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    How to Do a 1031 Exchange of Real Estate: Using a 1031 Qualified Intermediary (Qi) 2Nd Edition
    How to Do a 1031 Exchange of Real Estate: Using a 1031 Qualified Intermediary (Qi) 2Nd Edition
    How to Do a 1031 Exchange of Real Estate: Using a 1031 Qualified Intermediary (Qi) 2Nd Edition
    Ebook228 pages2 hours

    How to Do a 1031 Exchange of Real Estate: Using a 1031 Qualified Intermediary (Qi) 2Nd Edition

    By Edwin V. Horan MS

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    About this ebook

    How to Do a Like Kind Exchange of Real Estate
    If you own investment, business, or rental real estate this book can save you thousands of dollars in capital gains taxes. It is a true how to do book.
    The IRS requires a taxpayer to use a qualified intermediary if they wish to take advantage of the ‘safe harbor’ procedures established in the IRS regulation for a deferred exchange. This book explains the important and mandatory tasks for both the qualified intermediary (QI) and the taxpayer in an exchange.

    Simple to follow instructions and forms in this book will help you –
    — Learn if your property qualifies for a 1031 like kind exchange
    — Figure how much tax you will have to pay Uncle Sam if you sell
    — Determine what your reinvestment requirements will be
    — Know what documentation is required
    — Understand the exchange escrow requirements and rules
    — How to report the exchange to the IRS
    and much more !!!
    LanguageEnglish
    PublisherTrafford Publishing
    Release dateApr 16, 2020
    ISBN9781698700366
    How to Do a 1031 Exchange of Real Estate: Using a 1031 Qualified Intermediary (Qi) 2Nd Edition
    Author

    Edwin V. Horan MS

    About the Author Ed Horan was one of the original FEA ‘Certified Exchange Specialist®’. Ed holds a Masters’ Degree in Business. He is a nationally recognized expert on IRC section 1031 Like Kind Exchanges. He founded Realty Exchange Corporation in 1990, a company that only serves as a qualified intermediary, and is a senior consultant. In his prior career he served as a pilot and comptroller with the United States Air Force, and was licensed as a real estate broker. Ed has been a frequent writer and lecturer on residential real estate investments, exchanges, and the impact of taxes on real estate transactions and real estate professionals, including the impact of the Tax Cuts and Jobs Act (TCJA). He was approved as a Continuing Education Instructor in Maryland, Delaware, Virginia and the District of Columbia. He is the winner of the national Real Estate Educators award for the ‘Best Single Education Program’.

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      Book preview

      How to Do a 1031 Exchange of Real Estate - Edwin V. Horan MS

      Copyright 2020 Edwin V. Horan, MS.

      All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the written prior permission of the author.

      ISBN: 978-1-4907-9996-4 (sc)

      ISBN: 978-1-6987-0036-6 (e)

      Library of Congress Control Number: 2020904101

      Because of the dynamic nature of the Internet, any web addresses or links contained in this book may have changed since publication and may no longer be valid. The views expressed in this work are solely those of the author and do not necessarily reflect the views of the publisher, and the publisher hereby disclaims any responsibility for them.

      Any people depicted in stock imagery provided by Getty Images are models, and

      such images are being used for illustrative purposes only.

      Certain stock imagery © Getty Images.

      Trafford rev. 04/15/2020

      23409.png www.trafford.com

      North America & international

      toll-free: 1 888 232 4444 (USA & Canada)

      fax: 812 355 4082

      CONTENTS

      Chapter 1 Why Do A 1031 Exchange?

      Economic Reasons

      Other Reasons

      Why Not Do An Exchange?

      Chapter 2 History of Like-Kind Exchanges

      Old Tax Law

      Four Exchange Periods

      First Exchange Period

      Second Exchange Period

      Third Exchange Period

      Fourth Exchange Period

      National Organization

      Chapter 3 Criteria for an Exchange

      What is a 1031 Exchange?

      Criteria for a 1031 Tax Deferred Exchange

      What is Like-Kind?

      What Section 1031 Does Not Cover

      Additional Qualifying Exchanges

      Chapter 4 Tax Impact of A Sale

      Sale Without a 1031 Exchange

      Income Tax Brackets

      Recapture of Depreciation/Section 1250 Gain

      3.8% NII Tax Rules and Thresholds

      Additional 0.9% Medicare Tax

      Personal Exemption/Itemized Deductions Limits

      Alternate Minimum Tax (AMT)

      Tax Forgiven Upon Death

      Estimated Tax Payments

      Capital Gain Tax Worksheet

      Application of 20% Capital Gain Rate

      No Interest or SALT Limitation on Business Property

      Chapter 5 Reinvestment Requirements

      Total Deferral Of Capital Gains Tax

      Depreciation Tax

      Acquisition Cost

      Earnest Money Deposit

      Partial Tax Deferred Exchange

      Boot and the Reduced Price for the Replacement

      Size of Loan

      Purchase of Partial Ownership

      Chapter 6 Critical Elements

      Critical Elements

      Intent

      Control of Funds

      Form and Documentation

      Like-Kind Properties

      Time Limits

      Continuity of Title

      Disqualified Person

      Chapter 7 Identification and Exchange Periods

      Time Limits

      On Time Extension

      Extension For Presidentially Declared Disasters

      Identification Rules

      Identification of Property to be Built

      Separate Properties

      Identification of a Partial Interest

      When Does the Transfer or Receipt of Property Occur?

      Identification Option

      Chapter 8 1031 Exchange Process

      Deferred Exchange

      Use of Qualified Intermediary

      The Exchange Process

      Advance Preparation of Exchange Documentation

      Early Replacement Property Contract

      Chapter 9 Related Persons

      Introduction

      Basic Law

      Reason for the Law

      Exceptions

      What Is The Two Year Period?

      Definition Of A Related Person

      Avoiding Related Person Status

      Sale Of Relinquished Property To Related Person

      SUMMARY

      Chapter 10 Reverse Exchanges

      Reverse Exchange Background

      IRS Revenue Procedure 2000-37

      Basic 1031 Exchange Required

      Exchange Accommodation Titleholder (EAT)

      Reverse Exchange Agreement (QEAA)

      How Does the Process Work

      Amendment of Rev. Proc 2000-37

      Non-Safe Harbor Parking

      Chapter 11 Basis –Depreciation –Recapture

      Importance of Basis

      Definition of Basis

      Adjusted Basis

      Different Starting Basis

      What is Depreciation?

      Current History of Depreciation

      Current Depreciation Rules

      Depreciation Incorrectly Taken

      Depreciation of 1031 Replacement Property

      Recovery Period

      Depreciation Recapture

      Estimate of Depreciation

      Start of Depreciation

      Expense vs. Improvement

      Chapter 12 Second and Vacation Homes

      Second Home or Vacation Property

      Different Categories For Second Homes

      What Is Personal Use?

      Safe Harbor IRS Revenue Procedure 2008-16

      Rental Outside the Safe Harbor

      Conversion to Principal Residence

      Chapter 13 1031 Strategies

      Introduction

      Improvement on Owned Property

      Shared Equity Financing Agreement

      Installment Sale and Treatment of Note from Buyer

      Combining IRC Sections 121 and 1031

      Auctions

      Dealer Property

      Suspended Passive Losses

      Delaware Statuary Trust (DST)

      Triple New Lease

      Conservation or Scenic Easement

      Refinance of Replacement Property

      Gas, Oil and Mineral Right Exchanges

      Property Subdivision and 1031 Exchange

      Timber Exchange

      Estate Taxes

      Conclusion

      Chapter 14 Declared Disasters And Official Duty in Combat Areas

      Declared Disasters

      IRS Press Releases

      Extension of ID and Exchange Period End Dates

      QI Coordination

      Affected Taxpayers

      Combat Zone Service

      Chapter 15 Federal and State Activity

      Federal Activity

      State Activity

      State Conformity

      Virginia QI Law

      Maryland Withholding

      California Claw-Back

      Chapter 16 Reporting The Exchange

      Reporting Form

      Receipt of Replacement Property in Following Year

      On-time Extension

      Completing Form 8824

      No ID Submitted

      Cash in Following Year

      Instructions

      Chapter 17 Exchange Miscellany

      Introduction

      Failed QI

      Bank QI Merger Issue

      Contract for Deed

      Self-Directed IRA

      Development Rights

      Cost Segregation

      Section 468b and 7872

      Exchange of Leasehold

      Partnership Exchanges

      Sale and Leaseback

      Flipping Properties

      IRC Section 1033 – Involuntary Conversions

      Like-Kind Exchange and Installment Sale

      Chapter 18 1031 and Conversion to Principal Residence

      Introduction

      Conversion

      1031 Exchange Received Property

      Selling a Home Taxation Rules

      Non-Qualified Use

      Suspension of Five-Year Period

      Combining Sections 121 and 1031

      Chapter 19 Final Summary

      Prior Chapters

      Basic Reinvestment

      Critical Rules

      Warnings

      Exchange Checklist

      Appendices

      Appendix A

      26 U.S. Code § 1031.Exchange of Real Property Held for Productive Use or Investment

      Appendix B

      26 CFR § 1.1031(k)-1 - Treatment of Deferred Exchanges.

      Appendix C

      Revenue Procedure 2000-37

      Revenue Procedure 2008-16

      IRS Form 1040 – Schedule E

      Exchange Checklist

      DEDICATION

      This book is dedicated to my family. To my recently passed wife Jane, my two children Bill and Cynthia, and to my four grandsons, Kevin and Max, who are military helicopter pilots, and to Jeff and Will.

      ACKNOWLEDGEMENTS

      Any book on a subject as technical as IRC Section 1031 requires a great deal of research and study. I wish to acknowledge the authors of a book, updated annually, that I have used extensively over the years.

      Mary Foster and the late Jerry Long are the authors of ‘Tax-Free Exchanges Under §1031’, the premier text and reference book for real estate, legal and accounting professionals involved in like kind exchanges. Their kind advice and assistance has been graciously given to me on many occasions.

      Also, the staff and officers of the Federation of Exchange Accommodators (FEA) receive our special thanks for all of their efforts to keep the membership appraised of the many changes taking place with exchange legislation and IRS rulings. The establishment of the prestigious FEA Certified Exchange Specialist® (CES®) program brought national recognition to those professional qualified intermediaries who have demonstrated their knowledge, experience and ethical behavior.

      IMPACT OF TAX CUT AND JOBS ACT (TCJA)

      In late December 2017, the Congress passed and the President signed the Tax Cuts and Jobs Act (TCJA).

      It had a major impact on many areas of taxation and investment.

      Section 13303. of the Act amended IRC Section 1031 to eliminate PRIVATE PROPERTY exchanges. It retained REAL PROPERTY (Real Estate) 1031 exchanges.

      Major effort by the Federation of Exchange Accommodators (FEA)and other organizations saved the 1031 exchange for real estate.

      A copy of the current amended IRC Section 1031 is in the Appendix in the rear of this book.

      Chapter 1

      WHY DO A 1031 EXCHANGE?

      1. Economic Reasons. When the owner (taxpayer) wants to better their rental real estate, wishing to move up, to a better economic business opportunity or invest in a better location they will want to do a 1031 exchange. They will want to do a 1031 exchange so that they will have the cash needed to acquire replacement property and continue their investment in the economy. The basic rational for doing a Section 1031 exchange has always been Congress’ desire not to impose a tax on theoretical gain when tax payers continue their investment in like-kind property without an intervening actual or constructive receipt of cash or non-like kind property. A like-kind exchange deferral allows a taxpayer to shift to a more productive like-kind property, normally moving up while helping the economy grow.

      2. Other Reasons. While there are prime economic reasons for doing a 1031 exchange, the following reasons have been culled from the writings of industry leaders.

      • Deferral of taxes when property sold

      • Relocation of investment

      • Keeping all the equity available (no loss to taxes)

      • Consolidation of investments

      • Diversification of investment property

      • No requirement that two parties want each other’s property

      • No requirement settlements be simultaneous

      • Few limitations on type of replacement property (real estate for real estate)

      • Less management (DST or triple net)

      • Opportunity for greater cash flow

      • Available leverage when moving up

      • Non depreciable to depreciable

      • Tax – free loan

      • No capital gain recognized on death

      • Heirs inherit property at current FMV

      • Avoidance of 3.8% tax

      • Availability of reverse exchange

      • Conversion to principal residence

      3. Why Not Do An Exchange? If you are selling investment real estate and plan to purchase replacement real estate in the near future, it is foolish not to consider a tax deferred like-kind exchange and take advantage of Uncle Sam’s tax-free loan. Since every investor has a unique situation (such as having suspended passive losses), they should discuss any planned exchange with their CPA or tax advisor.

      If you go to Calculate Gains on top menu at www.1031.us you may automatically compute the tax due if you were to sell the property, and the 1031 exchange reinvestment requirements for a 1031 exchange.

      Chapter 2

      HISTORY OF LIKE-KIND EXCHANGES

      1. Old Tax Law. What surprises most investors is that a law covering the exchange of property has been around for so long. When the income tax was created by Congress in 1918 all gained was taxed. However, in 1921 Congress created Section 1031 predecessor and it relatively unchanged over the years.

      2. Four Exchange Periods. When we look at exchanging today, historically we can divide the time into four periods. The first period is from the start to 1979. The second period is from 1979 to 1990, with the third period running from 1979 to 2017. The fourth period started with the passage of the ‘Tax Cut and Jobs Act’ (TCJA). This legislation restricted 1031 exchanges to real property (i.e. real estate)

      3. First Exchange Period. This period which starts from the early start in 1921 extends to 1979 is a very quiet period in exchanging in which only a few exchanges were completed. Those investors who had sharp professional attorneys and CPAs were the ones who made use of exchanging. This period came to an end with the United States Ninth Circuit Court decision in 1979 to approve deferred exchanges. Their decision, the famous Starker cases, established an important precedent. It basically said taxpayers could transfer their property to one party and receive the replacement property later from a third party, This, set off a wave of exchanges particularly on the West Coast.

      4. Second Exchange Period. During the second period from 1979 to 1990 there was great deal of action by Congress to keep up with the Ninth Circuit Court decision in the 1979 Starker case. In recognition of the Starker decision, Congress modified Section 1031 of the Internal Revenue Code to ‘codify’ the deferred exchange as we know it today. In the Deficit Reduction Act of 1984 the Congress also established the 45-day identification and the 180-day exchange periods. The Tax Reform Act of 1986 had a major impact on residential investments and lead to the growth of tax-deferred exchanges. This act eliminated preferential capital gains treatment, enacted ‘passive loss’ and eliminated accelerated depreciation for real estate. These changes almost eliminated the tax benefits of owning investment real estate. The tax-deferred like-kind exchange became one of the few remaining benefits for real estate investors. The Congress and IRS have continued over these past decades to modify the exchange rules. In the 1989 change to the IRC it was decreed that foreign and domestic property was not considered like kind and thus could not be exchanged. The restrictions on related party exchanges (the addition of Section 1031(f) were also established.

      5. Third Exchange Period. We can say that during the third period that Congressional action to modify the Internal Revenue Code 1031 was very active. Beginning in the third period in 1990 the U.S. Treasury and the Internal Revenue Service became very active with the publication of the new exchange regulations, Revenue Procedures and Private Letter Rulings. The exchange ball really started to roll with the draft publication in May of 1990 in the Federal Register of the proposal to add regulations for deferred exchanges. There were many public comments and a hearing was held on September 5, 1990. After consideration of the comments submitted the IRS adopted and published the final regulations for 1031 exchanges in June 1991.

      While many regulation captions appear under Section 1.1031-0 of the final regulations the regulatory sections must written about and discussed is Sections 1.1031(k)-1, Treatment of deferred exchanges. In addition to the publication of the exchange regulations in 1990 there have many Revenue Procedures and Private Letter Rulings published on 1031 activities during this period. A summary of the regulatory changes considered important are listed below. Many of these are discussed in detailed in this book.

      Revenue Procedure 2000-37, established procedures for accommodation of reverse exchanges. This was amended by Revenue Procedure 2004-51 to restrict taxpayer ownership of replacement property within 180 days of transfer to exchange accommodator titleholder (EAT).

      Revenue Procedure 2002-22, provided criteria for getting a TIC ruling.

      Revenue Ruling 2002-83 was published in November 2002 to clarify the purchase of the replacement property from a related party.

      Revenue Ruling 2004-86 states a beneficial interest in a Delaware Statutory Trust (DST) is an interest in real property and thus qualifies in a 1031 exchange.

      Revenue Procedure 2005-14 was published in February 2005 permits exclusion of gain where appropriate under both Section 121 and under Section 1031.

      Revenue Procedure 2005-27 provided separate instruction for exchangers in section 17 of the procedure for taxpayers in a presidentially declared disaster area.

      Private Letter Ruling (PLR) 2004-4002 confirmed that Section 1031(f) did not apply if the related person seller is also doing an exchange and not cashing out.

      Effective

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