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Like-Kind Real Estate Exchanges in North Carolina: Tax-Deferred Exchanges Under §1031 I.R.C.

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August 22, 2018
Author: Derrick M. Tharpe
Organization: Wells Fargo


The concept of the tax-deferred exchange is quite simple: If a taxpayer exchanges current property for like-kind replacement property there is no immediate tax consequence resulting from the transaction. Any realized gain is deferred until the eventual sale of the replacement property. However, the IRS has imposed mechanical requirements on the execution of a §1031 Exchange which must be strictly adhered to if the taxpayer is to achieve a successful tax-deferred exchange.

I. EXCHANGE BASICS
A. Background
Under §1031 of the Internal Revenue Code a taxpayer may exchange property currently held for investment or productive use in a trade or business, for similar or like kind property. If the exchange of property is carried out consistent with the provisions of §1031 then the taxpayer will receive a deferral of the capital gains tax associated with the transfer.

1. Legislative Rationale: The legislative rationale which forms the basis for tax deferred exchanges is that the exchange of an asset for a similar asset of equal or greater value represents a continuity of investment which should not be taxed at the time of the exchange.
2. The §1031 tax-deferred exchange is not a new concept. In fact the earliest guidance was set forth in 1921. IRC §202 (c); IRC §1001; IRC § 1031.
a. Although establishing the initial framework for the conduct of an exchange, these regulations left many issues central to a tax-deferred exchange unresolved. As a result, taxpayers exercised, and the Courts accommodated, wide latitude in structuring various exchange transactions. See, Starker v. Commissioner, 602 F.2d 1341 (9th Cir. 1979); Estate of Bowers v. Commissioner, 94 T.C. 582 (1990); Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1990).
3. However, as a result of the landmark legal decision in Starker v. Commissioner, basic guidelines were established which made exchange opportunities much more practical for the taxpayer. Starker v. Commissioner, 602 F.2d 1341 (9th Cir. 1979)
4. IRC §1031 & Treas. Reg. §1.1031.
Through the Tax Reform Act of 1984 and subsequent 1991 Treasury Department Regulations, rules were adopted which imposed the mechanical requirements that define the current structure of §1031 exchanges, including the “Safe Harbor” rules as well as the 45 day identification period and 180 day replacement period. IRC §1031; Treas. Reg. §1.1031.

B. Definitions
Relinquished Property -The property that the taxpayer begins the exchange with. This is the property the taxpayer wishes to dispose of in the exchange.
Replacement Property – This is the property the taxpayer intends to acquire in the exchange and the property the taxpayer ends the exchange with.
Buyer – The party that acquires the relinquished property from the taxpayer.
Seller – The party that owns the replacement property which the taxpayer wishes to acquire.
Qualified Intermediary – The Qualified Intermediary is one of the safe harbors created by the Regulations Also called the QI, the QI acts on behalf of the taxpayer as a facilitator for the 1031 exchange. The QI must be an independent third party, and is designated by the taxpayer to receive the proceeds from the sale of the taxpayer’s relinquished property. In effect the QI sells the relinquished property and uses the proceeds to purchase the replacement property.
Boot – In an exchange of real property, Boot is any consideration received by the taxpayer other than real property. There are 2 kinds of boot:
1. Cash Boot: Cash boot is cash or any thing else of value received by the taxpayer as a result of the exchange
2. Mortgage boot: Mortgage boot is any relief from debt the taxpayer received as a result of the exchange
If the taxpayer receives boot in any form he or she will be taxed on the amount of boot received.
Basis – This is the starting point for determining the gain loss in the transaction. Generally, basis is the cost of the relinquished property.
Exchangor – Taxpayer

II. QUALIFIED EXCHANGE PROPERTIES
A. Ineligible properties
Despite the flexibility offered by § 1031, certain properties are ineligible for like kind exchange treatment. These properties include:
1. Stock in trade or other property held primarily for sale (Inventory); Treas. Reg. 1.1031(a)-1(i).
2. Stocks, bonds or notes; Treas. Reg. 1.1031(a)-1(ii).
3. Other securities or evidence of indebtedness; Treas. Reg. 1.1031(a)-1(iii).
4. Partnership Interests; Treas. Reg. 1.1031(a)-1(iv).
5. Certificates of trust or beneficial interests; Treas. Reg. 1.1031(a)-1(v).
6. Choses in action. Treas. Reg. 1.1031(a)-1(vi).

B. “Held For” Requirement
1. In determining the viability of a §1031 exchange transaction, the taxpayer must first determine whether the properties to be exchanged will meet the qualified purpose requirement of §1031.
a. Pursuant to § 1031(a)(2) property will not be eligible for nonrecognition treatment unless it is held by the taxpayer:
1. For use in a trade or business; or
2. For investment. .
b. However, neither §1031 nor the Regulations define the terms “held for productive use in trade or business” or “held for investment”.
c. The determination as to whether the property is held for a qualified purpose is a question of fact, See Gulf Stream Land & Development
Corp., 71 TC 587 (1979)
d. The Qualified Purpose is to be determined at the time the exchange takes place. Klarkowski v. Comm., TC Memo 1965-328, aff’d 385 F.2d 398 (CA7 1967).
• As such, the prior or subsequent use of either the relinquished or replacement property in the hands of another party is immaterial to the exchange. Rev Rul 75-291: Alderson v. Comm., 317 F2d 790 (CA9 1963).
e. Burden of Proof: It should also be noted that the taxpayer has the burden of proof in establishing that the property has been held for a qualified purpose. Land Dynamics v. Comm., TC Memo 1978-259.
2. Although not determinative, an important consideration in evaluating whether the exchange property meets the qualified purpose requirement is the amount of time which the property has been held by the taxpayer.
a. While there is no specific holding period for either the relinquished or replacement property, the longer the property has been held the more likely the taxpayer will be able show the requisite purpose. See Ltr Rul 8429039, The IRS has stated that a 2 year holding period would be sufficient holding period for the qualified use test.

C. The Like-Kind Requirement
1. Like-Kind Property:
Under §1031, the property which the taxpayer intends to exchange must be like kind to the replacement property the taxpayer plans to acquire.
a. In the context of a tax-deferred exchange, “like kind” refers to the nature or character of the property, not its grade or quality. Treas. Reg. 1.1031(a)-1(b).
b. The regulations further provide that both real property and personal property may be exchanged. Treas. Reg. 1.1031(a)-1(b).
1. Real Property is NOT like-kind to Personal Property: The distinction as to whether the property to be exchanged is real or personal property is critical, as real property is not like-kind to personal property. Treas. Reg. 1.1031(a)-1(b).

2. Additionally, the definition of like kind is much more restrictive for personal property transactions.
c. Generally, the determination as to whether the property to be exchanged is either real or personal property, is based upon the law of the state in which the property is located. Aquilino v. U.S., 363 U.S. 509 (1960); Coupe v. Commissioner, 52 T.C. 394 (1969).
d. Note: The Regulations do make specific reference to a 30 year lease as real property, Treas. Reg. 1.1031 (a)-1(c)(2), and remaining option periods under the lease are to be considered in calculating the 30 year term of the lease. Century Electric Company v. Commissioner, 192 F. 2d 155 (8th Cir. 1951).
2. Real Property
a. Real Property like-kind to other Real Property:
As to the exchange of real property (or real estate), the regulations are extremely broad, and provide that, as a general rule, all real property is like kind as to all other real property. Treas. Reg. 1.1031(a)-1(b). 1. For example, improved real property is like kind with raw land; and
2. An apartment complex is like kind with a retail shopping center. See Treas. Reg. 1.1031(a)-1(b).
b. As such, like kind is not defined by the value of the real estate to be exchanged, but rather it is established by the underlying character of the property.
c. Real Property located in the United States is not like kind to Real Property located outside the United States. IRC §1031(h)(1)

3. Personal Property
a. Although many tax professionals are familiar with the use of §1031 exchanges upon the disposition of highly appreciated real estate, the taxdeferred exchange of personal property has been relatively underutilized. However, the disposition of personal property, due to the accelerated depreciation of assets, often presents a valuable opportunity for §1031exchanges.
b. Like-Class: While the definition of like kind for real property is very broad, the like kind requirement for personal property is much more specific. §1031 contains a “like-class” safe harbor for the exchange of most types of personal property. Treas. Reg. 1.1031(a)-2. Under this “like class” safe harbor, personal property may qualify as like kind if the properties to be exchanged are
1. Within the same “General Asset Class”, See Rev Proc 87-56, 1987-2 C.B 674; OR
2. Within the same “Product Class”, as defined by the North American Industry Classification System (NAICS) as set forth in the Executive Office of the President, Office of Management and Budget, North American Industry Classification System.
c. However, personal property which does not qualify under the like class safe harbor may still qualify for IRC §1031 treatment if the taxpayer can demonstrate that the properties to be exchanged are in fact like kind. Treas. Reg. 1.1031(a)-2(a).
d. Foreign Personal Property
Personal Property assets which are used predominantly within the United States are not like kind with personal property assets used predominantly outside the United States. IRC §1031(h)(2).
e. Multiple Asset Exchanges
Reg. §1.1031 (j)-1

A Multiple Asset Exchange is one in which more than one relinquished property is transferred and more than one property is received as replacement property within the same exchange group; OR An exchange where multiple assets are transferred requiring the use of more than one exchange group.

1. Exchange Group
In a multiple asset exchange, each property to be sold or received by the taxpayer must be segregated into EXCHANGE GROUPS. Reg. §1.1031(j)-1(b)(2)(I)
a. An Exchange Group is made up of relinquished property assets to be transferred and corresponding replacement property assets to be received as part of the exchange.
b. All assets in a particular exchange group are like kind or like class to all other assets within the exchange group.
c. Each exchange group must include at least one relinquished property asset to be transferred and at least one replacement property asset to be received.

2. Liabilities
The liabilities which the taxpayer assumes as part of the exchange transaction are netted against the relief from liabilities the taxpayer realizes as a result of the exchange. Reg. §1.1031(j) 1(b)(2)(ii).
a. Assumed liabilities are allocated to the exchange group in proportion to the FMV of the replacement property received.
b. There is no tracing of liabilities to specific assets.
c. Relief from liabilities is generally treated as boot received by the taxpayer.

3. Residual Group
A Residual Group is established to include property which is a part of the transaction but is not eligible for like kind exchange treatment. Reg. §1.1031 (j)-1(b)(2)(iii)
a. The Residual Group may include:
• Properties which are not like kind
• Properties which are not eligible for §1031 exchange treatment.
b. The Residual Group is often used to balance the value of items received and transferred as part of the exchange transaction.

4. Basis of the Property Received: §1.1031(j)-1(b)(3) & (c)
The aggregate basis of the property received in a particular Exchange Group is equal to the sum of the following:
• The aggregate basis of the relinquished properties transferred;
• Plus the amount of recognized gain as to the Exchange Group;
• Plus the amount of the Exchange Group surplus; (or less the amount of the Exchange Group deficiency)
• Plus the amount of the assumed liabilities for the Exchange Group.

\
1. Elements of the Basis Calculation
a. Recognized Gain: For each exchange group, gain is recognized as to the lesser of the realized gain and the exchange group deficiency.
Realized Gain is equal to the FMV (aggregate) of the relinquished properties transferred over the aggregate basis of the properties transferred.
b. Surplus and Deficiency:
Exchange Group Surplus is equal to the excess of the FMV (aggregate) of the replacement properties received for a particular exchange group over the FMV (aggregate) of the relinquished properties transferred from the exchange group.

Exchange Group Deficiency will result where the FMV (aggregate) of the property received is less than the FMV (aggregate) of the property transferred.

III. § 1031 Safe Harbors
A. Constructive Receipt
1. A §1031 tax-deferred transaction is defined by the exchange of property for other like kind property.
2. However, if a taxpayer receives the proceeds from the sale of the relinquished property prior to acquiring the replacement property, the transaction will constitute a sale and not qualify as a tax-deferred exchange. See Treas. Reg. 1.1031(k)-1(f)(1).
3. Avoidance of Constructive Receipt:
The central element in structuring a deferred exchange is the avoidance of actual or constructive receipt of the sale proceeds (or “boot”) by the taxpayer.
a. According to the Regulations the taxpayer is in receipt of the funds if taxpayer receives the economic benefit of the money; or when the funds are credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon the proceeds. See Treas. Reg. 1.1031(k)-1(f)(1).

B. The Safe Harbors
1. To assist the taxpayer in avoiding actual or constructive receipt of the proceeds from the sale of the property, the 1991 Regulations provided newly defined “Safe Harbors” for the conduct of §1031 exchanges.
a. Through the establishment of these safe harbors, the Regulations provided taxpayers with mechanisms which, if followed, would preclude a determination by the IRS that the Taxpayer is in actual or constructive receipt of money, boot or the other proceeds from the exchange.
2. The Safe Harbors provided by 1.1031(k)-1(g) are:
a. Security or Guarantee Arrangements, Treas. Reg. 1.1031(k)-1(g)(2).
b. Qualified Escrow, Treas. Reg. 1.1031(k)-1(g)(3).
c. Qualified Intermediaries, Treas. Reg. 1.1031(k)-1(g)(4).
d. Interest & Growth Factors, Treas. Reg. 1.1031(k)-1(g)(5).

3. Qualified Intermediary
a. Role of the Qualified Intermediary
The most significant Safe Harbor created by the 1991 Regulations is that for Qualified Intermediaries. Treas. Reg. 1.1031(k)-1(g)(4).
1. A Qualified Intermediary (“QI”) is an independent third party who is designated by the taxpayer to receive the proceeds from the sale of the taxpayer’s relinquished property.
2. Following receipt of the funds, the QI will continue to hold the proceeds throughout the entire term of the exchange.
3. As a result of this direct conveyance of funds to the QI, the taxpayer is able to avoid constructive receipt of the proceeds from the relinquished property sale.
b. At present, the regulations regarding the use of a QI are clear and sufficiently generous to allow a high degree of flexibility in structuring transactions so that most tax-deferred exchanges are currently conducted using a QI.
c. In selecting a Qualified Intermediary, the taxpayer should be aware that certain persons may be disqualified from acting as the Intermediary.
1. Most notably, any person who has acted as the taxpayer’s employee, attorney, accountant or real estate broker/agent within the two (2) years preceding the exchange may not act as the Intermediary. Treas. Reg. 1.1031(k)-1(k)(2).
d. The Exchange Agreement
To effectuate a §1031 exchange using the Qualified Intermediary safe harbor, the taxpayer and the Intermediary must enter into an Exchange Agreement prior to the sale of the relinquished property.
1. The Exchange Agreement defines the QI/taxpayer relationship and must set forth the procedures, consistent with the terms of §1.1031(k)-1, for accomplishing a like kind exchange through the use of an Intermediary.
2. The G-6 Limitations: Most notably, the Exchange Agreement must specifically limit the taxpayer’s right to receive, pledge, borrow or otherwise obtain the benefits of the relinquished property sale proceeds prior to the expiration of the exchange period. Treas. Reg. 1.1031(k)- 1(g)(6). These restrictions are often referred to as the G-6 limitations, in reference to the cited location in the Treasury Regs.

3. The exchange Agreement also provides:
a. Upon execution of the Exchange Agreement the taxpayer must also assign all rights and duties under the relinquished property sales contract to the Qualified Intermediary.
b. Thereafter, upon the sale of the relinquished property, the proceeds from the sale are forwarded to the QI.
c. The QI will then hold these proceeds until the taxpayer’s acquisition of the replacement property.
d. Prior to the acquisition of the replacement property, the taxpayer must also assign the replacement property purchase contract to the QI.
e. The QI will then transfer the proceeds to the seller of the replacement property to complete the §1031 exchange.
4. Because the proceeds from the relinquished property sale are held by the Qualified Intermediary throughout the exchange process, the taxpayer is deemed not to be in constructive receipt of the proceeds.
e. Direct Deeding
1. Despite the fact that the QI receives an assignment of both the relinquished property sales contract and the replacement property purchase contract, the regulations do not require the QI to take legal title to the properties involved in the exchange. Rather the regulations provide that the relinquished property may be directly conveyed to the buyer, and the seller may directly convey the replacement property to the taxpayer. Treas. Reg. 1.1031(k)-1(g)(4)(v); See also Rev. Ruling, 90-34.
a. This mechanism of “direct deeding” has become the preferred method of undertaking an exchange as it allows the taxpayer to avoid duplication of costs associated with the closing and transfer of property.
4. Security & Guarantee Arrangements
a. This Safe Harbor provides that, the obligation of the taxpayer’s transferee (ie., the buyer or the qualified intermediary) to transfer the replacement property to the taxpayer may be secured by any of the following:
1. Mortgage or Deed of Trust
2. A standby letter of credit
3. A guarantee of a third party
Treas. Reg. 1.1031(k)-1(g)(2)
b. In effect, a mortgage or deed of trust may be placed on the relinquished property to secure the obligation of the transferee to acquire the replacement property and then transfer it to the taxpayer.
1. The benefit of this particular safe harbor is that under normal circumstances the imposition of the security interest would violate the constructive receipt rules.
2. The safe harbor provides that the particular security interest, if included among the three listed in the Regulations, will not be considered in determining whether the taxpayer is in constructive receipt of the proceeds
5. Qualified Escrow & Qualified Trust
a. Under this safe harbor the third party’s obligation to acquire and transfer the replacement property to the taxpayer may be secured by cash (or a cash equivalent) if the cash is held in a Qualified Escrow account or a Qualified trust. Treas. Reg. 1.1031(k)-1(g)(3).
b. In order to qualify under this safe harbor the Qualified Escrow or Qualified
Trust must:
1. Specifically limit the taxpayer’s right to receive, pledge, borrow or otherwise obtain the benefits of the relinquished property sale proceeds prior to the expiration of the exchange period. Treas. Reg.
1.1031(k)-1(g)(6).
2. The escrow holder or qualified trustee must not be a disqualified person as defined in Treas. Reg. 1.1031(k)-1(k).
6. Interest & Growth Factors
a. The Interest & Growth Factors safe harbor provides that the taxpayer may be entitled to receive any interest or growth factor with respect to the exchange. Treas. Reg. 1.1031(k)-1(g)(5).
b. So long as the proper G-6 limitations, Treas. Reg. 1.1031(k)-1(g)(6), are in place the receipt of the interest will not be considered constructive receipt of the funds by the taxpayer.
Example : If the exchange proceeds from the sale of the relinquished property are held by a QI, the taxpayer may be entitled to receive any interest on those funds during the time they are held by the QI and the entitlement to the interest will not be considered constructive receipt.
c. Any interest or growth factor received by the taxpayer must be reported as income to the taxpayer and is not part of the deferral amount. Treas. Reg. 1.1031(k)-1(h)(2).

IV. § 1031 TIME LIMITS
A. §1031 Exchange Periods
Pursuant to IRC §1031, there are strict time limits imposed upon all tax-deferred exchanges. Following the transfer of the relinquished property which the Taxpayer intends to exchange, the Taxpayer then has
1. 45 days to identify the replacement property and
2. 180 days to actually purchase the property. Treas. Reg. 1.1031(k)-1(b).
a. Both the 45 and 180 day time periods are calculated from the date upon which the Taxpayer transfers the relinquished property. Treas. Reg. 1.1031(k)-1(b)(2).
b. If there are multiple transfers of relinquished property, the respective time periods begin to run on the date of the earliest transfer. Treas. Reg. 1.1031(k)-1(b)(2)(iii).

B. Identification Period
1. Pursuant to IRC §1031, the Taxpayer must identify the replacement property within 45 days after the transfer of the relinquished property. Treas. Reg. 1.1031(k)-1(b)(2)(i); IRC §1031(a)(3)(A).
a. The identification of the replacement property must be in writing; and
b. Must be delivered to the appropriate party, usually the Qualified Intermediary.
c. The written Identification must be delivered prior to the expiration of the 45 day period. Treas. Reg. 1.1031(k)-1(c)(2).

2. If, however, the taxpayer completes the acquisition of the replacement property prior to the expiration of the 45 day identification period, there is no need to designate the property in a written document. Treas. Reg. 1.1031(k)-1(c)(1).

C. Replacement Period
1. IRC 1031 requires that the Taxpayer must complete the purchase of the replacement property before the earlier of:
a. 180 days following the transfer of the relinquished property: OR
b. The due date of the Taxpayer’s tax return for the year in which the transfer of the relinquished property occurred. Treas. Reg. 1.1031(k)-1(b)(2)(ii); IRC §1031(a)(3)(B).
1. If taxpayer’s return is due prior to the expiration of 180 days, the taxpayer will have less than 180 days to close on the replacement property, unless he or she requests an extension for filing the return.
Example: If the relinquished property closing occurs on Dec. 1, 1999, the Taxpayer will have 45 days within which to identify the replacement property. However, if the due date for his or her individual tax return is on April 15, 2000, this is prior to the expiration of the 180 day period. Therefore, the taxpayer must acquire the replacement property on or before April 15, 2000 or obtain an extension for filing his or her return. See Example provided in Treas. Reg. 1.1031(k)-1(b)(3).
D. Strict Compliance
1. When considering a §1031 exchange, the Taxpayer should be aware that there are no exceptions to these deadlines.
2. The 45 and 180 day time periods terminate on exactly midnight of the respective dates, and are calculated without regard to weekends or holidays.

V. IDENTIFICATION OF REPLACMENT PROPERTY
A. Written Identification
As stated previously, following the transfer of the relinquished property, the taxpayer has 45 days to provide written identification of the replacement property which he or she intends to purchase to complete the exchange.
1. As to the nature of the identification required, §1031 requires the written identification to “unambiguously” describe the replacement property to be acquired. Treas. Reg. 1.1031(k)-1(c)(3).
2. For the taxpayer, careful preparation and review of the written identification is essential. If an improper identification is submitted, it may be determined that the taxpayer failed to acquire substantially the same property as he or she identified and thereby eradicating any taxable benefit of the exchange.

B. Real Property Identification
1. Real Property: The regulations provide 3 examples of unambiguous descriptions of real property: Treas. Reg. 1.1031(k)-1(c)(3).
a. Legal description; or
b. Street address; or
c. A distinguishable name.

C. Personal Property Identification

2. Personal Property: For an exchange of personal property, the regulations require a specific description of the particular type of property. Treas. Reg. 1.1031(k)-1(c)(3).
Example: The example provided by the regulations indicates that for a truck, the identification should include the specific make, model and year. Treas. Reg. 1.1031(k)-1(c)(3)

D. Identifying Multiple or Alternative Properties
For purposes of a §1031 Like-Kind Exchange , a taxpayer may also identify multiple or alternative Replacement Properties. However, §1031 imposes mechanical, and oftentimes confusing, limitations on the number of properties which may be identified. Pursuant to the regulations, the maximum number of Replacement Properties which may be identified are set forth in the following rules.
1. 3 Property Rule
The taxpayer may identify three replacement properties without regard to the fair market value of the properties. Treas. Reg. 1.1031(k)-1(c)(4)(i)(A);
OR
2. 200% Rule
The taxpayer may identify any number of replacement properties limited by the total fair market value not to exceed 200% of the fair market value of all Relinquished Properties valued as of the date they are transferred by the taxpayer. Treas. Reg. 1.1031(k)-1 (c)(4)(i)(B).
3. 95% Rule
However, if the taxpayer violates both the 200% rule and the 3 property rule, the taxpayer is deemed not to have identified any replacement property, with the following exception; If the fair market value of the Replacement property actually received by the taxpayer is at least 95% of the total fair market value of all identified Replacement Properties. Treas. Reg. 1.1031(k)-1 (c)(4)(ii)(B).
4. Property Received Within 45 Days
Any property received within 45 days following the sale of the relinquished property will qualify for 1031 treatment, Treas. Reg. 1.1031(k)-1 (c)(4)(ii)(A);
5. For further analysis please see the following related articles:
a. Early Distributions From 1031 Exchange Accounts-Another Look at a Strange New Ruling, L. S. Weller, 93 Journal of Taxation 73 (August 2000).
b. Premature Distributions From 1031 Exchange Accounts–New Ruling Provides Guidance, Howard J. Levine, 93 Journal of Taxation 7 (July 2000).

VI. OTHER ISSUES
A. SAME TAXPAYER REQUIREMENT
1. In order to satisfy the exchange requirement of §1031, the same taxpayer that disposed of the relinquished property must acquire the replacement property. Chase v. Comm. , 92 TC 869 (1989).
a. Most commonly this issue arises in transactions which involve;
1. Husband & wife and only one name may appear on either property; Ltr Rul 8429004.
2. Circumstances involving the death of a taxpayer; Rev. Rul 64-161, 1964-1
CB 298; Goodman v. Comm., 199 F2d 895 (CA3 1952); Estate of Gregg v. Comm., 69 TC 468 (1977).
3. Property held in a Trust; Rev Rul 92-105, 1992-2 CB 204.
4. Corporate transactions affected by mergers and reorganizations and acquisitions by subsidiaries; TAM 9252001.
5. Partnerships and Limited Liability Companies;
a. For purposes of the exchange the partnership is viewed as an entity not an aggregate of its partners.
b. If partnership property is exchanged the partnership is viewed as the exchanging party and the partnership, not the individual partners, must acquire the like kind property. See TAM 9227002, TAM 9818003.

B. RELATED PARTY EXCHANGES
1. Another factor to consider in evaluating exchange transactions is the relationship among the parties involved in the exchange.
2. § 1031 (f) & (g) address transactions where the taxpayer exchanges property with a related person. IRC §1031(f) & (g).
a. Although not prohibited Related party transactions are burdened with significant restrictions
b. The related party rules were intended to prevent taxpayers from using the gain deferral provisions of 1031 to shift the basis of properties.
c. The rules are a response by the Service to abuses by tax advisors prior to the 1984 regulations
3. 2 Year Holding Period: These provisions generally state that in such transactions tax-deferred treatment will be denied if either the taxpayer or the related party disposes of the property received in the exchange within 2 years of the last transfer of the exchange. IRC §1031(f).
Example: If the taxpayer purchases the replacement property from a related party, the taxpayer must hold the property for 2 years before disposing of it
a. Any gain resulting from the sale will be recognized as of the date of the disqualified disposition.
b. There are limited exceptions to this 2 year period:
1. If a subsequent disposition occurs as the result of an involuntary conversion
2. The transfer occurs after the death of the taxpayer or the related person;
OR
3. If the taxpayer can satisfy the Service that the subsequent transfer was not done primarily to avoid taxation. IRC §1031(f)(2).
c. However, be very careful in trying to manipulate the 2yr period. The 2yrs can be suspended if the holder’s risk of loss is significantly diminished by:
1. The holding of put on the property
2. The holding by another person of a right to acquire the property
3. A short sale IRC §1031(g)(1).
4. Most obviously the definition of a related person includes family members such as siblings, spouse, ancestors or lineal descendants. But a related person is not limited to only family members – it may also include affiliated corporations and certain fiduciary relationships. IRC §1031(f)(3).
a. The full list of related parties is set out within IRC § 267(b) & 707(b)(1).
5. Additionally, there is a catchall provision which says that a related party exchange is disqualified if it is part of a transactions structured to avoid the purposes of § 1031. IRC §1031(f).

C. EARNEST MONEY
1. Replacement Property Deposit
Often the Taxpayer will request that the intermediary make an earnest money deposit on the replacement property from the exchange proceeds.
a. In order to avoid constructive receipt, this should only be done after the replacement property purchase contract has been assigned to the QI.
b. If the contract is terminated the escrow instructions should provide that the money be returned to the QI and not to the taxpayer to avoid constructive receipt.
2. If the taxpayer makes the earnest money deposit on the replacement property from their own funds:
a. The seller may refund the funds to the taxpayer if the QI provides the seller with a replacement earnest money deposit.
OR
b. The QI can reimburse the taxpayer for the deposit, but only after the Taxpayer has received the replacement property in order to avoid the G-6 limitations. Treas. Reg. 1.1031(k)-1(g)(6).
3. The taxpayer can also request the QI to pay other items prior to the purchase of the replacement property such as loan fees or appraisal fees.
a. If these fees typically appear on the closing statement then the QI can make such payment without affecting the safe harbor. Treas. Reg. 1.1031(k)-1 (g)(7).
4. Relinquished Property Deposit
On the sale of the relinquished party, once the exchange agreement is in place and the sales contract has been assigned to the QI, the buyer should make any earnest money deposit directly to the QI.
a. If the Taxpayer has already received the earnest prior to the execution of the exchange agreement and assignment to the QI:
1. The deposit amount may be refunded to the buyer at the closing of the relinquished property
2. The buyer would then include the deposit amount in the total sales proceeds paid to the QI.

D. CONSTRUCTION OF REPLACEMENT PROPERTY
The taxpayer may wish to make improvements to the replacement property and have the value of those improvements included in the cost of the replacement property.
1. According to the Regulations any improvements constructed on property owned by the taxpayer do not qualify as replacement property for the 1031 exchange.
2. As a result, any improvements which the taxpayer wants to include as part of the tax deferral must be completed prior to the taxpayer’s acquisition of the replacement property. See Bloomington Coca-Cola Bottling Company v. Commissioner, 189 F2d 14 (7th Cir. 1951); J. H. Baird Publishing Co.v. Commissioner, 39 TC 608 (1962).
a. Prior to the taxpayer’s acquisition, the owner of the replacement property under construction must not be the taxpayer’s agent.
b. In transactions involving Real Property the improvements do not have to be completed in order for the transaction to qualify as a valid exchange
1. However, any construction done after the 180 day period is outside the exchange and is considered taxable boot. Treas. Reg. 1.1031(k)-1 (e)(4).
c. Personal Property - the like kind requirements are much more stringent – the improvements must be complete when the replacement property is received by the taxpayer
3. Identification: On or before the 45th day the taxpayer must identify the replacement property, including land and improvements, with the requisite specificity. Treas. Reg. 1.1031(k)-1(b)(2)(i); IRC §1031(a)(3)(A)
a. The Replacement Property received must be substantially the same as the property identified.
1. If the description is significantly different, the identification will fail and the transaction will not qualify as a 1031 exchange. Treas. Reg. 1.1031(k)-
1 (e)(3).
2. Typical or usual production variations are not taken into account.

b. If the improvements will not be completed by the 180th day:
1. For purposes of the 45th day identification the taxpayer must make his or her best effort to identify the estimated stage of completion as of the 180th day.
2. The identification should include the best available and most practical description of the improvements and the land. Treas. Reg. 1.1031(k)-1 (e)(2).
3. The Replacement Property received with construction incomplete is substantially the same as the property identified if:
a. The replacement property is real property under local law.
b. The property received is substantially the same as the property identified. Treas. Reg. 1.1031(k)-1 (e)(3)
E. “SAFE HARBOR” REVERSE EXCHANGES UNDER Rev. Proc. 2000-37
1. In most reverse like kind exchanges, the circumstances of the transaction demand that the replacement property be purchased prior to the sale of the taxpayer’s relinquished property.
2 .In a reverse exchange, the designated property is held by an accommodating 3rd Party (“parked”) until such time as the §1031 exchange may be carried out as a deferred or simultaneous transaction. The property held by the accommodation party may be either the relinquished property or the replacement property.
a. Exchange First Model
The accommodation party acquires the replacement property and transfers it to the taxpayer in exchange for the taxpayer’s relinquished property. The accommodation party will then hold the relinquished property until it is transferred to a third party buyer.
b. Exchange Last Model
In the more common transaction, the accommodation party will acquire and hold the replacement property. The replacement property is held by the accommodation party until such time as the taxpayer has sold the relinquished property. The relinquished property proceeds are then used by the taxpayer to purchase the “parked” replacement property from the accommodation party.
3. Revenue Procedure 2000-37
Revenue Procedure 2000-37, released on September 15, 2000, established a “safe harbor” for the conduct of Reverse Exchange transactions. In doing so Rev. Proc. 2000-37 established guidelines which, if followed, guarantee that a reverse exchange “parking” arrangement will not be attacked by the Service on the basis of a lack of economic substance.
• Pursuant to 2000-37 the IRS will accept the taxpayer’s designation of property held by the accommodation party as the relinquished or replacement property; and
• Pursuant to 2000-37 the IRS will view the exchange accommodation titleholder as the owner of the property if it is held in a Qualified Exchange Accommodation Arrangement (QEAA).
a. Requirements of a Qualified Exchange Accommodation Arrangement
(QEAA) Under 2000-37
1. Beneficial Ownership: The exchange accommodation titleholder
(“EAT”) must have qualified indicia of ownership of the held property.
2. Intent: The taxpayer must intend for the property held by the EAT to be the replacement or relinquished property for §1031 like kind exchange.
3. QEAA Agreement: The taxpayer and EAT must enter into a qualified exchange accommodation agreement. The agreement must be entered into no later than 5 days after the transfer of the property to the EAT.
4. 45 Day Identification: The taxpayer must identify the relinquished property within 45 days following the transfer of the designated property to the EAT.
5. 180 Day Limit: Within 180 days following the transfer of the property to the EAT, the property held by the EAT must be transferred to the taxpayer as replacement property or to a 3rd party as the relinquished property.
6. 180 Day Total : the total time period during which the replacement property and relinquished property may be held in a QEAA cannot exceed 180 days.
b. Effect of Revenue Procedure 2000-37
If the requirements of the safe harbor are met, the IRS will not scrutinize the relationship between the taxpayer and the EAT as to the benefits and burdens of ownership or the arm’s length nature of the arrangement. In addition, under the QEAA several other factors become immaterial in analyzing the exchange including the terms of financing, and limitations on the EAT’s risk of loss.

VI. CONCLUSION
Tax-deferred exchanges are intended to allow business owners, individuals, and corporations to transfer the full value of one asset or group of assets to another of likekind without currently paying capital gain taxes on the transaction. While conceptually the transaction appears clear, the taxpayer should seek the advice of his or her tax counsel to determine whether, given the particular property and the current tax situation, it would be favorable to consider a tax-deferred exchange transaction. Tax-deferred exchanges are highly regulated and both taxpayers and tax advisers should use due care in exchange matters and adhere to the Regulations to the fullest extent possible.


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