section 1031 like kind...

Presenting a live 110‐minute webinar with interactive Q&A

Section 1031 Like‐Kind ExchangesNavigating Regulations and Guidance for Diverse Transactions and Structures

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JANUARY 19, 2011

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Joseph Mandarino Partner Stanley Esrey & Buckley AtlantaJoseph Mandarino, Partner, Stanley Esrey & Buckley, Atlanta

Douglas Stives, Specialist Professor of Accounting, Monmouth University, West Long Branch, N.J.

Robert Barnett, Member, Capell Barnett Matalon & Schoenfeld, Jericho, N.Y.

Joyce Welch, Director, Deloitte Tax, San Diego

For this program, attendees must listen to the audio over the telephone.

Joyce Welch, Director, Deloitte Tax, San Diego

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S ti Lik Ki d E h Section 1031 Like‐Kind Exchanges Webinar

Jan. 19, 2011

Douglas Stives, Monmouth [email protected]

Joseph Mandarino, Stanley Esrey & [email protected]

Robert Barnett, Capell Barnett Matalon & [email protected]

Joyce Welch, Deloitte Tax [email protected]

Today’s Program

Material Aspects Of Sect. 1031; Like-Kind Exchange Tax Impact[Joseph Mandarino]

Recent IRS Guidance[Do glas Sti es]

Slide 6 – Slide 31

Slide 32 – Slide 44[Douglas Stives]

Reverse Exchanges, In Detail[Joyce Welch]

Related-Party Rules, In Detail Slide 63 – Slide 75


[Joseph Mandarino]

Selecting A Qualified Intermediary[Douglas Stives]

Ne Wrinkles In Ta Deferred E changes


Slide 81 Slide 114New Wrinkles In Tax-Deferred Exchanges[Joyce Welch and Robert Barnett]

Ramifications Of New Tax Law[Douglas Stives]



MATERIAL ASPECTS OF SECT Joseph Mandarino, Stanley Esrey & Buckley

MATERIAL ASPECTS OF SECT. 1031; LIKE‐KIND EXCHANGE TAX IMPACT

O i F Thi S iOverview For This Section• Main statutory requirements

― Qualifying property

― Like-Kind property

― Holding period requirements/same taxpayer

― Related party rules

• The math: How gain is calculated• The math: How gain is calculated

― Boot and boot offset rules

― Debt rules

• Variations

― Multiple property exchanges

― Deferred exchangesDeferred exchanges

― Reverse exchanges

7

G l R iGeneral Requirements

Qualifying property

Like-kind propertyLike kind property

Holding period requirements

Same taxpayer/related party rules

8

Q lif i P P IQualifying Property: Part I

• Per se exclusions

― Stock in trade or other property held primarily for sale

Stocks bonds or notes― Stocks, bonds, or notes

― Other securities or evidences of indebtedness or interest

― Interests in a partnership

― Certificates of trust or beneficial interests

― Choices in action

9

Q lif i P P IIQualifying Property: Part II

• Must be:

― Held for investment

H ld f d ti i t d /b i― Held for productive use in a trade/business

• Held for investment

Test applied at time of exchange― Test applied at time of exchange

― Change in motivation is okay

• Productive use in trade/business

― Generally means personal use property cannot qualify

― But, IRS has approved exchange with minimal personal useuse.

10

Lik Ki d P R iLike‐Kind Property Requirement

R l t• Real property

• Personal property• Personal property

11

R l PReal Property• The IRS and the courts have been very liberal in treating The IRS and the courts have been very liberal in treating

virtually any real property interest as of like-kind to another interest in real property.

U i d l d― Unimproved land

― Developed land

Commercial real estate― Commercial real estate

― Residential real estate

― Fee simple titleFee simple title

― Leasehold interest (of 30 years or more)

― Rural farmland

― Urban tract

12

P l PPersonal Property

• Generally, the IRS authorities are more restrictive in the case of personal property than real property (with the exception of the new rules for depreciable personal property).

• Depreciable tangible personal property

• Intangible property

13

Depreciable Tangible Personal Property I

• Items of depreciable tangible personal property are treated as like-kind if they are in the same general asset class or product like kind if they are in the same general asset class or product class.

• This is a significant simplification of the general like-kind test and permits large groups of property to be exchanged under Sect. 1031.Sect. 1031.

14

Depreciable Tangible Personal Property II

General asset classes (excerpts)

• Office furniture, fixtures and equipment

• Information systems (computers and peripheral equipment)

• Data-handling equipment, except for computers

• Automobiles, taxis

• Buses

• Light general-purpose trucks

• Heavy general-purpose trucks

• Tractor units for use over-the-road

T il d il d i• Trailers and trailer-mounted containers

• Vessels, barges, tugs and similar water transportation equipment, except for those used in marine construction

• Industrial steam and electric generation and/or distribution systems (asset • Industrial steam and electric generation and/or distribution systems (asset class 00.4)

15

I ibl PIntangible Property

• The IRS rules are far stricter in the case of intangible vs. tangible personal property.

• Example: Goodwill of one business can never be of like-kind to the goodwill of another business.

• IRS rules set up two-part test:

Are the nature or character of the rights involved similar ― Are the nature or character of the rights involved similar (example: patent vs. copyright)?

― Are the nature or character of the underlying property similar?

• Example: Copyright on a novel exchanged for copyright on a different novel. IRS says these are like-kind.

• Example: Copyright on a novel exchanged for a copyright on a song. p py g g py g gNOT LIKE-KIND.

16

H ldi P i d R iHolding Period Requirement• Statute applies to “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 pinvestment.”

• Implicit holding period requirement

• If a taxpayer acquires property and then immediately exchanges it, or receives property in an exchange and then immediately disposes of it, the exchange may not qualify.

• There is no good guidance on this point.

• Some practitioners believe that a pre-exchange holding period of six to 12 months should suffice, if there was no plan to exchange the property at the time of acquisition.

17

S TSame Taxpayer

• The same taxpayer must relinquish the outbound property and acquire the inbound propertyacquire the inbound property.

• Where the outbound property is acquired immediately before p p y q yan exchange, the IRS may argue that the exchanging party was really an agent for the prior owner.

18

R l d P R l G lRelated Party Rules: General

• If a taxpayer and a related party enter into an exchange, and either property is disposed of within two years, then the exchange does not qualify under Sect. 1031 for either party (gain/loss is taxed at the time of the subsequent disposition).

• A more detailed analysis of these rules is contained later in this slide deck.

19

M h H G i I C l l dMath: How Gain Is Calculated

• Unlike with the installment sale rules there is no “election • Unlike with the installment sale rules, there is no election out” of Sect. 1031.

― If the exchange is covered, then no gain or loss is recognized.

• Even if a perfectly valid 1031 exchange occurs, gain can be recognized in several respects:g p

― 1031 does not trump the recapture rules of 1245 and 1250.

G i i i d t th t t f b t ( lik― Gain is recognized to the extent of any boot (non-like-kind property, cash, liabilities, etc.) that is received.

• Generally, loss is not recognized in a valid 1031 exchange, even if boot is present.

20

B R l G lBoot Rules: General

• Generally, if a taxpayer receives boot in an exchange that otherwise qualifies under Sect. 1031, then gain is recognized to the extent of the FMV of the boot, but not in excess of the realized gain on the transaction.

Step 1: Determine realized gain― Step 1: Determine realized gain

― FMV of boot and like-kind property received less adjusted basis of outbound property

― Step 2: Determine FMV of bootStep 2: Determine FMV of boot

― Amount of any cash

― Amount of any debt or liability on the outbound property

― Amount of any of debt or liability of the taxpayer which is Amount of any of debt or liability of the taxpayer which is assumed by the other party

― FMV of any non-like-kind property

― (But, see netting discussion)( , g )

― Step 3: Recognize the lesser amount of Step 1 or Step 2

21

B R l N i IBoot Rules: Netting I

• The IRS rules contain special “boot netting” rules that apply if boot is both given and received.

U f t t l th dl l l• Unfortunately, they are needlessly complex.

• Boot in the form of liabilities

If t i li d f li bilit i h th t i ll ― If a taxpayer is relieved of liability in an exchange, that is generally treated as boot.

― If the taxpayer assumes or takes the inbound property subject to a liability, he or she can net the two liability amounts in determining liability, he or she can net the two liability amounts in determining the boot received.

― Example: Outbound property with $200 mortgage; inbound property taken subject to $100 mortgage → net boot = $100

22

B R l N i IIBoot Rules: Netting II

• Other forms of boot

• When a taxpayer gives or receives other forms of boot (cash, non-like-kind property), the netting rules are more non like kind property), the netting rules are more complicated.

• Generally, a taxpayer can net any type of boot given only against boot that is received in the form of liability reliefagainst boot that is received in the form of liability relief.

― Example: Outbound property with $200 mortgage; inbound property taken subject to $300 mortgage → net boot = $0

― Example: Outbound property with $200 mortgage; inbound property taken subject to $300 mortgage and inbound property taken subject to $300 mortgage and cash received of $75 → net boot = $75

23

B R l N i IIIBoot Rules: Netting III

Taxpayer is relieved of a liability, or outbound property is taken subject to a liability

Taxpayer receives cash or non-like-kind property

Taxpayer assumes a liability or takes the inbound property

NETTING PERMITTED NETTING NOT PERMITTED

inbound property subject to a liability

Taxpayer gives cash or NETTING PERMITTED NETTING NOT p y gnon-like-kind property PERMITTED

24

B R d i F EBoot Reduction For Expenses

• Generally, a taxpayer can reduce the amount of boot deemed to be received by his or her expenses incurred in the to be received by his or her expenses incurred in the exchange.

i ll ll di id l i h • Virtually all direct expenses paid at closing, such as origination, escrow, document prep and processing fees, as well as recordation taxes, and similar expenses should qualify.

25

Liabilities Added Immediately Before Exchange

• Sometimes, the parties will place mortgages on the properties immediately before the exchange to even up values.immediately before the exchange to even up values.

• This can be a useful way to avoid complexities with the boot i lnetting rules.

• Unfortunately, there is little consistent guidance on whether Unfortunately, there is little consistent guidance on whether this will be respected.

26

V i iVariations

• Variations

― Multiple property exchanges

― Deferred exchanges― Deferred exchanges

― Reverse exchanges

• More detailed discussions of these variations can be found later in the slide decklater in the slide deck.

27

V ill M d lVanilla Model

• Taxpayer relinquishes the outbound property and acquires the • Taxpayer relinquishes the outbound property and acquires the inbound property simultaneously.

― Buyer of outbound property and seller of inbound b iproperty can be separate parties.

― This almost never happens.

28

M l i l P E hMultiple Property Exchange• In the personal property realm, it is common for large groups of items

to be exchanged.

― Example: Trucking company exchanges 50 old rigs for 50 new rigs.

• If all the properties are like-kind, then the exchange is relatively straightforward.

― If not, then a complex set of rules kicks in

― Like-kind outbound and inbound properties are grouped together, and a boot/residual group also is set up.

― Complicated liability netting and gain recognition rules are applied.

― Generally this is seen as better for the taxpayer than a property-by-property determination of gain. But, it is critical to run the analysis and ensure that you are comfortable with the calculations before closing.

29

D f d F d E hDeferred Forward Exchange

• Taxpayer relinquishes the outbound property on day 0.

• On or before day 180, taxpayer acquires the inbound property.

― Buyer of outbound property and seller of inbound property can be separate parties.

― Safe harbor rules and QI are often critical.Safe harbor rules and QI are often critical.

30

D f d R E hDeferred Reverse Exchange

• Exchange accommodator acquires the inbound property on day 0.

• Taxpayer relinquishes the outbound property to a third party at some point between day 0 and day 180.

• On or before day 180, EA transfers the inbound property to the taxpayer.p y

― Safe harbor rules are critical. But, increasingly these transactions are occurring outside of the safe harbor.

31

RECENT IRS GUIDANCEDouglas Stives, Monmouth University

RECENT IRS GUIDANCE

Problems With Delayed ExchangesProblems With Delayed Exchanges

• Missed 45‐day identification or 180‐day replacement deadline?

There are no exceptions or extensions

The gain must be grecognized

Consider penalty language in contract, if purchase of replacement property is delayedpurchase of replacement property is delayed.

33

Problems With Delayed Exchange (Cont.)Problems With Delayed Exchange (Cont.)

• What happens if the qualified intermediaryWhat happens if the qualified intermediary steals the money or goes bankrupt?

• Rev Proc 2010 14 says:• Rev. Proc. 2010‐14 says:

It’s an installment sale!

Which means:

Bad news: You no longer have a 1031 exchange. g g

Good news: YOU PAY TAX IF & WHEN MONEY IS RECEIVED using the installment sale rulesRECEIVED, using the installment sale rules.

34

Example From Rev. Proc. 2010‐14p

• Sale by QI on May 6, 2010 for $150,000Adj t d b i $50 000Adjusted basis = $50,000 Gain = $100,000

ID f l b ll• ID of replacement property by seller on June 1, 2010 (within 45 days)f l f b k d• QI files for bankruptcy or disappears – No closing on new property byNov. 2, 2010 (180 days)

• Gain needs to be reported for 2010, but is not t d tiltaxed until money appears.

35

Example From Rev. Proc. 2010‐14 (Cont.)

If QI i• If QI exits

bankruptcy and pays seller p y p y

$130,000 in 2011:

Gain is recomputed at $80,000, which is taxed in 2011

36

Related‐Party ExchangesRelated Party Exchanges

• General related‐party rule:

Exchange will not qualify for §1031 if either transferred or replacement property istransferred or replacement property is disposed of within two years (questions on Form 8824, Part II, Lines 9 & 10)Form 8824, Part II, Lines 9 & 10)

37

Related Party Exchanges (Cont )Related‐Party Exchanges (Cont.)

• Internal Revenue Code does Not say you can’t exchange with a relativeexchange with a relative.

• You just need to complete Part II of Form 8824 for the year of sale and the next two years.

38

Related Party Exchanges (Cont )Related‐Party Exchanges (Cont.)

• If a related party buyer disposes of property within two years of the last transfer, the 1031 fails and the gain is taxed.

• Gain on sale is triggered

if replacement property acquired from aif replacement property acquired from a related party is sold within two years.

39

Related‐Party Exchanges (Cont.)Related Party Exchanges (Cont.)

• Exceptions that override the two‐year holdingExceptions that override the two year holding period for exchanges with related parties (Form 8824 Part II Line 11)– Death

– Involuntary conversion

– Other non‐tax‐avoidance purposes; explanation must be submitted with Form 8824

40

A Recent Case

Ocmulgee Fields, Inc. v. Comm., (11th Cir.)

09 13395 Aug 13 2010 affirmed Ocmulgee Fields09‐13395, Aug. 13, 2010 affirmed Ocmulgee Fields, Inc. v. Comm., 132TC No. 6, March 31, 2009

• OFI (the seller) transferred shopping ( /$ ll )center (w/$6 million gain) to QI.

• Accommodator sold shopping center.• OFI indentified commercial property owned by Treaty Fields (a related party).

41

Related‐Party Exchange Case

• Court decided OFI‐Treaty exchange occurredCourt decided OFI‐Treaty exchange occurred first followed by Treaty selling shopping center within 2 years – even though Treaty never had title to shopping center – despite use of a QI.

l d d l f• Court ruled OFI and Treaty were guilty of “basis shifting,” and primary motivation of transaction was tax avoidancetransaction was tax avoidance.

• Treaty’s sale triggered OFI’s $6M gain ANDTreaty s sale triggered OFI s $6M gain, ANDTreaty’s gain of $4M was also taxed.

42

CCA 201013038 An Example Of What You Can’t DoYou Can t Do

• Related parties = A retail farm equipment• Related parties = A retail farm equipment dealer and an equipment leasing company

• If the leasing company sells a combine using a• If the leasing company sells a combine, using a QI, to an unrelated party; and

• The leasing company purchases replacement• The leasing company purchases replacement property, using the QI, from the related retail dealer. dea e

43

CCA 201013038

Conclusion

• 1031 is violated, and motivation is tax1031 is violated, and motivation is tax avoidance.

• Leasing company replaced low‐basisLeasing company replaced low basis equipment with new equipment from a related company.

• Leasing company sold depreciable equipment.• Dealer sold inventory.Dealer sold inventory.• Gain is taxed to leasing company.

44

REVERSE EXCHANGES, IN Joyce Welch, Deloitte Tax

,DETAIL

Contacts

Joyce WelchReal Estate Tax ServicesDeloitte Tax LLP, San Diego619 237 [email protected]

This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other p , g g, , , , g , ,professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss q p p ysustained by any person who relies on this presentation.

46

R Lik Ki d E hReverse Like‐Kind ExchangesI. A reverse like-kind exchange involves acquisition of replacement g q p

property prior to the sale of relinquished property.

II N t d b th l tiII. Not covered by the regulations

III. Safe harbor for “parking arrangements” established in Rev. Proc. p g g2000-37

A. Modified by Rev. Proc. 2004-51

IV. Provides structure that IRS will not challenge, if requirements are met

47

R Lik Ki d E h (C )Reverse Like‐Kind Exchanges (Cont.)

I. Why use?

I Seller requires closing now; sale is delayedI. Seller requires closing now; sale is delayed.

II New facility constructionII. New facility construction

III. Extend 45-/180-days time limits for deferred exchangesy g

48

Reverse ExchangesS f H b R i tSafe Harbor Requirements

I.Role of exchange accommodation titleholder (EAT)

II Q lifi d h d ti t (QEAA)II.Qualified exchange accommodation agreement (QEAA)

III.Qualified indicia of ownership (QIO)Q p (Q )

IV.Identification and replacement periods

49

Reverse ExchangesS f H b I (C t )Safe Harbor Issues (Cont.)

I.Who can act as EAT?

II.Financing purchase of replacement property

A D bt tA. Debt terms

B. Guarantees

III Control of propertyIII.Control of property

A. Lease terms

IV.Transfer of property to taxpayerp p y p y

A. Put/call options

50

R Lik Ki d E h (C )Reverse Like‐Kind Exchanges (Cont.)

I. Two types

A Exchange first: Accommodator immediately exchanges A. Exchange first: Accommodator immediately exchanges relinquished property with taxpayer.

B. Exchange last: Accommodator holds replacement property until relinquished asset is sold.

51

Reverse Like‐Kind Exchanges (Cont.)Parking title to the replacement property(Restructured as a simultaneous exchange on Phase II)

SellerPhase One

(Loan From ExchangerCash

Replacement Property

Accommodation TitleholderAccommodation

Qualified Exchange Exchanger

Accommodation Agreement

Intermediary holds title to replacement property until exchanger can sell relinquished property.

52

Reverse Like‐Kind Exchanges (Cont.)gParking title to the replacement propertyPhase Two

Exchanger

Exchan

Assi g

BuyerAccommodation

Titleholderge A

greem

gnments

Qualified

ment

Used to Repay

Cash

Qualified Intermediary

Used to Repay Exchanger’s Loan

53

Reverse Like‐Kind Exchanges (Cont.)Parking title to the relinquished property(structured as a simultaneous exchange on Phase One)

Phase OneExchanger

Phase One

Exchange

Assign

Loan from Exchanger to AT for equity from Relinquished Property and QEA Agreement

Accommodation Titleholder Seller

e Agreem

nments m

ent

Qualified Intermediary

54

Reverse Like‐Kind Exchanges (Cont.)g ( )

Parking title to the relinquished property

Accommodation TitleholderPhase Two

(Used to Repay Exchanger’s Loan CashRelinquished Property

Buyer

forReplacement Property)

When relinquished property is sold, intermediary transfers title to buyer.

55

B ild T S i E hBuild‐To‐Suit Exchanges

I. Replacement property can be build-to-suit

A Construction cannot be performed by taxpayerA. Construction cannot be performed by taxpayer.

B. Construction by affiliate is vulnerable to anti-abuse rule of y§1031(f)(4) unless it is a direct exchange.

C. Construction must be performed by seller-developer, QI or EAT (EAT is preferred).

56

Build‐To‐Suit Exchanges:The Coca‐Cola Conundrum

I. If am accommodator constructs improvements on land already owned by taxpayer, then transfers improvements in exchange for fee interest in other land, there is no exchange.

A. Bloomington Coca-Cola v. Comr.; Rev. Rul. 67-255

II. Built-to-suit exchanges can usually only be structured as reverse exchanges, due to §1031(a)(3)(B).

57

G idGuidance

I. IRS view is that land and building cannot be exchanged for new building built on land already owned by taxpayer (Rev. Rul. 67-255).

II T f f t ’ l d t th t f t ti II. Transfer of taxpayer’s land to another party for construction period, followed by transfer back to taxpayer, may be disregarded (DeCleene).

58

G id (C )Guidance (Cont.)

I. Taxpayer cannot acquire land from an affiliate (§1031(f)(4); Teruya Brothers; Rev. Rul. 2002-83).

II. PLRs 200251008 and 200329021 approved transactions in which an EAT:

A A i d 30 l l i l d d b ffili t f tA. Acquired 30-plus lease in land owned by affiliate of taxpayer

B. Constructed leasehold improvements

59

G id (C )Guidance (Cont.)

A. Transferred leasehold interest plus improvements to taxpayer as replacement property structured to satisfy Rev Proc as replacement property – structured to satisfy Rev. Proc. 2000-37

B. Unknown whether limitations of Rev. Proc. 2004-51 apply to this transaction

60

Use Of Reverse Exchange To A i F l P tAcquire Foreclosure Property

I.Taxpayer wants to acquire property in foreclosure as replacement property in an exchange.

A. EAT must acquire QIO in order to satisfy Rev. Proc. 2000-37.

B EAT must be a party to “bid in” at foreclosure sale B. EAT must be a party to “bid-in” at foreclosure sale.

61

I T R tiIncome Tax Reporting

I.EAT must agree to report ownership of parked property, pursuant to QEAAg.

II.Accommodator ownership will dictate reporting requirements depending on whether the EAT entity is a:depending on whether the EAT entity is a:

A. Corporation

B. Partnership

C. LLC

62

RELATED PARTY RULES IN Joseph Mandarino, Stanley Esrey & Buckley

RELATED‐PARTY RULES, IN DETAIL

R l d P R l G lRelated Party Rules: General

• General rule

• Basis shifting

• Guidance

64

R l d P R l G l (C )Related Party Rules: General (Cont.)

• Under 1031(f), if a taxpayer and a related party enter into an exchange and either property is disposed of within two years exchange and either property is disposed of within two years, then the exchange does not qualify under Sect. 1031 for either party.

• If 1031(f) applies, any gain/loss is taxed at the time of the subsequent disposition.subsequent disposition.

65

Wh A R l d P i ?Who Are Related Parties?

• A related person is any person bearing a relationship to the taxpayer described in sections 267(b) or 707(b)(1).

• Sect 707(b)(1) relationshipsSect. 707(b)(1) relationships

― A partnership and a person owning, directly or indirectly, more than 50% of the capital interest, or the profits interest, in such partnership; or

― Two partnerships in which the same persons own, directly or indirectly, more than 50% of the capital interests or or indirectly, more than 50% of the capital interests or profits interests

66

Sect 267(b) Relationships: Part ISect. 267(b) Relationships: Part I• Members of a family (brothers and sisters (whether by the whole or

half blood) spouse ancestors and lineal descendants)half blood), spouse, ancestors, and lineal descendants)

• An individual and a corporation for which more than 50% of value of the outstanding stock is owned, directly or indirectly, by or for such individual;individual;

• Two corporations that are members of the same “controlled group”

• A grantor and a fiduciary of any trust

A fid i f d fid i f h if h • A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts

• A fiduciary of a trust and a beneficiary of such trust

• A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts

• A fiduciary of a trust and a corporation for which more than 50% of value of outstanding stock is owned, directly or indirectly, by or for trust or by or for a person who is a grantor of the trust

67

Sect 267(b) Relationships: Part IISect. 267(b) Relationships: Part II• A person and a tax-exempt organization that is controlled directly or

indirectly by such person or (if such person is an individual) by indirectly by such person or (if such person is an individual) by members of the family of such individual

• A corporation and a partnership, if the same persons own (A) more than 50% of value of the outstanding stock of the corporation; and (B) than 50% of value of the outstanding stock of the corporation; and (B) more than 50% of the capital interest, or the profits interest, in the partnership

• An S corporation and another S corporation if the same persons own • An S corporation and another S corporation, if the same persons own more than 50% of value of outstanding stock of each corporation

• An S corporation and a C corporation, if the same persons own more than 50% of value of the outstanding stock of each corporation; orthan 50% of value of the outstanding stock of each corporation; or

• Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate

AND – all the above are subject to constructive ownership rules!!

68

B i Shif iBasis Shifting• Adam owns Blackacre with FMV of $100 and tax basis of $100.Adam owns Blackacre with FMV of $100 and tax basis of $100.

• Eve owns Whiteacre with FMV of $100 and tax basis of $25.

• Adam and Eve are spouses.

• Eve would like to sell Whiteacre. If Eve sells Whiteacre, she will have a $75 gain.

• If Adam and Eve enter into a like-kind exchange and swap properties, Eve will take Blackacre with a tax basis of $25, and Adam will take Whiteacre with a tax basis of $100.

• If Adam sells Whiteacre, but for Sect. 1031(f), he would have no gain on the sale.

69

H ldi P i dHolding Period

• If a related party exchange occurs, then both parties must hold the received properties for two (2) years.

• BUT – the holding period is extended for any time during which BUT the holding period is extended for any time during which either party’s “risk of loss” with respect to its property is substantially diminished by:

― The holding of a put with respect to such property,

― The holding by another person of a right to acquire such property, orp p y,

― A short sale or any other transaction.

70

P i d Di i i IPermitted Dispositions: I

• Despite the foregoing, certain dispositions are permitted during the holding period.

― A disposition after the earlier of the death of the taxpayer A disposition after the earlier of the death of the taxpayer or the death of the related person;

― A disposition that occurs in a compulsory or involuntary i if th h d b f th th t conversion, if the exchange occurred before the threat or

imminence of such conversion; or

― A disposition with respect to which it is established to the satisfaction of the IRS that neither the exchange nor such disposition had as one of its principal purposes the avoidance of federal income tax

71

P i d Di i i IIPermitted Dispositions: II

Th thi d “ t” h i i t id bl t • The third “out” has given rise to considerable commentary. Because basis shifting is the stated rationale for Sect. 1031(f), a transaction that does not implicate basis shifting should be approved by the IRS.

72

Anti‐Abuse Rulet buse Ru e• Sect. 1031(f) contains language that Sect. 1031 shall not apply

to any exchange that is part of a transaction (or series of transactions) “structured to avoid the purposes” of the related party rules.

• There is very little guidance on this ruleThere is very little guidance on this rule.

• If a taxpayer overtly enters into a related party exchange, then the burden or “cost” is compliance with the holding period rules.

• If a taxpayer tries to avoid related party rules in form, but not in substance, then this anti-avoidance rule prohibits any part in substance, then this anti avoidance rule prohibits any part of Sect. 1031 from applying.

• For example, the IRS takes the position that using a QI to mask di h i h l d i h ia direct exchange with a related party triggers the anti-

avoidance rule.73

Authorities/Guidanceut o t es/Gu da ce• Rev. Rul. 2002-83

U f QI t id l t d t l t i ti― Use of QI to avoid related party rules triggers anti-avoidance rule

• PLR 2002-51-008

― Appears to sanction a related party parking arrangement

• PLR 2010-27-036

― Related party exchange outside of Sect. 1031(f) and does not trigger anti-avoidance rule

T B th U f QI i l t d t h / ti• Teruya Brothers: Use of QI in related party exchange/anti-avoidance rule applied

• Ocmulgee Fields: Use of QI in related party exchange/anti-g Q p y gavoidance rule applied

74

Ob iObservations

• Related party exchanges are common.

Dili l t d ti t?• Diligence – are related parties present?

• Consider/weigh cost of holding period requirement

• Use of QI will not defeat related party rules• Use of QI will not defeat related party rules.

• Basis shifting analysis

• Consider PLRConsider PLR

75

SELECTING A QUALIFIED Douglas Stives, Monmouth University

SELECTING A QUALIFIED INTERMEDIARY

Selecting A Q.I.

Independent intermediary cannot be:Independent intermediary cannot be:

• Lawyery

• Accountant

• Realtor

Within two years prior to closing

77

Factors To Consider SELECTING AF Q.I.

When Selecting A Q.I.• Intermediaries are mostly unregulated! y g

• Several have left town with $ millions

• Licensed: CPA, attorney, bank, title company

• Insured for E&O/malpractice – ask for proof

• Experience

d d bl ?• Is contract understandable?

• Do they answer questions?

• Where is money invested?• Where is money invested?

– Bank account: FDIC limit is $100,000

– Brokerage account: Unlimited coverage – ask for proofBrokerage account: Unlimited coverage ask for proof

78

Selecting A Q.I.Selecting A Q.I.

• SELLING CONTRACTSELLING CONTRACT

should include simple

l hlanguage such as:

“Seller intends to utilize IRC 1031 to defer gainSeller intends to utilize IRC 1031 to defer gain in sale and has engaged Curchin 1031 Exchange LLC as qualified intermediary”Exchange, LLC as qualified intermediary

79

Selecting A Q.I. (Cont.)Selecting A Q.I. (Cont.)

• AT CLOSING:AT CLOSING:

Q I needs to sign HUD 1 statement for saleQ.I. needs to sign HUD 1 statement for saleand replacement.

Proceeds (including deposit) must go directlyto Q.I. for investment in escrow account.

80

J W l h D l i T

NEW WRINKLES IN TAX

Joyce Welch, Deloitte TaxRobert Barnett, Capell Barnett Matalon & Schoenfeld

NEW WRINKLES IN TAX‐DEFERRED EXCHANGES

Sh t S lShort Sales

I.What is a short sale?

A. A short sale occurs when a lien holder accepts less than the amount it is owed as satisfaction for its lien claim.

B. Short sale is a “sale,” for tax purposes, and may be a disposition eligible for §1031 treatmenteligible for §1031 treatment.

i. Practical problem: No proceeds to reinvest

82

Sh t S l (C t )Short Sales (Cont.)

A Transactions considered a functional equivalent of a foreclosure A. Transactions considered a functional equivalent of a foreclosure, (e.g., deed-in-lieu) tax consequences depend on whether debt is recourse or non-recourse. 2925 Briarpark Ltd. v. Comr.

B. If debt is recourse, transaction is bifurcated as part “sale,” part “debt forgiveness ”debt forgiveness.

i. Sale is equal to FMV of property.

ii. Debt forgiveness is the debt balance not repaid.g p

83

Sh t S l (C t )Short Sales (Cont.)

A Any “debt forgiveness” is considered income not from dealings A. Any debt forgiveness is considered income not from dealings in property and not eligible for deferral under §1031; it may be eligible for deferral/exclusions under §108.

B. Example:

Property worth $500k encumbered by recourse debt of $750k is sold in a short salesold in a short sale.

Result: Sale proceeds = $500k; COD = $250k

84

IntroductionIntroduction

• Consider the individual vs. entity

• Individual shareholders and partners often have different goals.S t t “CASH OUT ”– Some want to “CASH OUT.”

– Some want to participate in 1031 exchange.

85CAPELL BARNETT MATALON & SCHOENFELD, LLP.

PurposePurpose

• The primary purpose of IRC §1031 is to provide taxpayers the opportunity to exchange property that they hold for business or pp y g p p y yinvestment purposes for similar property purposes.


Statutory RequirementStatutory Requirement

• IRC §1031(a) states that no recognition of any gain or loss is required if “property held for productive use in a trade or business or q p p y pfor investment … is exchanged solely for property…which is to be held for productive use in a trade or business or for investment” (emphasis added).


Holding Requirement

• The taxpayer must remain invested in the same kind of property and not• The taxpayer must remain invested in the same kind of property and not express any intent to liquidate or to use the property for personal purposes.

• One recent case defined the inquiry as whether “the taxpayer’s economic situation is in substance the same after as it was before the transaction.”

• Maloney v. Comm’r, 93 T.C. 89 [July 25, 1989], 62 F.3d 396 [Fifth Circuit 1995].

CAPELL BARNETT MATALON & SCHOENFELD, LLP. 88

Possible Considerations

• Complete §1031 exchange

• Use debt financing to “cash out” the desired partners/shareholders– Tax considerations to entity– Tax considerations to shareholder – dividend/redemption– Tax considerations to retired partner §731; §751


Dropdown

• What if debt financing is not available or appropriate?

• Consider “dropdown” of property; entity distributes property to its members prior to the exchangep g

• Individuals then own the property as tenants in common.

• Individuals decide whether to participate.


The Holding RequirementThe Holding Requirement

• Lack of clear statutory guidance

• Creates uncertainty as to whether the holding requirement is violatedCreates uncertainty as to whether the holding requirement is violated

• IRS historically contested such transactions

• IRS claims that the real intent is to liquidate or to use property for personal purposes.


Revenue Ruling 77-337• Revenue Ruling 77-337

– In 77-337, 1977-2 C.B. 305, the IRS took the position that tax non-iti il bl t h h ld i d IRC §recognition was unavailable to a shareholder in a prearranged IRC §

333 corporate liquidation.– The IRS refused to attribute the corporation’s use of the property to its

h h ldshareholder.– As a result, the “held for productive use in a trade or business or for

investment” requirement under § 1031(a)(1) was not met.– In Rev. Rul. 75-292, 1975-2 CB 333, the IRS asserted that an

individual’s transfer of replacement property to a wholly owned corporation would fail to meet the “held for” requirement.

– The IRS reached its conclusion from the fact that the replacement property was not being held by the taxpayer who effected the exchange, but rather by his corporation.


Magneson

• In Magneson, however, Rev. Rul. 75-292 was not followed in a partnership transaction.

• In Magneson, the taxpayer first completed a like-kind exchange g , p y p gimmediately prior to contributing the exchanged property to a partnership.

• The IRS asserted that the taxpayer had not in fact held the property forThe IRS asserted that the taxpayer had not in fact held the property for investment purposes, because the exchange of properties was immediately followed by a contribution to a partnership.


Magneson (Cont.)

• The Tax Court sustained the like-kind exchange under §1031. It stated that “the taxpayer’s economic situation after the exchange … [was] fundamentally the same.”

• The court opined that the transfer to the partnership was essentially a continuation of the investment, because the transfer was simply a change in form of ownership which did not trigger any gain or loss or accelerate any reporting requirements.


Magneson (Cont.)

• The Magneson court also noted that the petitioner’s basis in the exchanged property remained the same, since it was a non-taxable contribution to a partnership.

• Hence, the court in Magneson held that the subsequent transfer of exchanged property to a partnership under IRC §721 did not interfere with g p p y p p §§ 031’s requirement that the property be held for business purposes or for investment.


Magneson: 9th CIRCUIT

• The Ninth Circuit Court of Appeals affirmed the Tax Court’s decision on slightly different grounds.

• The Court of Appeals determined that the differences between control and management rights of the taxpayer’s general partnership interest received in a §721 contribution to a limited partnership and fee ownership in real property was not significant enough to deny non-recognition treatment under §1031(a).

• The Ninth Circuit held that the “critical attributes in the taxpayer’s relationship to the property are those relevant to holding the property for investment.”


IRS Takes Narrow Interpretation

• Any distributions of property by a partnership or by a corporation prior to an exchange must not contravene the requirement that the property be held for business or investment purposes, both before and after the exchange.

• The IRS takes a very narrow interpretation of the statutory requirement.y p y q


Court Interpretations

• Fortunately, the courts have generally not followed the IRS’ restrictive interpretations.

• A review of the case history and the factors that courts have focused upon provides helpful guidance in structuring such transactions.


Bolker v. Commissioner

• The Tax Court in Bolker v. Comm’r refused to follow Revenue Ruling 77-337 and determined that real property distributed in a corporate li id ti h ld b th t f i t tliquidation was held by the taxpayer for investment.

• 81 T.C. 782 [October 20, 1983], aff’d 760 F.2d 1039 [Ninth Circuit 1985]


Bolker: Tax Court• Found for taxpayer

• Despite fact that exchange agreement was entered into upon liquidation

• The Tax Court opined that “[a] trade of property A for property B both ofThe Tax Court opined that [a] trade of property A for property B, both of like-kind, may be preceded by a tax-free acquisition of property A at the front end, or succeeded by a tax-free transfer of property B at the back end.”

• Thus, the court determined that the relinquishment by the taxpayer of the corporation’s stock for the corporation’s real property was “essentially thecorporation s stock for the corporation s real property was essentially the same investment” and entitled the taxpayer to subsequently exchange this property in a Sect. 1031 transaction.


No Pre-Arranged PlanNo Pre Arranged Plan

• The Tax Court found no pre-arranged plan,

• Property was held by shareholder for three months prior to the exchangeProperty was held by shareholder for three months prior to the exchange.

• Negotiations for subsequent exchange were prepared by the INDIVIDUAL SHAREHOLDERSHAREHOLDER.


9TH CIRCUIT

• Upheld Tax Court• Upheld Tax Court

• No statutory requirement to hold property indefinitely

• Looked at taxpayer’s actions and statements

• The court stated that “if a taxpayer owns property which he does not intend to liquidate or use for personal pursuits, he is ‘holding’ that property ‘for productive use in trade or business or for investment; within the meaning of §1031 (a).”


Mason v. Commissioner

• The trend of upholding §1031 like-kind exchanges was followed in Mason v. Comm’r (T.C. Memo F.2d 420 [11th Circuit 1989].

• In Mason, a partnership distributed real estate to its partners in , p p pliquidation of their interests.

• The taxpayer and his partner then exchanged their interests in theThe taxpayer and his partner then exchanged their interests in the distributed real property immediately following their receipt of these parcels from the partnership.


Mason (Cont.)Mason (Cont.)

• Tax Court viewed the transaction as a pro-rata liquidation and distribution of partnership assets pursuant to §731.

• Followed by a §1031 exchange by the partners (boot was received)

• 11th Circuit upheld the Tax Court• 11th Circuit upheld the Tax Court.


Post-Sect. 1031 Dropdownp

• Here the §1031 exchange occurred at the entity levelHere, the §1031 exchange occurred at the entity level.

• Followed by a dropdown of the property received in the exchange


Maloney v. CommissionerMaloney v. Commissioner

• Corporate §1031 exchange

• ONE MONTH before distributing the exchanged property to shareholders in a §333 liquidation.§ q

• IRS cried “HOLDING VIOLATED” – intent was to liquidate, not hold, the propertyproperty.

• This intent to liquidate is equivalent to the intent to sell.


Maloney (Cont.)

• Tax Court upheld §1031 non-recognition• Tax Court upheld §1031 non-recognition.

• The corporate liquidation and distribution of the exchanged property to its shareholders were not the same as cashing out of an investmentits shareholders were not the same as cashing out of an investment.

• The court was influenced by the fact that the shareholders received the exchanged real estate with the intent to continue holding such property as an investment, and found that this was a continuation of the corporate taxpayer’s required holding of the property, for investment purposespurposes.


Maloney (Cont.)Maloney (Cont.)

• 5th Circuit upholds Tax Court.


Proper Formalities

• Must be followed

• Chase v. Commissioner - 92TC 874(1989)

• Partnership negotiated a sale prior to conveying an interest in the• Partnership negotiated a sale prior to conveying an interest in the property to partners.

P t hi id f th §1031 h• Partnership paid expenses of the §1031 exchange.

• Deed to the partners was not properly recorded until just prior to the §1031 exchange.

• Court held that taxpayers were not the proper owners prior to the p y p p pexchange (did not receive deed or rental income).


GuidanceGuidance

• Avoid prearranged §1031 agreementsAvoid prearranged §1031 agreements

• Be mindful of a step-transaction-type challenge


Guidance (Cont.): H M h Ti ?How Much Time?

• Bolker: 9th Circuit acknowledged scarcity of authority– Liquidation planned before §1031 exchange was consideredLiquidation planned before §1031 exchange was considered– Taxpayers held distributed property for three months prior to

exchange transaction.IRS did not therefore raise step transaction attack and court– IRS did not therefore raise step transaction attack, and court refused to consider.


Guidance (Cont.)Guidance (Cont.)

• IRS has not approved entity transfers to or from partnerships or corporations in a §1031 context.

• Courts are accommodating and will look at the nature of the transaction.

• Careful documentation and adherence to formalities


Guidance (Cont.)Guidance (Cont.)

• Separate the entity transaction from the §1031 exchange

• Review shareholder/partnership agreementsReview shareholder/partnership agreements

• Careful drafting and recording of deeds


Disregarded EntitiesDisregarded Entities

• Several recent private letter rulings have permitted use of disregarded entities such as SMLLC to hold replacement property.g p p p y

• See, e,g., PLR 200807005.


RAMIFICATIONS OF NEW TAX Douglas Stives, Monmouth University

RAMIFICATIONS OF NEW TAX LAW

New Tax LawNew Tax Law

Si d b h id 20 0• Signed by the president on Dec. 17, 2010

• Extended and doubled IRC 168(k) to permit 100% depreciation for NEW personal (not real p p (estate) property put in service

from 9/8/10 to 12/31/11from 9/8/10 to 12/31/11

116

New Tax Law: 100 DepreciationNew Tax Law: 100 Depreciation

• Application to IRC 1031: 100% depreciationApplication to IRC 1031: 100% depreciation can be used for 1031 replacement property on full basis which includes:full basis, which includes:

C b i f li i h dCarryover basis from relinquished property

AND

Additional funds (“boot” ) invested

117

New Tax Law: 100% Depreciation (Cont.)New Tax Law: 100% Depreciation (Cont.)

• Example:• Example:

h b lld fA construction company exchanges a bulldozer for a front‐end loader

(same class of equipment) .

Bulldozer was being depreciated over 5 years and had adjusted basis of $50,000 at time of trade.

118

IRC 168 Example (Cont.)IRC 168 Example (Cont.)

Cost of new equipment was $150 000 less trade‐Cost of new equipment was $150,000 less tradein allowance for bulldozer of $90,000 requiring cash payment (boot) of $60 000requiring cash payment (boot) of $60,000

Basis of new equipment = $110,000 (adjusted basis of $50 000 plus $60 000 cash)basis of $50,000 plus $60,000 cash)

NEW LAW allows full deduction for $110,000 in f dyear of trade.

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section 1031 like kind...

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