THE POWER OF EXCHANGEAn Introduction to 1031 Exchanges for Investors

Presented by:

Lynne Bagby, CES®, Northeast Division Manager

Asset Preservation, Inc. - A Leading National 1031 Exchange Qualified Intermediary

One Washington Mall, 14th floor, Boston, MA 02108

800.883.1031 www.apiexchange.com lynne@apiexchange.com

Overview IRC Section 1031 Exchanges Capital Gain Taxation / Hold, Sell or Exchange IRC Section 1031 Code and Exceptions Investor Motives and Like-Kind Property The Exchange Equation / Requirements for Full Deferral 1031 Exchange Formats and Variations Delayed Exchanges and the 45/180 Day Requirements Rules of Identification and How to Identify Property Highlights of the Delayed Exchange Process Qualified Intermediary (“QI”) Due Diligence

Since 1921, the tax code has provided investors with a significant tax advantage – the IRC Section 1031 tax deferred exchange (“1031 exchange”).

1031 exchanges allow taxpayers holding property for use in a trade or business or held for investment the ability to defer all taxes that would otherwise be incurred upon the sale of a property.

1031 exchanges provide the ability to defer depreciation recapture, federal and state capital gain taxes and the net investment income tax (if applicable).

IRC Section 1031 Exchanges

Capital Gain Taxation 20% maximum capital gain tax rate for high earners

Net investment income tax of 3.8% pursuant to IRC Section 1411, if applicable (applies to “net investment income” over a threshold of $200K/single and $250K/married filing jointly)

Capital gain taxation can include 4 components:

1) Taxation on depreciation recapture at 25% - plus2) Federal capital gain taxes at 20% or 15% - plus3) 3.8% tax on net investment income - plus4) The applicable state tax rate (0% - 13.3%)

Real estate investors face several options:

Hold: Wait as the market continues to come back.

Sell: Sell the property and pay taxes owed. Invest net after-tax proceeds in other investments outside of real estate.

1031 Exchange: Defer all capital gain taxes with a fully deferred exchange and redeploy equity that would have been used to pay capital gain and other taxes into the purchase a larger replacement property – or – perform a partially deferred exchange and receive some “boot.”

Hold, Sell or 1031 Exchange?

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 either for productive use in a trade or business or for investment.”

IRC Section 1031 Code

“

Stock in trade or other property held primarily for sale

Stocks, bonds, or notes

Other securities or evidences of indebtedness or interest

Interests in a partnership

Certificates of trust or beneficial interest

Choses in action

IRC Section 1031 Exceptions

Investors use 1031 exchanges to increase their rate ofreturn and improve their investment position using:

Leverage

Diversification

Consolidation

Cash flow

Management relief

Increase depreciation

Estate planning

Investor Motives

Like-Kind Property

What Property is Excluded?

• Principal Residence• Property Held for Sale and Dealer Property

Qualifying Real Property

• Any real property held for productive use in a trade or business or investment = real property held for productive use in a trade or business or investment

Qualifying Personal Property

Like-Kind Property Issues

“Intent” is the taxpayer’s subjective intent

The IRS will look at objective factors that either support or negate the taxpayer’s intent to hold for investment

All facts and circumstances taken into account

The holding period is one (of many) factors

Ideally the taxpayer has multiple factors to establish the intent to hold for investment

Contrary facts may lead the IRS to conclude the property was not held for investment purposes

Goolsby v. Commissioner (April 1, 2010)

Reesink v. Commissioner (April 23, 2012)

Intent to Hold for Investment

The taxpayer acquired property of greater value, reinvesting all net equity and increasing the debt on the replacement property.

Analysis: There is no boot.

  Relinquished Replacement Boot

Value $900,000 $1,200,000  

- Debt $300,000 $660,000 $ 0

- Cost of Sale $60,000

Net Equity $540,000 $540,000 $ 0

The Exchange Equation

For full tax deferral, a taxpayer must meet two requirements:

1. Reinvest all net exchange proceeds2. Acquire property with the same or greater debt.

Two-Party Trade (“Swap”)

Three-Party Format (“Alderson”)

Delayed Exchange with a Qualified Intermediary (“QI”)

Reverse Exchange (“Parking Arrangement”)

Improvement Exchange (“Parking Arrangement”)

Reverse/Improvement (“Parking Arrangement”)

Formats & Variations

Direct Deed

SALEDirect Deed

PURCHASE

$ $

Taxpayer

QualifiedIntermediary SellerBuyer

The Delayed Exchange

0 45 Days 180 Days

Identification Period

Total Exchange Period

Time Requirements

45 Day Identification Period: The taxpayer must identify potential replacement property(s) by midnight of the 45th day from the date of sale.

180 Day Exchange Period: The taxpayer must acquire the replacement property by midnight of the 180th day, or the date the taxpayer must file its tax return (including extensions) for the year of the transfer of the relinquished property, whichever is earlier.

Three Property Rule: The taxpayer may identify up to three properties of any fair market value.

200% Rule: The taxpayer may identify an unlimited number of properties provided the total fair market value of all properties identified does not exceed 200% of the fair market value of the relinquished property.

95% Rule: If the taxpayer identifies properties in excess of both of the above rules, then the taxpayer must acquire 95% of the value of all properties identified.

Identification Rules

Identification must be:

Made in writing

Unambiguously describe the property

Hand delivered, mailed, telecopied or otherwise sent

Sent by midnight of the 45th day

Delivered to the Qualified Intermediary or a party related to the exchange who is not a disqualified person

Identification Rules

1. Establish the taxpayer’s intent

2. Consult with an experienced QI and tax/legal advisor prior to closing the sale of the relinquished property.

3. Ensure that the Sale Contract is assignable and that they buyer is made aware of such assignment in writing.

4. Include a 1031 Exchange Cooperation Clause in the contract to establish three things:

a) Intent to perform a 1031 tax deferred exchange;b) Release the buyer from liabilities or costs from the exchange;c) Notify the buyer in writing of assignment.

Highlights of the Delayed Exchange

Sale of Relinquished Property

1031 Exchange Contract Language

Buyer is aware that Seller intends to perform an IRC Section 1031 tax deferred exchange. Seller requests Buyer’s cooperation in such an exchange and agrees to hold Buyer harmless from any and all claims, costs, liabilities, or delays in time resulting from such an exchange. Buyer agrees to an assignment of this contract by the Seller.”“

5. The QI’s Exchange Agreement, Assignment and other exchange documents must be executed prior to closing on the sale of the relinquished property. (The QI is the reflected as the seller on the closing statement).

6. The taxpayer must identify the property to be acquired in accordance with the Rules of Identification.

7. The taxpayer must close on the replacement property by the 180th calendar day (or their tax filing date – whichever is earlier) from the close of the relinquished property sale.

Highlights of the Delayed Exchange

This is the most important choice a taxpayer will make in a Section 1031 exchange.

Paramount to every 1031 exchange is the safety of funds held by the Qualified Intermediary (QI).

Careful scrutiny is required as there are currently no regulations at the federal level.

“QI” Due Diligence

Does the QI offer customers the written backing of a large creditworthy entity?

What is the financial rating and balance sheet of this entity?

Does the QI conduct due diligence on the depositories holding the funds and monitor them?

“QI” Due Diligence

Does the QI offer segregated accounts?

Does the QI offer a qualified escrow account?

Does the QI offer a qualified trust account?

Does the QI have sufficient fidelity bond coverage?

“QI” Due Diligence