Is it Necessary to Assign the Purchase Agreement to Your Qualified Intermediary?

Many people ask “Why do I have to assign my purchase agreement to my Qualified Intermediary in a 1031 exchange?” And furthermore, “Why do I have to give notice to all of the other persons involved in the purchase agreement that I am assigning my contract to my intermediary.” It seems intrusive to have to give everyone notice that you are doing an exchange. Why is it anyone’s business?

Old School Requirements

Let’s go back in time before the current treasury regulations were in place. Back then we would actually deed or transfer our property to the qualified intermediary. The Intermediary acted as a straw man, so that they became the seller of the relinquished property and the purchaser of the replacement property. In other words, your Intermediary actually went into title and then participated in the transfer or the purchase of the property.

Modern 1031 Tax Techniques Allow Mere Assignment

Today, qualified intermediaries do not have to legally take title. We can accomplish the same function by simply assigning to the Intermediary our rights in the relinquished property purchase agreement, or our rights in the replacement property purchase agreement. That is deemed to be the same as if the Intermediary actually took our property from us, or received the replacement property for our benefit.

Faster, Cheaper Direct Deeding for 1031 Exchanges

The benefit here is that we do not have to deed a property. We do not have to pay for extra recording fees, and we do not have to go through all of that extra hassle of actually deeding the intermediary into the chain of title. However, the treasury regulations say that if you are going to have direct deeding, (that is, the exchangor deeds the relinquished property to the buyer, and the seller of the replacement property deeds the replacement property to the exchangor) then we have to give written notice of this assignment to the Intermediary to all of the other parties to the purchase agreement. Remember, in old common law, an assignment was never considered effective unless all of the parties to that agreement were given notice.

Why Would the IRS Adopt an Old Common Law Assignment Rule?

So why would the treasury regulations have adopted this old rule? I think it is to prevent unscrupulous folks from fabricating a 1031 exchange. They can’t say, “You know that deal that we did back last year? That was a 1031 exchange.” The way to catch them in that lie would be to say, “Well, show us where you gave written notice to the other parties of the purchase agreement." If they can’t show, well then maybe it wasn’t a 1031 from the outset.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Similarities & Differences Between States

Not all property qualifies for 1031 exchange treatment. In particular, Congress has said that foreign property is not like-kind to US property.

So if I have a business property in Canada or Mexico and I sell it I may be subject to taxes because I'm a US taxpayer making a gain somewhere in the world. The way that section 1031 of the Internal Revenue Code is written you are taxed on income from wherever it's derived.

Under 1031 you can defer that gain but in order to acquire a qualifying property you’d have to buy another foreign property. So a foreign to foreign exchange works but foreign to US does not work.

State Law Differences

Now let's talk about some state law differences. In some states, a mobile home may be taxed and treated as personal property, much like we think of an RV or a car. In other states, a mobile home maybe consider real estate, particularly if it's affixed or strapped down to the Earth. Water rights oftentimes are considered personal property rights in some states and in other states are real property. Crops or other things that grow in the earth may be considered personal property in some states and real estate in others. So when you’re doing a 1031 exchange you want to look closely at the type of property and whether it qualifies, and what its character is – real estate or personal property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What to Know About Deed & Transfer Tax In a Reverse 1031 Exchange

In a reverse 1031 exchange, the qualified intermediary forms an entity that acts as a straw man to acquire the replacement property.

Exchange Accommodation Title-Holder

That straw man is called an Exchange Accommodation Title-Holder (EAT). This EAT typically holds title to the replacement property until the old relinquished property is disposed of and then the EAT (or straw man) deeds the property to the exchangor to complete their like-kind exchange.

The sad situation is that the Exchange Accommodation Title-Holders already paid deed tax once when it received the parked property from the seller and now is being subjected to transfer tax again when the replacement property is deeded to the exchangor.

State Differences

Some states are very aggressive in taxing the transfer of the parked replacement property to the exchangor in what’s called deed tax or transfer tax. Not all states are as aggressive as say Pennsylvania or Wisconsin in collecting deed tax from the intermediaries entity to the exchangor.

In Minnesota, the Minnesota Department of Revenue has been much more accommodating in limiting the transfer tax to the value of the exchange services provided by the exchange accommodation title holder. Other states are imposing the transfer tax on the entire value of the property being conveyed.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Restricting 1031 Exchanges Would Create a “Lock-In” Effect

There are many reasons why President Biden’s proposed restriction on 1031 exchanges should not be passed. In this article, we are going to explain a few of these reasons that 1031 exchanges should not be touched.

Commercial Real Estate is Hurting

Due to the pandemic and other factors, core segments of real estate (hotels, malls, entertainment venues) are currently beaten-down. Restricting 1031 exchanges would exacerbate the problems they are currently experiencing.

1031 Exchanges Incentivize Capital Investment

Taxpayers who engage in 1031 exchanges invest more capital into their replacement properties than non-tax motivated purchasers. They also have lower LTV rations, which decreases risk in the system. 1031 exchangors are also likely to have the ability to make a larger down payment on replacement property. This leaves them with more capital to invest in improvements and upgrades. More investment in building improvements leads to greater investment returns, higher rents and property values, and higher prices at disposition.

The “Lock-In” Effect

Restricting 1031 exchanges would create a “lock-in” effect, which would result in fewer transactions and declining prices. To avoid large tax bills, many taxpayers would choose to hold on to sub-optimal assets. This would exact a cost on the economy - properties would be more highly leveraged and investors would spend less on capital improvements.

Eliminating the lock-in effect by preserving 1031 exchanges allows taxpayers to preserve their investment capital and acquire larger properties, upgrade facilities and redeploy their capital into other areas. These activities create jobs and contribute to the local and state tax bases.

Follow these Tips to Secure Your Funds During a 1031 Exchange

So you’ve decided to do a 1031 exchange. You're going to sell your relinquished property, and your proceeds are going to get wired out into the interwebs. Who knows where your money is going and who knows how safe and secure your exchange funds are?

There's been a couple of cases where 1031 intermediaries have goofed up.

In one case that came out of Minnesota, a taxpayer’s monies were used by the intermediary to invest in Internet stocks. The internet stocks bubbled and the intermediary didn't have the cash to pay back for the purchase of the replacement property.

In a much larger case called Land America Exchange – a huge national 1031 exchange company had invested the funds allegedly in securities that became illiquid and when it came time for people to complete their exchanges they weren't able to access their funds to acquire the replacement properties.

This Begs the Question: How can I Know if my Money is Safe?

The best way to make sure that your money is safe is to never ever allow your funds to be co-mingled with anyone else’s funds. When you set up a 1031 exchange you need to make sure that you have a separate segregated bank escrow account. You need to know what that account number is and you need to know that that account is only going to be used for your funds.  It's not co-mingled with the operating account of the intermediary, and it’s not commingled with any other money.

If you have your money separately segregated you know exactly where it is during the entire process - that's great.

But wouldn’t it be great if you could lock down that money in a dual-signature account? The first signature required to release any funds would be the intermediary’s because they’re the holder of the account. But the second co-authorization could be the taxpayers for whom we’re doing the exchange.

So we want to get a co-written authorization from the taxpayer to make sure that it’s proper and appropriate to transfer out these funds to make sure they're returning them to the taxpayer of the exchange or for the purchase of the replacement property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved