1031 Exchanges by leader6

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									1031 Exchanges
   Like-Kind Real Estate Exchanges
   Presented by:
   Andrew J. Haliw III, J.D., Haliw & Associates
   Peter Piddoubny, J.D.
   Assisted by: Vaishali G. Dangat, University of Chicago Law
   School; Summer Associate, Haliw & Associates
Purpose of 1031 Exchange

   Tax Deferral
       A 1031 Exchange is the structuring of a
        sale of certain kinds of property so that
        the seller‟s profit is not currently taxed.
       The seller‟s profit or gain is deferred to a
        future date.



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Purpose

   A 1031 exchange is like a traditional
    IRA or 401K retirement plan.
       The capital gains that otherwise would be
        taxable are deferred until a holder begins
        to cash out of the retirement plan.
       Same principle holds for tax-deferred
        exchanges – as long as the money
        continues to be re-invested into other real
        estate, the capital gains can be deferred.

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What Property Types Qualify?

   The property must:
       Be held either for investment, for
        business or trade use, or for the
        production of income.
       The property must be of like kind.
       A personal residence may NOT be
        exchanged.
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Section 1031 of the Internal
Revenue Code

   “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.”
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What is like kind property?

   Example: Personal Property must be
    exchanged for Personal Property
       Exchanges of livestock of opposite sex
        will NOT qualify.
       Exchanges of corporate stock shares in
        different companies will NOT qualify.



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What is like kind property?

   But Section 1031 is most often used
    for sales of Real Property.
   Real Property must be exchanged for
    Real Property
     Real Estate Examples:
         Commercial property for commercial
          property.


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Qualified Intermediary

   A Qualified Intermediary typically
    steps in to receive the taxpayer‟s
    interest in the relinquished property.
       Purpose:
           To ensure that the taxpayer never receives
            the proceeds from the sale of the old property
           Otherwise the exchange for the portion of the
            sales proceeds received by the taxpayer will
            be disqualified from the tax deferral.
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Qualified Intermediary
   The Qualified Intermediary holds the
    proceeds from the sale of the relinquished
    property until the acquisition of the
    replacement property is ready to close.
       He/she deposits the proceeds from the sale of
        the relinquished property to purchase the
        replacement property.
       After the transaction is complete, he/she delivers
        the property to the taxpayer, without the
        taxpayer ever having „constructive receipt of the
        funds.‟

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Boot
   Definition: “Something given in addition to.”
   Boot Received: the money or fair market value of
    other property received by the taxpayer in an
    exchange.
       Money: all cash equivalents, debts, liabilities, or
        mortgages of the taxpayer assumed by the other party, or
        liabilities to which the property exchanged by the taxpayer
        is subject.
       Other Property: Property that is non-like-kind;
        examples – personal property, a promissory note from the
        buyer, a promise to perform work on the property, a
        business, etc.

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Boot


   A taxpayer may receive Boot even
    inadvertently, so a taxpayer must
    understand what can result in Boot if
    the taxpayer wants to avoid taxable
    income.


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Boot: Most Common Sources

   Cash Boot
       Usually Net Cash Received: the difference
        between the cash received from the sale of the
        relinquished property and cash paid to acquire
        the replacement property.
       Can result when a taxpayer is „trading down‟ –
        i.e., the sale price of replacement property is
        less than that of the relinquished.



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Boot: Most Common Sources

   Debt Reduction Boot
       Occurs when a taxpayer‟s debt on
        replacement property is less than the
        debt which was on the exchange
        property.
       Like the Cash Boot, Debt Reduction
        Boot can occur when a taxpayer is
        „trading down‟ in the exchange.

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Boot: Most Common Sources

   Sales Proceeds used to pay non-
    qualified expenses
       Example: service costs at closing that aren‟t
        closing expenses.
       Taxpayers – encouraged to bring cash to the
        closing of the sale of their property to pay for:
           Non-transaction costs (rent perorations)
           Utility escrow charges
           Tenant damage deposits transferred to buyer
           Any other charges unrelated to the closing
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Boot: Most Common Sources
   Excess Borrowing to acquire replacement
    property
       Borrowing more money than needed to close on
        replacement property will not allow the taxpayer
        to receive tax-free money from the closing.
       Funds from a loan will be first applied toward the
        purchase. If the addition of exchange funds
        creates a surplus at closing, all unused
        exchanged funds will be returned to the
        Qualified Intermediary – to be used to acquire
        more replacement property.
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Boot: Most Common Sources


   Non-Like-Kind Property that is
    received from the exchange, in
    addition to Like-Kind property




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Advice to exchangers
   Always trade „across‟ or up, but never trade down.
       Purpose: to avoid receipt of boot, as cash, debt reduction,
        or both.
   Always bring cash to the closing of the replacement
    property to cover loan fees or other charges that
    aren‟t qualified costs.
   Do not receive property that is not Like-Kind.
   Do not over-finance the replacement property, since
    financing should be limited to the amount of money
    necessary to close on the replacement property in
    addition to exchange funds that will be brought to
    the replacement property closing.

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Qualification Requirements for
a 1031 Exchange

   The replacement property must be of equal
    or greater value of the relinquished property.
   All of the proceeds from the relinquished
    property must be used to acquire the
    replacement property.
   The taxpayer may NOT receive the
    proceeds from the relinquished property‟s
    sale.

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To Summarize

   Since the taxpayer is merely
    exchanging one property for another
    property of like kind, the taxpayer
    receives NOTHING that can be used
    to pay taxes.



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Simultaneous v. Non-
Simultaneous Exchanges

   The sale of the relinquished property and
    the acquisition of the replacement property
    do not have to be simultaneous.
   Starker Tax Deferred Exchange: a non-
    simultaneous exchange
   Qualified Intermediary: must be used
    by taxpayer for a non-simultaneous
    exchange.

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Other qualifications for a Non-
Simultaneous Exchange

   Taxpayer must follow guidelines of IRS, and
    use the proceeds of the sale to buy more
    qualifying, like-kind, investment or
    business property.
   The replacement property must be
    „identified‟ within 45 days after the sale of
    the old property and the acquisition of the
    replacement property must be completed
    within 180 days of the old property‟s sale.
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Time Limitations
         The 1031 exchanges begins on the earliest of
          the following:
           The date the deed records.
           The date possession is transferred to the buyer.
         The 1031 exchange ends on the earlier of the
          following:
           180 days
           The date the Exchanger‟s tax return is due, including
            extensions, for the taxable year in which the
            relinquished property is transferred.


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Important Dates

    Identification Period: the first 45 days
     of the exchange period.
    Exchange Period: a max of 180 days.
    Multiple Relinquished Properties: if
     the exchanger has multiple relinquished
     properties, the deadlines begin on the
     transfer date of the first property. The
     deadline cannot be extended. (including
     for holidays)
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Identification Period

     Example:
         If exchanger by mistake identifies
          condominium A, when condominium B was
          intended, this doesn‟t permit a change in
          identification after the 45-day Identification
          Period expires.




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Time Limit Difficulties


   Identifying a replacement property
    within the first 45 days after the sale of
    the relinquished property
       IRS does not allow extensions




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IRS Rules


    IRS Rules: IRS rules control the length
     of time that the replacement property
     must be held before it may either be sold
     or used to enter into a new tax deferred
     exchange.



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Rules: Use of Land

   Both the relinquished property and
    the replacement property must be
    held either for investment or for
    productive use in trade or business.
   A personal residence can‟t be
    exchanged.


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Rules: Use of Land

   Proceeds from the sale must be
    invested in a Like Kind asset within
    180 days of the sale. However, the
    property must be identified within 45
    days, but up to three properties may
    be identified.


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Rules: Use of Land


   Restrictions are imposed on the
    number of potential Replacement
    Properties.




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Rules: Use of Land
   More than one potential Replacement Property
    can be identified if one of these rules are satisfied:
       The Three-Property Rule: Any three properties
        regardless of their market values
       The 95% Rule: Any number of replacement properties if
        the fair market value of the properties actually received by
        the end of the exchange period is at least 95% of the
        aggregate FMV of all the potential replacement properties
        identified.
       The 200% Rule: Any number of properties as long as the
        aggregate fair market value of the replacement properties
        doesn‟t exceed 200% of the aggregate FMV of all of the
        exchanged properties as of the initial transfer.

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Eight Steps in a Typical 1031
Exchange



   Step 1: Retain the services of tax
    counsel/CPA.




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Step 2

   Sell the property, including the Cooperation
    Clause in the Sales Agreement:
       “Buyer is aware that the seller‟s intention is to
        complete a 1031 Exchange through this
        transaction and hereby agrees to cooperate with
        seller to accomplish the same, at no additional
        cost or liability to buyer.”
       Make sure your escrow officer/closing agent
        contacts the Qualified Intermediary to
        order the exchange documents.
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Step 3
   Enter into a 1031 exchange agreement with your Qualified
    Intermediary, in which the Qualified Intermediary is
    named as principal in the sale of your relinquished property
    and the subsequent purchase of your replacement property.

   The 1031 Exchange Agreement must meet with IRS
    Requirements, especially with regard to the proceeds.

   Along with said agreement, an amendment to escrow is
    signed that names the Qualified Intermediary as seller.

   Direct Dealing: Normally the deed is prepared for recording
    from the taxpayer to the true buyer. It‟s not necessary to have
    the replacement property identified at this time.

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Step 4
   The relinquished escrow closes, and the closing statement
    reflects that the Qualified Intermediary was the seller,
    and the proceeds go to your Qualified Intermediary.
   The funds should be placed in a separate and completely
    segregated money market account to ensure liquidity and
    safety.
   The closing date of the relinquished property escrow is Day 0
    of the exchange, and that‟s when the exchange clock begins
    to tick.
   Written identification of the replacement property must be sent
    within 45 days and the identified replacement property must
    be acquired by the taxpayer within 180 days.



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Step 5
   The taxpayer sends written identification of the address or
    legal description of the replacement property to Haven
    exchange, on or before Day 45 of the exchange.
   It must be signed by everyone who signed the exchange
    agreement, and it may be faxed, hand delivered, or mailed
    either to the Qualified Intermediary, the seller of the
    replacement property or his agent, or to a totally unrelated
    attorney. Send it via certified mail, return receipt requested.
   You will then have proof of receipt from a government agency.




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Step 6

   Taxpayer enters agreement to buy the
    replacement property.
   It includes the Cooperation Clause:
       “Seller is aware that the buyer‟s intention
        is to complete a 1031 Exchange through
        this transaction and hereby agrees to
        cooperate with buyer to accomplish the
        same, at no additional cost or liability to
        seller.”
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Step 7
   When escrow is prepared to close and prior to the
    180th day, the Qualified Intermediary forwards
    the exchange funds and growth proceeds to
    escrow. The closing statement shows the
    Qualified Intermediary as the buyer.
   The Qualified Intermediary sends a final
    accounting to the taxpayer, showing the funds
    coming in from one escrow and out to the other – all
    without constructive receipt by the taxpayer.



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Step 8

   The taxpayer files form 8824 with the
    IRS when filing taxes – or whatever
    document as required by the particular
    state.




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Sources



   Wikipedia, online encyclopedia
       Legal information




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Sources

   References for checks on accuracy:
       Advanced Like-Kind Real Estate Exchanges in
        Texas, Volume 1 and Volume 2. October 19,
        2006. Dallas, Texas.
           Presented by: William E. “Ed” Allen III, CPA; Joseph
            M. Harrison IV, J.D; and Greg Lehrmann, J.D.
       Like-Kind Real Estate Exchanges. August 30,
        2007. San Antonio, Texas.
           Presented by Katherine E. David, J.D. and Greg
            Lehrmann, J.D.

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