The New Year and 1031 exchanges

If you are in the middle of an exchange, you might be wondering about your exchange that carries over into the new year.

If you are a taxpayer currently conducting a 1031 exchange and your 180 deadline is in 2008, you should NOT file your income tax return prior to completing your exchange. If you proceed with filing your return, you will not be in compliance with section 1031 regulations. Also, if your deadline for completing the exchange is after the April 15th filing date (for personal tax returns) - you will need to file for an extension to complete your exchange.

Otherwise, when you file your return, your replacement period ends - even if your 180-day period is still open. If you have not completed the acquisition, you've invalidated your exchange and guess what? Yep. You now get to pay tax on the sale of that old property.

If you are using a professional Qualified Intermediary, they should be sending you a letter or contacting you by phone to remind you and/or your accountant - just in case you forget this rule. If you are using someone that doesn't, tie a string around that finger, write a note on your refrigerator and call your accountant and make sure they know not to file that return before you've completed your exchange. Oh, and get a QI that does.

"May all your troubles last as long as your New Year's resolutions"
Joey Adams

Possible relief for clients of bankrupt 1031 exchange companies

The IRS recently indicated that it is contemplating tax relief, in some form, for taxpayers have who have not able to complete their like-kind exchange because they used a qualified intermediary (QI) that went bankrupt. In many cases, clients of these bankrupt 1031 exchange companies have not only lost the principal held by the accommodator, they are now subject to capital gains tax and depreciation recapture because they failed to complete their exchange.

In a letter to Representative Barney Frank, a client of a bankrupt 1031 exchange provider requested that the issue of an extension of the period to complete a 1031 like-kind exchange be exteneded. The IRS responded to Rep. Frank that Code Sec. 1031 does not provide for an extension of the statutory replacement period. They also noted that the law only authorizes it to postpone deadlines for Presidentially-declared disasters or terrorist or military actions. However, the Qualified Intermediary that declared bankruptcy action is not subject to one of the events covered under a disaster. Thus, the IRS indicated it does not have the authority to suspend or extend a statutorily mandated due date.

The IRS also said that because of the number of QI businesses that have experienced financial difficulties resulting in bankruptcy filings, the are considering action to provide some type of relief. The nature of that relief was not specified.

The IRS has expressed a willingness to help homeowners that have been subject to foreclosure. While some form of relief for taxpayers for clients of bankrupt QIs is possible from the IRS, there is also the possibility that Representative Frank or other legislators may work to provide statutory relief. Unfortunately, this doesn't get the principal back. That is up to the bankruptcy proceedings - a slow and often times frustrating and disappointing process for these "creditors".

The issue of selecting a competent and secure Qualified Intermediary is highlighted by these recent failures of exchange providers. We focused on What to Look for in a Qualified Intermediary, a couple weeks back. I would encourage you to please review that article along with other references on our linked websites to the right for further guidance.

AMT patch without revenue offsets

Last week the House approved the Senate-passed version of the "Tax Increase Prevention Act of 2007". President Bush is expected to sign the Act. It provides for a one-year patch of the AMT for 2007 but does not offset the revenue cost of the measure with revenue raising provisions.

Under the Act, the AMT exemption amounts for 2007 for individuals will increase from $66,250 for married individuals filing jointly and surviving spouses, up from $62,550 for 2006, $44,350 for unmarried individuals, up from $42,500 for 2006; and $33,125 for married individuals filing separately,up from $31,275 for 2006. It also allows the sum of personal nonrefundable credits (dependent care credit, elderly and permanently disabled credit, mortgage credit, etc) may offset both regular tax and AMT.

Keep in mind, this is only a temporary fix. Congress will still need to address the AMT exemption and the allowance to offset AMT taxes with credits during the 2008 session or the exemptions figures will revert back to the levels set in 2000 ($45,000, $33,750 and $22,500, respectively) and the offsets will go away.

So will they? It probably depends on your political viewpoint and whether they will fix what is sure to a problem for a growing number of taxpayers. One thing can be said, 2007 will result in less tax revenue as a result of the changes and some that were scheduled to creep into AMT will now stay out of this progressive tax. Unique to the passage of this Act is that it didn't involve increasing revenue or offsetting the lower tax with higher taxes in another area. It is widely runoreed that a more permanent fix to the AMT system would have to involve a higher capital gain tax rate - roughly back a 20% long-term rate.

What to Look For in a Qualified Intermediary

Recent news about 1031 exchange accommodators filing bankruptcy or committing fraud with client funds has highlighted the need to carefully select a Qualified Intermediary. Today we'll focus on what items a taxpayer should look at when selecting a QI.

Most important in selecting a Qualified Intermediary is security of funds. When interviewing or researching exchange providers, one should look first and foremost to the financial backing of the company. Not all Qualified Intermediaries have the financial capacity should a problem occcur with the funds they hold. Many are small shops owned by an individual, CPA or law firm. These individual owner providers rely on the honesty and ethics of one or a few individuals. In addition, these individuals may not have the financial capacity to recover should some issue surface within the operation.

Seeking a 1031 exchange provider that is backed by a bank, title company or publically-traded company provides a level of security. If the QI has financial problems, the parent company is there to absorb any losses. In most cases, the exchange business is a relatively small piece of these larger entities and losses can be easily addressed with the financial capacity of the parent. In addition, working with a bank or title subsidiary adds a level of confidence that the QI has greater security measures (checks and balances and separation of duties) within its operation. These controls minimize the ability of one employee to commit fraud. In addition, most bank or title-owned QIs have conservative investment policies that prohibit the QI from speculating on the principal or investing in riskier investments.

One should also ask to the level of fidelity bonding (essentially insurance) that the QI maintains. Most larger QIs will have substantial policies of $10, $25 or $50 million to protect client money. Still, a potential client should not go too far in relying solely on the fidelity bonding. First, it is a policy of the company that protects the client only if the company makes a claim against the bond. In other words, the owner, not the client will be the one to make the claim against the bond. Second, most bonding is on a 'per occurance' basis. Most fidelity bonding is often misinterpreted as a 'per transaction' bonding. So, if the company you have chosen has a $1 million bond but is holding $5 million, there is essentially a 20 cents on the dollar bonding coverage.

Another important security measure is the investment of the exchange funds held in trust. This is important in that, while you have an exchange agreement with a QI, the funds are technically their funds during the exchange period. If the owner of the Qualified Intermediary decides to invest in a high risk hedge fund or wildcat oil project losing the principal, your claim is protected by the exchange agreement alone. It is important to know where your exchange funds are invested. How safe is your principal and how accessible is information about the investment of those funds?

As an additional measure, some QIs place each client's funds in a segregated account. Others pool the funds in an investment account. If problems occur with the funds, pooling is protected only by the exchange company's internal subaccount journal entries. Segregated accounts provide a clearer picture that the funds held in that account are for the benefit of a specific client. While the account will be in the name of the exchange intermediary, it can specified by notating or naming the account for that client.

Safety is of utmost importance in selecting an exchange accommodator. While Qualified Intermediaries must also posses the professional knowledge and customer service that you would expect from a financial partner, your first screening should involve safety. After all, all the expert advice and friendliness in the world will not replace your money if the QI fails.

If you would like further information about What to Look for in a Qualified Intermediary, please contact any of the professionals at 1031 Corporation.

Failed 1031 Exchange at the End of a Tax Year

What happens to a 1031 exchange if a taxpayer sells his relinquished property and is unable to locate a suitable like-kind replacement property within the IRS deadlines? Well, obviously the exchange has not been completed and the gain and depreciation recapture is taxable. But what happens if an exchange is started before the end of the year and cashes out or receives cash after the end of the year? When does the tax liability on the gain get reported? In the case of a failed or partial tax-deferred, like-kind exchange, a taxpayer may be able to defer some of his tax liability into the following income tax year rather than the income tax year in which the relinquished property closed.

Taxpayers who use the delayed exchange safe harbors and meet the requirements of the regulations are entitled to report any gain recognized on the exchange under the installment sale method of tax accounting (See Reg. §1.1031(k)-1(j)(2)). However, the regulation applies only if the Exchange Property is eligible for like-kind exchange treatment and if the taxpayer had a bona fide intent to enter into a 1031 Exchange.

This means that if a taxpayer enters into a delayed exchange before the end of the year and cashes out or receives cash after the end of the year, the gain on the exchange will be reported like an installment sale subject to the rules of IRC §453. The sale of the Relinquished Property will be reported in the year of sale like an installment sale. Cash received after the end of the year from the Qualified Intermediary is taxed in the following tax year. We should note that the tax due from depreciation recapture is not deferred into the following income tax year and is due in the taxable year in which the taxpayer sold the relinquished property.

Does this seem like a great method of deferring income from one tax year to the next by having a Qualified Intermediary hold the cash temporarily? No - unless there was a bona fide intent to complete a 1031 Exchange and there was an Exchange Agreement with a Qualified Intermediary specifically prohibiting access to the exchange funds until the following tax year under the requirements of Section 1.1031 of the Treasury Department Regulations.

We always recommend investors have a team of trusted professional advisors - an attorney, an accountant, a broker, an escrow officer and a Qualified Intermediary. This team will be of even greater importance in a failed exchange occuring over two tax years. A taxpayer should review his or her exchange agreement and consult with his team of professional advisors to determine when the right to obtain access to, or receive the benefits from, the 1031 exchange funds occured. This will help to determine when the income tax liability is due and whether a portion of the tax can be deferred into the following income tax reporting year.

Role of the Qualified Intermediary

The role of the Qualified Intermediary is essential to completing a successful and valid delayed exchange. The Qualified Intermediary is the glue that puts the buyer and seller of property together into the form of a 1031 Exchange. Where such an intermediary (often called an exchange facilitator) is used, the intermediary will not be considered the agent of the taxpayer for constructive receipt purposes notwithstanding the fact that he may be an agent under state law and the taxpayer may gain immediate possession of the money or property under the laws of agency.

In order to take advantage of the qualified intermediary "safe harbor" there must be a written agreement between the taxpayer and intermediary expressly limiting the taxpayer's rights to receive, pledge, borrow or otherwise obtain the benefits of the money or property held by the intermediary.

A qualified intermediary is formally defined as a person who is not the taxpayer or a disqualified person who enters into a written agreement (the "exchange agreement") with the taxpayer and, as required by the exchange agreement, acquires the relinquished property from the taxpayer, transfers the relinquished property, acquires the replacement property, and transfers the replacement property to the taxpayer. The qualified intermediary does not actually have to receive and transfer title as long as the legal fiction is maintained.

The intermediary can act with respect to the property as the agent of any party to the transaction and further, an intermediary is treated as entering into an agreement if the rights of a party to the agreement are assigned to the intermediary and all parties to the agreement are notified in writing of the assignment on or before the date of the relevant transfer of property. This provision allows a taxpayer to enter into an agreement for the transfer of the relinquished property (i.e., a contract of sale on the property) and thereafter to assign his rights in that agreement to the intermediary. Providing all parties to the agreement are notified in writing of the assignment on or before the date of the transfer of the relinquished property, the intermediary is treated as having entered into the agreement and, upon completion of the transfer, as having acquired and transferred the relinquished property.

There are no licensing requirements for Intermediaries. They need merely be not an unqualified person as defined by the Internal Revenue Code in order to be qualified. The Code prohibits certain "agents" of the taxpayer from being qualified. Accountants, attorneys and realtors who have served taxpayers in their professional capacities within the prior two years are disqualified from serving as a Qualified Intermediary for a taxpayer in an exchange.

Vacation home exchange oversight recommended

A recent report from the Treasury Inspector General for Tax Administration says like-kind Exchanges require greater oversight to ensure taxpayer compliance. One area of particular importance to taxpayers is increased oversight of vacation or second home exchanges.

It is fairly clear that a vacation home used exclusively by the owner or related parties may not be exchanged. When the home is not used exclusively by such persons, or where this is some rental history or attempts to rent, there is no published position by the IRS.

According to the report, this leaves “unrebutted, the sales pitch of like-kind exchange promoters” who may encourage taxpayers to exchange non-qualifying vacation homes. Many of these promoters also advise the taxpayer on exchanging primary residences with gain over the IRC § 121 gain exclusion. It also notes that realtors “who may not be well versed in tax law” may advise amateur real property “flippers”, who are really dealers, that these flips qualify for § 1031. Likewise, taxpayers also claim an exchange despite that they’ve taken possession of the cash proceeds from the sale. Unscrupulous or uninformed promoters are taking advantage of the IRS’s silence on the vacation home issue.

The IRS agrees to act on the Report’s three recommendations. They have agreed to provide additional guidance regarding exchanges of second and vacation homes that were not used exclusively by the owners. It will also caution taxpayers to be wary of individuals promoting improper use of like-kind exchanges.

The Report concludes that the IRS is relying on taxpayers to voluntarily comply, and this has resulted in underreporting of gain. Hence, it states, section 1031 is a “promising target” for additional research to improve reporting compliance.

Mortgage market improvements good news for 2008

According to recent comments from the National Association of Realtors senior economist, Lawrence Yun, 2008 should be a good year for the residential real estate market.

• Conditions are improving for consumers
• Widening credit availability should help release pent up demand
• Mortgage rates are improving
• While sub-prime loans have disappeared, FHA loans see to be the replacement

While sales are off from the peak they hit in 2005, 2007 should go down as one of the fifth highest years in history for existing home sales. With one in sixteen households buying a new home this year, home sales are expected to total nearly 5.8 million in 2007. This number is projected to increase to 6.1 million in 2008.

Commercial Real Estate Broker exemption considered

On November 9th, the National Association of Realtors (NAR) submitted a request to the Securities and Exchange Commission (SEC) on the organization’s exemption from securities broker/dealer registration. Under the requested exemption, a licensed real estate agent or broker that is predominantly engaged in, and has substantial experience in, commercial real estate to provide real estate services and receive compensation from buyers purchasing Tenant-In-Common (TIC) fractional ownership.

Under NAR’s request, a Real Estate Advisory Fee could be paid by the purchaser. It also allows the fee to paid on behalf of the purchaser by a sponsor or issuer of a TIC security that would reduce the commmission or compensation received by a registered broker-dealer involved with the TIC security transaction.

The requested exemption would allow for a potential purchaser of a TIC Security to benefit from the real estate expertise of a commercial real estate professional, while still receiving necessary protections afforded by security laws. It would also limit the role of the commercial real estate professional and real estate firm involved in the transaction. NAR believes this would be consistent with the SEC's mission to protect investors while allowing the public to benefit from a licensed broker's knowledge and experience.

The requested exemption will enter the Federal Register at the end of November. The public then has thirty days to review and comment on the request. After the close of the comment period, the SEC will review the request as well as the public comments and determine the outcome.

This ruling could have a significant impact on the Tenant-In-Common industry. If commercial real estate professionals are not allowed to provide real estate services to, and receive commission from, investors, the exposure to undivided partial ownership interests in real property might be limited.

Farm Bill cloture

I just wanted to provide a quick update to our post last week about the Farm Bill (H.R. 2419). As you may know, this bill carries a number of tax provisions. Included among these is Section 12507, which provides that collectibles, such as artwork and coins, are ineligible for exchange treatment under Section 1031 (what this has to do with farming is beyond me). Under Section 12504, it also amends the standard definition of “like-kind” for certain agricultural properties.

While the House passed the bill back in July, the Senate has not moved on the bill. President Bush has threatened a veto of the bill due to many of the provisions. Before recessing, the Senate, by a vote of 55-42, failed to invoke cloture (which in normal man's speak means to end debate on the issue) on the bill. What does this mean? Failure to invoke cloture is essentially the same effect as killing the bill.

1031 property "Held for" investment purpose

Many times, people will ask, "How long do I need to hold a property to be considered investment property under 1031 rules?

In order to qualify for a 1031 Exchange, both the relinquished and the replacement properties must have been acquired and “held for investment or for use in a trade or business." The amount of time is not specified in the Code or Regulations. In a private letter ruling (Ltr Rul 84-20939), the IRS ruled that two years was an adequate holding period. But, they did not go as far as saying two years is mandatory. Tax and exchange professionals generally consider a minimum of one year to qualify as "held for" investment purposes. This seems to fit with the long-term capital gains requirement.

If a taxpayer acquires a property immediately before an exchange, or if he buys a replacement property and immediately disposes of it following an exchange, it was probably not going to meet the “held for” requirement. But what about the owner that purchases a property for investment and changes his or her mind three, six or eight months after owning the property?

In short, there is no safe harbor holding period for complying with the “held for” requirement. Compliance is based on the taxpayer’s intent demonstrated by facts and circumstances surrounding the taxpayer’s property acquisition. It most likely comes down to what the taxpayer does with the property and how much evidence he or she has to support that original intent.

Here are a few transaction examples having potential for an IRS finding that the “held for” requirement has not been met:

• The taxpayer purchases a property, spends three months remodeling it and immediately proceeds to sell and exchange it.


• The taxpayer acquires replacement property and immediately lists the newly acquired property for sale. In this case, clearly the intent was not to acquire the property for investment purposes.


• The taxpayer acquires replacement property and immediately converts the property to a personal residence or vacation home.


• The taxpayer receives a deed from a partnership and immediately sells it or acquires replacement property and immediately transfers the property to an LLC, partnership or corporation.

While no time is outlined in the regulation, a significant period of time between purchase and sale is desirable to reduce the risk of possible “held for” issues in an exchange. How long? It's not clear. If there is any doubt, sound tax professional advice should be considered. In an audit, the burden of proof is on the taxpayer to support his compliance with the “held for investment or productive use in a trade or business” requirement.

Proposed Farm Bill would limit agricultural exchanges

The United States Senate has unveiled the “Food and Energy Security Act of 2007”, otherwise known as the “Farm Bill,” which combines agricultural program proposals with tax proposals formerly included in the “4-H Bill.” The Farm Bill is currently under consideration by the full Senate. The proposed bill, as currently crafted, has a potentially negative impact for farmers and ranchers with respect to 1031 exchanges. It will limit their options to do a tax-deferred exchange out of farmland and into other real estate investment property.

As part of the bill, the Senate is proposing to change the 'like-kind' standard to provide that “unimproved agricultural real property” is not like-kind to “improved real property”. “Unimproved agricultural real property” is defined as agricultural land that is enrolled in certain farm subsidy programs, unless the agricultural land is permanently retired from the farm subsidy programs prior to the date of an exchange transaction. Much of America's agricultural land is subject to these subsidy programs.

What does this mean for exchanges of agricultural properties? It prevents farmers, ranchers and owners of agricultural property from exchanging out of improved agricultural property (livestock facilities, grain elevators, machine sheds, fence, tile etc.) and into the subsidized agricultural land. It also prevents farmers and ranchers from exchanging the subsidized agricultural land for any improved real property, including commercial, residential and tenancy-in-common (TIC) properties. Finally, it prevents owners of commercial and residential investment properties from exchanging into the subsidized agricultural land.

Most likely, these provisions will result in agricultural land owners having limited choices in exchanging their farm or ranch land. If they decide they'd like to reinvest their land sale proceeds into an improved investment property they will be forced to pay the tax or exchange and lose the land's future ability to qualify for subsidies (thus potential reducing the value in the land). As you can see, this provision will have a significant impact on those that work with agricultural land and on those communites that are located in agricultural-based areas.

We believe this is a bad provision. If you agree, please let your Senator know that you oppose Section 12504 too.

Basic types of 1031 exchanges

A Simultaneous Exchange is an exchange in which the closing of the relinquished property and the replacement property occur on the same day. Ideally, these closings are scheduled back-to-back so there is essentially no time interval between sale and purchase. This type of exchange is covered under the safe harbor regulations established by the IRS in 1991.

A Delayed Exchange is an exchange where the replacement property is closed at a date after the closing of the relinquished property. The exchange is not simultaneous or on the same day. This type of exchange is sometimes referred to as a "Starker Exchange" after the well known Supreme Court case that is the grandfather of a delayed exchange. In 1991, section 1031 of the Internal Revenue Code provided guidelines and strict time frames for completion of a delayed exchange.

A Reverse Exchange (Title-Holding Exchange) is an exchange in which the replacement property is purchased before the relinquished property is sold. Usually the Intermediary takes title to the replacement property and holds title until the taxpayer can find a buyer for his relinquished property. Subsequent to the closing of the relinquished property (or simultaneous with this closing), the Intermediary conveys title to the replacement property to the taxpayer.

An Improvement Exchange (Title-Holding Exchange) is an exchange in which a taxpayer desires to acquire a property and arrange for construction of improvements on the property before it is received as replacement property. The improvements are usually a building on an unimproved lot but could also include enhancements made to an already improved property. This type of exchange is completed in order to create adequate value to close on the exchange so that a trade down in value does not occur. The Code and Regulations do not permit a taxpayer to construct improvements on a property as part of a 1031 Exchange after he has taken title to property as exchange replacement property. Therefore, it is necessary for the Qualified Intermediary to close on, take title, and hold title to the property until the improvements are constructed. Once sufficient value has been added, the QI conveys title to the taxpayer as replacement property. Improvement Exchanges may be done in combination with either a delayed exchange and reverse exchange, depending on the circumstances. In 2000, the IRS issued safe harbor guidance on Reverse Exchanges (including title-holding exchanges for construction or improvement).

Section 1031 Exchange defined

A 1031 Exchange, also sometimes called a Like Kind Exchange or a Starker Exchange, is a way of structuring the sale of property so that the seller’s taxable profit or gain is deferred. If the property that is sold is replaced with another “like kind” property and if the transaction is properly structured, the seller’s profit or gain may be deferred out to the date the replacement property is sold (or perhaps longer if the replacement property is subsequently exchanged).

The logic behind a 1031 Exchange is that since the taxpayer is simply exchanging property for another "like kind" property, thetaxpayer has received nothing to pay taxes. All gain is in still being held in the form of property, so no gain or loss should be recognized or for income tax purposes.

Let's take a look at the actual section of the code where this benefit originates for a definition of what this means. 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."

It is a common misunderstanding that the relinquished property sale, and the replacement property acquisition have to be simultaneous. However, the majority of exchanges that have occurred over the past twenty five years are not simultaneous. This was the result of the 1984 Starker tax court case (and, hence, the name Starker Exchange). In 1991, the IRS issued the present day section 1031 rules.

For a non-simultaneous exchange, the taxpayer must use a Qualified Intermediary (also sometimes ccalled an Exchange Accommodator or Facilitator), follow IRS guidelines, and use the proceeds of the sale to buy qualifying, like-kind, investment or business property. The IRS rules require specific time clocks to be followed. 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 sale of the old property.

Section 1031 is most often used in connection with the sale of real property. For real property exchanges under Section 1031, any property that is considered "real property" under the law of the state where the property is located will be considered "like-kind" so long as both the old and the new property are held by the owner for investment, or for active use in a trade or business, or for the production of income.

Some exchanges of personal property can qualify under Section 1031, however, the classifications of what is "like kind" become a lot more specific and limiting. Shares of corporate stock in different companies will not qualify. Exchanges of partnership interests in different partnerships and exchanges of livestock of different sexes do not qualify.

In order to obtain full benefit, the replacement property must be of equal or greater value and all of the proceeds from the relinquished property must be used to acquire the replacement property. The taxpayer cannot receive the sales proceeds of the old property. Exchanges are typically structured so that the taxpayer's interest in the relinquished property is assigned to a Qualified Intermediary prior to the close of the sale. That way, the taxpayer does not have access to or control over the funds when the sale of the old property closes.

At the time the relinquished property is sold, the proceeds are sent directly to the Qualified Intermediary. The proceeds from the sale of the relinquished property are deposited by the QI and held until the purchase the replacement property. After the acquisition of the replacement property closes, the QI delivers the property to the taxpayer and the exchange is complete.

Introduction to 1031 Like Kind Exchanges

A 1031 Exchange (Tax-Deferred Exchange) Is One Of The Most Powerful Tax Deferral Strategies Remaining Available For Taxpayers. Anyone involved with advising or counseling real estate investors should know about tax-deferred exchanges, including Realtors, lawyers, accountants, financial planners, tax advisors, escrow and closing agents, and lenders. Taxpayers should never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.

The Advantage of a 1031 Exchange is the ability of a taxpayer to sell income, investment or business property and replace with like-kind replacement property without having to pay federal income taxes on the transaction. A sale of property and subsequent purchase of a replacement property doesn't work, there must be an Exchange. Section 1031 of the Internal Revenue Code is the basis for tax-deferred exchanges. The IRS issued "safe harbor" Regulations in 1991 which established approved procedures for exchanges under Code Section 1031. Prior to the issuance of these Regulations, exchanges were subject to challenge under examination on a variety of issues. With the issuance of the 1991 Regulations, tax-deferred exchanges became easier, affordable and safer than ever before.

The Disadvantages of a Section 1031 Exchange include a reduced basis for depreciation in the replacement property. The tax basis of replacement property is essentially the purchase price of the replacement property minus the gain which was deferred on the sale of the relinquished property as a result of the exchange. The replacement property thus includes a deferred gain that will be taxed in the future if the taxpayer cashes out of his investment.

Exchange Techniques. There is more than one way to structure a tax-deferred exchange" under Section 1031 of the Internal Revenue Code. However, the 1991 "safe harbor" Regulations established procedures which include the use of an Intermediary, direct deeding, the use of qualified escrow accounts for temporary holding of "exchange funds" and other procedures which now have the official blessing of the IRS. Therefore, it is desirable to structure exchanges so that they can be in harmony with the 1991 Regulations. As a result, exchanges commonly employ the services of an Intermediary with direct deeding.

Exchanges can also occur without the services of an Intermediary when parties to an exchange are willing to exchange deeds or if they are willing to enter into an Exchange Agreement with each other. However, two-party exchanges are rare since in the typical Section 1031 transaction, the seller of the replacement property is not the buyer of the taxpayer's relinquished property.