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STAN BOTELLO
Shorewood Realtors
3300 Highland Avenue
Manhattan Beach, CA 90266
310-795-0898
310-546-7561 Ext 463
Stan@SellingBeachProperty.com
Shorewood Realtors
3300 Highland Avenue
Manhattan Beach, CA 90266
310-795-0898
310-546-7561 Ext 463
Stan@SellingBeachProperty.com
Exchange Guidelines
History of Exchanges
The basic concept of tax-deferred exchanging was introduced into the Internal Revenue Code in 1921in an attempt to eliminate a problem the Treasury Department was having with taxpayers reporting tax losses on barter-type two-party exchanges. This is the reason that taxpayers no longer have the option of reporting a qualifying exchange as either taxable or non-taxable. However, the barter-type exchange, which caused so much administrative concern, is significantly different from the kind of multi-party transactions that characterizes the present world of tax-deferred exchanging.
The first major change, which was a departure from the barter-type exchange, occurred in 1935 when the board of tax appeals rendered a decision in the case of Mercantile Trust Company of Baltimore vs. Commissioner. The exchange involved a property owner, the taxpayer, a buyer of the taxpayer's property, and a seller of like-kind replacement property. It is interesting to note the transaction also involved a title company that acted as a fourth party facilitator in the transaction. The taxpayer did not want to sell its property because of the tax consequences. Instead, they transferred their property to the title company, which in turn transferred it to the buyer. The title company took the buyer's money and purchased the replacement property, and then transferred it to Mercantile. This was all carried out on a simultaneous basis. The key to the transaction was that all the legs of the transaction were carried out pursuant to appropriate contracts entered into between the respective parties.
The Board of Tax Appeals rejected the Internal Revenue Service's argument that the transaction did not give rise to an exchange because the title company acted as the agent of the buyer. The Tax Board held that the exchange did in fact meet the requirements of Section 112 of the Internal Revenue Code (Section 112 was the forerunner of Section 1031). The courts reasoned that even if the title company was the agent of the buyer, it would not have mattered, because it still would have resulted in an integrated transaction in which the taxpayer received, and was entitled only to receive, like-kind replacement property, and not the buyer's purchase price of the relinquished property.
The rule made in this case has not changed over the years and is still the rule today: ALL OF THE LEGS OR SEGMENTS OF AN EXCHANGE MUST CONSTITUTE AN INTEGRATED, MUTUALLY INTERDEPENDENT TRANSACTION. There has not been any significant change in the test enunciated in Mercantile in the entire 60 years since that decision!
Types of Exchanges
There are Five (5) major types of tax-deferred exchanges: Simultaneous, Delayed, Reverse "Build-to-suit", and Personal Property 1031 Tax Deferred Exchanges.
A Simultaneous Exchange occurs when the relinquished (sale) property and the replacement (acquired) property are transferred concurrently. Taxpayers doing such an exchange often think it is acceptable if the two transactions close on the same day, and that this alone will satisfy the requirements of an exchange. Taxpayers who do not employ a Qualified Intermediary may be surprised to discover their transaction does not qualify for tax deferral, as without the Intermediary, the seller may be deemed to have "constructive receipt" of the sale money. The Qualified Intermediary creates the reciprocal trade by receiving the relinquished property and acquiring the replacement property. The Intermediary also provides the paper trail validating the flow and structure of the transaction and ensures the compliance with Treasury Regulations.
A Delayed Exchange is much like the Simultaneous, but allows the taxpayer to close escrow on the replacement property at a later date than the relinquished property sale. There are some important rules, which must be followed to effectuate a valid Delayed Exchange:
The newly issued Revenue Procedure (REV. Proc.2000-37) provides a safe harbor for reverse exchanges entered into on or after September 15, 2000 provided the taxpayer does the following:
Build-to Suit: The taxpayer can choose to make repairs or build a structure as part of the replacement property. These types of exchanges can be complicated and very time consuming for everyone involved. The taxpayer must first identify the improvements to be made during the identification period, but the Qualified Intermediary must take title to the land in which the improvement will be built, and must contract for the repairs or construction. There are restrictions on how the sale funds can be handled, and the time periods for completion of the work and conveyance of the improved real property must be done prior to the expiration of the 180-day exchange limit.
A Personal Property Exchange allows the taxpayer to exchange planes, business, boats, etc. and other personal property held for investment purposes or the productive use for trade or business, but the definition of "Like Kind" is more specific than that of real property. Please call us for more details regarding the Personal Property Exchange.
Identification of Replacement Property
The taxpayer has 45 days from the close of the relinquished property in which to identify Replacement Property. When identifying replacement property, you have a choice between two rules.
1st Rule: The first rule is known as the three-property rule.
The taxpayer may identify a maximum of three (3) replacement properties without regard to fair market value.
2nd Rule: This rule is known as the 200% rule.
When identifying more than three (3) properties, the total aggregate value of all properties identified cannot exceed 200% of the relinquished property value (or twice the amount of sale price).
Example: Relinquished property sold for $200,000.00 2 x $200,000 = $400,000.00
(The Taxpayer can identify a maximum of $400,000 in Replacement Properties)
REPLACEMENT PROPERTY: Once the taxpayer has located a "like-kind" replacement property, ERI will be assigned into the Contract/Escrow Instructions as the Buyer. When this transaction is ready to close, funds held by ERI will be deposited into to escrow to fund the closing. Should escrow require additional funds to close, the taxpayer can deposit funds directly into escrow. The replacement property must be acquired on or before the following dates: 1) 180 days from the date of the transfer of the relinquished property, or 2) the date the tax return is due for the tax year in which the replacement property is transferred (the taxpayer has the right to request an extension)..
How Do Most Exchanges Come Into Being?
At the time of listing their property for sale or before an offer is accepted, the seller should inform their broker that they want to do a tax-deferred exchange. The broker should state the seller's intention as part of the listing and purchase agreements. The buyer is to acknowledge and agree to cooperate with the sellers exchange at no cost to the buyer. This is usually done prior to the opening of escrow, however it can be done in escrow.
When a tax-deferred exchange is the ultimate aim of the taxpayer, it is necessary that the taxpayer be restricted from any access or use of the proceeds from the disposition of his property. The essence of an exchange is the transfer of property between owners, while that of a sale is the receipt of cash for property - whether that receipt is actual or constructive if the taxpayer has--or could get--control of the cash.
History of Exchanges
The basic concept of tax-deferred exchanging was introduced into the Internal Revenue Code in 1921in an attempt to eliminate a problem the Treasury Department was having with taxpayers reporting tax losses on barter-type two-party exchanges. This is the reason that taxpayers no longer have the option of reporting a qualifying exchange as either taxable or non-taxable. However, the barter-type exchange, which caused so much administrative concern, is significantly different from the kind of multi-party transactions that characterizes the present world of tax-deferred exchanging.
The first major change, which was a departure from the barter-type exchange, occurred in 1935 when the board of tax appeals rendered a decision in the case of Mercantile Trust Company of Baltimore vs. Commissioner. The exchange involved a property owner, the taxpayer, a buyer of the taxpayer's property, and a seller of like-kind replacement property. It is interesting to note the transaction also involved a title company that acted as a fourth party facilitator in the transaction. The taxpayer did not want to sell its property because of the tax consequences. Instead, they transferred their property to the title company, which in turn transferred it to the buyer. The title company took the buyer's money and purchased the replacement property, and then transferred it to Mercantile. This was all carried out on a simultaneous basis. The key to the transaction was that all the legs of the transaction were carried out pursuant to appropriate contracts entered into between the respective parties.
The Board of Tax Appeals rejected the Internal Revenue Service's argument that the transaction did not give rise to an exchange because the title company acted as the agent of the buyer. The Tax Board held that the exchange did in fact meet the requirements of Section 112 of the Internal Revenue Code (Section 112 was the forerunner of Section 1031). The courts reasoned that even if the title company was the agent of the buyer, it would not have mattered, because it still would have resulted in an integrated transaction in which the taxpayer received, and was entitled only to receive, like-kind replacement property, and not the buyer's purchase price of the relinquished property.
The rule made in this case has not changed over the years and is still the rule today: ALL OF THE LEGS OR SEGMENTS OF AN EXCHANGE MUST CONSTITUTE AN INTEGRATED, MUTUALLY INTERDEPENDENT TRANSACTION. There has not been any significant change in the test enunciated in Mercantile in the entire 60 years since that decision!
Types of Exchanges
There are Five (5) major types of tax-deferred exchanges: Simultaneous, Delayed, Reverse "Build-to-suit", and Personal Property 1031 Tax Deferred Exchanges.
A Simultaneous Exchange occurs when the relinquished (sale) property and the replacement (acquired) property are transferred concurrently. Taxpayers doing such an exchange often think it is acceptable if the two transactions close on the same day, and that this alone will satisfy the requirements of an exchange. Taxpayers who do not employ a Qualified Intermediary may be surprised to discover their transaction does not qualify for tax deferral, as without the Intermediary, the seller may be deemed to have "constructive receipt" of the sale money. The Qualified Intermediary creates the reciprocal trade by receiving the relinquished property and acquiring the replacement property. The Intermediary also provides the paper trail validating the flow and structure of the transaction and ensures the compliance with Treasury Regulations.
A Delayed Exchange is much like the Simultaneous, but allows the taxpayer to close escrow on the replacement property at a later date than the relinquished property sale. There are some important rules, which must be followed to effectuate a valid Delayed Exchange:
-
The exchange must be set up
before the close of escrow on the relinquished (sale) property.
-
The taxpayer must identify
the replacement (acquired) property within 45 days after the close of
the relinquished (sale) property.
-
The taxpayer must acquire
the replacement property within 180 days from the close of the
relinquished property, or by the tax return filing of the relinquished
property, whichever comes first.
-
The taxpayer must reinvest
all net proceeds into the replacement property.
-
The taxpayer must obtain a
debt of equal or greater amount on the replacement property.
The newly issued Revenue Procedure (REV. Proc.2000-37) provides a safe harbor for reverse exchanges entered into on or after September 15, 2000 provided the taxpayer does the following:
-
The safe harbor allows a
taxpayer to
treat. the Exchange Accommodation Titleholder (E.A.T.) as the
beneficial owner of the property for federal income tax purposes. The
parked property must be held under a Qualified Exchange Accommodation
Agreement.
-
The E.A.T. must hold legal
title or similar ownership to the property being parked.
-
The taxpayer must have the
intent to park
with E.A.T. either the relinquished or the replacement property as part
of a 1031 tax deferred exchange.
-
No later than five (5)
business days
after the transfer of ownership of the property to the E.A.T., the
taxpayer and E.A.T. must enter into a written agreement indicating that
this is an exchange and that the accommodating party will be treated as
the owner of the property for tax purposes.
-
Within 45 days after the
transfer of
ownership of the replacement property to the E.A.T., the taxpayer must
identify the property to be relinquished.
-
No later than 180 days after
the transfer
of ownership of the property (replacement or relinquished) to the
E.A.T., the replacement property must be transferred to the taxpayer or
the relinquished property to the ultimate to buyer.
Build-to Suit: The taxpayer can choose to make repairs or build a structure as part of the replacement property. These types of exchanges can be complicated and very time consuming for everyone involved. The taxpayer must first identify the improvements to be made during the identification period, but the Qualified Intermediary must take title to the land in which the improvement will be built, and must contract for the repairs or construction. There are restrictions on how the sale funds can be handled, and the time periods for completion of the work and conveyance of the improved real property must be done prior to the expiration of the 180-day exchange limit.
A Personal Property Exchange allows the taxpayer to exchange planes, business, boats, etc. and other personal property held for investment purposes or the productive use for trade or business, but the definition of "Like Kind" is more specific than that of real property. Please call us for more details regarding the Personal Property Exchange.
Identification of Replacement Property
The taxpayer has 45 days from the close of the relinquished property in which to identify Replacement Property. When identifying replacement property, you have a choice between two rules.
1st Rule: The first rule is known as the three-property rule.
The taxpayer may identify a maximum of three (3) replacement properties without regard to fair market value.
2nd Rule: This rule is known as the 200% rule.
When identifying more than three (3) properties, the total aggregate value of all properties identified cannot exceed 200% of the relinquished property value (or twice the amount of sale price).
Example: Relinquished property sold for $200,000.00 2 x $200,000 = $400,000.00
(The Taxpayer can identify a maximum of $400,000 in Replacement Properties)
| 1) 123 Main Street, Any town, TX | |
Value: | $75,000.00 |
| 2) 1031 USA Avenue, Any town, WA | |
Value: | $135,000.00 |
| 3) 555 Exchange Lane, Any town, NY | |
Value: | $65,000.00 |
| 4) 1212 Tax Alley, Any town, CA | |
Value: | $125,000.00 |
| TOTAL VALUE LISTED | |
$395,000.00 | |
|
|||
REPLACEMENT PROPERTY: Once the taxpayer has located a "like-kind" replacement property, ERI will be assigned into the Contract/Escrow Instructions as the Buyer. When this transaction is ready to close, funds held by ERI will be deposited into to escrow to fund the closing. Should escrow require additional funds to close, the taxpayer can deposit funds directly into escrow. The replacement property must be acquired on or before the following dates: 1) 180 days from the date of the transfer of the relinquished property, or 2) the date the tax return is due for the tax year in which the replacement property is transferred (the taxpayer has the right to request an extension)..
How Do Most Exchanges Come Into Being?
At the time of listing their property for sale or before an offer is accepted, the seller should inform their broker that they want to do a tax-deferred exchange. The broker should state the seller's intention as part of the listing and purchase agreements. The buyer is to acknowledge and agree to cooperate with the sellers exchange at no cost to the buyer. This is usually done prior to the opening of escrow, however it can be done in escrow.
When a tax-deferred exchange is the ultimate aim of the taxpayer, it is necessary that the taxpayer be restricted from any access or use of the proceeds from the disposition of his property. The essence of an exchange is the transfer of property between owners, while that of a sale is the receipt of cash for property - whether that receipt is actual or constructive if the taxpayer has--or could get--control of the cash.
Information provided with the permission of Exchange Resources, Inc.
Providing Intermediary Services for Los Angeles, Orange County, San
Francisco, Dallas and the Inland Empire.