Section 1031 For Pros Handbook

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Section 1031 For Pros Handbook

  1. 1.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Flawless Section 1031 Exchanges for Over 27 Years                  It is estimated that 20-25% of the nearly $200B in annual real estate transactions could benefit from a Section 1031 Exchange, and that only 3% take advantage of this powerful tool. Edmund & Wheeler, as a Qualified Intermediary (QI), has been facilitating Section 1031 Exchanges for over 27 years. We have developed “The Power of Section 1031” to provide a solid understanding of Section 1031 basics and the strategic ways in which Section 1031 can be utilized and to assist accounting professionals in recognizing opportunities for their clients. Section 1031 For Professionals* *Accountants, Attorneys, Enrolled Agents and Financial Planners Course Handbook Edmund & Wheeler, Inc. QI 567 Cottage Street Littleton, NH 0561 603-444-0020 www.section1031.com exchange@section1031.com
  2. 2.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Welcome To Section 1031 for Professionals. This workbook has been designed to assist you during the course, and to provide a reference tool for you in the future. The session is broken down into three sections as described below. Web references have been made throughout the document so that you can do further topical research as required. Web references are indicated with a grey arrow. If you have additional questions or concerns after you complete this course, Edmund & Wheeler is always available by email at exchange@section1031.com, by phone at 603-444-0020, or on the Web at www.section1031.com. Our practice provides professionals with Section 1031 consulting at no charge! Section 1&1a Introduction & 1031 Basics Section 2 Case Studies & Real-life Examples Section 3 Alternate Exchange Opportunities Section 1 provides you with an outline of this course, an introduction  to the Section 1031 Exchange and the essential elements required for  successful exchanges. Section 1a provides specific accounting  information.    This section lasts approximately 2 hours and begins on Page 3.  www.section1031.com Section 2 contains case studies of the various types of Exchanges as  well as real‐life examples of actual transactions that will assist you in  developing your own Section 1031 strategies.    This section lasts approximately 1 hour and begins on Page 35.  Section 3 outlines the viable alternatives for Exchanges that can be  used for diversification, relocation or the desire of a client wishing to  exit from the real estate investment class.     This section lasts approximately 1 hour and begins on Page 55.  Summary Section 1031 Glossary 1 Page Course Summary – “Must Have Section 1031 Concepts”  Commonly used phrases and Section 1031 definitions.  45/180 Calculation Charts  This section begins on Page 72.   
  3. 3.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Contents Introduction...................................................................................................................................................5 About Edmund & Wheeler, Inc......................................................................................................................6 Primary Objectives of This Course ...............................................................................................................7 What Is A Section 1031 Exchange ...............................................................................................................8 The Five Critical Elements of an Exchange ..................................................................................................8 The Regulation .............................................................................................................................................8 An Exchange at a glance..............................................................................................................................9 Section 1031 (a)(1) IRS Code.......................................................................................................................9 Exceptions to Section 1031 ..........................................................................................................................13 Investment Purpose and the Benefits of an Exchange .................................................................................14 The Essential Elements ................................................................................................................................14 Replacement Property Rules........................................................................................................................15 Real Property (What is Like Kind?)...............................................................................................................16 Examples of Like-kind...................................................................................................................................17 Personal Property.........................................................................................................................................18 Timing Is Everything .....................................................................................................................................18 Can Anyone Handle an Exchange?..............................................................................................................19 Who Qualifies for an Exchange? ..................................................................................................................19 The Qualification Tool...................................................................................................................................20 The Five Most Common Section 1031 Misconceptions................................................................................22 Section 1 Introduction & 1031 Basics
  4. 4.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Contents How the Different States Approach Section 1031.........................................................................................24 Reporting an Exchange to the IRS ...............................................................................................................25 Form 8824 ....................................................................................................................................................26 Completing Form 8824 (Part I) .....................................................................................................................28 Completing Form 8824 (Part II) ....................................................................................................................29 Completing Form 8824 (Part III) ...................................................................................................................30 What is Boot? ...............................................................................................................................................31 What is New Money?....................................................................................................................................31 Exchanges That Cross Two Tax Years ........................................................................................................31 Can a Failed Exchange Be Fixed? ...............................................................................................................32 Section 1031 and Partnerships.....................................................................................................................33 Section 1031 or Section 1033?.....................................................................................................................34 Section 1a Section 1031 & Accounting
  5. 5.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Too many professionals get caught up in the belief that  Section 1031 is only about deferring capital gains. While it  is one of the remaining tax deferral tools available, it’s  actually a LOT about leverage. Clients using what they  would have paid immediately in capital gains taxes to  improve the quality and value of their holdings and plan  for their financial future, is REALLY what Section 1031 is  all about.  Section 1031 has been a part of the Internal  Revenue Service Code since 1921!  Look at it as a gift from Uncle Sam, but don’t tell anyone.  Ok, let’s do the math. These numbers suggest that  investors paid the Government over $5B in capital gains  taxes when in fact, they could have used this money in  their own portfolios, interest free, for as long as they  would like. Wait a minute…  Why is this so? We have found that many professionals  that we deal with on a day‐to‐day basis are unclear of the  many strategic uses of Section 1031. Unfortunately, there  are still many that don’t even know of its existence, and  fail to recognize even its most basic uses.  As professionals, you have a certain responsibility to your  clients regarding the tax ramifications of their  transactions.  Holders of investment real estate should be  made aware of the tools that are available to help them  strengthen their real estate portfolios. Section 1031 is one  of the more powerful tools.  We hear over and over again from accounting  professionals how thankful their clients were that they  understood Section 1031 and helped them to explore the  possibilities. Indeed, many of our accounting partners  have saved their clients hundreds of thousands of dollars  in capital gain expense, giving them more money to  invest.  
  6. 6.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                 George Foss, QI                                John Hamrick, Instructor  In 1981, Mr. George Foss, III, our founder and co‐principal was a prominent real estate  broker in Northern New Hampshire. After reading about the concept of a Section 1031  Exchange, he was immediately intrigued, and saw the opportunity to add an interesting twist  to his real estate deals by helping clients to take advantage of this virtually unknown gift  from Uncle Sam.  27 years and thousands of successful exchanges later, George Edmund & Wheeler remains  the foremost authorities on Section 1031 in the New England states, and have completed  exchanges with clients in 48 of 50 states.  The firm has provided Section 1031 education and consulting to hundreds of New England  real estate professionals and has helped them to save their clients over $100 Million in  capital gains taxes. 
  7. 7.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Today will begin by providing you with some of  the very important basic aspects of Section  1031. We find that may investors absolutely  qualify for 1031 treatment, but their advisors  are sometimes lacking in this basic  understanding.    We will then be exploring Section 1031 from the  professional’s viewpoint, going through some  real live examples and relating some  information on alternative exchange strategies.      This course has been designed to assist you in  becoming proficient in the basics of a Section  1031 Exchange.   An Exchange can be a very complex and time‐ consuming endeavor. As QI’s, we understand all  of the mechanics and the myriad of rules and  regulations surrounding an Exchange. Our goal  for this session is to provide you the knowledge  and tools required to assist your clients in  recognizing the tremendous opportunities  provided by Section 1031.      Section 1031 is not just a tax deferral vehicle. It  is a powerful part of your client’s overall  investment strategy, their exit strategy from a  business, and an integral part of their estate  planning.  Bottom line is that the taxes that are deferred  can be used to leverage larger investments,  diversify portfolios and substantially increase  wealth.   
  8. 8.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Section 1031 is fundamentally about the relocation and  reallocation of your client’s real estate assets, all without  paying capital gains taxes. Relocation could be across the  street, or across the nation. Clients can relocate their  holdings to several markets, creating geographical  diversity. They can also reallocate holdings by combining  multiple holdings into one more valuable property. They  can sell apartment buildings and Exchange for single‐ family housing units, or they can opt for one of the  passive real estate investments available and leave the  day‐to‐day management of real estate to a professional  property management team.      Section 1031 exchanges are reported on Form 8824,  attached to the Form 1040 Tax Return.  It is important  that all of the documentation leading up to and used  during the exchange explicitly states that an exchange is  taking place and not an ordinary sale.  The taxpayer  cannot touch the funds or it will trigger the tax.  The  Relinquished Property and the Replacement property  must be investment/business use property in the  taxpayer’s hands.  All exchanges must be concluded  within 180 days, as may be reduced by the initial due date  of the Federal Tax Return.          An exchange is handled in the same manner as a regular  sale with the exception that a third party, the Qualified  Intermediary (QI), provides documentation, acts as  Escrow Agent, and handles all funds.   
  9. 9.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09   Section 1031 (a) Nonrecognition of gain or loss from exchanges solely in kind (1) In general 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 either for productive use in a trade or business or for investment. (2) Exception This subsection shall not apply to any exchange of— (A) stock in trade or other property held primarily for sale, (B) stocks, bonds, or notes, (C) other securities or evidences of indebtedness or interest, (D) interests in a partnership, (E) certificates of trust or beneficial interests, or (F) choses in action. For purposes of this section, an interest in a partnership which has in effect a valid election under section 761(a) to be excluded from the application of all of subchapter K shall be treated as an interest in each of the assets of such partnership and not as an interest in a partnership. www.section1031.com/PDFs/New PDFs/IRC1031.pdf
  10. 10.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 (3) Requirement that property be identified and that exchange be completed not more than 180 days after transfer of exchanged property For purposes of this subsection, any property received by the taxpayer shall be treated as property which is not like-kind property if— (A) such property is not identified as property to be received in the exchange on or before the day which is 45 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (B) such property is received after the earlier of— (i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or (ii) the due date (determined with regard to extension) for the transferor’s return of the tax imposed by this chapter for the taxable year in which the transfer of the relinquished property occurs. (b) Gain from exchanges not solely in kind If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. (c) Loss from exchanges not solely in kind If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized. (d) Basis If property was acquired on an exchange described in this section, section 1035 (a), section 1036(a), or section 1037 (a), then the basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized on such exchange. If the property so acquired consisted in part of the type of property permitted by this section, section 1035 (a), section 1036(a), or section 1037 (a), to be received without the recognition of gain or loss, and in part of other property, the basis provided in this subsection shall be allocated between the properties (other than money) received, and for the purpose of the allocation there shall be assigned to such other property an amount equivalent to its fair market value at the date of the exchange. For purposes of this section, section 1035 (a), and section 1036 (a), where as part of the consideration to the taxpayer another party to the exchange assumed (as determined under section 357 (d)) a liability of the taxpayer, such assumption shall be considered as money received by the taxpayer on the exchange. (e) Exchanges of livestock of different sexes For purposes of this section, livestock of different sexes are not property of a like kind.  
  11. 11.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 (f) Special rules for exchanges between related persons (1) In general If— (A) a taxpayer exchanges property with a related person, (B) there is non-recognition of gain or loss to the taxpayer under this section with respect to the exchange of such property (determined without regard to this subsection), and (C) before the date 2 years after the date of the last transfer which was part of such exchange— (i) the related person disposes of such property, or (ii) the taxpayer disposes of the property received in the exchange from the related person which was of like kind to the property transferred by the taxpayer, there shall be no non-recognition of gain or loss under this section to the taxpayer with respect to such exchange; except that any gain or loss recognized by the taxpayer by reason of this subsection shall be taken into account as of the date on which the disposition referred to in subparagraph (C) occurs. (2) Certain dispositions not taken into account For purposes of paragraph (1)(C), there shall not be taken into account any disposition— (A) after the earlier of the death of the taxpayer or the death of the related person, (B) in a compulsory or involuntary conversion (within the meaning of section 1033) if the exchange occurred before the threat or imminence of such conversion, or (C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax. (3) Related person For purposes of this subsection, the term “related person” means any person bearing a relationship to the taxpayer described in section 267 (b) or 707 (b)(1). (4) Treatment of certain transactions This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection. (g) Special rule where substantial diminution of risk (1) In general If paragraph (2) applies to any property for any period, the running of the period set forth in subsection (f)(1)(C) with respect to such property shall be suspended during such period. (2) Property to which subsection applies This paragraph shall apply to any property for any period during which the holder’s risk of loss with respect to the property is substantially diminished by—
  12. 12.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 (A) the holding of a put with respect to such property, (B) the holding by another person of a right to acquire such property, or (C) a short sale or any other transaction. (h) Special rules for foreign real and personal property For purposes of this section— (1) Real property Real property located in the United States and real property located outside the United States are not property of a like kind. (2) Personal property (A) In general Personal property used predominantly within the United States and personal property used predominantly outside the United States are not property of a like kind. (B) Predominant use Except as provided in subparagraphs (C) and (D), the predominant use of any property shall be determined based on— (i) in the case of the property relinquished in the exchange, the 2-year period ending on the date of such relinquishment, and (ii) in the case of the property acquired in the exchange, the 2-year period beginning on the date of such acquisition. (C) Property held for less than 2 years Except in the case of an exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection— (i) only the periods the property was held by the person relinquishing the property (or any related person) shall be taken into account under subparagraph (B)(i), and (ii) only the periods the property was held by the person acquiring the property (or any related person) shall be taken into account under subparagraph (B)(ii). (D) Special rule for certain property Property described in any subparagraph of section 168 (g)(4) shall be treated as used predominantly in the United States.    
  13. 13.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 As can be seen from the Section 1031 statute language, at #2: 2) Exception This subsection shall not apply to any exchange of— (A) stock in trade or other property held primarily for sale, (B) stocks, bonds, or notes, (C) other securities or evidences of indebtedness or interest, (D) interests in a partnership, (E) certificates of trust or beneficial interests, or (F) choses in action. So these things cannot be exchanged under Section 1031.  This was not always the case.  The original statute was passed on March 8, 1921, and was silent on the items named  above, especially (B) stocks, bonds, or notes.  It didn’t take Roaring 20’s Investors long to  figure out that they could sell shares with losses and exchange shares with gains.  Two  years later, in 1923, the party was over, and all of the exceptions except (D) were added;  (D) came along in 1984.   
  14. 14.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 It’s important to understand the difference  between investment property and property  “held for sale.”  Property that is held for sale is  technically inventory in the hands of the  taxpayer and is therefore not eligible for Section  1031 treatment.                Section 1031 Exchanges can be used as a  strategy to achieve tax deferral while changing  the location and the type of property held.  As a  tax‐planning tool, it will achieve greater net  equity over time and increased cash flow.  Section 1031 can also unravel partnership issues  and allow investors to exchange from active to  passive real estate holdings.          The Exchange Agreement created by the  Qualified Intermediary gives the QI legal  standing by way of an assignment of the  Contract Rights in both the old property and the  new property.  From the Exchangor’s  perspective, a sale does not occur, but rather an  exchange of properties.  Both must be used by  the taxpayer for investment or productive use.   The “Like‐Kind” Test must be satisfied.   
  15. 15.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 There are three separate rules for identifying Replacement property.  The most common  rule is termed the “3 Property Rule.”  It doesn’t matter how many properties were sold  in an exchange, it is a cap on the number of choices of limitless value.  Identifying three  properties within the 45‐day deadline will be challenging.  Three, two, or even one  property can be selected, but it’s a good policy to identify more than one so a backup  property is available.  More than one can be purchased.   The 200% Rule is available to taxpayers who want to identify and/or acquire more than  three properties.  The limitation in using the 200% Rule is that the total value of what is  identified cannot exceed twice the value (or 200%) of the Relinquished Property.  This  rule works well for larger dollar transactions when the taxpayer wants to diversify the  investment into multiple properties.  The 95% Rule is the most perilous choice.  It will allow the taxpayer to ignore the value  and the number of choices with the requirement that once the properties are identified,  the taxpayer MUST acquire 95% of them (by value).   In nearly 30 years of practice this  rule has been used by a client in only one instance.  NOTE:  Now is your only opportunity to add an Alternative Investment such as a Tenant‐ in‐Common (TIC) property; an UP‐REIT; or an Oil & Gas Lease to one of these lists.  Only  Structured Sales, which convert all or what’s left of a Section 1031 Exchange to a Section  453 Installment Sale, can be elected later, after the 45th  day.   More on this later…….                 
  16. 16.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 The point to remember is that it does not matter the type of real estate that the taxpayer owns, it is how the property is used  in their hands.  It must be for investment, commercial or business use.  A single‐family residence is like kind to every other kind  of real property as long as the single‐family residence is NOT Personal Use or Dealer Property.    These are ALL Like Kind!   
  17. 17.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Question:     “Can you do a 1031 exchange when selling and assigning the rights under a long  term cell tower lease valued based upon anticipated income from rent?”  Answer:      A cell tower lease is typically on a patch of land on which the tower is erected, and a  right‐of‐way access to the site.  The Landlord owns the land & easement which is leased,  and the tenant owns, and must later remove the improvements.  The lease would  describe all of this, and state an initial term plus a number of options to renew.    If you can add the number of years remaining in the initial term and in all of the options  to renew together and get a result that equals or exceeds 30 years, then the leasehold is  exchangeable for another leasehold of 30 years or more, or for a fee interest in real  estate.  Said another way, the lease must have 30 or more years left to run counting all  options to renew to be exchangeable for a fee.  The underlying properties must be of  Like‐Kind.  IRS Regs 1.1031(a)‐1(c).       The income from the lease has no bearing on the exchangeability of the asset; it's  only that the lease pertains to real property and that it has a remaining term that  qualifies, as above.  However, the income does play a part in the valuation of the lease, as  to be completely tax‐deferred; the Replacement Property must be valued equal to or  greater than the Relinquished Property.  So, the payments to be made under the lease in  the future have to be given a Present Value.    
  18. 18.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 When Section 1031 was first codified in 1921, it was for the benefit of farmers who  objected to paying a two (2%) percent capital gains tax on their farm property, both real  and personal.   Certain items of personal property are exchangeable as long as they fall  into the same asset class or product code.   All aircraft is like‐kind to all other aircraft for  instance, but is not like kind to other items of machinery.  The North American Industry Classification System for Sectors 31‐33 is the best sources for  determining like kind for personal property.    www.census.gov/naics (for a complete description of the allowable categories) The Exchange will begin on the day the deed is  conveyed to the purchaser.  The 45 day and 180 day  clocks will begin the following day.  Contracts for sale  and purchase do not trigger the beginning on an  exchange, it always happens on the day of the first  leg of the transaction.  This is also true for reverse  exchanges.   Only Presidentially declared disasters would provide  for extension of these time sensitive dates.     
  19. 19.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09   A “Qualified Intermediary” is one who is not  “Disqualified.”  The Regulations are specific in stating  that one who has served the Taxpayer in almost any  capacity in the past 2 years is disqualified to be the Q.I.  Trusted friends and non‐relatives (cousins, in‐laws, etc.)  can technically serve, but one wants a Qualified  Intermediary with a thorough knowledge of the Code  and the Regulations.  The Exchange Agreement must have this statutory  language included that prohibits the taxpayer from any  type of use of the funds prior to the end of the  Exchange period.      The first step is to engage the Qualified Intermediary to  create a written Exchange Agreement.   The QI is  required to have standing in the exchange and this will  be accomplished with an assignment of the contracts.   Specific guidance will be provided to the Settlement  Agent and the funds will be directed to the QI for the  acquisition of the new property.   Most importantly, the  QI will provide guidance to the taxpayer to avoid the  pitfalls.  Transactions with related parties are  prohibited unless other rules are followed.          Exchanges can be conducted regardless of whether the  taxpayer is an individual or some form of other entity.   It is important to remember that the same taxpayer  must sell and then buy.  The IRS is tracking the taxpayer  identification number (EIN).  Single member LLC’s and  revocable trusts (disregarded for tax purposes) may  also exchange property.   
  20. 20.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 DOES YOUR SITUATION QUALIFY FOR A SECTION 1031 EXCHANGE This tool has been developed to help you quickly identify Section 1031 opportunities?   Plans for the Money  The greatest benefit from capital gains  deferral will be obtained by reinvesting the  entire price (less costs) from the sale of  investment  property. It is possible to extract  cash at closing; however, the amount you take  will be subject to tax.  Amount Invested  How was the property acquired and how long  has it been owned?  Was it purchased, was it  exchange into it, was it given or inherited by  the taxpayer?    The answers to these and other questions will  determine whether the cost basis, and what  the exposure is to Capital Gains Tax.  If the  gain exceeds $20,000 then an Exchange should  be considered (Rule of thumb).        Mortgage Balance  The outstanding mortgage debt is paid off at closing in the same manner as any other closing; and debt paid off must be  replaced when the new property is acquired or new cash added to offset any difference. Any debt relief not offset by new cash  will result in taxable boot.  On Last Two Tax Returns or Vacant Land  A taxpayer’s return provides the IRS with an audit trail of past activity.  Rental property must have appeared on Schedule “E” of  the return (or the corporate equivalent) if the property is portrayed as held for investment or for use Trade or Business. The  only exception will be vacant land.  How Long Owned  Dealers are not permitted to use Section 1031; generally their assets are “held for sale”, not “held for investment”. In order for  a property to be considered for long‐term capital gain treatment, it must have been owned by the taxpayer for at least one  year, preferably two.   Type of Replacement Property  Section 1031 requires that the property be “like‐kind”; all real property is like‐kind to all other real property.  The Like‐kind test  is more stringent for personal property     www.section1031.com/PDFs/New PDFs/WhatQualifies.htm
  21. 21.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09   Choices of Replacement Property  Under the simple rules, taxpayers may  select up to three potential new properties  and can buy any one, two or all three of  them.    More choices are available; however, the  dollar value of the choices is capped at  200% of the value of the old property.  Can Meet 45 Day Requirement  After the closing of the old or Relinquished  Property, taxpayers have 45 days to make  formal identification of Replacement  Property choices. No substitutions are  permitted after the 45th day.  Can Meet 180 Day Requirement  After the closing of the old or Relinquished  Property, taxpayers will have 180 days to  acquire the new or Replacement Property.  Exchanges must be accounted for within the same tax year; often it is necessary to extend the due date of the tax return to  accomplish this task and to get the full benefit of 180 days for a year‐end exchange.  Third Party Handling of Money  Receipt of funds by the taxpayer at closing is not permitted in a Section 1031 Exchange.  A Qualified Intermediary must be  designated to facilitate this process so that the taxpayer never has Constructive Receipt of the funds.      Relatives and attorneys or accountants that have represented the taxpayer in the last two years are prohibited from acting as  the Qualified Intermediary.  Have qualification questions?  Contact a respected Qualified Intermediary if you have any questions regarding your specific situation. Many  Intermediaries, like Edmund & Wheeler, Inc., provide this consultation free of charge. A good relationship with a  Qualified Intermediary can assist your practice in better serving its clients!            www.section1031.com/PDFs/New PDFs/WhatQualifies.htm
  22. 22.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 The Five Most Common Section 1031 Misconceptions Well before delayed exchanges were codified (by IRS) in 1991, all simultaneous exchange transactions of Real  Estate required the actual swapping of deeds plus the simultaneous closing among all parties to a 1031 exchange.  In most cases these types of exchanges were comprised of many of exchanging parties, as well as numerous  exchange real estate properties. Now today, there's no such requirement to swap your own property with  someone else's property, in order to complete an IRS approved exchange. The rules have been refined and ratified  to the point cash rather than the property deeds can be used.          There was a time when all types of exchanges had to be closed on a simultaneous (same day) basis, now they  (1031) are rarely completed this way. As a matter of fact, a majority of the exchanges executed are closed now as  delayed exchanges.        Don’t make this mistake. There is a common misconception that “Like‐Kind” is literal.  There are currently 2 types  of properties that qualify as a 'like‐kind':  Property held for investment and/or Property held for a productive use,  as in a trade or business.          This statement is a perfect example of another 1031 exchanging myth. There are no provisions within either the  IRS Code or the US Treasury Regulations that can restrict the amount and number of real estate properties that  can be involved in an exchange.  Thus, in exchanging out of several properties into one replacement property or  the reverse of this in selling of one property and acquiring several others, are all perfectly acceptable strategies.      You can take cash out of a Section 1031 Exchange; however, the cash that you take out will be immediately taxable. 
  23. 23.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Contents How the Different States Approach Section 1031.........................................................................................24 Reporting an Exchange to the IRS ...............................................................................................................25 Form 8824 ....................................................................................................................................................26 Completing Form 8824 (Part I) .....................................................................................................................27 Completing Form 8824 (Part II) ....................................................................................................................28 Completing Form 8824 (Part III) ...................................................................................................................29 What is Boot? ...............................................................................................................................................31 What is New Money?....................................................................................................................................31 Exchanges That Cross Two Tax Years ........................................................................................................31 Can a Failed Exchange Be Fixed? ...............................................................................................................32 Section 1031 and Partnerships.....................................................................................................................33 Section 1031 or Section 1033?.....................................................................................................................34 Section 1a Section 1031 & Accounting
  24. 24.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                       Why do cash‐strapped states permit Section 1031 Exchanges?    Because by failing to do so, they miss out on investment capital that would have otherwise come to them, and studies have  shown that there are more dollars arriving than leaving on a net basis.  But these dollars have owners, and it’s these owners of  funds that hesitate to invest in locales where they cannot later get their money out.  In recent examples, Georgia, Mississippi, Oregon and South Carolina all had laws on the books that said that a Section 1031  Exchange within the state was fine, but outside the state was not; going outside the state subjected the entire gain (both gain  before the funds arrived and gain while the funds were in‐state) to the state capital gains tax.  Needless to say, billions of dollars that would have otherwise gone to these four states went elsewhere.  Now all four have  repealed these laws, in Georgia’s case, retroactively.  Montana is the most recent state to consider, and then reject an out‐of‐ state limitation on Section 1031.    Pennsylvania, however, doesn’t seem to get it:  Section 1031 is not recognized even in‐state, and PA state tax on all real estate  transfers, sales or exchanges, is due.  New Hampshire follows the Federal Rules very closely (but see below), as does Maine, Vermont and Rhode Island.  In these  latter three states, one must present a Waiver of Withholding to the Settlement Agent or state taxes will be due.  This Waiver  Rule also exists in NJ, NY, MD, SC, GA, CA, OR, HI and in other states.  Vermont has a special rule for its 6‐Year Land Gains Tax:  Both the Relinquished (old) Property and the Replacement (new)  Property must be in‐state, but the Holding Period shifts too, so the New Property starts at a higher point on the 6‐year  Exclusion Ladder.  (For EVEN or UP Exchanges only; for DOWN Exchanges, some of the Land Gains Tax is due.)  New Hampshire Warning:  The name(s) on the deed to the Relinquished Property must exactly match the name(s) on the deed  to the Replacement Property.  The only exception is a revocable (grantor) trust, which New Hampshire (and IRS) ignores.  Do not let your client take the new property in a single‐member LLC (SMLLC) unless the old property was in the same SMLLC;  any change of entity, although it may be disregarded for IRS purposes, is FULLY RECOGNIZED for New Hampshire Business  Profits Tax (BPT) purposes.    This means, for the moment, than Tenant‐in‐Common (TIC) investments are out of bounds for NH taxpayers, because of the  fact that the TIC sponsor insists that the investment be held in a newly created (Delaware) SMLLC.  The state has issued Notices of Assessment to taxpayers for transactions as far back as 2005.  Litigation is pending.  Stay  tuned…. 
  25. 25.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Reporting an Exchange to the IRS  IRS Form 8824, a dual‐use form for reporting Like‐Kind Exchanges and Section 1043  conflict of interest sales.  We are only concerned with Parts I, II, and III.  Part I:  Describes the property sold and bought; the relevant dates; and whether  Related Parties were involved.  Part II:  Related Party Section.  The form is misleading in that it appears to be possible  to be able to buy the Replacement Property from a relative:  You cannot, unless the  Related Party is also exchanging, and the funds are ultimately given to an Un‐Related  Party.  However, you can sell your Relinquished Property to a relative, provided both  you and the relative hold what is received for two years after the conclusion of the  exchange.  Further, you and the Related Party must report to IRS on this form (Parts I &  II only) for the two subsequent tax years that neither you nor the Related Party sold or  otherwise disposed of the property you or they received in the exchange.  Note how a seemingly innocent event in the life of your relative (they sell your old  place) can trigger your tax!  Watch out for this.    Part III:  The numbers.  We will get to this below.             
  26. 26.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09
  27. 27.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09
  28. 28.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                                       Part I:  Information Section (line by line instructions) Line 1:  This is a brief description and the address of your Relinquished (old) Property.  Line 2:  This is a brief description and the address of your Replacement (new) Property.    Line 3:  When did you take ownership of your Relinquished (old) Property?  Month/day/year    Line 4:  When did you transfer the Relinquished (old) Property?  Month/day/year  Line 5:  When did you identify the Replacement (new) Property to the QI?  Month/day/year  Line 6:  When did you receive the Replacement (new) Property?  Month/day/year  Line 7:  Was the property given or received made with a Related Party?  Yes/No   Potential Audit Issues:  Does the property described on Line 1 appear on past returns in Schedule E, or is it vacant land or  other investment property?  Will the property described on Line 2 qualify for and be similarly  listed on Schedule E?    Is Line 3 vs. Line 4 more than 1 year (preferably 2)?  Does Line 4 vs. Line 5 exceed the 45 days?   Does Line 4 vs. Line 6 exceed 180 days, as adjusted for due dates of the return for the tax year in  Line 4?    Will the Schedule E filings for this Taxpayer reflect the gaps of ownership indicated by the entries  on Lines 4 & 6?   
  29. 29.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                                     Part II:  Related Party Section (line by line instructions) If this Part applies to your situation, question the Taxpayer closely to be sure that it  was the Relinquished Property (and not the Replacement Property) that was acquired  by the Related Party; this is OK, if both the Taxpayer and the Related Party file this  form for this and for the next two tax years.  However, if the Taxpayer purchased his  Replacement (new) property from a Related Party and that person did not also  exchange, then this transaction has failed and the tax is due.  See Revenue Ruling  2003‐83.  See: http://www.unclefed.com/Tax‐Bulls/2002/rr02‐83.pdf  Line 8:  Related Party Information.  Your Relatives can be found in Section 267(b) &  707(b)(1)  Line 9:  Within the last 2 years, did the Relative who bought your (old) property sell it?   Yes/No  Line 10:  Within the last 2 years, did you sell the (new) property?  Yes/No  If either answer is “Yes”, then the Taxpayer must qualify for one of three exceptions:  Line 11(a):  There was a death of either of you.  Line 11(b):  There was an involuntary conversion (Section1033) of either property.  Line 11(c):  If Taxpayer’s new property was provided by a Related Party and that  person also did a Section 1031 Exchange, then the answers to Lines 9 & 10 will be  “No;”  nevertheless, attach an explanation to the return, and identify (with EIN) the  party from whom you bought.   
  30. 30.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                                   Part III:  Financial Section  (line by line instructions)  Lines 12‐14 pertain to property given up for which no like‐kind property was received.  Tax is recognized  on Line 14.  The term “Other Property” means property of an un‐like kind.  Line 15:  All “Boot” goes on this line.  Any entries on this line fall to Line 23, and are recognized.   Examples are cash received that was not replaced (“Cash Boot”); any decrease in net indebtedness  (“Mortgage Boot”); and the FMV of any Other Property received (such as a vehicle, gemstones, fine art,  etc.) that the parties may have used to balance their transaction.   Line 16:  FMV of the Replacement (new) Property.                          Line 17:  Add Line 16 + 15.  Line 18:  Adjusted basis of the Relinquished (old) Property + all net cash that was added + any increase in  net indebtedness + all closing costs & exchange fees.   (Old Basis + “New Money”)         Line 19:  Subtract Line 18 from Line 17.  This is the Realized Gain.  Line 20:  Enter the smaller of Line 19 or Line 15, but not less than $0.00.  Note that any entry on Line 15  is now here.  Line 21:  If the old Property was depreciable, and the new one is not, there will be some depreciation  recapture.  Reduce Line 20 by this amount and report on Form 4797.  Line 22‐23:  This is the Recognized Gain.  If even or up and no boot, this number will be $0.00 
  31. 31.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                           Boot Netting Rules:  1.  Cash paid to buy New Property offsets cash received  and/or any debt relief in the sale of old property.    2.  Debt assumed or incurred to buy the New Property  offsets any debt relief (but not any Cash received) in the  sale of the Old Property.            “New Money” goes on Form 8824, Line 18:  Net new cash and Net new debt adds to the Adjusted  Basis, however, Other Property added (vehicle, computer,  etc.) does not.  If Other Property is added, pay tax on  these articles on Lines 12‐14.  Strike Price is the selling price of the Relinquished (old)  Property less sales costs.              Set the closing of the Old Property to fall in these  windows to give your Client an election under Reg   1.1031(k)‐1(j) (Coordination of Sec. 1031 & 453):    Provided the Client had a bona‐fide intention to exchange  at the start of the Exchange Period, and the Client  receives Cash Boot in the next Tax Year,  they can elect  which year to pay tax on said boot.  However, tax on  Mortgage Boot must be paid in the year of receipt.   
  32. 32.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                                                                   So, if your Client has sold an asset and then learns about Section 1031 after the closing,  they can:    1.Un‐close with the Buyer.  The more time that has passed the harder this will be,  especially if a bank has recorded a mortgage and disbursed funds.  To un‐close, the  Buyer must receive the funds back and your Client must receive the deed back.  Be  prepared for adverse Transfer Tax consequences, but in some cases, Corrective Deeds  have been used.  2.Re‐close with the Buyer properly, using a Q.I.   An Exchange Agreement is prepared  and executed.  Settlement Instructions are issued.  An Escrow Account is established.  A  new deed is prepared, signed with the later date and recorded.  Buyer’s funds now go  through the QI to the Qualified Escrow Account.  The time periods begin.   3.  As a general matter, Rescissions are expensive, and gaining the full cooperation of  the Buyer and their Bank may prove to be impossible.  4.  Must be done in the same tax year; transactions cannot be rescinded after the end of  the tax year.             
  33. 33.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09                         Partnership interests (or those of any entity) are NOT  EXCHANGEABLE per Section 1031(a)‐2.  “Drop & Swap” is where a partnership distributes to its  partners tenancy‐in‐common interests in its assets;  these people subsequently exchange while the  partnership sells.  The technique can be made to work if  the distributee partners establish separate holding  periods in the assets before the exchange (1 year  minimum, 2 years better).  Gets pretty awkward.  Form 1065, Question 14:  “At any time during the tax  year, did the partnership distribute to any partner a  tenancy‐in‐common or other undivided interest in  partnership property?”    Nor does the “Swap & Drop” technique work either,  where the entire partnership does the exchange and  then distributes some or all of the property it receives to  departing partners.    Again, the issue appears to be one of “holding period;”  the partnership has a holding period in the relinquished  assets, and IRS wants to see a continuation of this  holding period in the replacement assets.  Form 1065, Question 13:  “Check this box if, during the  current or prior tax year, the partnership distributed any  property received in a like‐kind exchange or contributed  such property to another entity (including a disregarded  entity)”    So, what to do?  Preserve the partnership, its holding  period and its EIN # at all costs; remember, to be a  partnership, there must be 2 or more members.  Close on the asset to be sold, and elect to receive some  “boot” at the closing, which will  be cash and some debt  relief; distribute this “boot” to the departing partners.   The rest of the partnership exchanges in the usual way,  and the partnership receives like‐kind replacement  property, which it will keep.  This leaves the answers to both Questions 13 & 14 on  Form 1065 “No.”  Reflect the cash and debt relief distributions (“boot”) on  the K‐1’s of the departing partners. 
  34. 34.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09   When faced with a disaster loss or a condemnation, a decision must be made:  Does the taxpayer  stick with the rules of Section 1033 (Involuntary Conversions), or does s/he attempt to comply with  Section 1031?  In a Section 1033 transaction, the taxpayer can handle funds, and has more time (2+ years) to  replace the lost/taken property, but this replacement must be “similar or related in service or use”  to the old property.  IRC 1033(a)‐(1).  So, under these rules, it is impossible to replace an improved  property with an unimproved one, or a dwelling for a warehouse, etc.  However, let’s say that your property is under agreement of sale and it is damaged by fire or storm  prior to closing.  You could either assign the insurance check to the buyer and close as a Section  1031 Exchange, or you could renegotiate the price of your old property, and close as a combined  Section 1031 Exchange (as to the land and the undamaged portion), and as a Section 1033  Involuntary Conversion (as to the insurance proceeds).  You could handle the insurance funds but  not the rest; Section 1031 time periods would have to be observed and the Replacement Property  must be such that you could add the lost improvement to it before the expiration of 2 years.  Another situation is where a governmental taking is being discussed, but the taxpayer has not yet  received a formal “Notice of Eminent Domain.”   Under these conditions, a Section 1031 Exchange  can be set up to receive the proceeds and reinvest them in “Like‐Kind”  (as opposed to “Similar  Kind”) property.  An example of this was a Conservation Easement (“CE”) sold to a Southern New  Hampshire town (which had voted to take it if necessary).  The funds were reinvested in ranchland  and a mountain cabin in Montana, like‐kind to the CE under Section 1031, but definitely not similar  kind to a CE under Section 1033.       
  35. 35.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09   Contents Hypothetical Example – Pay Taxes/Defer Taxes..........................................................................................36 The Most Common Exchange Types............................................................................................................39 Reverse Exchanges – Choice of Entity.........................................................................................................39 Reverse Exchanges – Transfer Taxes..........................................................................................................39 A Note on Second Homes ............................................................................................................................40 Edmund & Wheeler Case Studies ................................................................................................................41 Case Study 1 – Delayed Exchange ..............................................................................................................42 Real-life Example – Trading a Campground for Several Properties ....................................................43 Real-life Example – 6 Properties for a Dozen Condos.........................................................................43 Converting Investment Property into Personal Residence...................................................................44 Case Study 2 – Reverse Exchange..............................................................................................................45 Real-life Example – Buying a New Property before the Old Property Sells .........................................46 Acquire a Rental Property for a Family Member..................................................................................46 Case Study 3 – Build-to-suit Exchange ........................................................................................................47 Real-life Example – Commercial Property for Raw Land with Improvements......................................48 Case Study 4 – Delayed Build-to-suit Exchange ..........................................................................................48 Real-life Example – Industry Specific Building on Identified Property..................................................50 Case Study 5 – Delayed Exchange, Reverse Format...................................................................................51 Real-life Example – Acquiring Abutting Property to Primary Residence ..............................................52 The Four Simple Qualification Questions .....................................................................................................53 Section 2 Case Studies & Real-life Examples
  36. 36.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 These two Property Owners have identically valued  properties with identical tax consequences, however, one  chooses to sell and the other chooses to use The Power of  Section 1031, and take an interest‐free loan from the  Federal and State Government.              These are the assumptions.  The Federal Tax is 15% and  the State Tax is 5%, but past depreciation these taxpayers  have taken will be recaptured at the rate of 25%.   However, the second Property Owner has no intention of  funding the tax, as a Section 1031 Exchange is planned.   Another assumption is that the values of the Replacement  Properties grow at a uniform 6% rate per year, without  compounding.   After 5, 10 and 15 years we will take a  look at each situation.           The two properties both sell for $300,000, but one  Property Owner elects to pay the tax ($65,000) while the  other elects to accept the interest‐free loan.  They both  reinvest, but one has $65,000 more than the other, and as  a consequence, his investment commands more monthly  cash flow.  So the effects of the interest‐free loan are  immediate: The Property Owner who took the loan earns  $325 more per month on his investment than his tax‐ paying counterpart.   
  37. 37.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Now let’s look at the situation 5 years out.  Each owner  sells his investment, but again Owner #1 pays the tax  while Owner #2 elects to take a further advance on the  interest‐free loan.  Further, since more principal was  invested, the value of the 2nd  Owner’s investment is worth  almost $100,000 more than the 1st  Owner’s.  Granted this  difference is pre‐tax, but read on....            At 10 years, the pattern repeats: Owner #1 pays taxes  again, but Owner #2 accepts a further advance on the  interest‐free loan.  This equity is worth $145,664 more  than Owner #1, and, as a consequence, it commands $728  more income per month.                We conclude the example here, but you get the idea: By  deferring the tax at the beginning, Owner #2 has made  good use of free government money.  This investment is  now worth $221,044, and consequently commands a  monthly income of $3296, more than $1056 more per  month than Owner #1's income.   
  38. 38.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 And here is a summary of the wealth  building effects.  Owner #2's equity is worth  more than $211,044 than Owner #1's, and  has grown by 119% (instead of 49.3%)  thanks to the use of the tax‐free loan.   Further, at this point, let’s pretend that  Owner #2 takes leave of his senses and  decides to pay the tax instead of exchanging  again and again.    The total taxes due from Owner #2 at the 15‐year point are $136,810, which leaves this owner $74,234 ahead of  Owner #1 on an after‐tax basis.  This is the true comparison because, after all, Owner #1 was paying tax all the  way through, and Owner #2 was deferring it, by use of The Power of Section 1031.  At the 15th year, Owner #2 has received an  additional $92,779 in cash flow over Owner #1.    Can any sensible investor afford to ignore these  two figures??    When you think about it, Owner #1 has reduced  his estate and lessened his lifestyle because of his  failure to take advantage of Section 1031.  For this reason, any taxes that can be legally  deferred should be deferred so that the extra  funds can be put to work. 
  39. 39.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 cbrady@garnethill.com   By far, the most common type of Exchange is the Delayed  Exchange. This simple Exchange allows a client to sell his  property, identify a new property (within 45 days), and  then purchase a Replacement property (s) with the funds.   Often times The Reverse and Build‐to‐Suit Exchanges are  misunderstood and not presented to clients. This can be  and extremely costly mistake. Often times the clients that  have the most to gain by an Exchange do not realize that  these types of Exchanges are possible. Not only are they  possible, they tend to be the most powerful vehicles for  leveraging the Government’s money!        We prefer to use a C‐Corporation in our practice. One can  have a fiscal tax year without IRS permission, so we set  the start of the corporation’s fiscal year to be just before  the commencement of the exchange.  Only 180 days of the fiscal year will be used, leaving the  balance of the fiscal year to prepare and file an “initial”  and “Final” tax return (Form 1165).  You definitely do not want a tax filing requirement in the  middle of an exchange, when the EAT is loaded with  assets and debt.  At the end of the exchange, however,  the EAT’s figures are all zeroed out.      Transfer taxes are a fact of life.  Thus, on small  transactions, a Reverse Exchange may not make economic  sense.  Calculate the taxes the Client would pay on a straight sale:   if the exchange expenses and transfer taxes are a small  percentage of this to obtain full tax deferral, then it’s  worth it to proceed with a Reverse Exchange.  Remember,  the tax is being loaned by the Government to your Client,  without interest. 
  40. 40.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Beware – this is one of the most frequently addressed issues when discussing a  Section 1031 Exchange. There are many investors who would love to Exchange into  a mountain get‐a‐way, the short answer is that second homes typically DO NOT  qualify for Section 1031 treatment; however:  The savvy investor will Exchange into a property that they wish to eventually own as  their second home. They need to hold the home as an investment for a minimum of  24 months after the Exchange as rental property.    A few simple rules must be followed when renting out an investment property:   The property can be rented to a family member, but the family must pay fair  market rent for the property.   The Property must be rented a minimum of two weeks per 12 month period  X 2.  It is very important to save any documentation associated with the  rental including receipts, advertisements, property management  Agreements, etc.   You are allowed to use the property for “fun” for a maximum of 14 days or  10% of the rental period, whichever is greater.     Extra days for maintenance are allowed, but you are well advised to keep a  diary of the property including all visits and expenses related to it for  maintenance, taxes, etc. This will help to document your intent.  www.irs.gov/pub/irs-drop/rp-08-16.pdf
  41. 41.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Case Studies Over the many years that Edmund & Wheeler has been facilitating Exchanges, we have discovered that exchanges  generally can be described in 5 distinct types. The most common type is Case Study 1 – the Delayed Exchange. We  will be reviewing each case study, along with some real‐life examples of how these Exchanges work.  Exchange Type Case Study Description Delayed Exchange (Existing Property) Direct Format  1  In this format, the client gets the most common type of Section 1031 Exchange.  Delayed/Simultaneous Exchange (Existing Property) Reverse Format (Exchange Last)  2 In this format, property desired by the Exchange client is parked in a Single Purpose Entity (SPE) until the client's current property can be sold.  Delayed Build-to-suit Exchange Direct Format  3  In this format, the client gets a Section 1031 Exchange and acquires new, improved property, built-to-suit.  Delayed/Simultaneous Build- to-suit Exchange Reverse Format (Exchange Last)  4 In this format, property desired by the client is parked in a Single Purpose Entity (SPE) until the client's current property can be sold. During the parking period, the new property is improved by the SPE to the client's wishes.  Delayed Exchange (Existing Property) Reverse Format (Exchange first) 5  In this format, property desired by the client can be purchased immediately by Client, as Client's old (Relinquished) property is parked in a Single Purpose Entity (SPE) until it can be sold to buyer. www.section1031.com/cases.htm
  42. 42.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 CASE STUDY 1 ABDC Delayed Exchange (Existing Property) Direct Format In this format, the Client (A) gets a Section 1031 Exchange between steps 3 and 7 assuming all of the rules have been followed. This is the most common type of exchange.  The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing. The Purchase and Sale Agreement to sell the Relinquished Property. This step may take place before Step 1 (the only out- of-sequence exception).  The closing of the Relinquished Property; if several are involved, the first in chronological order. In this step, the deed to the property is given to the Buyer.  Rather than going to the Exchangor, the Buyer's funds are used to pay all of Exchangor's expenses (including mortgages, if any), with the NET going directly to a money center bank into a separate, interest- bearing account established in the Exchangor's name and Social Security number.  This is an interactive step encompassing all communications post-closing with the Exchangor and Edmund & Wheeler, Inc. Included are the 45-day Identification Letter, instructions on how much of the account to be expended on particular properties, and final approval to close on the final choice(s).  These are the precise instructions to Exchangor's attorney, bank or Title Company for the closing of the Replacement Property, and the wire transfer of approved funding.   This is the Exchangor's receipt of the direct deed from the owner of the Replacement Property (C); the Exchangor achieves a Section 1031 Exchange between Steps 3 and 7, where in Step 3 a deed is given and in Step 7 a deed is received, and in between the Exchangor had no control (or Constructive Receipt) of funds.   
  43. 43.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 This Exchangor sold one large lakefront property and  proceeded to use the next 45 days driving up and down  the East Coast selecting Replacement Properties. He was  in the enviable position of being able to identify more than  three Replacement Properties (the simple rule). He used  the 200% rule (to identify as many properties as he  wanted as long as the total value of the properties  identified did not exceed twice the value of the  Relinquished Property). In the end, he acquired sixteen  new properties from Maine to Florida, many of them  single family (rental) residences, including two new  campgrounds.   This Exchange allowed him to diversify his portfolio, generate significant cash flow from his new properties, and pay no  capital gains tax. As they say in the business "one happy camper!" If he determines that one or more of his selections  doesn’t satisfy his investment objectives, then after a year or two, he can exchange again.   We are currently working with a client to acquire a  significant piece of commercial real estate in New England.  The client is in the process of selling six separate pieces of  property in order to aggregate sufficient funds to make the  new Replacement Property purchase. The client has been  extremely careful (with our guidance) to time his sales and  the new purchase all within a 180 day time frame. This is  key to the success of the Exchange due to the fact that he  will acquire not just one piece of property, but rather over  a dozen condominiums. You will recall that you have two  basic rules when it comes to identifying your Replacement  property choices, the Three‐Property Rule and the 200%  Rule. This Exchange is an example of yet a third method of identifying Replacement property. It allows the client to acquire  an unlimited number of properties, without regard to value or number as long as he acquires 95% (FMV) of what he  identified.  This can be a little nerve‐racking for the investor and it pays to have a back‐up plan.  http://www.section1031.com/EWIExchanges.htm 
  44. 44.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Our client exchanged out of a three unit building that had been held for many years.   In preparation for retirement, the client acquired a Florida rental property.  After  renting the Florida property for two years, our client will convert the use from rental  to personal and move into the property as a primary residence.  There isn’t any  prohibition against converting business/investment property to personal use.   Be  aware that upon the sale of the property, the client will NOT be entitled to the full  Section 121, personal residence exclusion of $250,000/$500,000.  It will be prorated  based on the time used as rental or second home after January 1, 2009.        http://www.section1031.com/EWIExchanges.htm 
  45. 45.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 CASE STUDY 2 ACBD-Delayed/Simultaneous Exchange (Existing Property) Reverse Format - Exchange Last In this format, property (C) desired by the client (A) is parked in a Single Purpose Entity (SPE) until client's current property (A) can be sold. Section 1031 Exchange occurs between steps 7 and 11.  The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing. Since the Replacement Property will be purchased (and Parked) before the sale of the Relinquished Property, a source of funds for the purchase must be arranged. This can be the Exchangor, or their bank. If a bank, the Exchangor will be expected to provide a guarantee.   This is the loan to the Single Purpose Entity (which the IRS has renamed an Exchange Accommodation Titleholder (EAT)) that will buy the Replacement Property from its owner (C) and hold it until the Relinquished Property (A) can be sold to the Buyer (B). This is the actual purchase of the Replacement Property from its owner (C). At this step, the Entity (and not the Exchangor) becomes the legal owner of the Relinquished Property. The 180-day Exchange Period commences. The Relinquished Property goes under Agreement of Sale to Buyer (B). The Exchangor gives Buyer (B) a deed, and the transaction closes; this step must occur before the 180th day, with enough margin to complete Steps 8-11. Rather than going to the Exchangor, the Buyer's funds are used to pay all of Exchangor's expenses (including mortgages, if any), with the NET going directly to a money center bank into a separate Qualified Escrow Account established in the Exchangor's name and Social Security number. As Edmund & Wheeler, Inc. is the signer on the Qualified Escrow Account, it causes the balance to be paid to the EAT in exchange for its deed for the Replacement Property executed in favor of the Exchangor. Before the deed can be issued, however, the EAT must pay off (or pay down to the extent of available cash) the loan made to it at Step 3, above. This is the Exchangor's receipt of the direct deed from the EAT as owner of the Replacement Property; provided the deed is delivered to the Exchangor on or before the 180th day. The Exchangor achieves a Section 1031 Exchange between Steps 7 and 11, where at Step 7 a deed is given and at Step 11 a deed is received, and in between the Exchangor had no control (or Constructive Receipt) of funds.
  46. 46.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 George’s favorite Exchange was an "acquire first,  reverse exchange". Sounds complicated, but it’s not.  Our client had negotiated the purchase of a significant  new property but had been unable to sell a piece of  existing property in time to do the deal. Rather than  jeopardize the purchase, we created a single purpose  entity (SPE), in this case, a Massachusetts trust, to  acquire the new (parked) property.   Edmund & Wheeler, Inc. was engaged to create the  new entity, hold the property until the old property  was sold and the proceeds are available to acquire the  "parked" property.   The Exchangor funded the purchase with his own and other bank resources. Once the old property was sold, the new  property was deeded to the Exchangor. Since it is not permissible to own the old and new property at the same time, this  strategy accomplished the Exchangor’s desired outcomes, again without capital gains tax.  This is a case where you can benefit your own family  without paying capital gains tax.  Our client wanted to  multi‐family rental property that had been owned for  many years and rented to college students.  The cash  flow was OK but there was deferred maintenance that  was starting to affect the market price of the property.     Meanwhile, the client’s daughter had moved to a  suburb of Chicago and wanted to acquire a property  that would be a safe secure primary residence and  provide her mom with a nice place to visit the  grandchildren.   A property was identified and purchased by an Exchange Accommodation Titleholder (EAT) with a loan from the client.  Later, our client negotiated the sale of the multi‐family property and the funds were repaid to her and the EAT deeded  her Illinois property, closing out the Exchange.  As long as the property remains as rental property in the hands of the client and fair market rent is charged, then this  strategy is perfectly acceptable.  The property can be gifted off in increments of $13,000 per person, per year.  http://www.section1031.com/EWIExchanges.htm 
  47. 47.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 CASE STUDY 3 ACBD-Delayed, Build-to-Suit (or Improvement) Exchange Direct Format In this format, client (A) gets a Section 1031 Exchange between steps 3 and 12 and acquires new, improved property. All rules MUST be followed.   The closing of the Relinquished Property; if several are involved, the first in chronological order. In this step, the deed to the property is given to the Buyer. This step starts the 45-day Identification Period and the 180-day Exchange Period. Rather than going to the Exchangor, the Buyer's funds are used to pay all of Exchangor's expenses (including mortgages, if any), with the NET going directly to a money center bank into a separate, interest-bearing Qualified Escrow Account established in the Exchangor's name and Social Security number. The Exchangor has identified property C (property needing improvements) as the Replacement Property; at this Step, Edmund & Wheeler, Inc. causes the necessary purchase price for this property to be advanced to the Single Purpose Entity (which IRS has renamed an Exchange Accommodation Titleholder (EAT)) which has been formed to own and improve the identified Replacement Property. This is the closing for Property C; this Step is the funding; and This Step is the legal acquisition. At (or hopefully well before) this time, Exchangor engages Contractors and Materialmen to effectuate the desired improvements. The vendors begin work, and soon enough, bills begin to arrive, addressed to the EAT, the legal owner of the property. All invoices are presented to the Exchangor for approval for payment from the Account. Upon such approval, further advances are made by the QI to the EAT to cover each payment. The vendors are timely paid, until funds are exhausted. This is the Exchangor's receipt of the direct deed from the EAT as owner of the Replacement Property; provided the deed is delivered to the Exchangor on or before the 180th day (as adjusted), the Exchangor achieves a Section 1031 Exchange between Steps 3 and 12, where at Step 3 a deed is given and at Step 12 a deed is received, and in between the Exchangor had no control (or Constructive Receipt) of funds.  The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing. The Purchase and Sale Agreement to sell the Relinquished Property. This step may take place before Step 1 (the only out- of-sequence exception).
  48. 48.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 This is a classic "build‐to‐suit" transaction. Our client sold a commercial property and  directed the proceeds of the sale by virtue of an Exchange Agreement to us as  Qualified Intermediary. We created a single purpose entity to conduct the business,  in this case a NH corporation. We then purchased, in the name of the new  corporation, a piece of raw land (which had been subdivided and permitted) using  the exchange proceeds. The client delivered specific instructions for the type of  building to be constructed on the site and directed who the contractor would be to  perform the work. We made a series of progress payments based on the work in  place and the "ok" to pay by the client.  Once all of the sale proceeds of the Relinquished Property were exhausted, the new  property was deeded to the client and the corporation was closed and tax return  filed on its behalf. The entire process was concluded within 180 days.    http://www.section1031.com/EWIExchanges.htm 
  49. 49.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 CASE STUDY 4 ACBD-Delayed/Simultaneous Build-to-suit Exchange Reverse Format - Exchange Last In this format, property (C) desired by the client (A) is parked and improved in a Single Purpose Entity (SPE) until client's current property (A) can be sold. Section 1031 Exchange takes place between steps 10 and 14.   This is the loan (and Line of Credit) to the Single Purpose Entity (which the IRS has renamed an Exchange Accommodation Titleholder (EAT)) that will buy the Replacement Property from its owner (C) and improve it and hold it until the Relinquished Property (A) can be sold to the Buyer (B). This is the actual purchase of the Replacement Property from its owner (C) by the EAT. At this step, the EAT (and not the Exchangor) becomes the legal owner of the Relinquished Property. The 180-day Exchange Period commences. At (or hopefully well before) this time, Exchangor engages Contractors and Materialmen to effectuate the desired improvements. The vendors begin work, and soon enough, bills begin to arrive, addressed to the EAT, the legal owner of the property. All invoices are presented to the Exchangor for approval for payment from the Line of Credit. The vendors are timely paid, until the predetermined match point has been obtained. The Relinquished Property (A) goes under Agreement of Sale to Buyer (B). The Exchangor gives Buyer (B) a deed, and the transaction closes; this step must occur before the 180th day, with enough margin to complete Steps 11-14. Rather than going to the Exchangor, the Buyer's funds are used to pay all of Exchangor's expenses (including mortgages, if any), with the NET going directly to a money center bank into a separate Qualified Escrow Account established in the Exchangor's name and Social Security number. As Edmund & Wheeler, Inc. is the signer on the Qualified Escrow Account, it causes the balance to be paid to the EAT in exchange for its deed for the Replacement Property executed in favor of the Exchangor. Before the deed can be issued, however, the EAT must pay off (or pay down to the extent of available cash) the loan made to it at Step 3, above. This is the Exchangor's receipt of the direct deed from the EAT as owner of the Replacement Property; provided the deed is delivered to the Exchangor on or before the 180th day, the Exchangor achieves a Section 1031 Exchange between Steps 10 and 14, where at Step 10 a deed is given and at Step 14 a deed is  The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing. Since the Replacement Property will be purchased (and Parked) before the sale of the Relinquished Property, a source of funds for the purchase must be arranged. This can be the Exchangor, or their bank. If a bank, the Exchangor will be expected to provide a guarantee.
  50. 50.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Our client required an industry specific building to be constructed on property that he  identified.  We created a single purpose entity to acquire the targeted land and then  began construction of the facility.  The construction was completed at day 135 and the  client moved his existing business in to the facility.  Once the former building was  vacant, it could be shown to prospective buyers and sold before day 180.      http://www.section1031.com/EWIExchanges.htm 
  51. 51.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 CASE STUDY 5 Delayed Exchange (Existing Property) Reverse Format - Exchange First In this format, property (C) desired by the client (A) can be purchased immediately by Client (A), as Client (A)'s old (Relinquished) Property (A) is parked in a Single Purpose Entity (SPE) until it can be sold to buyer (B). Section 1031 Exchange takes place between steps 3 and 6.    The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing. In consultation with the QI, the Exchangor determines what the NET proceeds would have been had the Relinquished Property sold that day; this is the cash amount of a loan to be made by the Exchangor to the Special Purpose Entity (Exchange Accommodation Titleholder (EAT)) that will buy the Relinquished Property from the Exchangor (A) and hold it until this property can be sold to the Buyer (B). In this Step, the Exchangor executes a deed to the Relinquished Property to the EAT. Not shown is a mortgage back to the Exchangor to provide for security. The 180-day Exchange period commences. The exact amount of the loan funds in Step 2 are turned over to Edmund & Wheeler, Inc. as QI. Since the Exchangor has identified Property C as the Replacement Property, the QI is instructed to fund its purchase. This is the Exchangor's receipt of the direct deed from the owner of the Replacement Property (C); the deed is delivered to the Exchangor almost immediately after the Steps above; the Exchangor achieves a Section 1031 Exchange between Steps 3 and 6, where in Step 3 a deed is given and in Step 6 a deed is received, and in between the Exchangor had no control (or Constructive Receipt) of funds. Exchangor's former property (the Relinquished Property) is now legally owned by the EAT, however, the Exchangor is expected to continue the marketing effort and to approve all offers. When Buyer (B) is found, the EAT executes a deed to the Exchangor's Relinquished Property in favor of this person. The Buyer (B) pays the purchase price to the EAT, which uses the funds to: Payoff the bank (if any); and To repay the initial loan from the Exchangor. 
  52. 52.   © 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. Rev 9.30.09 Our client had an opportunity to acquire abutting property to his primary residence.  The  new property was vacant land but included more than 500 feet of shore front land.  The  client arranged for a borrowing sufficient to acquire the new property but since he  couldn’t own the new property and the old property at the same time, he sold the old  property to a single purpose entity for the amount of money that he had just borrowed.  The old property deed was placed in the name of the entity.  Next, the entity passed the loan funds to Edmund & Wheeler, which in turn gave them to  the Seller of the shore front land, and this Seller deeded our client the property.  Then the client went to work to sell the old€

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