Section 1031 for Real Estate Professionals

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Class workbook for 3HR CE Real Estate class. Approved in NH, ME, VT.

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  • 1.FlawlessSection1031ExchangesforOver30Years Section 1031 For Real Estate Professionals 3 Hour Elective Course Approved by: The New Hampshire, Vermont & Maine Real Estate CommissionsEdmund & Wheeler, Inc. QI It is estimated that 20-25% of the nearly651 Main Street $200B in annual real estate transactionsP.O. Box 863could benefit from a Section 1031Franconia, NH 03580 Exchange, and that only 3% takeadvantage of this powerful tool. 603-444-0020 Edmund & Wheeler, as a QualifiedIntermediary (QI), has been facilitatingSection 1031 Exchanges for over 27 years. www.section1031.comWe have developed The Power of Sectionexchange@section1031.com1031 to provide a solid understanding ofSection 1031 basics and the strategic waysin which Section 1031 can be utilized and toassist real estate professionals inrecognizing opportunities for their clients. 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes onlyand do not constitute tax, accounting, legal or investment advice.

2. Welcome To Section 1031 for Real Estate Professionals. This workbook has been designed to assist you during the course, and to provide a reference tool for you in the future. The session is broken down into three sections as described below. Web references have been made throughout the document so that you can do further topical research as required. Web references are indicated with a grey arrow. www.section1031.com If you have follow-on questions or concerns after you complete this course, Edmund & Wheeler is always available by email at exchange@section1031.com, by phone at 603-444-0020, or on the Web at www.section11031.com. Our practice provides real estate professionals with Section 1031 consulting at no charge!Section1providesyouwithanoutlineofthiscourse,anintroductionSectiontotheSection1031Exchangeandtheessentialelementsrequiredfor1 successfulexchanges. Introduction & 1031 Basics Thissectionlastsapproximately1hourandbeginsonPage3.Section2containscasestudiesofthevarioustypesofExchangesasSection wellasreallifeexamplesofactualtransactionsthatwillassistyouin2 developingyourownSection1031strategies.Case Studies & Real-life Examples Thissectionlastsapproximately1hourandbeginsonPage20.Section3outlinestheviablealternativesforExchangesthatcanbeSectionusedfordiversification,relocationorthedesireofaclientwishingto3 exitfromtherealestateinvestmentclass. Alternate Exchange Opportunities Thissectionlastsapproximately1hourandbeginsonPage38.1PageCourseSummaryMustHaveSection1031Concepts SummaryCommonlyusedphrasesandSection1031definitions.BeginsonPage57.Section 1031 Glossary 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 2 3. Section1Introduction & 1031 BasicsContents Introduction.................................................................................................................................... 4 About Edmund & Wheeler, Inc. ..................................................................................................... 5 Course Outline .............................................................................................................................. 6 Primary Objectives of This Course................................................................................................ 6 What Is A Section 1031 Exchange................................................................................................ 7 The Five Critical Elements of an Exchange .................................................................................. 7 The Regulation .............................................................................................................................. 7 An Exchange at A glance .............................................................................................................. 8 Section 1031 (a)(1) IRS Code ....................................................................................................... 8 What is Investment Purpose? ....................................................................................................... 12 What Are the Benefits of an Exchange? ....................................................................................... 12 The Essential Elements ................................................................................................................ 12 Replacement Property Rules ........................................................................................................ 13 Real Property (What is Like Kind?) ............................................................................................... 14 Personal Property.......................................................................................................................... 15 Timing Is Everything ...................................................................................................................... 16 What Does The QI Do? ................................................................................................................. 16 Who Qualifies for an Exchange?................................................................................................... 16 The Qualification Tool ................................................................................................................... 17 The Five Most Common Section 1031 Misconceptions ................................................................ 19 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.3 4. ToomanyprofessionalsgetcaughtupinthebeliefthatSection1031isonlyaboutdeferringcapitalgains.Whileitisoneoftheremainingtaxdeferraltoolsavailable,itsactuallyaLOTaboutleverage.Clientsusingwhattheywouldhavepaidimmediatelyincapitalgainstaxestoimprovethequalityandvalueoftheirholdingsandplanfortheirfinancialfuture;isREALLYwhatSection1031isallabout.Section1031hasbeenapartoftheInternalRevenueServiceCodesince1921!LookatitasagiftfromUncleSam,butdonttellanyone. Ok,letsdothemath.Thesenumberssuggestthat investorspaidtheGovernmentover$10Bincapitalgains taxeswheninfact,theycouldhaveusedthismoneyin theirownportfolios,interestfree,foraslongasthey wouldlike.Waitaminute Whyisthisso?Wehavefoundthatmanyprofessionals thatwedealwithonadaytodaybasisareunclearofthe manystrategicusesofSection1031.Unfortunately,there arestillmanythatdontevenknowofitsexistence,and failtorecognizeevenitsmostbasicuses. Dontletyourclientsfindoutyoudidnttellthemthey couldhaveusedthispowerfultool. Asrealestateprofessionals,youhaveacertain responsibilitytoyourclientsregardingthetax ramificationsoftheirtransactions.Holdersofinvestment realestateshouldbemadeawareofthetoolsthatare availabletohelpthemstrengthentheirrealestate portfolios.Section1031isoneofthemorepowerfultools. Wehearoverandoveragainfromrealestate professionalshowthankfultheirclientswerethatthey understoodSection1031andhelpedthemtoexplorethe possibilities.Indeed,manyofourrealestatepartners havesavedtheirclientshundredsofthousandsofdollars incapitalgainexpense,givingthemmoremoneyto invest,whileearningmultiplecommissionsintheprocess! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.4 5. In1981,Mr.GeorgeFoss,III,ourfounderandcoprincipalwasaprominentrealestate brokerinNorthernNewHampshire.AfterreadingabouttheconceptofaSection1031 Exchange,hewasimmediatelyintrigued,andsawtheopportunitytoaddaninterestingtwist tohisrealestatedealsbyhelpingclientstotakeadvantageofthisvirtuallyunknowngift fromUncleSam. 27yearsandthousandsofsuccessfulexchangeslater,GeorgeEdmund&Wheelerremains theforemostauthoritiesonSection1031intheNewEnglandstates,andhavecompleted exchangeswithclientsin48of50states. ThefirmhasprovidedSection1031educationandconsultingtohundredsofNewEngland realestateprofessionalsandhashelpedthemtosavetheirclientsover$100Millionin capitalgainstaxes. GeorgeFoss,Founder,QI JohnHamrick,QI 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 5 6. Thiscoursehasbeendesignedtoassistyouin becomingproficientinthebasicsofaSection 1031Exchange. AnExchangecanbeaverycomplexandtime consumingendeavor.YourQIwillunderstand allofthemechanicsandthemyriadofrulesand regulationssurroundinganExchange.Ourgoal forthissessionistoprovideyoutheknowledge andtoolsyouwillrequiretoassistyourclients inrecognizingthetremendousopportunities thatSection1031provides. Section1031isnotjustataxdeferralvehicle.It isapowerfulpartofyourclientsoverall investmentstrategy,theirexitstrategyfroma business,andanintegralpartoftheirestate planning. Bottomlineisthatthetaxesthataredeferred canbeusedtoleveragelargerinvestments, diversifyportfoliosandsubstantiallyincrease wealthoveraperiodoftime. Dontworry,wewontgradeyou.Wewantto takeaninventoryofwhatourstudentsknow aboutSection1031priortothecourse. Whenthecourseisover,wewillretakethe quiz,andyouwillseehowfaryouvecomein justashorttime. GoodLuck! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.6 7. Section1031fundamentallyisabouttherelocationandreallocationofyourclientsrealestateassets,allwithoutpayingcapitalgainstaxes.Relocationcouldbeacrossthestreet,oracrossthenation.Clientscanrelocatetheirholdingstoseveralmarkets,creatinggeographicaldiversity.Theycanalsoreallocateholdingsbycombiningmultipleholdingsintoonemorevaluableproperty.TheycansellapartmentbuildingsandExchangeforsinglefamilyhousingunits,ortheycanoptforoneofthepassiverealestateinvestmentsavailabletothemandleavethedaytodaymanagementofrealestatetoaprofessionalpropertymanagementteam.Section1031exchangesarereportedonyourtaxreturnbyusingSchedule8824.Itisimportantthatallofthedocumentationleadinguptoandthroughouttheexchangeisexplicitthatanexchangeistakingplaceandnotanordinarysale.Thetaxpayercannottouchthefundsoritwilltriggerthetax.TheRelinquishedPropertyandtheReplacementpropertymustbeinvestment/businessusepropertyinthetaxpayershands.Allexchangesmustbeconcludedwith180days.AnexchangeishandledinthesamemannerasaregularsalewiththeexceptionthatathirdpartyQualifiedIntermediary(QI)providesthedocumentationandhandlesallfunds. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 7 8. www.section1031.com/PDFs/New PDFs/IRC1031.pdfSection 1031 (a)(1)(a) Nonrecognition of gain or loss from exchanges solely in kind(1) In generalNo gain or loss shall be recognized on the exchange of property held for productive use in a trade orbusiness or for investment if such property is exchanged solely for property of like kind which is to beheld either for productive use in a trade or business or for investment.(2) ExceptionThis subsection shall not apply to any exchange of(A) stock in trade or other property held primarily for sale,(B) stocks, bonds, or notes,(C) other securities or evidences of indebtedness or interest,(D) interests in a partnership,(E) certificates of trust or beneficial interests, or(F) choses in action.For purposes of this section, an interest in a partnership which has in effect a valid election under section 761 (a) to be excluded from the application of all of subchapter K shall be treated as an interestin each of the assets of such partnership and not as an interest in a partnership. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 8 9. (3) Requirement that property be identified and that exchange be completed not more than 180 days aftertransfer of exchanged propertyFor purposes of this subsection, any property received by the taxpayer shall be treated as property which is notlike-kind property if(A) such property is not identified as property to be received in the exchange on or before the day which is 45days after the date on which the taxpayer transfers the property relinquished in the exchange, or(B) such property is received after the earlier of(i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in theexchange, or(ii) the due date (determined with regard to extension) for the transferors return of the tax imposed by thischapter for the taxable year in which the transfer of the relinquished property occurs.(b) Gain from exchanges not solely in kindIf an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or ofsection 1037(a), if it were not for the fact that the property received in exchange consists not only of propertypermitted by such provisions to be received without the recognition of gain, but also of other property or money,then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of suchmoney and the fair market value of such other property.(c) Loss from exchanges not solely in kindIf an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or ofsection 1037(a), if it were not for the fact that the property received in exchange consists not only of propertypermitted by such provisions to be received without the recognition of gain or loss, but also of other property ormoney, then no loss from the exchange shall be recognized.(d) BasisIf property was acquired on an exchange described in this section, section 1035 (a), section 1036(a), or section1037 (a), then the basis shall be the same as that of the property exchanged, decreased in the amount of anymoney received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to thetaxpayer that was recognized on such exchange. If the property so acquired consisted in part of the type ofproperty permitted by this section, section 1035 (a), section 1036(a), or section 1037 (a), to be received withoutthe recognition of gain or loss, and in part of other property, the basis provided in this subsection shall beallocated between the properties (other than money) received, and for the purpose of the allocation there shall beassigned to such other property an amount equivalent to its fair market value at the date of the exchange. Forpurposes of this section, section 1035 (a), and section 1036 (a), where as part of the consideration to thetaxpayer another party to the exchange assumed (as determined under section 357 (d)) a liability of the taxpayer,such assumption shall be considered as money received by the taxpayer on the exchange.(e) Exchanges of livestock of different sexesFor purposes of this section, livestock of different sexes are not property of a like kind. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 9 10. (f) Special rules for exchanges between related persons(1) In generalIf(A) a taxpayer exchanges property with a related person,(B) there is non-recognition of gain or loss to the taxpayer under this section with respect to the exchange of suchproperty (determined without regard to this subsection), and(C) before the date 2 years after the date of the last transfer which was part of such exchange(i) the related person disposes of such property, or(ii) the taxpayer disposes of the property received in the exchange from the related person which was of like kindto the property transferred by the taxpayer,there shall be no non-recognition of gain or loss under this section to the taxpayer with respect to such exchange;except that any gain or loss recognized by the taxpayer by reason of this subsection shall be taken into accountas of the date on which the disposition referred to in subparagraph (C) occurs.(2) Certain dispositions not taken into accountFor purposes of paragraph (1)(C), there shall not be taken into account any disposition(A) after the earlier of the death of the taxpayer or the death of the related person,(B) in a compulsory or involuntary conversion (within the meaning of section 1033) if the exchange occurredbefore the threat or imminence of such conversion, or(C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor suchdisposition had as one of its principal purposes the avoidance of Federal income tax.(3) Related personFor purposes of this subsection, the term related person means any person bearing a relationship to thetaxpayer described in section 267 (b) or 707 (b)(1).(4) Treatment of certain transactionsThis section shall not apply to any exchange which is part of a transaction (or series of transactions) structured toavoid the purposes of this subsection.(g) Special rule where substantial diminution of risk(1) In generalIf paragraph (2) applies to any property for any period, the running of the period set forth in subsection (f)(1)(C)with respect to such property shall be suspended during such period.(2) Property to which subsection appliesThis paragraph shall apply to any property for any period during which the holders risk of loss with respect to theproperty is substantially diminished by 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 10 11. (A) the holding of a put with respect to such property, (B) the holding by another person of a right to acquire such property, or (C) a short sale or any other transaction. (h) Special rules for foreign real and personal property For purposes of this section (1) Real property Real property located in the United States and real property located outside the United States are not property of a like kind. (2) Personal property (A) In general Personal property used predominantly within the United States and personal property used predominantly outside the United States are not property of a like kind. (B) Predominant use Except as provided in subparagraphs (C) and (D), the predominant use of any property shall be determined based on (i) in the case of the property relinquished in the exchange, the 2-year period ending on the date of such relinquishment, and (ii) in the case of the property acquired in the exchange, the 2-year period beginning on the date of such acquisition. (C) Property held for less than 2 years Except in the case of an exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection (i) only the periods the property was held by the person relinquishing the property (or any related person) shall be taken into account under subparagraph (B)(i), and (ii) only the periods the property was held by the person acquiring the property (or any related person) shall be taken into account under subparagraph (B)(ii). (D) Special rule for certain property Property described in any subparagraph of section 168 (g)(4) shall be treated as used predominantly in the United States. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 11 12. Itsimportanttounderstandthedifferencebetweeninvestmentpropertyandpropertyheldforsale.PropertythatisheldforsaleistechnicallyinventoryinthehandsofthetaxpayerandisthereforenoteligibleforSection1031treatment.Section1031Exchangescanbeusedasastrategytoachievetaxdeferralwhilechangingthelocationandthetypeofpropertyheld.Asataxplanningtool,itwillachievegreaternetequityovertimeandincreasedcashflow.Section1031canalsobeusedtoconvertmanagementintensiveholdingsintopassiveholdingsTheExchangeAgreementcreatedbytheQualifiedIntermediarywillgivetheQIlegalstandingbywayofassignmentinboththeoldpropertyandthenewproperty.FromtheExchangorsperspective,asaledoesnotoccur,butratheranexchangeofproperties.BothmustbeusedbythetaxpayerforinvestmentorproductiveuseandrememberthatallrealpropertyisLikeKindtoallotherrealproperty. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 12 13. TherearethreeseparaterulesforidentifyingReplacementproperty.Themostcommon ruleistermedthe3PropertyRule.Itdoesntmatterhowmanypropertiesweresold inanexchange,itisthevaluethatisbeingmatched.Identifyingthreepropertieswithin the45daydeadlinewillbechallenging.Evenifyoueventuallyonlyselectoneproperty, itsagoodpolicytoidentifymorethanonesoabackuppropertyisavailableifthefirst choicebecomesunattainable. The200%Ruleisavailabletotaxpayerswhowanttoidentifyand/oracquiremorethan threeproperties.Thelimitationinusingthe200%Ruleisthatthetotalvalueofwhatis identifiedcannotexceedtwicethevalue(or200%)oftheRelinquishedProperty.This ruleworkswellforlargerdollartransactionswhenthetaxpayerwantstodiversifythe investmentintomultipleproperties. The95%Ruleisthemostperilouschoice.Itwillallowthetaxpayertoignorethevalue andthenumberofchoiceswiththerequirementthatoncethepropertiesareidentified, thetaxpayerMUSTacquire95%ofthem.Innearly30yearsofpracticethisrulehas beenusedbyaclientinonlyoneinstance. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 13 14. Thepointtorememberisthatitdoesnotmatterthetypeofrealestatethatthe taxpayerowns,itishowthepropertyisusedintheirhands.Itmustbeforinvestment, commercialorbusinessuse.Asinglefamilyresidenceislikekindtoeveryotherkindof realpropertyaslongasthesinglefamilyresidenceisNOTpersonaluseproperty. TheseareALLLikeKind! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 14 15. WhenSection1031wasfirstcodifiedin1921,itwasforthebenefitoffarmerswho objectedtopayingcapitalgainstaxontheirfarmproperty,bothrealandpersonal. Certainitemsofpersonalpropertyareexchangeableaslongastheyfallintothesame assetclassorproductcode.Allaircraftislikekindtoallotheraircraftforinstance,butis notlikekindtootheritemsofmachinery. TheNorthAmericanIndustryClassificationSystemforSectors3133isthebestsourcesfor determininglikekindforpersonalproperty.www.census.gov/naics(for a complete description of the allowable categories) 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 15 16. TheExchangewillbeginonthedaythedeedis conveyedtothepurchaser.The45dayand180day clockwillbegin.Contractsforsaleandpurchasedonot triggerthebeginningonanexchange,italways happensonthedayofthefirstlegofthetransaction. Thisisalsotrueforreverseexchanges. OnlyPresidentiallydeclareddisasterswouldprovidefor extensionofthesetimesensitivedates. ThefirststepistoengagetheQualifiedIntermediaryto createawrittenExchangeAgreement.TheQIis requiredtohavestandingintheexchangeandthiswill beaccomplishedwithanassignmentofthecontracts. SpecificguidancewillbeprovidedtotheSettlement AgentandthefundswillbedirectedtotheQIforthe acquisitionofthenewproperty.Mostimportantly,the QIwillprovideguidancetothetaxpayertoavoidthe pitfalls.Transactionswithrelatedpartiesare prohibitedunlesscertainrulesarefollowed. Exchangescanbeconductedregardlessofwhetherthe taxpayerisanindividualorsomeformofotherentity. Itisimportanttorememberthatthesametaxpayer mustsellandthenbuy.TheIRSistrackingthetaxpayer identificationnumber.SinglememberLLCsand revocabletrustswillbedisregardedfortaxpurposes. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 16 17. DOES YOUR SITUATION QUALIFY FOR A SECTION 1031 EXCHANGE This tool has been developed to help you quickly identify Section 1031 opportunities?www.section1031.com/PDFs/New PDFs/WhatQualifies.htm Plans for the Money The greatest benefit from capital gains deferral will be obtained by reinvesting all of the cash from the sale of your property. It is possible to extract cash at closing; however, the amount you take will be subject to tax. Amount Invested How did you acquire the property and how long have you owned it? Did you purchase it? Did you exchange into it? Was it given to you or did you inherit it? The answers to these and other questions will determine whether you have a low or high cost basis, and what your exposure is to Capital Gains Tax. If the gain exceeds $20,000 then an Exchange should be considered. Mortgage Balance The outstanding mortgage debt is paid off at closing in the same manner as any other closing; and debt paid off must be replaced when the new property is acquired or new cash added to offset any difference. Any debt relief not offset by new cash will result in taxable boot. On Last Two Tax Returns or Vacant Land Your tax return provides the IRS with an audit trail of your past activity. Your rental property must have appeared on Schedule E of your return (or the corporate equivalent) if you want to portray your property as held for investment or for use in your Trade or Business. The only exception will be vacant land. How Long Owned Dealers are not permitted to use Section 1031; generally their assets are held for sale, not held for investment. In order for a property to be considered for long-term capital gain treatment, it must have been owned by you for at least one year. Type of Replacement Property Section 1031 requires that the property be like-kind; all real property is like-kind to all other real property. The Like-kind test is more stringent for personal property. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.17 18. Choices of Replacement Property Under the simple rules, you may select up to three potential new properties and you can buy any one, two or all three of them. More choices are available, however, the dollar value of the choices is capped at 200% of the value of the old property. Can Meet 45 Day Requirement After the closing of the old or Relinquished Property, you will have 45 days to make your formal identification of Replacement Property choices. No substitutions are permitted after the 45th day. Can Meet 180 Day Requirement After the closing of the old or Relinquished Property, you will have 180 days to acquire the new or Replacement Property. Exchanges must be accounted for within the same tax year; often it is necessary to extend the due date of the tax return to accomplish this task and to get the full benefit of 180 days for a year-end exchange. Third Party Handling of Money Receipt of funds by the taxpayer at closing is not permitted in a Section 1031 Exchange. A Qualified Intermediary must be designated to facilitate this process so that the taxpayer never has Constructive Receipt of the funds. Relatives and attorneys or accountants that have represented the taxpayer in the last two years are prohibited from acting as the Qualified Intermediary. Have qualification questions? Edmund & Wheeler, Inc. has provided flawless Section 1031 exchanges for over 27 years. In fact, Exchanges are our only business. Contact our offices via phone or email if you have any questions regarding your specific situation.www.section1031.com/PDFs/New PDFs/WhatQualifies.htm 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.18 19. The Five Most Common Section 1031 Misconceptions Wellbeforedelayedexchangeswerecodified(byIRS)in1991,allsimultaneousexchangetransactionsofReal Estaterequiredtheactualswappingofdeedsplusthesimultaneousclosingamongallpartiestoa1031exchange. Inmostcasesthesetypesofexchangeswerecomprisedofmanyofexchangingparties,aswellasnumerous exchangerealestateproperties.Today,theresnosuchrequirementtoswapyourownpropertywithsomeone elsespropertyinordertocompleteanIRSapprovedexchange.Theruleshavebeenrefinedandratifiedtothe pointthatthecurrentprocessismuchmoreindicativeofyourqualifyingintent,ratherthanthelogisticsofthe RealEstatepropertyclosings. Therewasatimewhenalltypesofexchangeshadtobeclosedonasimultaneous(sameday)basis,nowthey (1031)arerarelycompletedinthistypeofformat.Asamatteroffact,amajorityoftheexchangesexecutedare closednowasdelayedexchanges. Dontmakethismistake.ThereisacommonmisconceptionthatLikeKindisliteral.Therearecurrently2types ofpropertiesthatqualifyasalikekind:Propertyheldforinvestmentand/orPropertyheldforaproductiveuse, asinatradeorbusiness. Thisstatementisaperfectexampleofanother1031exchangingmyth.Therearenoprovisionswithineitherthe IRSCodeortheUSTreasuryRegulationsthatcanrestricttheamountandnumberofrealestatepropertiesthat canbeinvolvedinanexchange.Thus,inexchangingoutofseveralpropertiesintoonereplacementpropertyor theviceversaofsellingofonepropertyandacquiringseveralotherproperties,areperfectlyacceptablestrategies andusesofa1031. YoucantakecashoutofaSection1031Exchange;however,thecashthatyoutakeoutwillbeimmediatelytaxable. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 19 20. Section 2 Case Studies &Real-life Examples Contents Hypothetical Example Pay Taxes/Defer Taxes.......................................................................... 21 Edmund & Wheeler Case Studies................................................................................................. 24 Case Study 1 Delayed Exchange .............................................................................................. 25 Real-life Example Trading a Campground for Several Properties ..................................... 26 Real-life Example 6 Properties for a Dozen Condos ......................................................... 26 Converting Investment Property into Personal Residence ................................................... 27 Case Study 2 Reverse Exchange .............................................................................................. 28 Real-life Example Buying a New Property Before the Old Property Sells ......................... 29 Acquire a Rental Property for a Family Member ................................................................... 29 Case Study 3 Build-to-suit Exchange ........................................................................................ 30 Real-life Example Commercial Property for Raw Land with Improvements ...................... 31 Case Study 4 Delayed Build-to-suit Exchange .......................................................................... 32 Real-life Example Industry Specific Building on Identified Property .................................. 33 Case Study 5 Delayed Exchange, Reverse Format .................................................................. 34 Real-life Example Acquiring Abutting Property to Primary Residence .............................. 35 The Four Simple Qualification Questions...................................................................................... 36 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 20 21. ThesetwoPropertyOwnershaveidenticallyvalued propertieswithidenticaltaxconsequences, however,onechoosestosellandtheotherchooses touseThePowerofSection1031,andtakean interestfreeloanfromtheFederalandState Government. Thesearetheassumptions.TheFederalTaxis15% andtheStateTaxis5%,butpastdepreciationthese taxpayershavetakenwillberecapturedattherate of25%.However,thesecondPropertyOwnerhas nointentionoffundingthetax,asaSection1031 Exchangeisplanned.Anotherassumptionisthatthe valuesoftheReplacementPropertiesgrowata uniform6%rateperyear,withoutcompounding. After5,10and15yearswewilltakealookateach situation. OK,herewego.Thetwopropertiesbothsellfor $300,000,PropertyOwner#1electstopaythetax ($65,000)whiletheotherelectstoacceptthe interestfreeloan.Theybothreinvest,butonehas $65,000morethantheother,andasaconsequence, hisinvestmentcommandsmoremonthlycashflow. Sotheeffectsoftheinterestfreeloanare immediate:PropertyOwner#2,whotooktheloan earns$325morepermonthonhisinvestmentthan histaxpayingcounterpart. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.21 22. Nowletslookatthesituation5yearsout.Eachownersellshisinvestment,butagainOwner#1paysthetaxwhileOwner#2electstotakeafurtheradvanceontheinterestfreeloan.Further,sincemoreprincipalwasinvested,thevalueofOwner#2sinvestmentisworthalmost$100,000morethanthatofOwner#1s.Grantedthisdifferenceispretax,butreadon....At10years,thepatternrepeats:Owner#1paystaxesagain,butOwner#2acceptsafurtheradvanceontheinterestfreeloan.Thisequityisworth$145,664morethanOwner#1,and,asaconsequence,itcommands$728moreincomepermonthWeconcludetheexamplehere,butyougettheidea:Bydeferringthetaxatthebeginning,Owner#2hasmadegooduseoffreegovernmentmoney.Thisinvestmentisnowworth$221,044,andconsequentlycommandsamonthlyincomeof$3,296,morethan$1,056morepermonththanOwner#1sincome. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 22 23. Andhereisasummaryofthewealthbuildingeffects.Owner#2sequityisworth$211,044morethanOwner#1s,andhasgrownby119%(insteadof49.3%)thankstotheuseofthetaxfreeloan.Further,atthispoint,letspretendthatOwner#2takesleaveofhissensesanddecidestopaythetaxinsteadofexchangingagainandagain.ThetotaltaxesduefromOwner#2atthe15yearpointare$136,810,whichleavesthisowner$74,234aheadofOwner#1onanaftertaxbasis.Thisisthetruecomparisonbecause,afterall,Owner#1waspayingtaxallthewaythrough,andOwner#2wasdeferringit,bytheuseofSection1031.Atthe15thyear,Owner#2hasreceivedanadditional$92,779incashflowoverOwner#1.Cananysensibleinvestoraffordtoignorethesetwofigures?? Evenafterthelastsale,ifOwner#2decidestoget outthegameandpayhistaxes,heisstillisover $160,000aheadofthegame! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.23 24. Case Studies OverthemanyyearsthatEdmund&WheelerhasbeenfacilitatingExchanges,wehavediscoveredthat exchangesgenerallycanbedescribedin5distincttypes.ThemostcommontypeisCaseStudy1theDelayed Exchange.Wewillbereviewingeachcasestudy,alongwithsomereallifeexamplesofhowtheseExchanges work.CaseExchange TypeDescriptionStudy1Delayed Exchange In this format, the client gets the most common(Existing Property) Direct type of Section 1031 Exchange. FormatDelayed/Simultaneous Exchange In this format, property desired by the Exchange (Existing Property) ReverseFormat2 client is parked in a Single Purpose Entity (SPE)until the clients current property can be sold. (Exchange Last)Delayed Build-to-suitIn this format, the client gets a Section 1031 ExchangeDirect Format3 Exchange and acquires new, improved property, built-to-suit.In this format, property desired by the client is Delayed/Simultaneous Build-parked in a Single Purpose Entity (SPE) until theto-suitExchange Reverse Format (Exchange Last)4 clients current property can be sold. During theparking period, the new property is improved bythe SPE to the clients wishes. In this format, property desired by the client can Delayed Exchange (ExistingProperty) Reverse Format(Exchange first)5 be purchased immediately by Client, as Clients old (Relinquished) property is parked in a Single Purpose Entity (SPE) until it can be sold to buyer. www.section1031.com/cases.htm 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 24 25. CASE STUDY 1ABDC Delayed Exchange(Existing Property)Direct FormatIn this format, the Client (A) gets a Section 1031 Exchange between steps 3 and 7 assuming all of the rules have been followed. This is the most common type of exchange.The Exchange Agreement withEdmund & Wheeler, Inc. which governs theoverall transaction. This document MUSTbe in force before the closing. The Purchase and Sale Agreementto sell the Relinquished Property. This stepmay take place before Step 1 (the only out-of-sequence exception).The closing of the Relinquished Property; if several are involved, the first in chronological order. In this step,the deed to the property is given to the Buyer. Rather than going to the Exchangor, the Buyers funds are used to pay all of Exchangors expenses(including mortgages, if any), with the NET going directly to a money center bank into a separate, interest-bearing account established in the Exchangors name and Social Security number.This is an interactive step encompassing all communications post-closing with the Exchangor and Edmund& Wheeler, Inc. Included are the 45-day Identification Letter, instructions on how much of the account to beexpended on particular properties, and final approval to close on the final choice(s).These are the precise instructions to Exchangors attorney, bank or Title Company for the closing of theReplacement Property, and the wire transfer of approved funding.This is the Exchangors receipt of the direct deed from the owner of the Replacement Property (C); theExchangor achieves a Section 1031 Exchange between Steps 3 and 7, where in Step 3 a deed is given and inStep 7 a deed is received, and in between the Exchangor had no control (Constructive Receipt) of funds. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 25 26. ThisExchangorsoldonelargelakefrontpropertyand proceededtousethenext45daysdrivingupanddown theEastCoastselectingReplacementProperties.Hewas intheenviablepositionofbeingabletoidentifymorethan threeReplacementProperties(thesimplerule).Heused the200%rule(toidentifyasmanypropertiesashe wantedaslongasthetotalvalueoftheproperties identifieddidnotexceedtwicethevalueofthe RelinquishedProperty).Intheend,heacquiredsixteen newpropertiesfromMainetoFlorida,manyofthem singlefamily(rental)residences,includingtwonew campgrounds.ThisExchangeallowedhimtodiversifyhisportfolio,generatesignificantcashflowfromhisnewproperties,andpaynocapitalgainstax.Astheysayinthebusiness"onehappycamper!"Ifhedeterminesthatoneormoreofhisselectionsdoesntsatisfyhisinvestmentobjectives,thenafterayearortwo,hecanexchangeagain. Wearecurrentlyworkingwithaclienttoacquirea significantpieceofcommercialrealestateinNewEngland. Theclientisintheprocessofsellingsixseparatepiecesof propertyinordertoaggregatesufficientfundstomakethe newReplacementPropertypurchase.Theclienthasbeen extremelycareful(withourguidance)totimehissalesand thenewpurchaseallwithina180daytimeframe.Thisis keytothesuccessoftheExchangeduetothefactthathe willacquirenotjustonepieceofproperty,butratherover adozencondominiums.Youwillrecallthatyouhavetwo basicruleswhenitcomestoidentifyingyourReplacement propertychoices,theThreePropertyRuleandthe200%Rule.ThisExchangeisanexampleofyetathirdmethodofidentifyingReplacementproperty.Itallowstheclienttoacquireanunlimitednumberofproperties,withoutregardtovalueornumberaslongasheacquires95%(FMV)ofwhatheidentified.Thiscanbealittlenerverackingfortheinvestoranditpaystohaveabackupplan. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 26 27. Ourclientexchangedoutofathreeunitbuildingthathadbeenheldformanyyears.Inpreparationforretirement,theclientacquiredaFloridarentalproperty.AfterrentingtheFloridapropertyfortwoyears,ourclientwillconverttheusefromrentaltopersonalandmoveintothepropertyasaprimaryresidence.Thereisntanyprohibitionagainstconvertingbusiness/investmentpropertytopersonaluse.Beawarethatuponthesaleoftheproperty,theclientwillNOTbeentitledtothefullSection121,personalresidenceexclusionof$250,000/$500,000.EffectiveJanuary1,2009thenumberofyearsofnonqualifiedresidentialuseisdividedbythetotalnumberofyearsownedtoproduceaproratedexclusion.Forexample,ifyouownapropertyfor10yearsandyourenteditforthefirsttwoyearsofownershipandlatermovedintoitandmadeityourprimaryresidence,thenyouwouldonlybeeligibletoexclude80%ofthesale,meaningyouwouldowegainson20%ofthesale. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 27 28. CASE STUDY 2 ACBD-Delayed/Simultaneous Exchange (Existing Property)Reverse Format - Exchange Last In this format, Property (C) desired by the Client (A) is parked in a Single Purpose Entity (SPE) until clients current Property (A) can be sold. Section 1031 Exchange occurs between steps 7 and 11. The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing.Since the Replacement Property will be purchased (and Parked) before the sale of the Relinquished Property, a source of funds for the purchase must be arranged. This can be the Exchangor, or their bank. If a bank, the Exchangor will be expected to provide a guarantee. As Edmund & Wheeler, Inc. is the signer on the QualifiedThis is the loan to the Single Purpose Entity (whichEscrow Account, it causes the balance to be paid to the EATthe IRS has renamed an Exchange Accommodationin exchange for its deed for the Replacement Property executedTitleholder (EAT)) that will buy the Replacement Propertyin favor of the Exchangor.from its owner (C) and hold it until the RelinquishedProperty (A) can be sold to the Buyer (B).Before the deed can be issued, however, the EAT mustpay off (or pay down to the extent of available cash) the loanThis is the actual purchase of the Replacementmade to it at Step 3, above.Property from its owner (C). This is the Exchangors receipt of the direct deed fromAt this step, the Entity (and not the Exchangor)the EAT as owner of the Replacement Property; provided thebecomes the legal owner of the Relinquished Property.deed is delivered to the Exchangor on or before the 180th day.The 180-day Exchange Period commences.The Exchangor achieves a Section 1031 Exchangebetween Steps 7 and 11, where at Step 7 a deed is given and atThe Relinquished Property goes under Agreement of Step 11 a deed is received, and in between the Exchangor hadSale to Buyer (B).no control (Constructive Receipt) of funds. The Exchangor gives Buyer (B) a deed, and thetransaction closes; this step must occur before the 180thday, with enough margin to complete Steps 8-11.Rather than going to the Exchangor, the Buyersfunds are used to pay all of Exchangors expenses(including mortgages, if any), with the NET goingdirectly to a money center bank into a separate QualifiedEscrow Account established in the Exchangors name andSocial Security number. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice.28 29. GeorgesfavoriteExchangewasan"acquirefirst, reverseexchange".Soundscomplicated,butitsnot. Ourclienthadnegotiatedthepurchaseofasignificant newpropertybuthadbeenunabletosellapieceof existingpropertyintimetodothedeal.Ratherthan jeopardizethepurchase,wecreatedasinglepurpose entity(SPE),inthiscase,aMassachusettstrust,to acquirethenew(parked)property. Edmund&Wheeler,Inc.wasengagedtocreatethe newentity,holdthepropertyuntiltheoldproperty wassoldandtheproceedsareavailabletoacquirethe "parked"property.TheExchangorfundedthepurchasewithhisownandotherbankresources.Oncetheoldpropertywassold,thenewpropertywasdeededtotheExchangor.Sinceitisnotpermissibletoowntheoldandnewpropertyatthesametime,thisstrategyaccomplishedtheExchangorsdesiredoutcomes,againwithoutcapitalgainstax. Thisisacasewhereyoucanbenefityourownfamily withoutpayingcapitalgainstax.Ourclientsolda multifamilyrentalpropertythathadbeenownedfor manyyearsandrentedtocollegestudents.Thecash flowwasOKbuttherewasdeferredmaintenancethat wasstartingtoaffectthemarketpriceoftheproperty. Ourclientnegotiatedasaleonthemultifamily propertyandengagedustohandlethetransactionasa Section1031Exchange.Theclientsdaughterhad movedtoasuburbofChicagoandwantedtoacquireapropertythatwouldbeasafesecureprimaryresidenceandprovidehermomwithaniceplacetovisitthegrandchildren.Apropertywasidentifiedandtheexchangefundswereusedtoacquirethenewsuburbproperty.Aslongasthepropertyremainsasrentalpropertyinthehandsoftheclientandfairmarketrentischarged,thenthisstrategyisperfectlyacceptable.Thepropertycanbegiftedoffinincrementsof$12,000perperson,peryear. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.29 30. CASE STUDY 3ACBD-Delayed, Build-to-Suit (or Improvement) ExchangeDirect FormatIn this format, Client (A) gets a Section 1031 Exchange between steps 3 and 12and acquires new, improved property. All rules MUST be followed. The Exchange Agreement with Edmund &Wheeler, Inc. which governs the overalltransaction. This document MUST be in forcebefore the closing.The Purchase and Sale Agreement tosell the Relinquished Property. This step maytake place before Step 1 (the only out-of-sequence exception). The closing of the Relinquished Property; if severalThe vendors begin work, and soon enough, bills begin toare involved, the first in chronological order. In this step, arrive, addressed to the EAT, the legal owner of the property.the deed to the property is given to the Buyer. This stepstarts the 45-day Identification Period and the 180-day All invoices are presented to the Exchangor for approvalExchange Period.for payment from the Account.Rather than going to the Exchangor, the Buyers Upon such approval, further advances are made by thefunds are used to pay all of Exchangors expensesQI to the EAT to cover each payment.(including mortgages, if any), with the NET goingdirectly to a money center bank into a separate, interest-bearing Qualified Escrow Account established in the The vendors are timely paid, until funds are exhausted.Exchangors name and Social Security number. This is the Exchangors receipt of the direct deed from The Exchangor has identified Property C (propertythe EAT as owner of the Replacement Property; provided theneeding improvements) as the Replacement Property; at deed is delivered to the Exchangor on or before the 180th daythis Step, Edmund & Wheeler, Inc. causes the necessary(as adjusted), the Exchangor achieves a Section 1031purchase price for this property to be advanced to theExchange between Steps 3 and 12, where at Step 3 a deed isSingle Purpose Entity (which IRS has renamed an given and at Step 12 a deed is received, and in between theExchange Accommodation Titleholder (EAT)) which has Exchangor had no control (Constructive Receipt) of funds.been formed to own and improve the identifiedReplacement Property.This is the closing for Property C; this Step is thefunding; andThis Step is the legal acquisition. At (or hopefullywell before) this time, Exchangor engages Contractors andMaterialmen to effectuate the desired improvements. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. 30 31. Thisisaclassic"buildtosuit"transaction.Ourclientsoldacommercialpropertyand directedtheproceedsofthesalebyvirtueofanExchangeAgreementtousas QualifiedIntermediary.Wecreatedasinglepurposeentitytoconductthebusiness, inthiscaseaNHcorporation.Wethenpurchased,inthenameofthenew corporation,apieceofrawland(whichhadbeensubdividedandpermitted)using theexchangeproceeds.Theclientdeliveredspecificinstructionsforthetypeof buildingtobeconstructedonthesiteanddirectedwhothecontractorwouldbeto performthework.Wemadeaseriesofprogresspaymentsbasedontheworkin placeandthe"ok"topaybytheclient. OnceallofthesaleproceedsoftheRelinquishedPropertywereexhausted,thenew propertywasdeededtotheclientandthecorporationwasclosedandtaxreturn filedonitsbehalf.Theentireprocesswasconcludedwithin180days. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 31 32. CASE STUDY 4 ACBD-Delayed/Simultaneous Build-to-suit Exchange Reverse Format - Exchange Last In this format, Property (C) desired by the Client (A) is parked and improvedin a Single Purpose Entity (SPE) until clients current Property (A) can be sold. Section 1031 Exchange takes place between steps 10 and 14.The Exchange Agreement with Edmund &Wheeler, Inc. which governs the overalltransaction. This document MUST be in forcebefore the closing. Since the Replacement Property will bepurchased (and Parked) before the sale of theRelinquished Property, a source of funds forthe purchase must be arranged. This can bethe Exchangor, or their bank. If a bank, theExchangor will be expected to provide aguarantee. This is the loan (and Line of Credit) to the SingleThe Exchangor gives Buyer (B) a deed, and thePurpose Entity (which the IRS has renamed an Exchange transaction closes; this step must occur before the 180th day,Accommodation Titleholder (EAT)) that will buy thewith enough margin to complete Steps 11-14.Replacement Property from its Owner (C) and improve itand hold it until the Relinquished Property (A) can be soldRather than going to the Exchangor, the Buyers funds areto the Buyer (B).used to pay all of Exchangors expenses (includingmortgages, if any), with the NET going directly to a moneyThis is the actual purchase of the Replacementcenter bank into a separate Qualified Escrow AccountProperty from its Owner (C) by the EAT. established in the Exchangors name and Social Securitynumber. At this step, the EAT (and not the Exchangor)becomes the legal owner of the Relinquished Property. TheAs Edmund & Wheeler, Inc. is the signer on the Qualified180-day Exchange Period commences. At (or hopefully Escrow Account, it causes the balance to be paid to the EAT inwell before) this time, Exchangor engages Contractors and exchange for its deed for the Replacement Property executed inMaterialmen to effectuate the desired improvements. favor of the Exchangor. The vendors begin work, and soon enough, bills begin Before the deed can be issued, however, the EAT mustto arrive, addressed to the EAT, the legal owner of the pay off (or pay down to the extent of available cash) the loanproperty. made to it at Step 3, above.All invoices are presented to the Exchangor forThis is the Exchangors receipt of the direct deed fromapproval for payment from the Line of Credit. the EAT as owner of the Replacement Property; provided thedeed is delivered to the Exchangor on or before the 180th day,the Exchangor achieves a Section 1031 ExchangeThe vendors are timely paid, until the predeterminedbetween Steps 10 and 14, where at Step 10 a deed is given andmatch point has been obtained.at Step 14 a deed is received, and in between the Exchangorhad no control (Constructive Receipt) of funds. The Relinquished Property (A) goes under Agreementof Sale to Buyer (B). 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice.32 33. Ourclientrequiredanindustryspecificbuildingtobeconstructedonpropertythatheidentified.Wecreatedasinglepurposeentitytoacquirethetargetedlandandthenbeganconstructionofthefacility.Theconstructionwascompletedatday135andtheclientmovedhisexistingbusinessintothefacility.Oncetheformerbuildingwasvacant,itcouldbeshowntoprospectivebuyersandsoldbeforeday180. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 33 34. CASE STUDY 5 Delayed Exchange (Existing Property) Reverse Format - Exchange First In this format, Property (C) desired by the Client (A) can be purchased immediately by Client (A), as Client (A)s old (Relinquished) Property (A) is parked in a Single Purpose Entity (SPE) until it can besold to Buyer (B). Section 1031 Exchange takes place between steps 3 and 6. The Exchange Agreement with Edmund & Wheeler, Inc. which governs the overall transaction. This document MUST be in force before the closing.In consultation with the QI, the Exchangor determines what the NET proceeds would have been had the Relinquished Property sold that day; this is the cash amount of a loan to be made by the Exchangor to the Special Purpose Entity (Exchange Accommodation Titleholder (EAT)) that will buy the Relinquished Property from the Exchangor (A) and hold it until this property can be sold to the Buyer (B).In this Step, the Exchangor executes a deed to the Relinquished Property to the EAT. Not shown is a mortgage back to theExchangor to provide for security. The 180-day Exchange period commences.The exact amount of the loan funds in Step 2 are turned over to Edmund & Wheeler, Inc. as QI.Since the Exchangor has identified Property C as the Replacement Property, the QI is instructed to fund its purchase. This is the Exchangors receipt of the direct deed from the owner of the Replacement Property (C); the deed is delivered tothe Exchangor almost immediately after the Steps above; the Exchangor achieves a Section 1031 Exchange between Steps 3and 6, where in Step 3 a deed is given and in Step 6 a deed is received, and in between the Exchangor had no control(Constructive Receipt) of funds.Exchangors former property (the Relinquished Property) is now legally owned by the EAT, however, the Exchangor isexpected to continue the marketing effort and to approve all offers. When Buyer (B) is found, the EAT executes a deed to theExchangors Relinquished Property in favor of this person.The Buyer (B) pays the purchase price to the EAT, which uses the funds to:Payoff the bank (if any); andTo repay the initial loan from the Exchangor. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice. 34 35. Ourclienthadanopportunitytoacquireabuttingpropertytohisprimaryresidence. Thenewpropertywasvacantlandbutincludedmorethan500feetofshorefrontland. Theclientarrangedforaborrowingsufficienttoacquirethenewpropertybutsincehe couldntownthenewpropertyandtheoldpropertyatthesametime,hesoldtheold propertytoasinglepurposeentityfortheamountofmoneythathehadjustborrowed. Theoldpropertydeedwasplacedinthenameoftheentity. Next,theentitypassedtheloanfundstoEdmund&Wheelerwhichinturngavethem totheSelleroftheshorefrontland,andthisSellerdeededourclienttheproperty. Thentheclientwenttoworktosellexistingpropertythatwasheldasarentalproperty bytheentityinFlorida.TheFloridapropertysoldwithin180daysandtheBuyersfunds werepassedthoughtheexchangetopaydownthedebtonthenewshorefront property. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 35 36. Nowthatyouunderstandallofthetechnicalaspectsof Section1031,itstimetosiftallofthisinformationinto aneasytounderstandformattohelpyouidentify exchangeopportunities.Sincewehavelearnedthatonlycertainpropertyqualifiesforexchangetreatment,wewanttounderstandifthepropertyhashadpersonaluse,beenusedforqualifiedpurposesandthetransactiondoesnotcontainitemsthatarenotexchangeable. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 36 37. Thiswillhelpusunderstandthetaxbasisofthepropertyintheclientshands.Ifwediscoverthatthepropertywasacquiredviaapreviousexchangethenitwillalmostcertainlyneedtobeexchangedagain.Thepropertyshouldhavebeenownedfornotlessthanoneyear(needlongtermtaxtreatmentqualification).ClientsoftenfailtounderstandthatsteppedtransactionsrequirespecialcareinSection1031transactions.Thebetterinformedweareatthebeginningoftheprocess,thebetterresultattheconclusionofthetransaction.Rightsizingthetransactionisimportantfor thedesiredresults.Understandingtheclientsobjectivesiskeytoadvisingthemonthecorrectstrategytoundertake.Goingevenorupinvaluewillavoidtaxablebootbutiftheclientwantssomecash,itisperfectlyacceptable;theywillputthatcashatriskoftaxationandnottheentiretransaction.Helpingthemselecttherightidentificationruletofollowisequallyimportanttothesuccessoftheexchange. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 37 38. Section 3Alternate Exchange OpportunitiesContents Tenants In Common (TIC) ............................................................................................................ 39Why use a TIC? .................................................................................................................... 39What is a TIC? ..................................................................................................................... 40How does it work? ................................................................................................................. 40Direct ownership vs. TIC ....................................................................................................... 41Case Study ............................................................................................................................ 42TIC Benefits .......................................................................................................................... 43Securities TICs vs. Real Estate NNN and Master Leases .................................................... 45 Umbrella Partnership Real Estate Trust (UPREIT) ....................................................................... 46Section 721 Exchange Overview .......................................................................................... 46UPREIT Benefits ................................................................................................................... 47 Oil & Gas Leases .......................................................................................................................... 48O&G Characteristics ............................................................................................................. 48O&G Benefits ........................................................................................................................ 49 Structured Sales ............................................................................................................................ 50The Structured Sale in Real Estate Transactions ................................................................. 51The Structured Sale and 1031 .............................................................................................. 52The Structured Sale and selling a business ......................................................................... 53Structure Sale Diagram ......................................................................................................... 54 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 38 39. OfthealternativeExchangestrategies,theTenantsIn Common(TIC)vehiclehasbecomeincreasinglypopular inthepastfewyears.TICsoffertheclientsthe opportunitytopassivelyinvestinaGradeARealEstate Offering,resultinginmonthlypaymentswithoutthe hasslesofowningandmanagingtypicalinvestment realestate. Since2002theIRShasrecognizedTICpropertiesas eligibleforExchangeunderSection1031.Sincethat time,hundredsofspectacularpropertieshavebeen purchasedbyTICsponsorsandsoldtoinvestorsthat wouldnottypicallyownthistypeofrealestate. Manyinvestorshaveownedandmanagedinvestment realestateontheirownforyears,allthewhiledealing withtheterribleTs.Manyinvestorswishtokeepa portionoftheirportfoliosintherealestateclass,but areverywearyofdealingwiththemanagement hassles! TICsprovideallofthebenefitsofowningcommercial realestate,withmanyadvantageswithoutdealing withtrash,toiletsandtenants. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.39 40. Asafractionalownership,agroupofowners(not toexceed35)cantakeownershipinGradeA investmentproperty. Acheckissenteachmonthwiththeappropriate shareoftherevenuesgeneratedbytheproperty, andthepropertiesaretypicallymanagedbythe bestpropertymanagersavailableinthearea. AlongwiththepositiveaspectsofowningaTIC, investorsarealsosubjecttocashcallsshouldthe propertiesexpensesexceeditsincome.TICsarepurchasedinmuchthesameway asanyproperty.Withtheprimarydifferencebeingthatthepropertyisidentifiedwellinadvance,andtheownershippositionisreserveduntilclosing. Notethatthereisalsononrecourse financinginvolved,withallthebenefits associatedwithExchangingwithdebt.SECTICsarepurchasedinthesamefashionasanyotherrealestate,exceptthetransactionsarecarriedoutbybroker/dealersandNOTrealestatebrokers.Thishasbeenaboneofcontentionintheindustryformanyyears,andtodatehasnotbeenresolved.Themeltdownof2008causedmanyoftheseTICStofail.Currentlytheindustryis attemptingtorebuilditself. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.40 41. RealEstateTICscanprovideaviablereplacementpropertyoptionfortherestofus!RETICSaremarketedbycompaniesthatspecializeinfractionalizingsmallerpropertiessothattheminimuminvestmentismuchsmaller.Further,RETICScanbeofferedandsoldbyrealestatebrokers,meaningthereisasolidopportunitytohelpclientswiththesaleoftheirwholeownershipproperties,earnacommission,thenworkwiththemtochooseapassiveoption.andearnanothercommission,ortwo! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only and do not constitute tax, accounting, legal or investment advice.41 42. 1 Freedomfromdaytoday managementresponsibilities.Withnomorepropertytomanage,youhavemoreleisuretimetorelaxorpursueotherInterests.Inaddition,becausesomeoneelseismanagingthepropertyforyou,therearenogeographicallimitations.Youarefreetoinvestinrealestatemarketsnationwide.2 Professionalpeoplemanagingthepropertyonyourbehalf. ThetypicalExchangeEquitydealisonalongtermleasetoaCreditRatedTenant(A+BBB)whowillhave strongfinancialsandextensiveexperienceinthemanagementandupkeepoftheproperty.Thisisthe underpinningoftheapproachofatypicalTICsponsor.Thisallowsthemtoexamineofferingsinallsectors, types,andlocationsofrealestate.Inaddition,becausemanysponsorscoinvestinthepropertiesthatthey sponsor,theyhaveavestedinterestintheperformanceoftheproperties.Youcanrelaxbecauseitisthe tenantsresponsibilitytomaintaintheproperty,andforthesponsortocollecttherents,servicethe mortgage(ifany),andhandlealloftheotherassetmanagementresponsibilities.3 Increasedmonthlycashflow. YourinvestmentinaTICinterestprovidesyouwithacheckeverymonth.Thecashflowthatownerstypically receivegenerallystartsat6.258%perannum.BecauseExchangorstakeonanewdepreciationschedule, however,cashdistributionsaretypically50100%taxsheltered,dependinguponassetclassandleverage. Theequityappreciationinwelllocatedrealestatespeaksforitself.4 Propertiesareidentifiedandresearchedforyou. TICsponsorsdoalloftheworkoflocating,negotiatingtopurchase,providingalloftherequireddue diligence,arrangingforthefinancing,andotherworknecessarytoacquirethenewinvestmentpropertyand setuptheTICprogram.AwiderangeofTICpropertiesexistforsale,inmanydifferentassetclassesand geographicallocations,sowiththehelpofyourTICsponsor,youwillbeabletoeasilyidentifypossible propertieswithintherequisite45days,andacquirethemwithin180days.Inmanycases,TICsponsorsoffer a"backup"incaseyourpreferredpurchasebecomesunavailableforsomereason.5 Investinlarger,safer,higherqualityinstitutionalproperties. AsaTIC,youendupwithalarger,higherqualitybuildingleasedtoCreditTenantswithgreaterfinancial strengthandstabilitythananyothertypeofrealestateinvestmenttypicallyavailabletoindividualinvestors. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 42 43. 6 Benefitfrommultipletaxadvantages. Notonlycanyoudefercapitalgainstaxesuntildeath,atwhichpointtheyareforgiven,butyoualso cangainadditionaltaxadvantagesthroughanewdepreciationscheduleandindoingsotypically shelter50100%ofyourcashflow.7 Gainnonrecoursedebt. Accreditedinvestorsassumeinstitutionalgrade,prearranged,nonrecourse(nopersonalguarantee) financingwitheasyapproval.Youcaninvestinpropertiesthathavenodebt,orinoneswithupto 75%leverage.8 Startinvestingwithaslittleas$50,000. TICinvestmentshaveamuchlowerminimuminvestmentthansoleownershipallowingforgreater flexibility.Variableinvestmentsizescanstartaslowas$50,000andcanbestructuredtomatchan ownersequityanddebtrequirements.9 Afirstclasswaytodiversifyyourassets. Largenetproceedsmaybesplitamongseveralproperties,andsoinvestedinseveraldifferent marketsandassetclasses.10 Preserveyourcapitalbyinvestinginpropertiesthatcontinuetoappreciate. Profitscanbelockedinbysellingoutofhighlyappreciatedmarketsandthenreinvesting100%of thenetproceedsfromthosesalesintogrowthmarkets.11 Simplifyyourestateplanning. TICcansimplifywealthtransferandestateissues.Afterall,itsmucheasiertodivideamonthlycheck amongheirsthanitistodivideabuilding. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 43 44. ComparisonofTenantInCommonStructuresSecurityInterest versusRealEstateNNN&MasterLease FeatureTIC asTIC asTIC asSecurityRealRealEstateEstate(NNN) (MasterLease) Full Disclosure of Fees and TransactionYes Yes No Costs Complete Reporting TransparencyYes Yes No Full Disclosure of Terms of Purchase & Yes Yes No Risk Factors Professional Asset ManagementYes Yes Yes Master Lease Default RemediesYes Yes No IRS Opinion for Rev Proc 2002-22 Yes Yes Yes IRS Opinion for Rev Proc 2004-86 Yes Yes Yes Property Management Conflict Yes NoYes Compliance with IRC Section 1031 Yes Yes Yes Downside ProtectionNoNoNo Investor Control of Management Yes Yes No Debt (Non-recourse) with Unanimous Yes Yes Yes Consent Accredited Investor Status RequiredYes NoNo Highly Regulated Sales Process Yes NoNo 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 44 45. TheOmnibusBudgetReconciliationActof1993 intheU.S.createdUmbrellaPartnershipREITs (UPREITs)AsopposedtoatraditionalREIT whererealestatewasdirectlyowned,inan UPREITstructure,aREITcouldownacontrolling interestinanoperatingpartnership(OP)that ownedtherealestate. Thisstructureallowspropertyownerstobenefit fromtaxdeferralswhenexchangingproperty interestforunitsinanOPbecauseanexchange ofpropertyinterestsforOPunitswillgenerally notrepresentasalefortaxpurposes. TheunitsofOPcouldlaterbeconvertedtoREIT shares(ataxableevent)whenthetaxbenefitsof suchconversionwerethegreatest,thus deferringcapitalgainstax. Section721allowsaninvestortoactually contributeapropertyintoaPartnership. Inexchange,theinvestorreceivesOPshares whicharethenconvertedtoREITshares. Pleasenote,thatonceaninvestorreceivesREIT shares,theyaresecurities,andfollowthesame regulationsassuch.Also,youcannotdoany furtherexchangeswiththistypeofvehicle. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.45 46. Paynocapitalgainstaxordepreciationrecapturetax Upgradepropertyholdingsintoinstitutionalqualityrealestate Eliminatehandsonpropertymanagementresponsibilities Diversifiedamongvariouspropertiesacrossthecountry Competitivemonthly/quarterlycashflowdistributions Nomonthlymortgageobligationsduetononrecoursefinancing Removesorminimizesrealestateholdingsfromtaxableestate Capitalgainstaxisforgivenorsteppedupatthedeathofinvestor OPunitsmaybetransferable,divisibleorgifted OPunitsmaybecomeliquidassetsuponconversion 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 46 47. Section1031classifiesaninvestmentinan Oil andGasProductionworkinginterestand RoyaltyInterestas"likekind"for1031 exchanges.Aworkinginterestisaleasehold interestwhichallowsthelesseetherightto searchforandproduceOilandGasonaparcel oflandandreceiveaportionoftheproceedsof theOil&Gasproduced.Eachfractionalowner ofanofferinghasthesamerightsasasingle ownerandcansubdivideorofferforsaletheir ownershipinterestatanytimeontheopen market. Liquidity Thereisanactivesecondarymarketfor establishedOilandGasProductiontosell directlytoinvestorsorbyauctionsspecializing inOilandGasProductionbasedonprojected productionandthecommodityprices. LifeofProduction Longtermprojectedproductionwithproved reservessupportedbyqualifiedthirdparty reports. AnnualReturn Averagepayoutof15%to18%perannumover theterm.Thispaymentmustbeconsideredas returnofinvestmentaswellasreturnon investmentasthefuturevalueofthe investmentwillbezerowhentheproductionis completed.TaxTreatmentIncomeiseligiblefortaxfreedepletionallowanceofapproximately15%whichisnotchargedbackuponthefuturesaleor1031exchangeoftheinvestors"fractionalinterest".DiversificationLongtermmanagementfreeinvestmentwithsecurecashflowwithawhollyownedinterestwiththeinvestorcontrollingthetimingandexitstrategy.ValuationTherearenodrillingrisksinOilandGasProduction.Investmentsarevaluedontheamountofpotentialproductionandthepriceofthecommodity.Priceswillincreaseanddecreaseandthereforepayoutswillvary.Overthelongtermgrowthshouldprovideanidealinflationhedge.InternationalUnlikerealestateOil&GasisaGlobalcommoditythatisnotsolelydependentontheUSeconomyandinterestrates. ClosingQuickandeconomicclosing. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.47 48. OneofthemanyadvantagesofO&Gisthat,unlikebuyingabuilding,anenergyassetpurchasecanoftenbetailoredtotheexactvaluationrequiredforyourexchange.Inaddition,manyenergyreplacementpropertyoptionsofferamuchlowerminimuminvestmentrequirementthanmanytraditionalrealestateorTenantInCommon(TIC) investments. UndertheprovisionsofSection1031,oilandgasassetsareconsidered"likekind"forallofthefollowingtypesofrealproperty:commercialproperties,minesandquarries,multifamilydwellings,residentialrentalproperties,restaurants,timberandtimberland,warehousesandundevelopedland.Thus,oilandgaspropertiesareoftenusedasreplacementpropertyforrealestateandotherinvestmentstodefercapitalgains. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 48 49. Whensomeoneissellingabusiness,professionalpracticeorrealestate,manyindividualsintheseandsimilarfinancialsituationswouldliketoliquidatetheirinvestmentwithouthavingtorecognizetheentireprofitastaxableincomeintheyearofthesale.Insteadoftakingalumpsum,thesellercannowdesignastreamofincometomeethisorherindividualneeds.Bymakingthesaleandhavingpartoftheproceedspayableovertime,thesellercanusethepaymentproceedsasasourceofincomeandmaybeabletorecognizethetaxablegainastheinstallmentpaymentsarereceivedordeemedreceived.Enablesa1031Rescueintheeventasellerisunabletoidentifysuitablereplacementpropertyfortheir1031exchange,astructuredsalecanbeexecutedasabackupplanpriortothecloseofescrow.However,thisoptionisonlyavailableiftheoriginalsalescontractcontainedwordingallowingforthepossibilityofastructuredsale,andifthestructuredsalescontractsaresignedbeforethecloseofescrow.(Asaprecaution,everysalescontractshouldincludesuchwording.Contactusforproperwordingtoincludethispossibilityinyoursalescontract.) 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 49 50. UsingaStructuredSaleforRealEstateTransactions Astructuredsaleisataxdeferralstrategyforsellersofrealestate.Itisanimproved versionoftraditionalinstallmentsales.Itallowsthesellertotakeadvantageoftax benefitsandincomesecuritythatwerenotpreviouslyavailable.Inastructuredsale thesellerisallowedtospreadtheircapitalgainstaxliabilityoveraspanofyears,while receivingguaranteedpayments. BenefitsDefercapitalgainstaxestotheyearyoureceivepaymentsEarnpretaxguaranteedrateofreturnonprincipalSetuppaymentstreamtoyourlikingPaymentsguaranteedbyALLSTATE StructuredSalesExamples: Homeownersellstheirresidenceforalargegain Homeownersellshousefor$2,000,000.Originalpurchasepricewas$500,000.Aftera $500,000exclusion,theyareleftwitha$1,000,000gain.Insteadofincurringalarge capitalgainstaxatthetimeofsale,thesellerelectstosetupaguaranteedstreamof income.Thesellernowcanstructurealloraportionoftheremaining$1,000,000and onlypaytaxesastheyreceivepayments.Thisisperfectforsupplementingretirement. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 50 51. ClientssellinganincomepropertyClientwantstogetoutofthelandlordbusinessbutrequiresthesteadystreamofincomethatthetenantsprovide.Byusingastructuredsale,theownercansetuphisstructuretomirrorhisformerincome,allthewhiledeferringhiscapitalgains.Investorthatisnotinterestedin1031exchangesandjustwantstogetoutofthemarketForthoseclientswhodonotwanttoutilizethe1031option,astructuredsaleistheperfectalternative.Likea1031exchange,astructuredsalewilldefercapitalgainstax,buttheinvestmentisanannuity,notalikekindpropertyexchange.FarmersellinghislandtodeveloperManyfarmersarehesitanttoselltheirlandtoadeveloperbecauseofhugecapitalgainsliabilityanduncertaintyabouthowtoinvesttheproceeds.Structuringaportionofthetransactioncanbethelittleextrathatmakesthedealhappen.Aguaranteedincomestream,resultingincontinuationofincomeanddeferralofcapitalgainsareallpotentialbenefitstothefarmer.HomeownerslookingtodownsizetheirresidenceManyhomeownersselltheirpropertyanddownsizeinordertotakeaprofit,retire,orrelocatetoalessexpensivemarket.Theycanstructuretheirprofittomatchtheirmortgageontheirnewhomeanddefercapitalgains.Iftheyareretiring,structureplanscanbesetuptopayaguaranteedincomefortherestoftheirlife. Astructuredsaleshouldalwaysbeidentified upfrontintheExchangeAgreementasan alternatestrategy. Astructuredsalecanalsobeusedtoarrange paymentsforanyproceedsofthesalethatare notusedtopurchasereplacementproperty (boot).Thiswillallowfulltaxdeferralatthe timeoftheExchange! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 51 52. Sellingabusinesscanbeaharrowingexperience.Oftentimes,sellershaveworked theirentireprofessionalcareerinbuildingtheirbusinesses.Inmanycases,these businessassetsrepresentthelargestportionofyourclientsfinancialassets. Businessbuyersinvariablywillseekownerfinancingwhennegotiatingtermsona potentialbusinesspurchase.Whileownerfinancingcanassistinclosingthedeal,there areinherentrisksassociatedwithcarryingpaperonabusiness.Namely,ifthebuyer shoulddefault,thentheincomestreamstopsandthesellerthengetshisbusiness back.Inmostcases,thisisthelastthingasellerwants. Typically,whenasellerisaskedtocarrypaper,aninstallmentsaleissetup.As discussed,thiscanberiskybusiness.Amuchsaferalternativeistosetupastructured salewherebythesellerisguaranteedhispaymentsregardlessofthefutureoutcome ofthebusiness. Structuredsalesalsoprovideanexchangevehicleforthosebusinessownerswhowant toexittherealestateclassintheirportfolios,whileprovidingasteady,management freeincomestreamfortherestoftheirlives. Notethatonceaclientexchangesintoastructuredsale,hecannotexchangeagain! 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 52 53. Assumingtheassetsbeingsoldqualifyforreportingontheinstallment method,hereshowtheprocesswouldtypicallywork:1. Thesellerentersintoaninstallmentsaleagreementunderwhichthebuyer promisestomakeperiodicpaymentsforastatednumberofyears.Theseller isNOTagreeingtotakenotefromthebuyer,ratherdelayhisreceiptofcash, andtodefercapitalgains2. Thebuyerassignshisorherperiodicpaymentobligationstoanassignment company.3. Theassignmentcompanyfundsthepaymentobligationbypurchasingan annuityfromaninsurancecompany.4. Theinsurancecompanybeginsmakingthepaymentstothesellerasagreedto underthetermsofthesaleandissuesanagreementtopayonthe performanceoftheassignmentcompany. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 53 54. HowDoYouSummarize54Pages? Section 1031 is an interest free loan from the government. Section 1031 is used in less than 10% of the transactions that it should be! Real Estate Professionals owe it to their clients to understand this powerful tool! More commissions. More Commissions. More Commissions. Section 1031 is about Relocation and Reallocation of assets without paying capital gainstax! Any real property can be exchanged for any other real property. Section 1031 can be used to dramatically increase the value of holdings by leveragingUncle Sams money. Ask the 4 Questions:1. Whatcha got?2. Howdya get it?3. What else ya got?4. Whatcha want? Nearly every taxpaying entity qualifies for a Section 1031 Exchange! Personal property can also be Exchanged. Like-kind is literal! There are replacement options available for Section 1031, understand them!oTenants-In-Common - Management free real estate investments in Grade A propertiesoUPREIT - Exchange into a real estate investment trust.oOil & Gas - A timely alternative to owning real-estate with the same benefits and flexibility.oStructured Sales - An annuity based paycheck for failed exchanges and business transfers. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 54 55. Section1031Glossary Section1031Exchange ThisverysimplyisaSection1031TaxDeferralwhichpermitstaxpayerstoreinvesttheproceedsfromthesaleof propertyheldforinvestmentorbusinesspurposesintoanotherinvestmentorbusinessproperty,anddefercapital gainstaxthatwouldotherwisebedueontheinitialsale. AdjustedBasis Theoriginalbasisplusanyimprovementcostsminusthefulldepreciationontheproperty. AgreementforTransfer Purchaseagreement,offerandacceptance,saleagreement,earnestmoneyagreement,realestatecontractor othercontractcontemplatingthepurchaseorsaleofrealproperty. Boot Thisisthepropertythetaxpayerreceivesintheexchangewhichdoesnotqualifyaslikekind"property.Cash proceedsarethemostcommonformofbootandabootissubjecttotaxation. CapitalGain Thecapitalgainiscalculatedasfollows:totalsellingpriceoftherelinquishedproperty,lessexchangeexpenses, lesstherelinquishedpropertysadjustedbasis.Theadjustedbasisistheoriginalcost,plusthecostofcapital improvements,lessdepreciationorcostrecoverydeductions.Capitalgainsmaybesubjecttodepreciation recaptureandotherrulesoftheIRS. ConstructionSection1031Exchange Youmayevenpurchasereplacementpropertythatisnotyetbuilt,providedthattheimprovementsonthe propertyarecompletedpriortotheexpirationofthe180days(whichcanbeverydifficult).InaConstruction Section1031Exchange,thepropertyisheldbyaspeciallyformedSinglePurposeEntitycalledtheEAT"Exchange AccommodationTitleholder".AConstructionExchangegenerallyhasgreatercomplexityandfeesthanaSection 1031Exchange. ConstructiveReceipt ThisisatermthatreferstotheSection1031Exchangorhavingunrestrictedcontroloftheequityfromtheproperty soldandaConstructiveReceiptwillinvalidateataxdeferredSection1031exchange. ContractSection1031Exchange A"ContractExchange"isthetaxdeferredexchangeof:TheBuyersownershipinaSalesContractonrealproperty, fordifferentrealproperty,orforacontractoroptionondifferentrealproperty;ortheOptionHoldersexchange ofanOptiontopurchaserealproperty,fordifferentrealproperty,orforanoptionorcontractondifferentreal property.Essentially,a"contractexchange"isaSection1031exchangeofanopenoptiontopurchase,oranopen SalesContract,ratherthanaSection1031exchangeoftheunderlyingrealestateitself. CooperationClause AclausethatisaddedtothepurchaseonsalesagreementrequiringthepersonwhoisnottheExchangortouse theirbesteffortstoassisttheExchangorinconsummatingaSection1031taxdeferredexchange. ExchangeAccommodationTitleholder TheExchangeAccommodationTitleholder"EAT"isaspeciallyformedLLCusedduringaConstructionExchangeor aReverseExchange. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 55 56. Exchangor Theactualowneroftheinvestmentpropertylookingtomakeataxdeferredexchange.Unfortunatelyan Exchangorcannotbeanownerthatwishestodefercapitalgainstaxonasecondhome.See"likekind"property definition. ExchangeFundsAccounta.k.a.theQualifiedEscrowAccount Theaccountestablishedbythequalifiedintermediary(QI)toholdtheexchangefunds. ExchangePeriod A180daywindowinwhichtheExchangorhastocompleteataxdeferredexchange.DuringtheExchangePeriod thereisa45dayIdentificationPeriodinwhichtheExchangormustidentifywhichpropertyorpropertiesthatwill bepurchased.BothtimeperiodsbeginonthedayofthesaleoftheRelinquishedProperty. TheFairMarketValue Thisislikelysellingpriceasdefinedbythemarketataspecificpointintime. ForwardDelayedExchange Atypeofexchangewhichoccurswhenapropertyissold"RelinquishedProperty"andanotherpropertyis purchased"ReplacementProperty"within180daysfollowingthesaleoftheRelinquishedProperty. IdentificationPeriod Thetimeperiodthatbeginsuponthe"closeofescrow"oftheRelinquishedProperty.Duringthis45dayperiod, theSection1031ExchangormustidentifytheReplacementPropertyinordertocontinuewiththeSection1031 exchangetransaction. IdentificationLetter AnIdentificationLetterformisusedtoidentifypotentialReplacementpropertyorproperties. IRSSection1031TaxCode Internalrevenuecodesection1031. "LikeKind"Property Thepropertiesinvolvedinataxdeferredexchangemustbesimilarinnatureorcharacteristics."Likekind"real estatepropertyisbasicallyanyrealestatethatisNOTyourpersonalresidenceorNOTasecondhome. TheNapkinRule YoumustbuyaReplacementPropertyofequalorgreatervaluetotheRelinquishedPropertyinorderto completelydefertheapplicablecapitalgainstax.Ifyoupurchaseapropertyoflesservalue,youwillberesponsible foranytaxonthedifference(Boot).Youmustuseallthecashproceedsfromthesaleonyourpurchaseinorderto completelydefertheapplicablecapitalgainstax.Ifyoudontuseallyourproceedsonthepurchase,youwillbe responsibleforanytaxonthedifference. OriginalBasis Thisisthepurchasepriceofapropertyanditisusedtocalculatecapitalgainsorlossesfortaxpurposes. PersonalProperty AnypropertybelongingtotheSection1031Exchangorthatisnonrealestaterelated. QualifiedEscrowAccount Theaccountestablishedbythequalifiedintermediary(QI)toholdtheexchangefunds. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice. 56 57. QualifiedIntermediary TheIntermediaryisalsoknownas,QI,Accommodator,FacilitatorandQualifiedEscrowHolder.Athirdpartythat helpstofacilitatetheexchangeandholdsfundsinescrow. RealEstateExchange AtypeofExchangeofrealpropertyforrealproperty.Alltypesofrealpropertyare"likekind"forotherreal property,includingvacantland,residential,commercial,andevensomelongtermleases. RelinquishedProperty TheoriginalpropertybeingsoldbythetaxpayerwhenexecutingaSection1031exchange. ReplacementProperty IsthenewpropertybeingacquiredbythetaxpayerwhenexecutingaSection1031exchange. ReverseExchanges ThisisthetypeofexchangeinwhichtheReplacementPropertyispurchasedbeforethesaleoftheRelinquished Property. RulesofIdentification TheguidelinesthatmustbefollowedwhenmakingaSection1031taxdeferredexchange,suchasthe3Property Rule,200%Rule,and95%Rule. SettlementAgent Definitionsinclude:Titleagent,closingofficer,escrowofficer,settlementofficer,closingagent,closingattorney, settlementattorney. TaxDeferredExchange TheprocedureoutlinedunderIRSCodeSection1031involvingaseriesofrulesandregulationsthatmustbemetin ordertotakefulladvantageofdeferringcapitalgainstaxonthesaleofinvestmentrealestate.Section1031tax deferredexchangesarealsocommonlyknownas:Starkerexchanges,delayedexchanges,likekindexchanges, 1031exchanges,Section1031exchanges,taxfreeexchanges,nontaxableexchanges,realestateexchanges,real propertyexchanges.Thoughallofthesetermsrefertothesamething,themosttypicaltermusedtodayisthe Section1031Exchange. TenancyInCommon(TIC) Afractionalorpartialownershipinterestinapieceofproperty,ratherthanowningtheentirepieceofproperty. ThreePropertyRule TheExchangormayidentifyupto3properties,withoutregardtotheirvalue. The200%Rule TheSection1031Exchangormayidentifymorethanthreeproperties,providedtheircombinedfairmarketvalue doesnotexceed200%ofvalueoftheRelinquishedProperty. The95%PercentRule TheSection1031Exchangormayidentifyanynumberofproperties,withoutregardtotheirvalue,providedthe Exchangoracquires95%ofthefairmarketvalueofthepropertiesidentified. 2008- 2012 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided foreducational purposes only and do not constitute tax, accounting, legal or investment advice.57