Presented by:

Citibank Financial Intermediaries Group

David M. Gorenberg, Esquire

Certified Exchange Specialist®

Presented:

Section 1031 Exchanges in the 21st Century – Regulatory Changes and Case Law Impact

Thank you.

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Important Disclosures

This presentation does not constitute legal or tax advice. Citibank and its employees do not provide tax or legal advice and are not responsible for advising customers on the laws or regulations pertaining to any 1031 exchange transaction. Citibank and its employees will not make any representations regarding the tax consequences of any 1031 exchange transaction. It is the customer’s responsibility to seek tax and legal advisors in connection with any 1031 exchange transaction.

IRS Circular 230 Disclosure: To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Citibank, N.A., Member FDIC. Citibank and Arc Design is a registered trademark of Citigroup Inc.

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Agenda

• 1031 Exchanges – Case Law and Regulatory Update

– The Good

• What is “Like-Kind” Property

– Real Property

– Personal Property

• Regulatory Review

– The Bad

• QI Fraud

• QI Bankruptcy

– The Ugly

• Choosing a QI

– Ethical Considerations

4 Section 1031 Exchanges in the 21st Century

“The Good”

5

Overview of the Statute and Regulations

6 Section 1031 Exchanges in the 21st Century

7

Why Exchange? - smaller property

Section 1031 Exchanges in the 21st Century

Why Exchange? - larger property

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Taxation 101

• Generally, all income is taxable, unless specifically exempted by law.

• Even illegal income, such as stolen or embezzled funds, must be reported on Line 21 of Form 1040.

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Source: Department of Treasury, Internal Revenue

Service, Publication 525.

Section 1031 Exchanges in the 21st Century

IRC Section 1031

• “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 for productive use in a trade or business or for investment.”

• §1031 provides for deferral of taxes, not complete elimination.

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Like-kind Property

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Foreign real property is not like-kind to U.S. real property.

Section 1031 Exchanges in the 21st Century

Business or Investment Use

• There are five tax classes of property:

1) property used in taxpayer’s trade or business;

2) property held primarily for sale to customers;

3) property which is used as your principal residence;

4) property held for investment; and

5) property used as a vacation home

• Section 1031 applies to the first and fourth categories (and perhaps the fifth)

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Less than Fee Interests in Real Property that Qualify for

Exchanges

• Leases with at least 30 years remaining, including renewal options

• Vendee’s interest in a land sale contract; not the vendor’s interest

• Undivided interest in one property for an undivided or 100% interest in another property

• Remainder interest in real property

• Timber rights, riparian rights, mineral rights

– As determined by state law

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Common Less-Than-Fee Exchanges

• Timber Rights

• Mineral Rights

• Oil Rights

• Riparian Rights

• Tenants in Common

• Transferrable Development Rights

• Others

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Like Kind Personal Property

• Under the regulations, personal depreciable property used in business or held for investment is exchanged with like-kind property if exchanged either for property of a like kind or like class

• Properties are of like class if they are in the same:

– General Asset Class – Rev. Proc. 87-56, or

– Product Class – SIC Manual (4 digits)

• Personal property is like kind if identical

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Common Personal Property Exchanges

• Aircraft

• Artwork

• Collectibles

• Equipment

• Fleet Vehicles

• Intellectual Property

– Licenses, Franchises, Patents, Trademarks

• Livestock

• Others

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Common Personal Property Exchanges

- Franchises Often Sold With Real Estate

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• Franchises may be exchanged for

other franchises

• Nature of the franchise must also be

like-kind

• Lexus is not like-kind to Ramada

• Lexus is like-kind to Ford

Section 1031 Exchanges in the 21st Century

Common Multi-Asset Exchanges

- Personal Property Often Sold With Real Estate

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• Personal Property for Personal Property

• Real Property for Real Property

Section 1031 Exchanges in the 21st Century

§1031 in a Nutshell

• To obtain complete deferral of capital gains taxes, the taxpayer should:

– Purchase replacement property that is equal or greater in value to the relinquished property

– Have equal or greater equity in the replacement property

– Have equal or greater debt on the replacement property

– Receive nothing except like-kind property

– Avoid constructive receipt of exchange proceeds

– Use a qualified intermediary

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Time Restrictions

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Day 0 Day 180 Day 45

Identification

Period

Exchange

Period

• 1984 Congress amends Section 1031

- 45 day identification period

- 180 day exchange period runs concurrent

- Or due date of tax return, whichever is earlier

- Calendar days, not business days

- No extensions

Section 1031 Exchanges in the 21st Century

Identification Requirements

• Signed, and in writing

• Delivered

– QI or seller of replacement property

• Unambiguously described

– Legal description

– Street address

– Distinguishable name (e.g., Mayfair Apartment Building)

• May be revoked or amended, with same formality as above

Section 1031 Exchanges in the 21st Century 21

Identification Rules

• 3 Property Rule – up to 3 properties, without regard to FMV;

or

• 200% Rule – any number of properties, so long as aggregate FMV does not exceed 200% of FMV of relinquished properties;

but

• 95% Exception – if first two rules violated, must acquire 95% of FMV of all identified properties

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Regulations: 1.1031

- safe harbors

• 1.1031(k)-1(g)

– (2) Security or Guarantee Arrangements

• Determination of whether the taxpayer is in actual or constructive receipt of the exchange funds is made without regard to existence of mortgage, standby letter of credit, third party guarantee, etc.

– (3) Qualified Escrow Accounts and Qualified Trusts

• Determination of whether the taxpayer is in actual or constructive receipt of the exchange funds is made without regard to whether the funds are held in a Qualified Escrow Account or Qualified Trust

– QEA – Escrow holder is not a disqualified person; escrow agreement contains “(g)(6)” limitations

– QT – Trustee is not a disqualified person; trust agreement contains “(g)(6)” limitations

– (4) Qualified Intermediary

– QI is not considered an agent of the taxpayer; is not a disqualified person; QI enters into “exchange agreement” that contains the “(g)(6)” limitations

– (5) Interest and Growth Factors

• Determination of whether the taxpayer is in actual or constructive receipt of exchange funds is made without regard to the fact that the taxpayer is or may be entitled to receive any interest or growth factor with respect to the deferred exchange.

Section 1031 Exchanges in the 21st Century 23

Regulations: 1.1031

- (g)(6) Limitations

• (i) An agreement limits a taxpayer's rights as provided in this paragraph (g)(6) only if the agreement provides that the taxpayer has no rights, except as provided in paragraphs (g)(6)(ii) and (g)(6)(iii) of this section, to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.

• (ii) The agreement may provide that if the taxpayer has not identified replacement property by the end of the identification period, the taxpayer may have rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property at any time after the end of the identification period.

• (iii) The agreement may provide that if the taxpayer has identified replacement property, the taxpayer may have rights to receive, pledge, borrow, or otherwise obtain the benefits of money or other property upon or after

– (A) The receipt by the taxpayer of all of the replacement property to which the taxpayer is entitled under the exchange agreement, or

– (B) The occurrence after the end of the identification period of a material and substantial contingency that –

• (1) Relates to the deferred exchange,

• (2) Is provided for in writing, and

• (3) Is beyond the control of the taxpayer and of any disqualified person (as defined in paragraph (k) of this section), other than the person obligated to transfer the replacement property to the taxpayer.

Section 1031 Exchanges in the 21st Century

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Treasury Inspector General for

Tax Administration

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Treasury Inspector General for Tax Administration

• Reference 2008-30-154; August 27, 2008

– “Guidance Could Be Enhanced for Deciding to Use a Qualified Intermediary in Like-Kind Exchanges”

• “This report presents the results of our review of qualified intermediary regulations and qualification requirements. The objectives of this review were to examine transactions subject to Internal Revenue Code Section 1031, assess the qualification requirements for qualified intermediaries, and determine the legal protections available to taxpayers. We conducted this review in response to a request by the Chairman of the United States House of Representatives Committee on Financial Services.”

Section 1031 Exchanges in the 21st Century 26

Regulations under Sections 468B and 7872

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Treasury decision 9413

- Regulations Update

• Designated settlement funds – escrow accounts, trusts, and funds used in deferred like-kind exchanges; loans to exchange facilitators.

• “468-B” Regulations – The regulations provide rules regarding the taxation of income earned on escrow accounts, trusts, and other funds used during deferred like-kind exchanges of property

• “7872” Regulations - regarding below-market loans to facilitators of these exchanges.

• Effective for all transactions commenced on or after October 8, 2008.

Section 1031 Exchanges in the 21st Century 28

468-B Regulations

• IF:

– The exchange funds are $2,000,000 or greater; OR

– The exchange funds remain with the QI for 6 months or longer

• THEN:

– All interest earned on the exchange funds must be paid to the taxpayer

• Applicable Federal Rate

• 91-day (13-week) T-Bill rate

Section 1031 Exchanges in the 21st Century 29

“The Bad”

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QI Bankruptcy

- A Tale of Two Cities

• Southwest Exchange

– Henderson, NV; Donald K. McGhan and others in his family

– 2007; 130+ clients; $97.5MM+

– Funds used to acquire breast implant company, 19-passenger jet, lavish meals, etc.

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QI Bankruptcy

- A Tale of Two Cities

• 1031 Tax Group

– Richmond, VA; Edward H. Okun and others in his business

– 2007; 300 +/- open exchanges; $151MM+

– Funds used to acquire jewelry, sports cars, helicopters, shopping malls and other “toys”

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QI Bankruptcy

- The LandAmerica saga

• Millard Refrigerated Services v. LandAmerica

– http://www.les1031creditorcommittee.com/76_3147.pdf

– DeGroot v. Exchanged Titles

• 159 B.R. 303 (1993)

– Cook v. Garcia

• 110 F.3d 67 , 1997 WL 143827 (1997)

– In re San Diego Realty Exchange Co., Inc.

• 24 F.3d 249, 1994 WL 161646 (1994)

– Cook v. 1031 Exchange Corp.

• 29 Va. Cir. 302, Not Reported in S.E.2d, 1992 WL 885015 (1992)

– In re. Sale Guaranty Corp.

• 220 B.R. 660 (1998)

Section 1031 Exchanges in the 21st Century 33

QI Bankruptcy

• Southwest Exchange $ 97.5 Million

• 1031 Tax Group $151 Million

• LandAmerica Exchange Services $424 Million

Total $672.5 Million

Section 1031 Exchanges in the 21st Century

State Regulation of Qualified Intermediaries

• Enacted

– California

– Colorado

– Idaho

– Maine

– Nevada

– Oregon

– Virginia

– Washington

• Pending

– Arizona

– Oklahoma

– Texas ≈ Bill Died

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“The Ugly”?

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Choosing a Qualified Intermediary

• Phone Book?

• Internet?

• Referrals

• Qualifications

– When was firm established

– Primary business, or sideline

– How many transactions completed

– Financial stability

– Security of exchange proceeds

– Fees, and what is included

– FEA

• www.1031.org

– Certified Exchange Specialist®

• www.1031ces.org

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Section 1031 Exchanges in the 21st Century

Your Questions

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On the Web:

39 Section 1031 Exchanges in the 21st Century

Contact Information

David Gorenberg, Esquire

Certified Exchange Specialist®

Senior Vice President, 1031 Exchange Services

Citibank, N.A.

1650 Market Street, Suite 3550

Philadelphia, PA 19103

Office: 267.385.3624

Fax: 866.767.8201

Mobile: 610.883.2181

E-mail: david.gorenberg@citi.com

THANK YOU!

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