Long-Awaited Taxpayer Victory Impacts Construction & Reverse 1031 Exchanges

The Tax Court finally issued an opinion in the Estate of Bartell case on August 10th, almost 10 years following the initial trial. The case dealt with a non-safe harbor reverse construction exchange where the accommodator did not put any equity into the project, the accommodation period lasted for 17 months, and the taxpayer guaranteed the construction loan.

Estate of Bartell

The IRS argued that the appropriate test for a non-safe harbor reverse exchange was whether the accommodator had the substantial benefits and burdens of ownership. The court, however, ruled in favor of the taxpayer on the basis that the accommodator had not acted as the taxpayer's agent.

This decision currently appears to be a major victory for taxpayers who want to accomplish construction exchanges lasting more than 180 days as well as reverse exchanges that might exceed 180 days. However, the IRS has 90 days to appeal this decision and it is likely to do so. 

Tips for Taxpayers

Affirmation on appeal is not certain. Anyone seeking to rely on this opinion must be careful to avoid both language of agency in the exchange documents as well as features that might suggest an agency relationship.

Note that this exchange occurred in the Ninth Circuit. The Tax Court relied heavily on the fact that Ninth Circuit cases have allowed wide latitude in structuring exchanges.

• Start Your 1031 Exchange: If you have questions about what types of property qualifies for 1031 treatment, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Whiteboard Video - Revoking Identified Properties in a 1031 Exchange

This whiteboard video answers the question: "can you revoke identified property in a 1031 exchange?" Check out more 1031 whiteboard videos here.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Mixing 1031 Identification by Receipt & Writing

Do the properties that I receive title to (by closing on) within the 45 day identification period reduce the number of additional replacement properties that I may identify or designate in writing under the Three-Property Rule, 200% Rule, or 95% Exception?

Internal Revenue Code

Internal Revenue Code Section 1031(a)(3) imposes both the 45 day Identification requirement and the 180-day due-date for federal tax return exchange period.

Treasury Regulation 1.1031(k)-(c) provides information on how to make your identification of replacement property before the end of the identification period.  It states that:

(1)    In general. For purposes of paragraph (b)(1)(i) of this section (relating to the identification requirement), replacement property is identified before the end of the identification period only if the requirements of this paragraph (c) are satisfied with respect to the replacement property. However, any replacement property that is received by the taxpayer before the end of the identification period will in all events be treated as identified before the end of the identification period.

Received Properties

As the properties that you actually receive within the 45 day identification period are treated or deemed as identified, these ‘received properties’ must also be included in computing the various identification rules (e.g., the Three-Property Rule, 200% Rule or 95% Exception).  This predicament is described in an illustration set out in Treasury Regulation 1.1031(k)-(c)(4)(iii) which states that:

For purposes of applying the 3-property rule, the 200-percent rule, and the 95-percent rule, all identifications of replacement property, other than identifications of replacement property that have been revoked in the manner provided in paragraph (c)(6) of this section, are taken into account. For example, if, in a deferred exchange, B transfers property X with a fair market value of $100,000 to C and B receives like-kind property Y with a fair market value of $50,000 before the end of the identification period, under paragraph (c)(1) of this section, property Y is treated as identified by reason of being received before the end of the identification period. Thus, under paragraph (c)(4)(i) of this section, B may identify either two additional replacement properties of any fair market value [*under the Three-Property Rule] or any number of additional replacement properties as long as the aggregate fair market value of the additional replacement properties does not exceed $150,000 [*under the 200% Rule].  *emphasis added

Remember that your 1031 proceeds from the disposition must be re-invested in like-kind properties within 180 days of the transfer of your first relinquished property.  These properties will only be considered to be like-kind if they are properly identified according to Treasury Regulation 1.1031(k)-(c)(4) which imposes limitations on the number of properties which can be identified as potential replacement properties.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Boundaries with Foreign Properties

Many people are subject to US capital gains taxes on the sale of their foreign property. These folks may be surprised to discover that the US government collects taxes on income from many sources. This is true, even if the income is derived from the sale of foreign property. United States taxpayers (including non-citizen US residents) are required to report their earned income and file tax returns no matter where they derive their income.

1031 Exchange Stops at the Border

An investor seeking to exchange into the United States, may be more surprised to learn that in order to qualify for tax deferral under Section 1031, the exchange must be of “like-kind property”; and, that in 1031(h), Congress wrote the law so that “property located in the United States and property located outside the United States is NOT considered to be “like kind.”

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

Defer the tax. Maximize your gain.

© 2016 Jeffrey R. Peterson – All Rights Reserved

Are REITs Eligible for 1031 Exchanges?

Many people have questions about what to do for their replacement property. Some people ask if they can sell their relinquished property and put the money into a REIT (Real Estate Investment Trust) with no tax consequences.

DSTs & Single Tenant Property

Generally, I prefer to see people invest into DSTs (Delaware Statutory Trusts) because there is more certainty that they qualify as like-kind real estate.

Another alternative is to exchange into a single tenant Net Net Net leased property such as a CVS or Walgreens that you own by yourself, because you maintain more control, but still have a less management-intensive property to deal with.

UPREIT

If you want to go the REIT direction, then an UPREIT (Umbrella Partnership Real Estate Investment Trust) may qualify, but be mindful you must first purchase and hold your like-kind fractional interest (tenant-in-common interest) in the replacement property real estate for a period of time before contributing it to the UPREIT partnership pursuant to Section 721 of the Internal Revenue Code.

My concern has been that people do NOT hold their fractional interests in the replacement property real estate for a sufficient period of time doing the §721 contribution and that partnership interests are specifically excluded from 1031 treatment. So if you immediately convert your replacement property into a non-qualifying partnership interest you may jeopardize the tax deferral under §1031.

Delaware Statutory Trust Alternative

A direct purchase of a REIT won't qualify for 1031 because they're either a beneficial interest in a trust or they’re some kind of other excluded property (stock or some kind of interest in a business entity). But the close cousin to the REIT, a Delaware Statutory Trust (DST), will qualify. A Delaware Statutory Trust is a smaller portfolio of real estate and the IRS says that when you buy an interest in a properly set-up Delaware Statutory Trust you are deemed to own the underlying real estate of the trust. So instead of thinking about REITs, change your thought pattern to Delaware Statutory Trusts to make sure that your replacement property is considered to be a like-kind interest in real property that qualifies under section 1031.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved