Welcome
Tax Deferred
1031 Real
Property
Exchanges
1
As a courtesy to others. . .
Please turn off
phones and pagers
2
Course Goal
 Recognize and evaluate when a 1031
tax-deferred exchange could be
advantageous
 Explain the tax saving benefits
 Work with the client and a team of
experts to structure the transaction
3
Objectives
 Gain an understanding of how the
rules governing 1031 tax-deferred
real property exchanges are
applied and how transactions are
put together
 Explain the tax deferral benefits of
a 1031 exchange
4
Objectives
 Recognize and evaluate situations in
which a 1031 tax deferred exchange
could be to the client’s advantage
 Involve and work with intermediaries
and other experts to structure the
transaction
5
Day One
 The Fundamentals
• Safe Harbors and Intermediaries
6
Day Two . . .
 Practicum – Case Studies
 Putting the Deal Together
 Completion Exam
7
Two Positive Economic
Outcomes . . .
 Deferral of capital gain taxes
 Preservation of equity
8
When……
 Business reasons should always be the
driving factor
 When the potential tax liability
outweighs both taxes and costs
9
Real Estate Professional’s Role . .
 Help the client think through the
pros and cons
 Identify exchangeable properties
 Interface with the team of professional
advisors
10
Basic Concept . . .
 Continue an investment without adverse
tax consequences
 Solution to the “tax-locked property”
dilemma
11
Basic Concept . . .
Sale
Purchase
Exchange
Purchase
Exchange
Time
12
Eligibility . . .
 Property must be held for investment or
productive use in trade or business
- AND  Exchanged for like-kind property
13
Business Objectives . . .

Diversify or
consolidate

Business needs
Estate planning

Financial strategy


Change of lifestyle


Relocation
Avoid cost
recapture
(depreciation)
14
Advantages . . .
 Capital gains tax deferred
 Heirs receive a stepped-up basis and tax on
accumulated capital gain is forgiven
 Tax-locked property is freed up
 Money available for reinvestment instead of
taxes
15
Disadvantages . . .
 Future tax rates could be higher
 Carryover of basis to replacement property
 Complex and expensive transactions
 Losses cannot be recognized
 Proceeds must be reinvested in real estate
 Time limits must be strictly adhered to
16
Capital Gains & Income Tax Top
Rates . . .
17
Four Basic Rules . . .
1.
Property must be held for investment or
productive use in trade or business
2.
Like kind property must be exchanged for
like kind
3.
Replacement properties must be identified
within 45 days
4.
Exchange must be completed within 180
days or tax due date
18
Rule 1
. . . Held for investment or
productive use in trade or business
 Personal residences cannot be exchanged
 Classification:
 relinquished property when transferred
 replacement property when received
 If owner occupies a unit as a personal
residence, the rental portion can be an
exchange, personal use portion receives
capital gain tax treatment
19
Rule 1
. . . Held for investment or
productive use in trade or business
Vacation Properties. . .
 Exchanges can be problematic if any personal
use of it–hard to document occupancy
 Considered personal residence if owner
occupied more than (greater of) 14 days, or
10% of the total days rented
20
Rule 1
. . . Held for investment or
productive use in trade or business
 Dealer property specifically excluded for 1031
exchange
 Dealer property: primarily for sale in ordinary
course of business
 Real estate brokers/agents are not
automatically dealers
21
Qualified property determined
by owner’s intent . . .
Not Qualified
Personal
Residence
Dealer
Property
Qualified
Vacant Land
(1221) &
Investment
Property
Used in Trade
or Business
(1231)
22
Rule 1
. . . Held for investment or
productive use in trade or business
Unqualified Property . . .

Personal residence

Dealer property

Stock, bonds, notes

Choses in action

Certificates of trust or beneficial interests

Securities or evidences of indebtedness

Interests in a partnership
23
Rule 2
. . . Like kind exchanged for
like kind
 All real estate held for investment or
productive use in trade or business is like-kind
 Property included in exchange that is not
like-kind is taxable boot
 Property located outside the U. S. (50 states
& DC) not like kind
 Exception, U.S. Virgin Islands
24
Rule 2
. . . Like kind exchanged for
like kind
Like Kind Exchange
Real Estate
Trade or
Business,
Investment
$
Personal
Property
25
Rule 3
. . . 45 Days to Identify
Replacement Property
 Identification period starts on the day that the
title to the relinquished property is transferred
 If multiple properties relinquished, date of
first transfer starts 45-day period
26
Rule 4
. . . 180 days or by tax due
date to complete exchange
 The replacement property must be
transferred before the EARLIER of 180 days
after the date of transfer of the relinquished
property, OR the due date, including
extensions, of the tax return for the tax year
of the exchange
27
Rule 4
. . . 180 days or by tax due
date to complete exchange .
 Count the days
 180 days does not equal 6 months *
* May file for an extension, but exchange
must be completed with 180 days.
28
Foreign Taxpayers
 Foreign Investment in Real Property Tax Act
of 1980 (FIRPTA)
 Applies when the transferor (seller) is a non-U.S.
taxpayer (individual or organization) and the property
is a U.S. real property interest (USRPI).
 Withholding agent (may be the real estate agent)
must withhold 10% of the amount realized (not gain)
and remit the it to the IRS within 20 days of
transaction.
29
Taxpayer Identification
Number (TIN)
 For an individual who cannot or does not
qualify to receive a Social Security number.
 Non-U.S. persons must provide a TIN when
they buy or sell U.S. real property.
30
Boot in 1031 Exchanges . . .
 Cash or unlike property received in the
exchange
 Taxable gain
 Fair market value is recognized
31
Rule 2
. . . Like kind exchanged for
like kind
Unqualified Property
Mortgage
Relief
Unqualified
Property in
an Exchange
Cash
=
Taxable Boot
32
Boot in 1031 Exchanges . . .
 Compare the fair market value of boot with
the gain that would result from selling the
property
 Taxable gain is the lesser of these two
amounts
33
Boot in 1031 Exchanges . . .
Example 2.1. . .Real estate with an adjusted basis of
$30,000 is exchanged for other real estate with a fair
market value of $100,000, plus $35,000 boot.
Total consideration received
$135,000
Less - Adjusted basis
$30,000
Total realized gain
$105,000 GAIN
Total boot received
$35,000
Taxable gain is the smaller of
the two
$35,000
34
Boot in 1031 Exchanges . . .

If either party assumes any of debts or
liabilities of the other as part of the
exchange, the amount of liability is
treated as cash boot
35
Boot in 1031 Exchanges . . .
Example 2.2. . . Allen exchanged real estate
with an adjusted basis of $30,000 for other real
estate with a fair market value of $100,000. In
addition, he received $35,000 cash and the other
party assumed a mortgage of $25,000.
36
Boot in 1031 Exchanges . . .
Step 1 - Total Gain Realized
Step 2 - Total Boot Received
FMV of like-kind property Allen
received
$100,000
Mortgage assumed by other party
$25,000
Cash boot received
Cash received
$35,000
Total boot received
$60,000
$35,000
Mortgage assumed by other party
$25,000
Total consideration Allen received
$160,000
Less basis of property given up
$30,000
Total gain realized
Taxable gain is lesser
amount . . . $60,000
$130,000
37
Boot in 1031 Exchanges . . .
Netting the Liabilities . . .
 Mortgage on relinquished property is boot
received
 Mortgage assumed may be offset against
this boot
38
Boot in 1031 Exchanges . . .
Example 2.3 . . .Christine exchanged land with a
mortgage of $10,000 for land with a mortgage of
$15,000. In addition, she received cash boot of
$6,000. After offsetting the mortgages, she has paid
$5,000 mortgage boot, but is not allowed to deduct
this boot paid from the cash boot received.
Her taxable boot received is $6,000.
39
Boot in 1031 Exchanges . . .

Transaction costs reduce both recognized
and realized gain on the sale side and
increase basis on the purchase side
 Includes: brokerage commissions and
closing costs such as title policy, escrow,
and recording fees
40
Boot in 1031 Exchanges . . .
Example 2.4 . . . Dave owned property with an
adjusted basis of $30,000 and exchanged it for likekind property with a fair market value of $100,000
plus $35,000 cash. He paid a $9,000 commission to
his real estate broker. Dave’s taxable gain is limited
to the net boot he received—$26,000.
A "loss" is not deductible.
41
Boot in 1031 Exchanges . . .

Cash boot paid offsets boot received

Mortgage boot paid offsets mortgage boot received

Mortgage paid, if more than mortgage assumed, may not
offset cash or unlike property

Other boot paid may be treated as the purchase price for
non-like kind property received

Selling expenses may offset boot received or net
mortgage relief if no cash or unlike property is received

Recognized gain may be offset by suspended losses
42
Basis . . .

Cost of a property for tax purposes
 If purchased outright, basis is the
price paid for the property plus
acquisition costs
43
Basis . . .

Capital improvements increase basis
 Items that provide a tax benefit
decrease basis, e.g. cost recovery
(depreciation)
44
Basis . . .
Property
Purchased
Cost recovery decreases basis;
recaptured at sale, taxed at 25%.
No cost recovery on land.
Property Sold
15% tax
25% tax
Capital Gain
Original
Basis
Cost Recovery
Recapture
Time 39 Years
45
Basis . . .
Very Important . . . Basis in the
relinquished property is carried over to
the replacement property, regardless of
the cost of either of the properties
46
Increases in Basis . . .
 Cash paid in to balance equities
 Liabilities/debts assumed on the
replacement property
 Improvements to the property
 Acquisition costs
47
Decreases in Basis . . .
 Depreciation
 Cash or nonqualified property
received
 Debt relief on the relinquished
property
 Reimbursement from an insurance
policy for casualty or theft loss
48
Equity . . .
Relinquished
Property
$50,000
Replacement
Property
$550,000
Equity
* Could
selling costs
$550,000
Equity
$400,000
Mortgage
Balance
Property A
$1 Million
$1,450,000
New
Mortgage*
finance $1.5
Million and
take out
$50,000 cash
(taxable).
Property B
$2 Million
49
Basis . . .
Relinquished
Property
$50,000
selling costs
$450,000
deferred
gain
$500,000
adjusted
basis
Property A
$1 Million
Replacement
Property
$450,000
deferred
gain
$1,550,000
substitute
basis
Property B
$2 Million
50
Exchange with Installment
...
 The installment sale gross profit
(recognized gain) is reduced by gain
not recognized in the exchange
51
Exchange with Installment
...
Example 2.5 . . . Frank owned, free and clear, an
investment property with a FMV of $100,000 and a basis
of $30,000. If he made a cash sale, he would be taxed on
$70,000. Frank decided to make a like-kind exchange for
an investment property owned by George. The FMV of
George’s property is $75,000. Frank receives George’s
property in the exchange and agrees to accept an
installment note for $25,000 to balance the equities.
Frank receives no payments of principal in the year of
sale.
52
Exchange with Installment
...
Example . . . Frank’s gross profit percentage is 100%—
the gross profit of $25,000 divided by contract price of
$25,000. Since he did not collect any payments in the
year of sale, he has no recognized gain in the year of the
exchange.
Each year following, 100% of the principal collected that
year will be recognized as taxable capital gain
53
Identifying Properties . . .
 No limit on the number/value of
properties to be relinquished
 Limits on number/value of replacement
properties identified
54
Identifying Properties . . .
Three Property Rule . . .
Maximum number of replacement
properties that may be identified is three
without regard to the FMV of the
properties
55
Identifying Properties . . .
200 Percent Rule . . .
Any number of properties if aggregate FMV
is not more than 200% of the aggregate
FMV of all the relinquished properties
56
Identifying Properties . . .
95 Percent Rule . . .
Any number of properties if by end of
exchange period (180 days) aggregate
value of replacement property acquired is
minimum 95% of aggregate FMV of all
identified property.
57
Incidental Property . . .
 Not separate from larger item of
property
 Typically transferred together
 Aggregate FMV is not more than 15%
of FMV of the larger item of property
58
Identifying Properties . . .
In Writing. . .
 Delivered, mailed, or telecopied (faxed),
on/before end 45-day identification
period to the other person involved in
the exchange
 Or part of written agreement signed by
all parties–includes the real estate agent
59
Revoking Identification . . .
 May be made at any time before the
end of the 45-day identification period
 Written document signed by taxpayer
60
Property to be Produced . . .
Property to be Produced /Built to Suit
 Qualifies as replacement property
 Estimated at FMV as of the date it is
expected to be received or would have
if construction had been completed
61
Property to be Produced . . .
 Additional production on
replacement property after received
does not qualify for like-kind
exchange
 Caution: exchange for services
62
Holding Period . . .
The holding period of the relinquished
property for capital gain tax treatment is
carried over to the replacement property
63
Holding Period . . . Related
Parties
Minimum two-year holding period . . .

If related parties involved in
exchange – relinquished or
replacement property

Additional reporting – Form 8824 for
two more years
64
Related Parties . . .
 Family members (siblings, spouse,
ancestors, and lineal descendants)
 Corporate relationships
 Partnerships
 Trusts
 Estates
 Organizational relationships
65
Holding Period . . . Residence
Received in Exchange
Minimum five-year ownership period . . .

Property received in exchange and
converted to personal residence must be
held 5 years in order to qualify for
$250,000 exclusion of gain on sale of
personal residence.
66
State Laws . . .
 Examine for both the state of the
relinquished property and
replacement property
67
Documenting Intent to
Exchange . . .

Listing Agreement . . . 1031 exchange
contingency if dependent on completion of a
tax-deferred exchange
 Exchange Agreement . . . Document
relationship between taxpayer & safe
harbor
68
Documenting Intent to
Exchange . . .

Sales Contract . . .notice of
assignment of rights if a qualified
intermediary involved
 Purchase Agreement . . . 1031
exchange contingency establishes
intent
69
Documenting Intent to
Exchange . . .

Escrow Instructions . . direct
how the proceeds should be
received and disbursed

These documents . . . not
required to be included with filing,
should be in place to prove intent
70
Reporting the Exchange . . .
IRS Forms . . .
 1099-S Proceeds From Real Estate
Transactions
 Form 8824 Like-Kind Exchanges
 Form 4797 Sales of Business Property
71
Types of Exchanges . . .
Simultaneous Exchange . . .
On the agreed day, the parties meet at
the closing table to swap deeds for the
properties
72
Types of Exchanges . . .
Deferred “Starker” Exchange
 T.J. Starker v. United States . . .
Exchanges do not have to be
simultaneous to qualify
 Landmark 1979 Federal Court case
73
Types of Exchanges . . .
 Deferred “Starker”: Relinquished
property transferred before replacement
property acquired
 Reverse “Starker”: Replacement
property acquired before relinquished
property transferred
74
Types of Exchanges . . .

Actual receipt . . . cash proceeds or
property are in the taxpayer’s
possession
 Constructive receipt . . . cash
proceeds or property can be drawn
or are in taxpayer’s control
75
Types of Exchanges . . .
Deferred “Starker” Exchanges . . .
 Key to successful transaction –
avoiding actual or constructive receipt
 Actual or constructive receipt by an
agent is actual or constructive receipt
by the taxpayer
76
Types of Exchanges . . .
 Qualified Exchange Accommodation
Arrangement (QEAA)
 Qualified Exchange Accommodations
Titleholder (QEAT) takes and holds title to the
replacement property
 “Parks” title with QEAT until replacement
property identified & exchange completed
77
Types of Exchanges . . .
Reverse Exchange . . .
 Taxpayer must complete agreement
with QEAT within 5 days of
accommodator acquiring replacement
property
78
Reverse Exchange SafeHarbor Guidelines . . .
 Complete within 180-days or the property held by
the QEAT is deeded to the taxpayer
 Identify relinquished property within 45 days
 Intermediary can hold title to replacement or
relinquished property
 Qualified Exchange Accommodations Agreement
(QEAA) completed within 5 days
79
Types of Exchanges . . .
Reverse Exchange . . .

Replacement property held in a QEAA may
not be owned by the taxpayer within the 180day period preceding the date of transfer of the
property to the Exchange Accommodation
Titleholder.
Rev. Proc. 2004-51
80
Types of Exchanges . . .
Delayed Closing or Deferred Exchange?
 Don’t confuse
 Delayed closing: relinquished
property "sale" does not close until
an agreed date
81
Types of Exchanges . . .
Example 2.6: Two Way Exchange
Edward
Central Court
(exchanger)
Susan
(seller)
Silver City
82
Types of Exchanges . . .
Three Way Exchange. . .
 Solves the dilemma of a two-way swap
 Why? Other owner seldom wants the
offered property, but would accept
another one, or prefers to sell the
property and take the cash proceeds
83
Types of Exchanges . . .
Example 2.7
Three Individual Transfers
Edward
Bob
(exchanger)
(buyer)
Susan
(seller)
84
Types of Exchanges . . .
Example 2.8
Exchange with Purchaser
Edward
(exchanger)
Bob
2
(buyer)
1
Susan
(seller)
85
Types of Exchanges . . .
Example 2.9
Exchange with Seller
Edward
Bob
(exchanger)
(buyer)
1.
2.
Susan
(seller)
86
Types of Exchanges . . .
Example 2.10
Escrow Holder as Accommodator
Edward
Bob
(exchanger)
(buyer)
Escrow
Susan
(seller)
87
Types of Exchanges . . .
Example 2.11
Exchange with an Intermediary
Edward
Bob
(exchanger)
(buyer)
Intermediary
Susan
(seller)
88
Tenants in Common . . .
 Enables small investor ownership
participation in premium commercial
& investment property
 Like-kind property for 1031 exchange
89
Tenants in Common . . .
 What it is not . . . a joint venture,
partnership, or limited partnership
 What it is . . . each investor owns an
undivided, fractional, interest
90
Tenants in Common . . .
Advantages . . .
 Avoid involvement in day-to-management
 Investment in high quality properties
 Comply quickly with 45-day identification
time limit
 Exchange a specific amount of value
 Upgrade and diversity a portfolio
91
Tenants in Common . . .
Advantages . . .
 Sponsors (specialized firms) research
properties, package investments, and
monitor performance
 Large, institutional-grade properties
92
Tenants in Common . . .
Caution . . .
SEC regulations bar a commission or referral
fee unless the real estate professional is a
licensed security dealer

 Agent may be compensated for counseling
services
 Can be paid from funds held by the QI, not
the sponsor
93
Four Safe Harbors . . .
Purpose . . . avoid actual or
constructive receipt of proceeds
1. Security or guarantee arrangements
2. Qualified escrow accounts and trusts
3. Interest and growth factors
4. Qualified intermediaries
94
Four Safe Harbors . . .
Security or Guarantee Arrangements
 Mortgage, deed of trust, or other
security interest in property (other than
cash or a cash equivalent)
 Standby letter of credit
 Guarantee of a third party
95
Four Safe Harbors . . .
Qualified Escrow Accounts & Trusts . . .
Escrow may not be held by the exchanger or a
related party, and the exchanger’s rights to
receive, pledge, borrow, or otherwise obtain the
benefits of the escrow account must be limited
96
Four Safe Harbors . . .
Escrow Account or trust funds may pay
transactional items if. . .
 Related to disposition or acquisition of
property, and
 Typically listed as the responsibility of a
buyer or seller on the closing statement
97
Four Safe Harbors . . .
 Exchanger may receive money or other
property directly from another party to
the transaction – not from a qualified
escrow, trust, or intermediary
 Why? Disqualifies safe harbor
98
Four Safe Harbors . . .
Interest and Growth Factors. . .
 Interest earned while the sale proceeds
are held by the QI may be paid into
escrow
 Received by the exchanger as earned
income upon completion of transaction
99
Four Safe Harbors . . .
Qualified Intermediary. . .
A person (or company) who facilitates the
exchange by making an agreement for the
exchange of properties
100
Four Safe Harbors . . .
Qualified Intermediary
 Transfers titles to properties
 Agreement with a person (other than
the exchanger) to transfer relinquished
property
 Agreement with the replacement
property owner to transfer that property
101
Four Safe Harbors . . .
 Direct deeding: intermediary acquires
rights to transfer deeds to the
properties
 Sequential deeding: intermediary
acquires deed to relinquished and
replacement properties and transfers
deeds
102
Four Safe Harbors . . .
Example 3.1A
Direct deeding by a Qualified Intermediary
Edward
(exchanger)
Bob
(buyer)
Qualified
Intermediary
Susan
(seller)
103
Four Safe Harbors . . .
Example 3.1B
Direct deeding by Exchanger and Seller
$1 million
cash
Bob
(buyer)
Edward
(exchanger)
$1 million
property
$1,000,000
$100,000
Qualified
Intermediary
$1 million
$900,000
Susan
(seller)
$900,000
property
104
Before
After
Edward owns Central
Court Apartments valued
at $1,000,000
Edward owns Silver City
Apartments valued at
$900,000 and has
$100,000 cash
Bob owns Central Court
Apartments valued at
$1,000,000
Bob has $1,000,000 Cash
Susan owns Silver City
Apartments valued at
$900,000
Susan has $900,000 cash
105
Four Safe Harbors . . .
Disqualification . . .
Intermediary may not be:
 Taxpayer
“Person” also
means corporate
entities
 Related person
 Agent of the taxpayer
 Person related to agent of taxpayer
106
Four Safe Harbors . . .
Disqualification . . .
Agent of the exchanger:
 Employee
 Attorney
 Accountant
Within two-year
period ending on
the date of the
transfer of the first
of the relinquished
properties
 Investment banker or broker
 Real estate agent or broker
107
Four Safe Harbors . . .
Disqualification . . .
Exceptions
 Performance of services that are solely
with respect to exchanges of real estate
 Performance of routine financial, title
insurance, escrow, trust services by a
financial institution, title insurance
company, or escrow company
108
How Are Real Estate Agents
Paid? . . .
Safe harbor arrangements allow the
real estate professional’s commission
to be paid on behalf of the taxpayer
as a “transactional item”
109
How Are Real Estate Agents
Paid? . . .
Caution: When tenants-in-common ownership
interest in involved in the exchange
 SEC views the ownership interest as a
security, bars payment of a commission
or referral fee unless the real estate
professional is a licensed security
representative
 Exchanger may compensate a real estate
agent for counseling services
110
Putting It All Together . . .
Evaluating exchange situations
 Assess the overall situation
 Experience and comfort level
 Change of mindset
 Even swap or value gain?
111
Putting It All Together . . .
Finding a qualified intermediary
 Member of the Federation of Exchange
Accommodators
 CES designation
 Bonded by insurance company
 Professional background, CPA?
Attorney?
112
Putting It All Together . . .
Finding a qualified intermediary
 Responsibility for losses
 Interest on the escrow account
 Accessible to your client and you
113
Putting It All Together . . .
Finding a qualified intermediary
 Other experts involved
 Adequate paper trail
 Accustomed to type/size of
transaction
 Specialty
 Licensed securities representative
114
Putting It All Together . . .
Watch out for…..
 Complying with time limits
 Lack of preparation
 Negotiating for only “Plan A” property
 Other obstacles that intervene
 Unscrupulous parties
115
Thank You . . .
Tax Deferred
1031 Real
Property
Exchanges
116