1031 Exchange:
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CITY 1031 EXCHANGE GUIDE |
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MESSAGE FROM BROKER/TOC
A. 1031 EXCHANGE BASICS
B. PASSING THE "PURPOSE"
TEST
C. LET'S TALK ABOUT BOOT
D. SOME ADVANCED 1031 TOPICS
D. SOME ADVANCED 1031 TOPICS
1. Can I Refinance
Property Before or After the Exchange?
If you have substantial equity in the relinquished property,
you generally cannot “cash out” such equity as part
of the exchange transaction itself because the receipt of such cash
will be characterized as “boot”. However, tax advisors
have developed strategies that may involve refinancing prior to
or after an exchange so as enable an investor to “pull out”
cash without such cash being treated as “boot”. Generally
speaking, there is no tax imposed on the proceeds of a refinance
transaction. While a detailed discussion of refinancing is beyond
the scope of this guide, here are some quick notes:
- Get Sound Tax Advice.
Any refinance strategy should be pursued only after extensive
consultation with a qualified tax advisor. Any refinance strategy
needs to consider the potential risks associated with an unfavorable
characterization of the transaction by the IRS. There is at least
the potential that the IRS will apply “step transaction”
principles to collapse the exchange and refinance into a single
transaction and characterize the cash received as “boot”.
- Post-Exchange Refinance May Be
Less Risky. Generally, refinancing the replacement
property after the exchange seems to be less risky as compared
to refinancing the relinquished property before the exchange.
- Have an Independent Business Motive.
Most tax advisors would agree that it is helpful if a refinance
is supported by an independent business motive (e.g. to take advantage
of a lower interest rate or longer amortization period).
- Build In a Time Window.
Most tax advisors believe that it is helpful to have an extended
period of time (6 months, 1 year, or perhaps 2 years, depending
upon how conservative an approach is to be taken) between the
exchange transaction and the refinance transaction. There are
also some tax advisors who recommend that the refinance occur
in a separate income tax reporting year as compared to the exchange
transaction.
- Document the Refinance Separately.
There is certainly broad agreement that, regardless of how little
time there is between the exchange and the refinance, it is important
to have separate documentation for each transaction.
2. Can I Replace
My Investment Property with a Partnership Interest?
In the cloudy world of 1031, one fact is very clear: a partnership
or LLC interest cannot qualify as either the relinquished property
or replacement property. However, some tax advisors have developed
advanced partnership planning and conversion strategies that may
enable a taxpayer to convert a partnership interest into a real
estate interest that does qualify for Section 1031 (such planning
issues are beyond the scope of this guide).
3. What is a “TIC”
Interest?
An increasingly sophisticated market has developed in “tenant-in-common”
(or TIC) interests which, when properly structured, can qualify
under Section 1031. A TIC interest is distinguished from a partnership
or LLC interest because a TIC interest is a direct ownership interest
in the real estate. The owner of the TIC interest is named in the
deed as being one of several direct co-owners of the property. Complex
rules govern the extent to which TIC owners can enter into an agreement
governing their rights and obligations to one another. If the TIC
owners enter into an agreement that looks too much like a traditional
partnership agreement, then the IRS can take the position that the
TIC interests are really partnership interests that do not qualify
for Section 1031.
4. What
is a “Build to Suit” Exchange?
In its most common application, this is a 1031 exchange in which
the investor purchases raw land as replacement property and then
constructs improvements on the land within 180 days of the sale
of the relinquished property. If properly structured, the improvements
can qualify with the raw land as replacement property. This type
of transaction is very complex and should not be pursued without
the involvement of both an experienced tax professional and a sophisticated
qualified intermediary.
5. What is a “Reverse” Exchange?
This is a 1031 exchange transaction
in which the replacement property is actually acquired from the
seller prior to the sale of the relinquished property. As with “build
to suit” exchanges, this type of transaction is very complex
and should not be pursued without the involvement of both an experienced
tax professional and a sophisticated qualified intermediary.
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