1031 Exchanges Apply to More than Real Estate

Whenever the phrase “1031 Exchange” comes up, most of us automatically think of exchanges of real estate since this is the most common type. However, 1031 exchanges are much broader than real estate and the Section 1031 rules apply to many different types of transactions described below.

Qualifying like-kind “real property” is a very broad type of asset under the “like-kind” rules of the Internal Revenue Code and Regulations. All of the following real estate interests qualify as "like-kind" to each other under Code Section 1031 -

• 100% ownership interests
• Fractional ownership interests
• 30+ year leasehold interests
• Conservation easements
• Transferable development rights
• Right-of-way easements
• Water rights
• Mineral rights
• Oil & gas interests
• Mutual irrigation ditch stock

Other types of property which are eligible for tax deferral under the 1031 Exchange rules include:

• Aircraft
• Automobiles and trucks
• Breeding livestock herds
• Information systems
• Machinery & Equipment
• Ships and boats
• Dairy cows
• Intangibles (i.e. mailing lists or client/patient files)

Sales taxes are often a motivating reason a taxpayer may want to structure a 1031 Exchange. For example, if a taxpayer sells an aircraft for $1 million and buys a replacement aircraft for $2 million, sales tax will apply to the $2 million purchase price of the replacement aircraft. If the taxpayer engages the services of an Exchange Intermediary to help him structure a qualifying “exchange,” the sales tax is limited to the “boot paid” - $1 million in this case. The difference in sales tax liability can obviously be significant.

Basic Rules. Only qualifying assets are eligible for a 1031 exchange. To qualify, the asset must be like-kind property held for business or investment purposes. Personal use property does not qualify.

Title to the replacement property must be in the same taxpayer name(s) as what was sold. In order to fully defer taxes, the replacement property must be of equal or greater value to that which was sold. If all cash proceeds are not reinvested, or a trade down in value occurs, some taxable gain will result. IRS-prescribed time requirements (45 day and 180 day requirements) must be strictly adhered to. Finally, the taxpayer cannot receive any of the net sales proceeds from the relinquished property sale.

Generally, a Qualified Intermediary is involved in the exchange to hold funds, assist the client and his tax professional and administer the exchange. While the rules of a 1031 exchange may seem challenging, an experienced Qualified Intermediary can make these hurdles easy to navigate.

Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions. See our Exchange Manual at www.1031cpas.com. 1031 Corporation is the Intermediary of choice for thousands of real estate professionals, CPAs and investors.

How To Report An Exchange Of Property Used Partly for Personal Residence and Partly for Investment Purposes

Revenue Procedure 2005-14 provides guidance on tax reporting issues under IRC §121 and §1031 for exchanges of property that are combination or dual-use residential and business/ investment property.

Background - A homeowner can exclude gain from the sale of a personal residence if he owned and used the property as his principal residence for at least two of the five years preceding the date of sale (IRC §121). The maximum amount of gain exclusion is $250,000 ($500,000 married filing joint). However, the maximum amount of gain exclusion is reduced by a fraction for any rental use (non-qualified use) of the residence occurring after January 1, 2009 compared to the total years of ownership. And, any depreciation taken on the property since May 6, 1997 is not eligible for the exclusion.

Treasury Regulation 1.121-1 issued in 2002 made it clear that the IRC §121 exclusion of gain on the sale of a personal residence applies to an entire structure that is used partly as a personal residence and partly for business or investment use. The business/investment portion of a combination or dual-use residential property is also eligible for tax deferral under IRC §1031.

Accordingly, residential property may be eligible for the §121 exclusion and §1031 tax deferral under both provisions of the Internal Revenue Code simultaneously. Revenue Procedure 2005-14 gives six examples of how to report exchanges of property eligible for exclusion under IRC §121 and §1031 in varying circumstances that can be summarized by the following examples. For purposes of these examples, assume the taxpayer is single and eligible for a gain exclusion of $250,000 under IRC §121. In practice, the maximum exclusion will probably have to be reduced for non-qualified use after January 1, 2009.

Rental Property Converted from a Personal Residence in a Prior Year. IRC §121 does not require a taxpayer to be residing in a residence at the date of sale in order to qualify for the gain exclusion. If the taxpayer owned and lived in a residence in two out of the past five years, it is eligible for gain exclusion under IRC §121 even if it is presently being used as a rental. The taxpayer can exclude gain up to $250,000 under IRC §121 except for any depreciation taken on the property since May 6, 1997. Gain resulting from depreciation or gain in excess of the §121 exclusion is eligible for tax-deferral under IRC §1031. Realized gain is first excluded under IRC §121 and then deferred under IRC §1031. Cash boot of up to $250,000 received on the exchange would be tax-free under §121 even though the residence was used partly for investment/business purposes. Basis in the Replacement Property is increased by any gain excluded under IRC §121 in excess of cash received under IRC §121. This can get tricky, see Rev. Proc. 2005-14 for specifics.

Combination Property - One Property, Two Structures. If a taxpayer owns a property with a residence on it and a second structure used for business purposes, the property is a combination property. Part of the property is eligible for gain exclusion under IRC §121 and part of the property is eligible for tax-deferral under §1031. The exchange has to be accounted for as if there were two properties being sold and exchanged. The value of the Replacement Property has to be allocated between personal and business uses and realized gain is measured separately for each property. If the exchange of the business use of the Relinquished Property for business use Replacement Property results in a trade-down, there will be taxable boot on the exchange of the business portion of the Relinquished Property. Gain attributable to the business portion of the Relinquished Property cannot be excluded under IRC §121 or vice versa. Basis in the Replacement Property is measured separately for the personal residence and business portions of the property under the normal rules.

Dual Use Property - One Structure Used Partly for Residential and Business Uses. Any gain resulting from cash or debt reduction boot realized on the exchange will be tax-free up to $250,000 under IRC §121 even if the gain is allocable to or results from a trade-down on the business portion of the Relinquished Property. That is, except for any depreciation taken on the Relinquished Property since May 6, 1997. However, gain resulting from depreciation taken on the property since May 6, 1997 is also eligible for tax-deferral under IRC §1031. Variations on this theme can be summarized as follows:

• 
  
  All gain on the Relinquished Property up to a maximum of $250,000 can be excluded under IRC §121 except for depreciation taken on the property since May 6, 1997. Depreciation taken on the property that is allocable to the 1031 portion of the property can be tax-deferred under IRC §1031. Depreciation on the property after May 6, 1997 that is allocable to the personal residence portion of the property cannot be deferred under §1031.


• 
  
  Cash (or debt reduction) boot received on the exchange is tax-free under IRC §121 up to a maximum of $250,000 even if it relates to the 1031 portion of the property. (Except for post May 6, 1997 depreciation).


• 
  
  Gain on the exchange allocable to the personal residence portion of the property in excess of $250,000 is taxable under IRC §121 and cannot be sheltered under IRC §1031.

Revenue Procedure 2005-14 does not address closing issues on exchanges of property used partly for residential purposes and partly for investment/business uses. Treasury Department Publication 523 (1998, now replaced by new Pub. 523) instructed taxpayers with Dual-Use Property to treat the sale as two sales. Intermediaries frequently separate an exchange of dual-use property in a similar manner with separate settlement statements so that the taxpayer can cash-out on the personal residence part and roll the 1031 part thru an exchange. As a result of Rev Proc 2005-14, this is no longer necessary for Dual-Use Property. Whatever cash is pulled out of the exchange of dual use property is allocated first to the personal residence. Separate settlement statements remain desirable for sales of Combination Property since all data will have to be prorated for Combination Property.

Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions. Our Exchange Manual is also available free of charge at www.1031cpas.com. 1031 Corporation is the Intermediary of choice for real estate professionals, CPAs and investors

Thank You to Our Clients and Friends for Over 20 Years in the 1031 Exchange Business!

Now that we are well into 2011, all of us at 1031 Corporation Exchange Professionals want to express our appreciation for the opportunity we have had over the last 20 years to be of service to our clients and friends.

2010 marked our 20th anniversary as an Exchange Facilitator. Beginning in Boulder County, Colorado we quickly began experiencing an opportunity to work with clients across Colorado and across the country from the east to the west coast. It has been a very gratifying experience for us and we appreciate the confidence our clients and friends across the country have expressed in us and our services.

In 2006, 1031 Corporation became a part of FirstBank of Colorado. With this partnership, clients of 1031 Corporation were able to be assured of the safety of their exchange funds in uncertain times in the industry and economy. FirstBank remains one of the top performing banks in Colorado with over 130 branches in Colorado, Arizona and California and over $10 billion in assets. We are proud to be able to offer such a high level of safety and security to our clients.

The Exchange Industry and related real estate market have seen many ups and downs over the past 20 years and we are currently emerging from one of the worst real estate downturns in recent memory. 2010 showed a steady increase in 1031 transactions and we are optimistic about the prospects for 2011.

At 1031 Corporation we are all dedicated to serving our clients at the highest level of competence and professionalism. Please accept our sincere thanks to all of you and feel free to call us at any time if we can be helpful.

Feel free to visit us and see our exchange manual at 1031cpas.com , or email us at 1031@1031cpas.com.

Exchanges of Aircraft and Equipment Can Still Save Taxes Even Though the 2010 Tax Relief Act Permits a 100% Write-Off for Replacement Purchases

For Aircraft and Equipment purchased and placed in service after 09/08/10 and before 2012 the up-front §168(k) Bonus Depreciation deduction is increased to 100% by the 2010 Tax Relief Act. If a taxpayer sells aircraft or equipment during this time frame, the entire taxable income from the sale, including depreciation recapture, can be offset by the purchase of NEW aircraft or equipment during the same tax year. The replacement property has to be NEW.

Does this make a 1031 exchange of aircraft or equipment obsolete or unproductive for a taxpayer purchasing NEW replacement property? Partially but not entirely.

We recently had a client who was exchanging a $1 million aircraft for a $2 million replacement aircraft. His exchange was failing under Code Section 1031 because he couldn’t acquire the replacement aircraft within the required 180-day replacement period. But, he was saving $50,000 in sales taxes with his exchange. His sales tax was based on the boot paid for the replacement aircraft ($1 million). Had he not been doing an exchange, his sales tax would have been based on the entire cost of the replacement aircraft ($2 million). The exchange saved this taxpayer $50,000 in sales taxes.

What if the taxpayer is replacing with USED replacement aircraft or equipment? Well, maybe the taxpayer can offset a sale with the purchase cost of the replacement property under Code §179 even though it is not eligible for the bonus depreciation write-off under the 100% Bonus Depreciation rules of §168(k). But, Section 179 deductions are limited to $500,000 in total and phase out for a taxpayer with purchases in excess of $2 million for the year.

In any event, sales tax savings can be substantial and taxpayers and their advisors need to take a look at sales tax issues before they decide that an aircraft or equipment exchange will not be helpful.

Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions. Our Exchange Manual is also available free of charge at www.1031cpas.com. 1031 Corporation is the Intermediary of choice for real estate professionals, CPAs and investors.

Exchanges In Process at End of Year - Planning Opportunities

Taxable Income recognized from a 1031 Exchange can be reported under the installment sale rules of IRC §453 if an exchange starts in 2010 and ends in 2011.

Taxpayers who meet the requirements of the regulations are entitled to report any gain recognized on an 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.

If taxpayer has entered into a delayed exchange before the end of 2010 and cashes out or receives cash after December 31, 2010, gain on the exchange can be reported like an installment sale subject to the rules of IRC §453. The Exchange is reported in 2010 but gain attributable to the cash received in 2011 is deferred under the installment sale rules until 2011 and reported on the 2011 return.

Or, if the taxpayer so elects, cash received from the Exchange can be reported in 2010 even though the cash was received in 2011. This gives taxpayers the opportunity of selecting the best year to report the gain attributable to the cash received. Since capital gains tax rates for 2011 will be higher than 2010 unless Congress elects to extend the 2010 rates, this option provides taxpayers with a tax-planning alternative which is flexible enough to accommodate whatever Congress does with the tax rates.

Talk to your tax advisor about your alternatives in this uncertain tax environment. Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions. Our Exchange Manual is also available free of charge at www.1031cpas.com. 1031 Corporation is the Intermediary of choice for real estate professionals, CPAs and investors.

Automatic Capital Gain Tax Rate Increases for 2011

Capital gains on the sale of assets held more than 12 months are taxed at a lower rate than ordinary income. The Jobs and Growth Tax Relief Reconciliation Act of 2003 and Tax Reconciliation Act of 2006 temporarily reduced the tax rate on long-term capital gains until January 1, 2011. At this time, the previous rates are scheduled to be automatically reinstated. Congress has been discussing a temporary extension of the current tax rates but this possibility remains uncertain at the present time.

As a result, taxpayers face uncertainty about whether they should be planning for taxable gains in 2010 or 2011. Or, whether they should defer their taxes under Code Section 1031 with an exchange of real estate or cash-out and take their gains in 2010 before a higher tax rate becomes effective.

Tax rates on long-term capital gains on a sale of real estate now and in 2011 can be summarized as follows if there is no further action by Congress –

Now - 15% for taxpayers in a regular tax bracket higher than 15%. Zero for taxpayers in a tax bracket of 15% or lower

2011 - 20% for taxpayers in a regular tax bracket higher than 15%. 10% for taxpayers in a tax bracket of 15% or lower.

Capital gains (long-term) attributable to depreciation taken on real estate investments are taxed at a rate of 25% (15% for taxpayers in a 10% or 15% tax bracket) before the above referenced tax rates begin to apply.

Commencing in 2013, a new Medicare tax of 3.8% will be imposed on capital gains from the sale of real estate for high-income taxpayers. High-income taxpayers are taxpayers with gross income of $200,000 for individuals or $250,000 for couples. This tax will only apply to the amount of gain which causes adjusted gross income to exceed the high-income threshold.

Talk to your tax advisor about your alternatives in this uncertain tax environment. You may find that a 1031 Exchange remains desirable as an alternative to paying taxes under either rate schedule. Call us at 888-367-1031 or email us at 1031@1031cpas.com if we can help with any questions.

Give us a call at 888-367-1031 or email us at 1031@1031cpas.com if we can help with questions about how a 1031 Exchange can help you. See our Exchange Manual and visit us at http://www.1031cpas.com/ for additional information on how 1031 exchanges can help you save taxes

Section 1033 Condemnation Sales & § 1031 Replacement Rules

A "condemnation sale" of property under IRC §1033 is not taxed if the taxpayer replaces with qualifying replacement property within specified time limits. Following is a summary of the more important rules to qualify for this tax treatment.

What Is A Condemnation Sale?

The involuntary conversion rules permit taxpayers who sell under the threat of condemnation to defer the gain on the sale (Code Section 1033(a) & Reg. Section1.1033(a)-1(a)). The IRS' position is that the threat of condemnation exists when the taxpayer learns through a reliable source that a governmental or quasi-governmental entity has decided to acquire the taxpayer's property, but only if there are reasonable grounds to believe that the condemnation or requisition will actually occur. The threat or imminence of condemnation thus exists if a taxpayer is faced with the alternative of either selling the property to the government, a quasi-governmental entity, or a third party; or having the property condemned.

What is a “Friendly Threat of Condemnation?”

Taxpayers often want to sell and are negotiating the sale of a property to a governmental entity and desire to take advantage of tax deferral under Code Section 1033. In order to qualify for the Section 1031 deferral, taxpayers must establish a “threat of condemnation.” One way to do this is to request from the governmental entity a “Friendly Threat of Condemnation” letter which informs the taxpayer that a condemnation is being considered if the sale negotiation falls thru. Governmental entities are usually cooperative with the taxpayer with this type of request.

What Is The Replacement Time Frame?

Taxpayers are granted three-years (IRC §1033(g)(4)) in which to replace real estate used in a trade or business (i.e. farm property). The three-year period commences with the earlier of the closing of the sale or threat of condemnation (IRC §1033(a)(2)(B)) and ends on the third anniversary of the end of the year in which the sale took place. Any other type of property disposed of in a condemnation sale is required to be replaced within two-years from the end of the year in which the sale took place. Extensions of time can be obtained by written request if necessary.

What Is Qualified Replacement Property?

For real estate used for investment or business purposes, qualified replacement property is "like-kind property" as defined under the rules of IRC §1031 tax-deferred exchanges (Reg. §1.1033(g)-1(a)). This means that any type of real property held for investment purposes will qualify for replacement of the sale of your farm land. The replacement property may be improved or unimproved under these rules. It is even possible to construct improvements on land a taxpayer is already in title on.

Does The Sale Cash Have To Be Escrowed Anywhere Under §1033?

There are no requirements for escrowing cash received from a condemnation sale under §1033. Taxpayers can use the cash as they wish. The replacement property can be 100% financed without using any of the cash you received from the sale of the condemnation property. There are no requirements for use of the condemnation sale cash for closing on replacement real estate.

How Do I Make A § 1033 Election and Report A Condemnation Sale On My Tax Return?

The condemnation sale should be reported on Form 4797 and the gain should be noted as "suspended under §1033." This will comply with the requirements for making an election to defer gain under §1033 as well as comply with the reporting requirements.

Additional Comments Regarding The Sale Of Personal Property

The §1031 and §1033 rules are generally very liberal as to what constitutes like-kind replacement property for real estate exchanges. The rules for replacement of Personal Property under §1033 are more restrictive. Under IRC §1033 replacement personal property must be "similar in use." Safe harbor like-kind replacement property for exchanges of personal property are provided under the General Asset Classes and Product Classes described below.

The General Asset Classes are found in the Regulations (§1.1031(a)-2(b)(2)). The Product Classes are found in Sectors 31, 32 and 33 (pertaining to manufacturing industries) of the North American Industry Classification System (NAICS) set forth in Executive Office of the President, Office of Management and Budget, North American Industry Classification System, United States, 2007 (NAICS Manual) as periodically updated.

Give us a call at 888-367-1031 or email us at 1031@1031cpas.com if we can help with questions about how a 1031 Exchange can help you.

See our Exchange Manual and visit us at http://www.1031cpas.com/ for additional information on how 1031 exchanges can help you save taxes.