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3 Property Rule
Identification of alternative replacement properties is valid
if the taxpayer identifies no more than three alternative
replacement properties as part of the same deferred exchange.
The values of the relinquished or replacement properties do
not matter.
95 Percent Rule
This rule involves a taxpayer transferring a single relinquished
property and in turn acquiring more than three replacement
properties whose aggregate value exceeds 200 percent of the
value of the relinquished property. This rule was adopted
to allow taxpayers who might want to complete such exchanges
as deferred exchanges. Accordingly, this rule was adopted
as a safety valve. Identification of alternative replacement
properties is valid even if the taxpayer fails to meet either
the three-property rule or the 200 percent rule, as long as
the taxpayer receives at least 95 percent of the aggregate
fair market value of all identified replacement properties
before the end of the exchange period.
200 Percent
Rule
This rule is applicable when the investor identifies more
than three alternative replacement properties. This identification
holds validity as long as the aggregate fair market value
of all such replacement properties at the end of the identification
period does not exceed 200 percent of the aggregate fair market
value of all the relinquished properties in the exchange.
721 Exchange
Section 721 of Internal Revenue Code permits an investor to
contribute a property to the partnership. No gain or loss
shall be recognized to the partnership or to any of its partners
in the case of a contribution of property to the partnership
in exchange for an interest in the partnership. This clause
however does not apply to gain realized from transfer of property
or to a partnership which will be treated as an investment
company, if the partnership were incorporated.
1031 Buyer Representation
Real Estate Brokerage Company with expertise in §1031
Exchanges. Their main function is to represent the interests
of the §1031 buyer rather than to the property broker
who has a fiduciary responsibility to the seller.
1031 Exchange
Internal Revenue Code, §1031 permits taxpayers to reinvest
the proceeds from the sale of property held for investment
or business purposes into another investment or business property,
and defer capital gains tax that would otherwise be due on
the initial sale.
1031
Tax Deferred Exchange
An exchange where, pursuant to "An Agreement" the
taxpayer transfers property held either for productive use
in a trade, business or for investment and receives a new
property for a similar purpose.
1991 Revisions
Year when the IRS held a hearing to "clean up" the
Tax Reform Act of 1984 and provide uniform terminologies.
A main result of this revision was that the IRS eventually
had a change of attitude toward Delayed Exchanges by accepting
them instead of fighting them.
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Accommodator
A third party that helps to facilitate the exchange. He is
not a related party to the exchanger. His job is to facilitate
the disposition of the Exchangors relinquished property and
the acquisition of the Exchangors replacement property. The
QI has no monetary interest except for the fees charged for
facilitating the exchange as defined in Section 1031 of the
Internal Revenue Code.
Acquisition Period
The Exchangor has a maximum of 180 days from the closing day of the relinquished property or the due date of that year's tax return, whichever occurs earlier, to acquire the replacement property.
Adjusted Basis
The basis of a property adjusted for any capital improvements or
depreciation. To calculate the adjusted basis, add the basis (the
cost of the property), to the cost of any capital improvements made
to the property during the taxpayer's ownership, and subtract the
depreciation taken on the property during that specific time period.
Once the adjusted basis is known, the gain or loss can be computed.
Appreciation
An increase in an asset’s value.
Asset Allocation
Dividing investments among different kinds of assets, such as stocks,
bonds, real estate and cash, to balance the risks of investing.
Asset allocation models vary based on an individual’s specific
financial goals and situation.
Basis
The amount you use to determine your capital gain or loss
from a sale or disposition of property. To determine the adjusted
cost basis for the property, one must start with the original
purchase cost. Then add any out-of-pocket expenses such as
brokerage commissions, escrow costs, title insurance premiums,
sales tax (if personal property) and other closing costs directly
related to the acquisition, cost of capital improvements and
principal payments of special assessments to the property.
Then subtract depreciation you have taken or were allowed,
any casualty losses taken and/or any demolition losses taken.
Basis in the Replacement Property
In an exchange, the deferral of the tax on the gain is accomplished
by requiring the taxpayer to carryover (substitute) the basis of
the relinquished property to the replacement property with suitable
adjustments in the event additional consideration is paid. ^Top
Boot
In an exchange of real property, any consideration received
other than real property is "boot." The amount of
gain recognized is always limited to the gain realized or
boot, whichever is the smaller amount. If the tax payer does
not want to receive boot, then the replacement property should
be with an equal or greater market value of the relinquished
property, and thus he receives no boot. In exchanges, there
are two types of boot: cash boot and mortgage boot. Cash boot
is cash or anything else of value received. Mortgage boot
is any liabilities assumed or taken subject to in the exchange.
Broker/Dealer
An individual or firm that is in the business of buying and selling
securities. Broker/dealers are registered with the Securities and
Exchange Commission (SEC).
Buyer
Person who wants to acquire the exchanger's property.
Capital Appreciation
Increased market value of an asset as measured by share price. ^Top
Capital Gain
The difference between the selling price of a property or
asset and its Adjusted Cost Basis.
Cash Boot
Cash Boot consists of any funds received by the Exchanger,
either actually or constructively. If an Exchanger does not
spend all of the proceeds from the sale of the relinquished
property, he/she will have actual receipt of the balance not
spent and will have to pay taxes on that amount.
Closing
The transfer of title of real property in a real estate transaction.
Concurrent
Exchange
A tax-deferred, like-kind exchange transaction wherein the
disposition of the relinquished property and the acquisition
of replacement property close or transfer at the same time.
A Concurrent Exchange is also referred to as a Simultaneous
Exchange
Condemnation
and Casualty Proceeds
Under section 1033 of the tax code, if a taxpayer replaces
property which has been condemned (for highway construction,
etc.) or reluctantly converted with other similar property,
the taxpayer may elect the non-recognition of gains provided
that the amount received upon conversion exceeds the cost
of the replacement property.
Constructive
Receipt
Exercising control over your exchange funds or other property.
Control over your exchange funds includes having money or
property from the exchange credited to your bank account or
property or funds reserved for you. Being in constructive
receipt of exchange funds or property may result in the disallowance
of the tax-deferred, like-kind exchange transaction thereby
creating a taxable sale.
Construction/ Improvement Exchanges
If the taxpayer intends to buy a newly constructed property,
or improve his existing property, as replacement property
in such an exchange then the new construction or improvements
are to be considered replacement property only if the work
must be completed prior to the taxpayer's acquisition of the
replacement property. Improvements done after the taxpayer
has acquired the property will not qualify as replacement
property. Improvements can be however done by a third party
prior to the taxpayer's receipt of the replacement property.
The third party can be an independent, such as a contractor,
or a qualified intermediary. If the improvements are done
within the 180-day exchange period, then they are typically
done by an Intermediary. It may be noted that in all such
cases the Intermediary must
(1) acquire a fee or fee-equivalent interest in the replacement
property,
(2) pay for the construction of the improvements during the
180-day period, and
(3) transfer the replacement property, as improved, to the
taxpayer to complete the exchange (it is critical for the
Intermediary to transfer the replacement property to the taxpayer
before the end of the 180-day exchange period even if the
Intermediary pays for all construction costs, replacement
property transferred after the 180th day is by definition
not like-kind).
Cooperation Clause
In the event Seller so elects, Buyer agrees to cooperate with
Seller in effecting a tax deferred exchange under Internal
Revenue Code Section 1031 as amended. Seller shall have the
right to elect this tax deferred exchange at any time prior
to the closing date and to assign this contract in connection
with such tax deferred exchange.
Deferral
Tax on an exchange transaction is not paid at the time of
transaction but at the time the replacement property is sold.
Deferral is accomplished by substituting, or carrying over
the basis of the taxpayer's relinquished property to the replacement
property making any necessary adjustments for additional consideration
paid.
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Deferred Exchange
The sale or disposition of real estate or personal property
(relinquished property) and the acquisition of like-kind real
estate or personal property (replacement property) structured
as a tax-deferred, like-kind exchange transaction pursuant
to Section 1031 of the Internal Revenue Code in order to defer
Federal, and in most cases state, capital gain and depreciation
recapture taxes.
Delayed
Exchange
Also known as non-simultaneous, deferred, and Starker. A delayed
exchange is when the Replacement Property is received following
the transfer of the Relinquished Property. All potential Replacement
Properties must be identified within 45 days from the transfer
of the Relinquished Property and the Exchanger must receive
all Replacement Properties within 180 days or the due date
of the Exchanger's tax return, whichever comes first.
Depreciation
Decline in value of an asset. Periodic wearing away of property
over the property’s economic life.
Depreciation
Recapture
The amount of gain resulting from the disposition of property
that represents the recovery of depreciation expense that
has been previously deducted on the Taxpayers income tax returns.
Direct Deeding
In this case either the relinquished property or the replacement
property can be deeded directly from seller to buyer without
deeding the property to the Qualified Intermediary.
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Disposition
The sale or disposal of property that causes a gain or a loss
including like-kind exchanges and involuntary conversions.
Diversification
Similar to asset allocation, diversification is a strategy
designed to reduce overall portfolio risk.
Equity
The value of a person’s ownership in real property or
securities. It includes the market value of a property or
business, less any claims or liens on it.
Escrow
This is a legal arrangement in which money, property or an
asset is delivered to a third party who is referred to as
an escrow agent. The money/property/asset is held in trust
pending a contingency or the fulfillment of a condition or
conditions in a contract such as payment of a purchase price.
Upon subsequent completion of that event, the escrow agent
delivers the asset to the proper recipient; otherwise the
escrow agent is bound by his or her fiduciary duty to maintain
the escrow account.
Exchangor
Also known as the ‘Taxpayer’ or ‘investor’.
An exchangor has property and would like to exchange it for
new property. While all parties in an exchange are theoretically
taxpayers, this term applies to the party who expects to receive
tax deferred treatment under Section 1031.
Exchange
Period(180 days)
It is the period of time during which an investor must complete
the acquisition of the replacement property in this tax-deferred,
like-kind exchange transaction. The exchange period is 180
calendar days from the transfer of the investor’s first
relinquished property, or the due date (including extensions)
of the investor’s income tax return for the year in
which the tax-deferred, like-kind exchange transaction took
place (whichever is earlier), and is not extended due to holidays
or weekends.
Exchange Requirement
The relinquished property must be exchanged for other property,
rather than sold for cash and using the proceeds to buy the
replacement property. Most deferred exchanges are facilitated
by Qualified Intermediaries, who assist the taxpayer in meeting
the requirements of Section 1031.
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Gain
The amount obtained for a property minus the property's adjusted
basis, and transaction costs. No matter what the adjusted
basis of a property is, there's no gain until the property
is transferred. There are two types of gain "realized
gain" and "recognized gain." Realized gain
is the difference between the total consideration (cash and
anything else of value) received for a piece of property and
the adjusted basis. Realized gain is not taxable until it
is recognized. Gain is usually, but not always, recognized
in the year which it is realized. If gain is not recognized
in the year it is realized, it is said to be deferred. In
an exchange under §1031, realized gain is recognized
in part or in full to the extent that boot is received. Where
only like-kind property is received, no gain is recognized
at the time of the exchange.
Government
Entities as Parties
A state agency is not allowed to exchange one piece of property
for another, but it can pay for one which is exchanged for
another. An intermediary is then the receiver of both pieces
of land as well as cash from the government and can make the
exchange.
Growth Factor
Interest earned for the duration of the exchange that is payable
at the end.
Identification
Period(45 Days)
The period of time during which an investor must identify
potential replacement properties for his tax-deferred, like-kind
exchange. The period is 45 days from the transfer of the investor’s
relinquished property and is not extended due to holidays
or weekends.
Income Property
Real estate that generates cash flow.
Intermediary
It’s an unrelated third party (i.e. 1031 Exchange Services,
LLC) that controls the tax-deferred, like-kind exchange transaction
in order to make easy the disposition of the Investor's relinquished
property and the acquisition of the Investor's like-kind replacement
property. The Intermediary has no financial interest except
for any compensation (fee) it may receive for acting as an
Intermediary. The Intermediary is technically referred to
as the Qualified Intermediary. He is also known as the Accommodator,
Facilitator or Intermediary.
Internal Revenue Code
(IRC) 1031
Section 1031 of the Internal Revenue Code (IRC) allows an
Exchangor to defer his/her capital gain tax and depreciation
recapture tax when he/she exchanges relinquished property
for like-kind or like-class replacement property.
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Installment
Sales
This refers to a transaction where one payment is to be made
after the close of a tax year. Gain will be seen in two separate
years, as well as interest income in the second year.
Investor
An investor has property and would like to exchange it for
new property. While all parties in an exchange are theoretically
taxpayers, this term applies to the party who expects to receive
tax deferred treatment under Section 1031.
Leasehold
Improvements Exchanges
These have similarities to the Construction/Improvement Exchange.
But in this case the taxpayer would like to construct improvements
on real property he already owns, taxpayer, as lesser, and
the qualified intermediary ("QI"), as lessee, may
enter into a greater-than-thirty-year lease. The terms of
the lease will require the QI to construct improvements thereon
which the QI will own as leasehold improvements. The QI will
then assign its interest in the leasehold and the constructed
improvements to the taxpayer prior to the end of the 180-day
period to complete the exchange.
Leverage
The degree to which an investor or business is using borrowed
money.
Like-Kind Property
Property that is exchangeable with another property. Refers
to the nature or character (like trade, business or for investment
purposes) of the property and not to its grade or quality.
Its also termed as “Real Property”.
Limited
Liability Company (LLC)
Members of Limited Liability companies enjoy the limited liability
offered by corporations and the minimum requirements of an
‘S’ corporation. Limited Liability Companies typically
contain two or more members and must file articles of organization
with the secretary of state, although single member LLC's
are allowed in certain states.
Liquidate
To convert assets into cash.
Mixed Use Property
Through bifurcation, a property which is of mixed use is divided
and then part of it is traded for a like-kind property. In
another example, half of a duplex which was a principle residence
could be abandoned, thus allowing it to become rental property
and available for a like-kind exchange.
Mortgage Boot or Debt
Relief
Mortgage Boot occurs when the Exchangor does not acquire debt
that is equal to or greater than the debt that was paid off;
and is therefore ‘relieved’ of debt. If the Exchanger
does not acquire equal or greater debt on the replacement
property, they are considered to be ‘relieved of debt’,
which is perceived as taking a monetary benefit out of the
exchange. Therefore, the debt relief portion is taxable, unless
offset by adding equivalent cash to the transaction. So an
Exchanger must buy of equal or greater value while spending
the NET (after costs) equity. It is absolutely acceptable
to take cash out of the exchange and pay taxes on that amount
only.
Multi-Asset Exchange
A multi-asset exchange involves both real and personal property.
If you intend to sell a hotel then it will include the underlying
land and buildings, as well as the furnishings and equipment.
If the taxpayer wants to exchange the hotel for a similar
property, then he would exchange the land and buildings as
one part of the exchange. The furnishings and equipment would
be separated into groups of like-kind or like-class property.
The groups of relinquished property will then be exchanged
for groups of replacement property.
Multi-Party/Multi Property Exchange
In such kind of an Exchange the Taxpayer transfers title to
the relinquished property to the Buyer. The Buyer pays cash
to the Seller. And the Seller then transfers title of the
replacement property to the Taxpayer. These steps all occur
simultaneously. This type of exchange is also called "Direct
Deeding".
Net Lease
A property lease in which the tenant pays all expenses normally
associated with ownership, such as utilities, maintenance, repairs,
insurance, and taxes. ^Top
Net Worth
Total assets minus total liabilities of an individual or company.
NNN Triple Lease
A lease that requires the tenant to pay for property taxes,
insurance and maintenance in addition to the rent (also referred
to as Net Net Net Lease or Triple Net Lease).
Non Recourse Loan
A loan whose terms include the lender agreeing that its sole remedy
in the event of failure to repay will be to foreclose against the
property securing the loan.
Operating
Costs
The day-to-day expenses of running a business.
Ordinary Income
Income other than capital gains.
Passive Income
Income derived from business investments in which the individual
is not actively involved, such as a real estate limited partnership.
Personal
Property
Personal Property is any property belonging to the Exchanger
that is not real estate. The "Like Kind" Rules are
more restrictive on personal property exchanges. For example:
You can exchange a 4 engine airplane for a 4 engine airplane
but not for a 2 engine airplane. You can exchange a painting
for a painting, but not for a piece of sculpture, even though
both are considered pieces of art.
Portfolio
All investments collectively owned by the same individual
or organization.
Proper Purpose
Both the relinquished property and replacement property must
be held for productive use in a trade or business or for investment.
Property acquired for immediate resale will not qualify. The
taxpayer's personal residence will not qualify.
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Qualified
Intermediary (QI)
QI in the real estate industry is often referred to as an
Exchange Accommodator or Facilitator who handles tax-deferred
like-kind exchange transaction(s). QI is responsible for a
number of important elements in the completion of a successful
tax-deferred like-kind exchange transaction.
However, a QI is responsible for:
» Preparation of proper documents for the exchange
transaction.
» Receiving, holding and safeguarding the exchange funds
throughout the transaction.
» Advising or consulting the individual or his professional
advisor(s).
Qualifying Property
Certain types of property are specifically excluded from Section
1031 treatment: property held primarily for sale; inventories;
stocks, bonds or notes; other securities or evidences of indebtedness;
interests in a partnership; certificates of trusts or beneficial
interest; and chooses in action. In general, if property is
not specifically excluded, it can qualify for tax-deferred
treatment.
Realized Gain
Gain that is not necessarily taxed. In a successful exchange the
gain is realized but not recognized and thus not taxed.
Recognized Gain
Amount of gain which is subject to tax when property is disposed
of at a gain or profit in a taxable transfer.
Relinquished
Property
The property to be sold or disposed of by the Investor in
the tax-deferred, like-kind exchange transaction. This was
formally called the ‘Down leg property’ and is
now called ‘Phase I’ property.
Replacement
Property
The like-kind property to be acquired or received by the investor
in a tax-deferred, like-kind exchange transaction. This was
formally called ‘Up leg property’ and is now called
‘Phase II’ property.
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Return
The profit made on an investment, expressed annually as a percentage
of the total amount invested.
Reverse Exchange
A tax-deferred, like-kind exchange transaction wherein the
replacement property is acquired first and the disposition
of the relinquished property occurs at a later date.
Risk
The possibility of loss of capital on an investment.
Safe Harbor
Safe harbors are Treasury Regulations which assist Qualified
Intermediaries and investors in structuring tax-deferred,
like-kind exchange transactions so they can be assured that
no constructive receipt issues will be encountered during
the exchange cycle.
Section 121
Under this Section gross income shall not include gain from
the sale or exchange of property if, during the 5-year period
ending on the date of the sale or exchange, such property
has been owned and used by the taxpayer as the taxpayer’s
principal residence for periods aggregating 2 years or more.
However, there are certain limitations to this Rule.
Seller
The person who owns the property that the taxpayer wants to acquire
in the exchange in a three or four party exchange. ^Top
Sequential
Deeding
The former practice of transferring or deeding title to an
investor’s relinquished property first to the Qualified
Intermediary and then sequentially and immediately transferring
or deeding title from the Qualified Intermediary to the buyer.
This is done in order to properly structure a tax-deferred,
like-kind exchange.
Simultaneous/Concurrent
Exchange
A tax-deferred, like-kind exchange transaction whereby the
disposition of the relinquished property and the acquisition
of the replacement property close or transfer at the same
time. A simultaneous exchange is also referred to as a concurrent
exchange.
Single Property - Two/Three
Party Exchange
The simplest kind of exchange is a two-party simultaneous
exchange of properties with equivalent fair market values
and no debt. The Two-Party Exchange is the purest form of
an exchange. The relinquished property is conveyed from the
Taxpayer to the Buyer and the replacement property is conveyed
from the Buyer to the Taxpayer. Both steps of the transaction
occur simultaneously. In a Two-Party exchange, the properties
are rarely of equal value, so in addition to the deeds of
conveyance, one party or the other will pay cash to balance
the equities.
Sponsor Firm
The real estate organization responsible for acquiring the
property, gathering investors, obtaining financing, property
and asset management, maintaining customer relations and reporting,
and paying monthly/quarterly distributions to investors.
Starker Exchange
A term used to describe delayed exchanges. "Starker vs.
Commissioner" established the delayed exchange concept.
The term "starker exchange" is used as another way
of referring to delayed, deferred or any other non-simultaneous
exchange.
Tax-advantaged
Having other tax benefits that typically result in tax savings.
Taxpayer
A Taxpayer has property and would like to exchange it for
new property. While all parties in an exchange are theoretically
taxpayers, this term applies to the party who expects to receive
tax deferred treatment under Section 1031.
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Tax Shelter
A technique that allows an investment to be legally exempt from
federal, state, and local taxes to varying degrees.
Tenant In Common
A form of holding title to real property. A TIC investment
represents co-ownership of real estate by two or more investors
who have equal rights of possession. TIC investors are on the
deed and considered a direct owner of the underlying real
estate.
Transaction Costs
Any cash paid by way of commission or other expense in an exchange.
Transaction costs are deducted in computing the consideration received.
Transfer Tax
A tax assessed by a city, county or state on the transfer of property
that may be based on equity or value. The use of direct deeding
in an exchange avoids additional transfer tax.
Vacation
Home Exchange
Vacation homes may qualify as investment property if personal
use is minimal, or the home is also rented. A property is
apparently not "held for investment" within the
meaning of IRC Section 1031 if losses from a sale or exchange
of the property cannot be deducted (the same definition also
applies to determine if a taxpayer may deduct the mortgage
interest related to a property as a "second home").
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