Todd R. Pajonas, Esq., President. Matthew K. Scheriff, CPA, EVP (877)

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2 Todd R. Pajonas, Esq., President Matthew K. Scheriff, CPA, EVP (877)

3 OVERVIEW AND MYTHS OF AN IRC 1031 TAX DEFERRED EXCHANGES An exchange is no longer an actual swap. It is sale and purchase with very little difference than a non-1031 transaction. Exchange documents create the transaction. The gain from the relinquished property is deferred into the replacement property.

4 HISTORY OF IRC 1031 Income tax first imposed in 1918 and required the recognition of a gain or loss on all dispositions of property. In 1921 provisions were made for non-recognition of a gain or loss in certain circumstances. This is the precursor to the current IRC In 1923 the Tax Reform Act of 1921 was limited in scope by excluding stocks, bonds, notes, choses in action, trust certificates, and other securities from non-recognition treatment. Starker v. U.S. (9th Circuit Ct. of Appeals 1979) created ability to do an exchange on a delayed basis. Tax Reform Act of 1984 codifies Starker into statute, but establishes 45 and 180 day limitations.

5 INVESTOR MOTIVES Consolidation / Management Relief Diversification Restart / Increase Depreciation Cash Flow Retirement Planning Estate Planning

6 IRC 1031 TAX DEFERRED EXCHANGES 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. Deferral of tax, NOT a tax free transaction.

7 LIKE KIND REAL PROPERTY RELINQUISHED PROPERTY 6 UNIT APARTMENT BUILDING

8 RELINQUISHED PROPERTY REPLACEMENT PROPERTY 6 UNIT APARTMENT BUILDING 5 UNIT APARTMENT BUILDING

9 RELINQUISHED PROPERTY REPLACEMENT PROPERTY 6 UNIT APARTMENT BUILDING 6 UNIT APARTMENT BUILDING

10 RELINQUISHED PROPERTY REPLACEMENT PROPERTY 6 UNIT APARTMENT BUILDING 6 UNIT APARTMENT BUILDING

11 RELINQUISHED PROPERTY REPLACEMENT PROPERTY LIKE KIND FOR REAL ESTATE IS MUCH MORE INCLUSIVE THAN THIS.

12 LIKE KIND PROPERTY

13 LIKE KIND PERSONAL PROPERTY LIKE KIND NOT LIKE KIND

14 LIKE KIND REAL PROPERTY INTENT Intent: actions over a period of time. LIKE KIND Held for productive use in a trade or business. or Held for investment purposes.

15 EXCHANGES OF LESS THAN FEE INTEREST Leases with at least 30 years remaining including renewal options. An undivided interest in one property for an undivided or 100% interest in another property. Air rights, easements, development rights, conservation easements.* * Real property interest determined by state law.

16 LIKE KIND TRIPLE NET LEASE AND TICS What is a Triple Net Lease Property? Deeded interest in a property where the tenant is responsible for most or all of the costs (mortgage, taxes, maintenance). Examples: CVS, Burger King, Home Depot, US Post Office. What is a Tenant-in-Common Interest? Undivided fractional ownership of real estate Co-ownership between two or more people Separate deeds for each undivided interest Generally, most tenant-in-common ( TIC ) programs are treated as real estate for exchange purposes and securities for sales purposes.

17 RULES TO OBTAIN A COMPLETE DEFERAL Purchase replacement property of equal or greater value to the relinquished property. Reinvest all of the net proceeds from the relinquished sale into the replacement property purchase. Obtain equal or greater financing on the replacement property as was paid off on the relinquished property. Receive nothing except like-kind property.

18 BOOT DEFINED The term BOOT does not appear anywhere in the Internal Revenue Code or Regulations. If the Exchanger does not use all of its net cash or have equal or greater liability on the replacement property, there is boot. If the Exchanger receives non-like kind property or uses exchange funds to pay for non-exchange transactional costs, there is boot.

19 BALANCING THE EXCHANGE Relinquished Replacement Boot Contract Price $750,000 $600,000 Debt $400,000 $325,000 $75,000 Costs $50,000 Net Equity $300,000 $275,000 $25,000 $100,000 Of Boot Is Recognized

20 EXCEPTIONS TO IRC 1031 Stock in trade or other property held primarily for sale Stocks, bonds, or notes Other securities or evidences of indebtedness or interest Interests in a partnership Certificates of trust or beneficial interest Choses in action

21 EXCHANGE SAFE HARBORS Use of Qualified Intermediary to create exchange transaction. Use of Qualified Escrow or Trust to hold the proceeds from the exchange. Use of a Guarantee or Security Arrangement to secure exchange proceeds. Interest paid on the exchange proceeds.

22 STEPS TO PREPARE SALE CONTRACT Start with contract you would normally use. Add exchange cooperation clause language to contract. If, for some reason, you do not want to disclose the transaction is being structured as a 1031 exchange, include a clause allowing seller to direct the payment of the purchase price. If seller is unwilling to sign Notice of Assignment form it should be mailed by certified mail to give proper notice. You may deposit the contract deposit in your escrow account so long as it is contingent on the transaction closing period.

23 EXCHANGE COOPERATION CLAUSE Buyer hereby acknowledges that it is the intent of the Seller to structure its sale as a tax deferred exchange under IRC Seller covenants that this will not delay the close of the subject transaction nor cause the Buyer any additional expenses. The Seller s rights under the purchase and sale agreement may be assigned to Legal 1031 Exchange Services, Inc., a Qualified Intermediary for IRC 1031 Tax Deferred Exchanges. Buyer agrees to cooperate with the Seller and the Qualified Intermediary to complete the exchange.

24 SETTLEMENT STATEMENT Settlement Statement is not required for a 1031 exchange but is good practice to prepare one. Seller should be listed as Legal 1031 Exchange Services, Inc. as qualified intermediary for exchanger name. List the exchange fee in the settlement charges section of the settlement statement if using a HUD. If exchanger is cutting a separate check for the fee it should be listed as POC.

25 STRUCTURING AN ESCROW Escrows, not properly handled, can invalidate an exchange. Exchanger can use non-transaction funds to deposit into escrow. If using exchange funds escrow agreement should read Upon satisfaction of the terms of this escrow agreement any remaining escrow funds shall be deposited with Legal 1031 Exchange Services, Inc. for exchange no. EX If 180 days have elapsed from the date of sale of the first relinquished property the funds may be returned directly to escrow depositor.

26 DELAYED EXCHANGE STRUCTURE 0 45 DAYS 180 DAYS

27 DELAYED EXCHANGE TIME LIMITS 45 DAY IDENTIFICATION RULE Exchanger has 45 days from the date of the sale of the first property to identify potential replacement property. 180 DAY EXCHANGE PERIOD Exchanger has 180 days from the date of the sale of the first property, or the date upon which Exchanger has to file its Federal tax return for the year in which the relinquished property was sold, to complete the acquisition of all replacement properties.

28 DELAYED EXCHANGE TIME LIMITS There are no individual extensions. 45 and 180 days are calendar days, not business days. Time limits begin to run on the earlier of the date the taxpayer transfers the benefits or burdens of ownership of the first relinquished property to a buyer, or recording a deed evidencing a transfer, whichever occurs first.

29 IDENTIFICATION RULES THREE PROPERTY RULE Exchanger may identify up to three properties regardless of value. 200% RULE Exchanger can identify an unlimited number of properties, provided that the total value of the properties identified does not exceed 200% of the value of all relinquished properties. 95% EXCEPTION If Exchanger identifies more than three properties which are worth more than 200% of the value of all relinquished properties than Exchanger must acquire 95% of the value of all properties identified.

30 PROCEDURE FOR PROPER IDENTIFICATION Identification must be made in writing. Unambiguously describe the property. Signed and dated by the taxpayer. Received by midnight of the 45 th day or postmarked by the 45 th day. Delivered to Exchanger s Qualified Intermediary or to a party related to the exchange who is not a disqualified person.

31 EXCHANGE VESTING ISSUES With very limited exception, the person or entity who relinquishes property must be the same person or entity to buy the replacement property. A good rule of thumb is that you must have the same tax identification number on both sides of the transaction.

32 EXCHANGE VESTING ISSUES STRUCTURING DISOLUTIONS FOR EXCHANGES INVOLVING ENTITIES If you dissolve an entity and make each former member a tenant in common they will be holding property for resale purposes unless done with property planning a year or more in advance of the contemplated sale (a/k/a drop and swap). If more than 50% of members/shareholders/partners wish to the exchange the most expedient solution is to make a distribution at the closing and let the surviving members do the exchange in the name of the entity. Major issue when less than 50% of the ownership interest wants to do an exchange. An existing entity will be deemed a new entity by the IRS if more than 50% of the ownership changes.

33 Partnership Tax Returns Form 1065 (Revised) Form is an information return used to report the income, deductions, gains, losses, etc., from the operation of a partnership and includes the following questions in Schedule B: 13. Check this box, if during the current or prior tax year, the partnership distributed any property received in a like-kind exchange or contributed such property to another entity (other than entities wholly owned by the partnership throughout the tax year). 14. At any time during the taxpayer year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in the partnership property?

34 PRIMARY RESIDENCE AND 1031 Mixed Use Property Vacation home, second home, retirement home as replacement property. Conversion of replacement property to a primary residence Primary Residence

35 VACATION HOMES AND SECOND HOMES Are vacation homes considered investment property or personal use property? PLR cited to structure vacation home sales and purchases as an exchange. Moore v. Commissioner (T.C. Memo ) made it clear that the property must be held for investment purposes, but did not clearly define of that standard might be applied. Rev. Proc was issued to clarify the qualifications for property held for dual purposes, as both an investment and personal use property (i.e., second home).

36 VACATION HOMES and SECOND HOMES REVENUE PROCEDURE A dwelling unit utilized for both personal and investment purposes qualifies for IRC 1031 treatment under the safe harbor if it is owned for 24 months and during such period: 1) The property is rented at fair rental for 14 days or more each year; and 2) The taxpayer s personal use does not exceed the greater of 14 days or 10% of the days rented. It is just a safe harbor. An exchange may still fall outside the parameters and meet the statutory requirements, but the exchanger should expect heightened scrutiny in such a case.

37 Tax Court Memorandum Goolsby v. Commissioner (April 1, 2010) The Tax Court denied the exchange when the taxpayer moved into the replacement property two months after acquiring it. Minimal efforts to rent (merely placed an ad for a couple of months with no further effort to gain rental exposure). Taxpayer began preparations to finish the basement within two weeks of purchase. The court also found the taxpayer liable for accuracy related penalty due to a substantial understatement of tax, as they failed to provide any evidence they acted with reasonable cause and in good faith.

38 IRC 121 PRIMARY RESIDENCE RULE CHANGES Housing Assistance Tax Act of 2008 (H.R. 3221) will affect any taxpayer selling their primary residence as defined in IRC 121 if they do not continuously use their property as their primary residence for the five years preceding the date of sale. Previously, so long as you used the property as a primary residence for 2 out of the previous 5 years you would be entitled to 100% of the capital gains tax exclusion of 121. H.R modifies 121 to provide that the exclusion will not apply to periods of non-qualified use prior to being used as a primary residence. However, non-qualified use after the property was a primary residence will not count against the homeowner.

39 ALTERNATIVE STRUCTURES

40 PARKING ARRANGEMENTS Reverse Exchange Exchanger is acquiring Replacement Property before disposing of Relinquished Property. Improvement Exchange Exchanger wishes to use Exchange Funds to increase the value of the Replacement Property. Reverse/Improvement Exchange Exchanger wishes to acquire and improve Replacement Property before selling Relinquished Property.

41 REVENUE PROCEDURE Effective September 15, 2000 Provides a safe harbor for reverse exchange transactions that stay within the parameters of the Revenue Procedure. Reverse exchanges may be structured outside the safe harbor.

42 REVERSE EXCHANGE Acquire the Replacement Property first. The Qualified Intermediary sets up an EAT to take legal title. Exchanger identifies the Relinquished Property to be sold within 45 days of acquisition of the Replacement Property. Exchanger sells the Relinquished Property within 180 days. The Reverse Exchange can also be set up under an alternative structure whereby the Relinquished Property is deeded to the EAT and the Exchanger takes direct title to the Replacement Property. The same 180 day timeline applies.

43 IMPROVEMENT EXCHANGE Exchange starts out as a forward moving exchange with exchange funds deposited with Qualified Intermediary. EAT uses funds to acquire Replacement Property. Pursuant to Exchanger s instructions EAT enters into construction agreement and uses exchange funds to build improvements to property. All improvements must be made before 180th day. There can be no prepayment of materials or to contractor.

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