How to Deal with Enhanced Development Rights in a 1031 Exchange

Sometimes people are contacted by a government entity or organization and they’re asked to convey enhanced development rights. These are restrictions imposed on the relinquished property in a 1031 exchange that burden the property and run with the land, sometimes perpetually. This article will explain some of the fundamentals of enhanced development rights as they relate to 1031 exchanges.

The 1031 Question

The first question many people have is:

• I’m going to get this big bill this big amount of cash for the sale of these enhanced development rights – can I do a 1031 exchange on it?

And the answer is yes. In a private letter ruling issued by the IRS, taxpayers have been given the green light to exchange or dispose of development rights and acquire fee title* and replacement properties. Another kind of relinquished property that may be given up are conservation easements that may be perpetual or for durations of 30 years or more. Those are very similar to the restrictions imposed through enhanced development rights. They have to be a significant and substantial (perhaps perpetual) transfer of rights in the property so much so that they are considered the equivalent of the title for federal tax purposes.

*Fee title (also sometimes called “fee simple”) is an estate or interest type of ownership giving the owner the highest possible or best interest in the land (subject only to the absolute sovereignty of the government).

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

A Few Common Questions Closers Have About 1031 Exchanges

Sometimes title closers have questions about the 1031 documents and what their responsibilities are to get the closing done correctly so they don’t mess up the 1031 exchange.

One of the most important things that the treasury regulations require is that the exchange or the party doing the exchange must sign their rights in the purchase agreement to their qualified intermediary.

Well that’s great, but under the old English common law, an assignment was not considered effective until all of the other parties to the purchase agreement had been given written notice and the IRS adopted the same requirement in the treasury regulations.

So at the time of closing that notice of assignment that the exchangor has assigned their rights in the purchase agreement to the intermediary – that notice must be given to the other parties. So for the relinquished property the notice would go to the buyer as well as any assignees of the buyer.

Further, if there are co-sellers (other parties conveying the relinquished property that are parties to that purchase agreement), they too should be given written notice. Now how do we prove that we gave all these people written notice? We ask them to sign an acknowledgement stating we have received this notice in writing.

So that’s part of the closing documents qualified intermediaries send to the seller to make sure that all of the proper parties are given the requisite notice.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How to Find a Replacement Property Before Selling Your Relinquished Property

Savvy investors like to think ahead when they’re doing a 1031 exchange. Ideally, you want to gain the advantage of locking up a replacement property before selling the old relinquished property. Here’s a common question people ask in this situation:

“Is it permissible for me to sign a purchase agreement or an option agreement to contractually find a seller to sell me a replacement property even before I close on my old relinquished property? Will that somehow foul up my 1031 exchange?”

Locking Up a Replacement Property

The answer is you can lock up a replacement property, you just can’t close on it before you’ve first disposed of the old relinquished property. So signing a purchase agreement, or an option agreement are proven practices. You just don’t want to inadvertently acquire them before you sell the old relinquished property.

Reverse 1031 Exchange

That being said, if you have to close on the replacement property first (before selling your relinquished property) there’s a solution for that too.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How Deed Tax & Transfer Tax Work in a Minnesota 1031 Exchange

In Minnesota, for the privilege of filing a deed or mortgage, the state of Minnesota charges a fee, sometimes called deed tax, transfer tax, or mortgage registration tax. Why is this important for people doing a 1031 exchange?

Reverse 1031 Exchange Considerations

This comes up primarily when we’re doing a reverse 1031 exchange in which an intermediary forms an LLC to acquire title to the replacement property. At the time that we receive title to that replacement property the seller typically pays the transfer tax. But once the exchange intermediary has title to the property we are going to eventually transfer that to our taxpayer. Will there be deed tax on that transfer?

The state of Minnesota really is quite flexible and accommodating in understanding that the deed tax has already been paid once by the seller of the replacement property to the intermediary. The subsequent transfer from the intermediary to the taxpayer is generally not taxed in Minnesota unless we’ve increased the value of the property by constructing improvements.

Other States

Now other states such as Wisconsin are much more aggressive in collecting the transfer tax and in those states you make it twice – once for the transfer to the intermediary and secondly from the intermediary to the taxpayer. Strategically we can talk about your situation and decide which property is most advantageous to park. Because of the reverse exchange rules we have the flexibility of parking either the relinquished property that will be sold or alternatively the new replacement property that will be received. Transfer tax can come into that equation and determine what’s the best property for you to park in your reverse exchange.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

When Should You Start Looking for 1031 Exchange Replacement Property

In a 1031 exchange, timing is everything and many investors have questions about when to take action during the exchange process. A lot of timing questions come up when dealing with replacement property. For example, when should you begin to look for replacement property? Can you begin before you sell your relinquished property? That’s our topic for this article.

Replacement Property Timing

When you begin a 1031 exchange by selling your relinquished property, the clock immediately starts ticking. At that point, you’ve only got 180 days to finish up your exchange. The first 45 of those days are set aside as your exchange period. This is the time during which you need to identify in writing the replacement property that you wish to exchange into.

That being said, it’s never a bad idea to start early and lay the groundwork for a successful exchange. You can certainly start looking for replacement property before you begin your exchange. In fact, doing so is a good strategy to ensure that your exchange runs smoothly.

1031 Exchange Services in MN

If you are searching for 1031 exchange services in Minnesota, you’ve come to the right place! CPEC1031 has been facilitating exchanges of real property for more than two decades. Our intermediaries can help you navigate the 1031 exchange process and, ultimately, save money in capital gains taxes. Contact our team today to learn more about our services and discuss the specifics of your like-kind exchange. You can find us at our primary office located in downtown Minneapolis. In addition to that, we have satellite offices around the country.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved