EASEMENTS, SECTION 1031 AND THE ICE CREAM STORE

One of our clients owns an ice cream store.  They were approached by a sign company to sell to the sign company a perpetual easement on the ice cream store property, for a billboard sign.   Can the proceeds received by the property owner from the sale of perpetual easement be deferred by using IRS Code Section 1031?

The answer in my humble opinion is YES it can qualify.  Remember, in a Section 1031 exchange the properties exchanged must be "like kind".    It has been determined that an easement is a right in real property.  In one of the leading cases in the "1031 industry", the court talked about a "bundle of rights".  The giving of a perpetual easement is the giving up of a part of that "bundle of rights". 

So in the case of the ice cream store, the owner of the property can sell a perpetual easement, giving up a right in that real estate, and use those funds to do an exchange for another type of real estate.  For that matter, they could exchange, using those funds, for a shopping center or an office building if they wanted to.  Remember, any type of real estate can be exchanged for any other type of real estate.  Gosh I love that part of the IRS Code.

IN A SECTION 1031 EXCHANGE, CAN A TAXPAYER REVOKE A PROPERTY THEY HAVE ALREADY IDENTIFIED?

In order to do a Section 1031 exchange, the taxpayer must sell an investment property or property used in a trade or business for a like kind property.   When the taxpayer sells its relinquished property, they then have 45 days from the closing date to "identify" what they might like to buy as a replacement property.  

What happens if they taxpayer identifies a property they no longer are interested in, that is the question.  The answer is:  the taxpayer may revoke the property identified at any time prior to the end of the identification period (the 45 days mentioned above).  This revocation must be in writing and signed by the taxpayer and finally should be sent to the party to whom the taxpayer originally identified the property they wish to revoke. 

The delivery of the revocation can be by hand delivery, mail, or telecopy--but again must be sent before the expiration of the 45 days.  For more information on identification and related subjects go to www.liberty1031.com and look up the resources section.  By the way, any of our Exchange Coordinators at Liberty 1031 Exchange Services can also get your the answers to these types of issues.

IN A SECTION 1031 EXCHANGE CAN A TAXPAYER ADD AN ADDITIONAL PARTY TO THE PURCHASE OF THE REPLACEMENT PROPERTY?

The head of our E-Marketing Dept. sent me a copy of an e-mail requesting information on the following issue:  Can an individual  taxpayer use the proceeds from the sale of its investment property(relinquished property), to purchase along with others, a replacement property?   

The answer is a firm YES THEY CAN.  For Example:  a taxpayer could sell a piece of investment RE(the relinquished property) for $1 million and purchase a $2 million replacement property, owning a 50% interest in the $2 million property, as a tenant in common with another party(ies).  In this example, both the taxpayer and their other co-owner (legally described as tenant in common) each would put up the same sum of money, $1 million each.

This leads to another question:  Could the other co-owner put a mortgage on the property in order to fund its $1 million contribution toward the purchase?  They could, but that would create another problem for the taxpayer, as that loan would become a lien on the entire property, which would allow IRS to take the position that the taxpayer who did an exchange really only put up $500,000 ,  not the full million.  I know this is a little complicated, that is why you need to make sure you are using a competent Qualified Intermediary.  You know where to find Liberty 1031.  Enough advertising--but I think you can agree that it is an interesting issue.

IDENTIFICATIONS ON A SECTION 1031 EXCHANGE

One of our prospective clients asked a provoking question.  After he closes on the sale of his relinquished property in a Section 1031 exchange,  he understands that he only has 45 days to identify what he would like to purchase as his replacement property(ies).   He read in our blog, that the 45 day identification period has no extensions (there are extensions, but only when given by the President of the United States, generally for those affected by disasters).  What he wanted to know  was could he fudge the date, in other words, could he give us an identification statement after the 45 days period had expired, but date it prior to the 45 day deadline?

The answer is NO HE CAN'T !!  He would be committing criminal tax fraud.  Liberty1031 and most other reputable Qualified Intermediaries will not be part of criminal fraud.  Additionally, that type of fraudulent act would open up the QI to losing its Qualified Intermediary status with IRS.  For the protection of all of our clients, identification statements are time stamped.  This protects our clients, should there be an audit by IRS. 

IS IT DIFFICULT TO DO A 1031 EXCHANGE?

That's a question Liberty 1031 gets asked at least 10 to 15 times a week. 

The answer is YES and NO.  It can be difficult if you have someone advising or working with you that really does not have the experience in handling 1031 exchanges.  It can be an easy experience, if you use an independent Qualified Intermediary(QI) who is knowledgeable and experienced in handling 1031 exchanges.  One of the first questions you might want to ask your independent QI, is whether they have a CES  (Certified Exchange Specialist) working for them.   .FYI—in order to obtain the CES designation, a QI must have been in the full time business of handling 1031 exchanges for at least 3 years and pass a very rigorous examination

That's one of the wonderful things about working at Liberty1031.  We prepare 8 documents when you sell your relinquished property and prepare 7 documents when you purchase your replacement property.  We have it down to a science.   With our Exchange Coordinators(EC), all of whom had to be real estate paralegals for at least 5 years, before we would hire them for training as EC's, we are able to literally have the documentation PDF'ed to the closing agent within 20 minutes of receiving all  the necessary information. It makes my life as the "Boss" a lot simpler.   Go back and look at our blog on how to select a QI or go to our website at: www.liberty1031.com for the information on how to select a QI.

Section 1031 and the same taxpayer requirement

Let's say you and your wife hold an investment piece of real estate in both names with right of survivorship. You both have decided to sell that investment property and transact a Section 1031 tax deferred exchange with the proceeds, which will result in no taxes being paid to either the State or Federal governments at that point in time.

The problem is that both you and your wife have decided to put the replacement property in just the husband's name. Will this still qualify for a tax deferred exchange under Section 1031 of the Internal Revenue Code?

The answer is NO it won't qualify!!! In fact, in a similar example, IRS ruled that when the replacement property is put in just one spouse's name, the non-titled spouse in effect "gifted" its interest to the spouse that now holds full ownership.

This results in the non-titled spouse being forced to report their 50% interest (if that's the percentage the non-titled spouse owned) as a sale on their income tax return--that means they will pay taxes on their profit, which is not necessarily what they had originally intended to do. Remember, the smart investor will always call us and their tax advisor first, before ever signing their contract, so that we can discuss their particular tax consequences.

Can a Cooperative Apartment qualify for a Section 1031 Exchange?

As a national Qualified Intermediary, I have handled Section 1031 exchanges in every state of the Union. As a result, I get asked this question a lot from my taxpayer clients that come from the Northeastern part of the United States, mainly, from the State of New York.

The reason for this is that Cooperatives, a/k/a "Co-ops" are very prevalent in New York. Ownership of a "Co-op" involves the ownership of stock in a cooperative corporation that owns not only the building but also the common areas of that building.

The "tenant" is a stockholder in the "Co-op" and has a proprietary lease on their particular apartment. The issue is whether the ownership of the "Co-op" corporation stock is "like kind" to other types of investment real estate? Normally stock ownership does not qualify for tax deferral treatment under Section 1031 (a). HOWEVER, (notice I emphasized with caps) the answer to the question above is another question: what does IRS and the particular state the investment property is in, hold the ownership of "Co-op" corporation stock to be?

Fortunately, most taxpayers will be happy to read that for tax purposes, both the States and IRS have held the ownership of "Co-op" stock to be the equivalent of owning the real estate and therefore can be exchanged into another type of investment real estate under Section 1031. Of course, all of the additional Section 1031 rules must be complied with. I realize this is a complicated subject, so for a more thorough discussion on these and other Section 1031 rules, visit our website at: www.liberty1031.com.

Time Deadlines and Section 1031

Q. Do I have to know what property I will be purchasing when I start the exchange?

Answer: No. You have 45 days from the sale of your relinquished property to identify your potential replacement properties.

Q. How long do I have to purchase my replacement property?

Answer: You have 180 days from the sale of your relinquished property by which you must close on the purchase of your replacement property/properties.

Q. What happens if my 45th or 180th day falls on a Saturday, Sunday, or holiday? Are there any extensions to these dates?

Answer: As a general principle, there are no extensions for either the 45- or the 180-day rules. However, the President of the United States has the authority to provide an extension to these deadlines. Recent examples of such extensions include the terrorist attacks of September 11, 2001 and recent floods and hurricanes.

Is a Section 1031 Exchange tax-free?

A 1031 exchange defers taxes; it generally does not eliminate them. The replacement property will carry the tax basis of the relinquished property – which means that upon the sale of the replacement property all tax will be due or the taxpayer can enter into another 1031 exchange and defer taxes again. With good estate tax planning, many taxpayers will not pay any estate taxes when they die and their heirs will receive their estate tax free and more importantly, with a stepped up basis.