The document discusses various aspects of 1031 exchanges, which allow taxpayers to defer capital gains taxes when exchanging one investment property for another. It explains the rules around like-kind exchanges, including that the properties must be held for investment purposes. It also outlines the guidelines for deferred exchanges, including that any cash or "boot" received in an exchange is taxable and the timelines for identifying and closing on a replacement property.

1. TAXATION
CHAPTER 14
1

2. 1031 EXCHANGES
I’ll exchange this
house…
…for this fourplex.
2

3. SELLING OR EXCHANGE
Mr. Walker has a 10-unit apartment building. The
units sell for $700,000 with selling costs of
$56,000. It has an adjusted basis of $244,000 and
an existing loan of $200,000. Find the gain, taxes
owed, and the net equity.
SP 700,000
– SE 56,000
= Net SP 644,000
– AB 244,000
= Gain 400,000
3

4. Taxes owed:
Gain 400,000
x Tax Rate 15%
Taxes 60,000
4

5. Net equity or cash out
Net SP 644,000
– Loans 200,000
Equity 444,000
– Taxes 60,000
Net Cash out 384,000
5

6. G = SP - SE – AB
In disposition of investment property there are
three ways to handle the gain:
1. Realize the gain.
2. Recognize the gain.
3. Defer the gain.
6

7. TWO PARTY EXCHANGES
Most people think of a two-party exchange. This is
where A and B exchange properties, and A gets
B’s property and B gets A’s property
AB BA
In real life this seldom (or never) happens.
7

8. THREE PARTY EXCHANGES
In a three-party exchange, we have a person who
wants to exchange (E), a seller (S), and a buyer
(B). There are two ways to complete this
exchange.
1. ES SE BE
2. S S
BE ES
8

9. S E B
Anybody can be the center (hub) of the exchange,
except the exchanger.
When a client who wants a 1031 tax–deferred
exchange, in the listing, a statement should
include that the client wants to make a 1031 tax–
deferred exchange and should be stated in the
multiple listing service (MLS).
9

10. BUY–UP RULE
If the exchanger has traded up in value and up in
equity, then the exchange is totally tax deferred.
Trade-up means the new property must be equal to
or greater in value than the old property. If the
exchanger withdraws any cash, the cash
withdrawn will be taxable.
Any trade down is a taxable event.
10

11. Mr. Evans wants an exchange and Mr. Samson
wants to sell his property. Mr. Evans’ FMV is
$500,000 with loans of $300,000. Mr. Samson’s
FMV is $700,000 and loans of $400,000.
E S Trade
Down
FMV 500,000 700,000 0
– L 300,000 400,000
= E 200,000 300,000 0
11

12. Mr. Evans went up in value and equity, thus E has
a tax differed exchange.
12

13. Mr. Evans wants to make an exchange and Mr.
Samson wants to sell his property. Mr. Evans’
FMV is $500,000 with loans of $300,000. Mr.
Samson’s FMV is $700,000 and loans of $400,000.
E S Trade
Down
FMV 500,000 700,000 0
– L 300,000 200,000
= E 200,000 200,000 0
13

14. Mr. Evans went down in value of $100,000 and
equity remained the same, therefore E has a
taxable event.
14

15. Mr. Evans wants to make an exchange and Mr.
Samson wants to sell his property. Mr. Evans’
FMV is $500,000 with loans of $300,000. Mr.
Samson’s FMV is $400,000 and loans of $400,000.
E S Trade
Down
FMV 500,000 400,000 100,000
– L 300,000 200,000
= E 200,000 200,000 0
15

16. The trade–down in value of $100,000 will be a
taxable event. The gain will be long–term Capital
Gains, and will pay $20,000 in Federal Taxes.
16

17. ENTITY RULE
The way the exchanger holds the property going
into the exchange is the way the exchanger must
hold the property coming out of the exchange.
17

18. There are three basic ways to hold property:
#1: Individual.
#2: Partnership
#3: Corporation
18

19. A and B are in partnership, the AB Company.
They are not getting along, so they decide to split.
The partnership AB owns one building. Each one
finds another building they want. AB Company
exchanges one building for two buildings. But the
partnership now owns two buildings.
So far, so good.
19

20. As soon as the exchange is completed they put
title of the property in their own names.
This now becomes an invalid exchange.
20

21. STEP-TRANSACTION
A step-transaction are two transactions where
the second transaction would not have done
without doing the first transaction.
21

22. INVESTMENT PROPERTY RULE
The property must be held for trade or business or
resale.
Mr. Brown buys a building for his real estate
business. Thus the building is being held for his
trade. Thus, the building would qualify for a 1031
exchange.
22

23. Ms. Knight buys a 10-unit apartment building for
investing. Thus, the building would qualify for a
1031 exchange
23

24. You can NOT exchange the following:
1. Stock in trade or Inventory.
2. Stock or bonds.
3. Interest in partnership
The answer to what is an investment and what is
inventory is determined by the taxpayer by the
taxpayer’s intent and actions.
24

25. Mr. Bullen buys 5 rental properties. He buys a
new property each year for 5 years. Lot 3, in
tract 35; lot 8 in tract 35, lot 13 in tract 35, lot 21
in tract 35 and lot 6 in tract 35. He exchanges lot
3 for another lot in Northern California.
25

26. 1 2 3 4 5 6
12 11 10 9 8 7
13 14 15 16 17 18
24 23 22 21 20 19
TRACT 35
Mr. Lentz owns the lots in the tract
lot marked in green: 3, 6,8, 13 and 21.
He exchanges lot 3 for another lot in
Northern California.
26

27. Is this a valid exchange?
What makes you think it is a valid or invalid
exchange?
27

28. NO.
He has inventory. 5 lots in the
same tract is a subdivision.
Subdivisions are considered
inventory, not investment
property.
28

29. LIKE-KIND RULE
You must exchange like-kind property.
The are two types of properties:
1. Personal Properties.
2. Real Properties.
Personal property and real property are NOT
like–kind.
29

30. PERSONAL PROPERTY
Three easy questions on like-kind personal
properties.
30

31. Question #1
Can you have a valid 1031 exchange by exchanging
gold coins for gold bullion?
31

32. Question #2
Farmer Boise exchanges his bull for a cow. Is
this a like–kind exchange?
32

33. Question #3
Mr. Anderson has a bowling alley and wants to
exchange it for a pool hall. Is this a valid
exchange?
33

34. ANSWERS TO QUESTIONS 1, 2, &
3
Question 1 NO
Question 2 NO
Question 3 NO
34

35. REAL PROPERTY
Three simple questions on like–kind real
properties.
35

36. Question #4
Mr. Ford wants to exchange an orchard for an
office building. Is this a like–kind property?
.
36

37. Question #5
Mr. Rooks wants to exchange a 50-year lease
for a rental house. Is this a like–kind
exchange?
50 year
Lease
.
37

38. Question #6
Mr. Minor wants to exchange mineral rights for a
commercial building, is this a like-kind exchange?
Minerals in the Ground
38

39. ANSWERS TO QUESTIONS 4, 5, & 6
Question 4 YES
Question 5 YES
Question 6 YES
39

40. REAL PROPERTY
1. Vacant land.
2. Improved real estate.
3. Leases (30 years or more).
4. Mineral and Water rights.
40

41. Simply stated, any piece of real property for any
piece of real property, held for investment.
.
41

42. NO-CHOICE RULE
The exchanger who qualifies for a 1031 tax-
deferred exchange has no choice: the exchanger
cannot recognize the gain or loss.
42

43. Mr. Haydon exchanged a property that had a
$50,000 loss in 1992. He sold some stock that had
$75,000 gain. He would like to write his loss of
$50,000 off against his gain of $75,000, leaving
him with a net profit leaving him with a net profit
of $25,000 to pay taxes.
Since it was an exchange, he cannot write off the
loss.
43

44. NO-LOSS RULE
In conjunction with the no-choice rule it states
that no loss can be recognized.
44

45. MONEY CONTROL RULE
At no time can the exchanger have control over
the buyer’s money.
45

46. DELAYED EXCHANGE
1. 45 days to designate new property.
2. 180 days to close escrow.
3. Cannot file tax return until escrow closes.
46

47. BOOT
FMV Boot – difference in value.
Mortgage Boot – difference in loans
Equity – difference in loans
47