchange proceeds – Fees, and what is included – FEA • www.1031.org – Certified Exchange Specialist® • www.1031ces.org 1031 Exchanges: The Art & Science of Capital Preservation32
  • 33. Contact InformationDavid Gorenberg, Esquire Kristina C. HarshanyCertified Exchange Specialist® Certified Exchange Specialist®Senior Vice President, 1031 Exchange Services Vice President, 1031 Exchange ServicesCitibank, N.A. Citibank, N.A.1650 Market Street, Suite 3550 1650 Market Street, Suite 3550Philadelphia, PA 19103 Philadelphia, PA 19103Office: 267.385.3624 Office: 267.385.3625Fax: 866.767.8201 Fax: 866.765.8874Mobile: 610.883.2181 Mobile: 610.883.2181E-mail: david.gorenberg@citi.com E-mail: kristina.c.harshany@citi.com33 1031 Exchanges: The Art & Science of Capital Preservation