<p>Sales of cell towers or billboards are quite common. The sale may be from one taxpayer to another or to a company who is in the business of aggregating these assets for its own business of acquiring, owning, and leasing such assets. The value of the cell tower or billboard is largely a function of the value of the lease, i.e. the rent, term, and strength of the lessee. Oftentimes the sale prices can be considerable, which in turn, may cause a significant tax event to the seller. In many instances, the availability of a tax deferred exchange under Section 1031 of the Internal Revenue&nbsp;Code can be the key to enabling a sale to take place.</p>

<h2>Use of Easement for Sale</h2>

<p>As many people know, <a href="https://www.accruit.com/blog/understanding-like-kind-requirement-1031-e…; target="_blank">1031 exchanges must involve like-kind property sold and purchased</a>. This means an interest in real estate must be exchanged for another interest in real estate. In the case of a cell tower or billboard sale, the key is structuring it so that the disposition of the asset is considered the sale of real estate. A sale of a lessor’s interest in a lease does not constitute a real estate interest. However, a real estate sale can be accomplished by creating, or transferring an existing easement, on which the cell tower or billboard is situated. There is substantial case law providing that easements generally are a real property interest. <a href="https://www.irs.gov/pub/irs-wd/1149003.pdf&quot; target="_blank">One particular Private Letter Ruling</a> provides validation of such a structure for the exchange of a cell tower easement. Although a Private Letter Ruling is “private” and can only be relied on by the recipient, the IRS does publish them to let the public know its position on the subject of the ruling.</p>

<h2>Facts of the Private Letter Ruling</h2>

<p>Facts of the PLR included a proposed “exclusive easement” for the site of the cell phone tower and “non-exclusive easements” for road access to the tower, maintenance, and access to the rooftop. transfer of the easement also included an assignment of the lease from the taxpayer to the easement owner. PLR references that most easements are perpetual unless the easement owner abandons the site for a number or years. It also states that a small number of easements are long term but not perpetual in duration.</p>

<p>This PLR provides a roadmap to structing an easement sale which includes the transfer of the lease of the cell tower or billboard located on the easement. It is important to note that the ruling references perpetual and long-term easements. That raises the question whether any cell tower or billboard sale requires a perpetual easement. In the PLR, the easement was to cease if the easement owner abandoned the property. That would seem to affect its otherwise perpetual nature. In addition, in the Analysis section of the PLR, the Service specifically noted that the “Taxpayer will acquire, own and lease perpetual and <em>long-term</em> easements…” [emphasis added]. In the Conclusion section of the PLR the Service states that “an easement acquired by Taxpayer under and Easement Agreement is an “interest in real property” that qualifies, under § 856(c)(5(B), as a real estate asset…”. There is no reference in the conclusion indicating that the long-term easement would be treated differently than a permanent easement.</p>

<p>Also, it should be noted that the taxpayer in the PLR was a REIT and there are some small differences between the Code section real estate definition for REITs and 1031, however those differences are not material for the treatment of the easements.</p>

<h2>No Inference from Treatment of Lessee’s Interest in a Long Term Lease</h2>

<p>People tend to equate the necessary easement term with the well know fact that a lessee’s interest in a lease with more than 30 years to run (including renewal options) is like kind to conventional real estate. Unfortunately, that is not particularly relevant to the issues above. In connection with the cell tower or billboard easement, it is the landowner’s interest in the easement that is being sold and the lessor’s interest in the lease being assigned. That is quite different than a lessee’s interest in a lease.</p>

<h2>Summary</h2>

<p>There is an active market in the sale of cell towers and billboards. Similar assets such as wind farms, solar arrays, turbines, roof top antennas, and fiber optic cable should be capable of being exchanged in the same manner as cell tower and billboard easements. While some of these assets are valued based upon the value of the lease associated with the asset, an owner’s interest in a lease cannot be the subject of a 1031 exchange. PLR 1149003 provides some guidance on how to structure the transfer of the lease value by selling the easement under the leased asset. To maximize the validity of the easement, it would be best if the easement were perpetual in nature. However, it may be possible to do the exchange that is long term in nature. As always, it is always advisable to consult with professional tax or legal advisors before proceeding with such a transaction.</p>

<p>As many have reported, Presidential candidate Joe Biden announced on Tuesday, July 21^st that he plans to raise cash for childcare and elderly services by revamping the rules for 1031 exchanges of real property to limit the tax deferral opportunity to taxpayers with annual incomes of less than $400,000 per year. Targeting 1031 exchanges such as what Biden proposes is not new. Various administrations of both parties have attempted for years to limit the extent of 1031 exchanges or repeal the provision to raise revenue for other programs. Ultimately those attempts have failed when, upon further consideration, they realized that they would have essentially jettisoned a tax provision that is not a “loophole” but was made a part of the Internal Revenue Code in 1921 because it embodied good tax policy and directly influenced economic growth. There were sound reasons this concept was put into the Tax Code nearly 100 years ago. Those policy considerations are true now more than ever.</p>

<h2>Why 1031 exchanges are important</h2>

<p>The reasons for Section 1031 exchanges have become even more important in the tough economic times created by the current pandemic. Repeal or limitation of 1031 exchanges would only run counter to our shared goal of pulling the Country out of current economic doldrums. The <a href="https://www.1031taxreform.com/ling-petrova/">empirical data amassed</a> by diverse groups in the real estate industry is overwhelming that real estate transactions and specifically the ability to defer capital gains by reinvesting in business use or investment property is one of the <a href="http://strongest economic drivers">strongest economic drivers</a> in our country.&nbsp;The temptation to use the dramatic limitation of Section 1031 is shortsighted when viewed in the context of the effect on many other persons, industries and taxing entities that benefit from the frequent transfer of real estate ownership.</p>

<h2>1031 exchange impacts Main Street America</h2>

<p>In addition, contrary to the often used refrain that rich persons or big real estate developers are the main beneficiaries of 1031 exchanges, the fact is that the bulk of real estate exchanges done in this country are in the $500,000 range and many times less than that. In those situations where the exchange value is higher, in situations involving family held Main Street businesses, farms, ranches and other properties, the value being exchanged represents sometimes multi-generational blood, sweat and tears expended in saving up a nest egg that can be used to improve the taxpayers’ properties and quality of life.</p>

<h2>1031 exchanges strongly influence economic growth</h2>

<p>Biden stated that he wants to limit 1031 exchanges so he can use the revenue gained to improve child care and care for the elderly. However, to that point, owners of elder care facilities and child care facilities have regularly used 1031 exchanges to shed themselves of an outmoded facility and upgrade into facilities that better serve the children and elderly folks in their charge. As prior administrations ultimately concluded, when considering the overall impact, it does not make good business sense to overly limit an investment tool that benefits all Americans, spanning all economic strata and demographics, and is one of the most powerful economic drivers this country has.</p>

<p>There are many requirements to ensure for a <a href="/property-owners/1031-exchange-explained">compliant 1031 exchange</a>. One frequently posed question by potential exchangers pertains to what property is considered "like-kind" to another property. It relates to the term “like-kind” referring to two real estate assets of a similar nature irrespective of class or quality, that (if exchanged by the rules) can be replaced without realizing any taxable gain.</p>

<p>The Internal Revenue Code (IRC) Section 1031 defines like-kind property as any property held for investment or use in a trade or business. The relinquished property and the replacement must be of like-kind to qualify for exchange treatment. Put simply, both properties involved in the exchange must be for use in a trade or business, or investment purposes. So, for example, although a personal residence or a vacation home is real estate, since it is held for personal use and not for investment, it would not qualify for exchange treatment. Property held as part of a dealer's or developer's inventory also does not qualify.</p>

<h2>What is "Like-Kind"?&nbsp;</h2>

<p>The rules provide that the words “like-kind” reference the nature or character of the property and not its class or quality. Under the Regulations, things to consider include “the respective interests in the physical properties, the nature of the title conveyed, the rights of the parties, and the duration of the interests.” Based on these provisions, like-kind is defined in the tax code quite liberally in that any real estate is like- kind to any other type of real estate. For example, whether the real estate is improved or unimproved is not significant. Many court cases and rulings have addressed the like-kind standard for real property. Regulations provide examples of like-kind real property, some of which are obvious, others less so. Below are examples of real property interests that can be exchanged for any other type of real estate:</p>

<ul>
<li>Strip center for multi-family rental</li>
<li>Vacant lot for improved property</li>
<li>Improvements on property not already owned</li>
<li>Oil, gas and other mineral interests</li>
<li>Water rights</li>
<li>Cell tower, billboard and fiber optic cable easements</li>
<li>Conservation easements</li>
</ul>

<p>The Regulations also require the replacement property be located within the United States and some of its territories and possessions to qualify as like-kind for property sold in the United States. For example, a taxpayer cannot use proceeds from the sale of an office building in Dallas to acquire an investment property in Mexico. While a Mexican condominium investment sounds like a great retirement plan after the extended rental period is over, it’s not going to pass muster with the IRS when it comes to Section 1031. Property located outside the United States is like-kind only to other property located outside of the United States.</p>

<h2 class="rtecenter">Like-Kind Requirements Takeaways</h2>

<ul>
<li>Like-kind real estate are assets of the same nature or character, irrespective of class or quality that can be exchanged without realizing tax liability under Section 1031</li>
<li>Properties must be held use in a trade or business, or investment purposes but do not need to be similar in class or quality</li>
<li>Any type of real estate is like-kind to any other real estate interest</li>
<li>Many non-traditional real estate interests are like-kind to conventional interests</li>
<li>Properties must be in the United States and some US territories and possessions in order to qualify as like-kind to other properties in the United States</li>
</ul>
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<p>Be sure to discuss 1031 exchange plans with a trusted Qualified Intermediary such as Accruit. Following the like-kind requirements is just one of several rules that must be adhered to in order to complete a successful <a href="https://www.accruit.com/property-owners/1031-exchange-explained&quot; title="1031 exchange">1031 exchange</a>.</p>

<p>There are many types of conventional 1031 exchanges. There are also a lot of exchange-related transactions not specifically covered by Internal Revenue Code §1031. The variety and the terminology associated with the transactions can be confusing to taxpayers. Definitions of many of the terms that follow can be <a href="https://www.accruit.com/glossary&quot; target="_blank">found in our glossary</a>. We hope this primer serves as a valuable guide to learning more about 1031 exchange transactions and the important role of Qualified Intermediaries such as Accruit.</p>

<h2>Two Party Simultaneous Exchanges</h2>

<p>The most basic of all 1031 transactions, the two-party simultaneous exchange involves two taxpayers who swap property with one another. To the extent one has to add cash to make up for a difference in value, the receipt of the cash by the other party is non “like-kind” property and therefore taxable to the recipient. In exchange vernacular the receipt of property which is not like-kind, in this example cash, and therefore taxable is referred to as “boot”.</p>

<p>Taxpayers doing a direct two-party simultaneous exchange do not necessarily need to use an exchange company facilitator provided the contracts are prepared properly and the transaction is closed as an exchange rather than simply two sales and two purchases. Some persons elect to close these deals using an exchange company and to follow the rules for delayed (non-simultaneous) exchanges in order to benefit from the “safe harbor” as to structure that is set forth in <a href="https://www.accruit.com/exchange-library/internal-revenue-service-Regul…; target="_blank">the rules</a>. In fact, recognizing that persons may wish to apply these rules to simultaneous exchanges, the preamble to the exchange Regulations provide:</p>

<p class="rteindent1"><em>The rules in the proposed Regulations, including the safe harbors, apply only to deferred (delayed) exchanges. Commentators noted that the concerns relating to actual or constructive receipt and agency also exist in the case of simultaneous exchanges. They requested that the safe harbors be made available for simultaneous exchanges. Upon review, the Service has determined it necessary to make only the qualified intermediary safe harbor available for simultaneous exchanges. The final Regulations provide, therefore, that in the case of simultaneous transfers of like-kind properties involving a qualified intermediary, the qualified intermediary will not be considered the agent of the taxpayer for purposes of section 1031 (a). Thus, in such a case the transfer and receipt of property by the taxpayer will be treated as an exchange.</em></p>

<h2>Three Party Simultaneous Exchanges</h2>

<p>Most of the points related to a two-party simultaneous exchange apply to this type of exchange as well. The primary difference with this type of exchange is that only one of the parties wishes to do an exchange and the second party has no property to transfer to the taxpayer/exchanger. However, the parties arrange so a third-party seller of a target property is identified. The second party buyer acquires the target property from the third party and exchanges that property with the taxpayer to enable the taxpayer to compete their exchange. This type of transaction also closes simultaneously with all parties at the closing table.</p>

<h2>Delayed or Deferred Exchange</h2>

<p>These types of exchanges are by far most common. Here the taxpayer sells to the party of choice and has 45 days to identify in writing potential replacement property and 180 days (sometimes earlier based on the due date for tax return filing) to acquire one or more of the properties identified. This type of transaction is covered by the <a href="https://www.accruit.com/exchange-library/internal-revenue-service-Regul…; target="_blank">exchange Regulations</a> and requires the use of a “qualified intermediary”. This party, usually an exchange company, acts as a middleman (hence the term intermediary) between the taxpayer, the buyer and the third-party seller. For tax purposes, it is as if the taxpayer <a href="https://www.accruit.com/blog/accruit-ten-thirty-what&quot; target="_blank">sold to the buyer through the intermediary and bought from the seller through the intermediary</a>. Unlike the prior types of exchanges, the sale of the old property and the acquisition of the new property are not simultaneous.</p>

<p>In addition, the Regulations require that the during the period between the sale and the purchase, the proceeds of the sale, i.e. the exchange funds, be held outside the actual or “constructive” receipt of the taxpayer. This can be accomplished in a number of ways, however the most common and simplest is to have the qualified intermediary hold the funds for the benefit of the client. If replacement property is not identified or is identified but not all funds are used for acquisition, all or a portion of the exchange funds are returned to the taxpayer.</p>

<h2>Reverse Exchanges</h2>

<p>Under the exchange Regulations, exchanges have to be completed in the proper sequence. This means the sale of the relinquished property must take place prior to the acquisition of the new or replacement property. However, on occasion the facts are such that a taxpayer must acquire the new property prior to the sale or risk losing the desired new property. This reverse sequence is often referred to as a “reverse exchange.” Since exchanges have to be done in the proper sequence, embarking on this type of transaction is more complicated than a properly sequenced forward transaction.</p>

<p>In September 2000 the IRS issued a <a href="https://www.accruit.com/sites/default/files/Rev%20Proc%202000-37_0.pdf&…; target="_blank">Revenue Procedure</a> providing a means of effectively tying up the new property without running afoul of the 1031 exchange Regulations. The reverse exchange technique, which is really a parking arrangement, essentially consists of the exchange company affiliate taking title to the new property on behalf of the taxpayer to avoid the taxpayer acquiring that property prior to selling the old property. Immediately after the sale of the old property (but no later than 180 days) the exchange company affiliate transfers the new property to the taxpayer. This technically creates the proper sequence.</p>

<p>A second similar technique is also available under the revenue procedure. This entails a sale on paper of the old property to the exchange company affiliate. Immediately after the sale the taxpayer acquires the replacement property. Again, this creates the proper sequence. The taxpayer and exchange company affiliate have <a href="https://www.accruit.com/blog/are-1031-reverse-tax-deferred-exchanges-re…; target="_blank">180 days to find a true buyer of the old property and the buyer’s funds make everyone whole</a>.</p>

<h2>Build-to-Suit or Improvement Exchange</h2>

<p>Build-to-Suit, also known as Construction-to-Suit or Improvement Exchanges pertain to situations where a taxpayer desires to use a portion of the proceeds from the sale of the relinquished property to build on vacant new property or to make improvements to new property being acquired. Since exchanges must be “like-kind” exchanges of real estate, once the taxpayer takes ownership of the new property, any value of improvements completed is considered payment for labor and materials which is not real property and therefore not considered like-kind. This problem can be overcome with a technique which is essentially a reverse exchange.</p>

<p>More specifically, the exchange company affiliate can take title to the replacement property on behalf of the taxpayer and cause the desired improvements to be made while under ownership of the exchange company affiliate. Upon the earlier of 180 days or the completion of the improvements the <a href="https://www.accruit.com/blog/can-property-improvement-costs-be-part-103…; target="_blank">entire value of the real property and improvements</a> is conveyed directly to the taxpayer to complete their exchange.</p>

<h2>Non-Safe Harbor Reverse Exchanges</h2>

<p>The types of reverse and construction exchanges referenced to this point are creatures of the <a href="/sites/default/files/Rev%20Proc%202000-37_0.pdf" target="_blank">Revenue Procedure</a> which outlines the safe harbor requirements for such transactions. Among other requirements of the safe harbor as to structure, the deals are required to wrap up within 180 days from the inception. However, in the real world it is not always practical to complete such transactions within that limited time frame. Especially in the case of significant new construction there are many reasons why the improvements cannot be in place in time to adhere to that short time period.</p>

<p>However, dependent on circumstances, there may be a window of opportunity to do reverse or construction type exchanges for a longer period. While there are no IRS rules explicitly allowing this longer structure, there are various cases and rulings which provide a basis for these transactions. Further the safe harbor Revenue Procedure tacitly acknowledges that these deals may take place even though not explicitly covered in the Revenue Procedure</p>

<p>Further, the Service recognizes that “parking” transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of “parking” transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure…”.</p>

<p>These are generally significant sized properties and the transactions are usually quite complicated. The taxpayer is best served if he/she has knowledgeable professional advisers and can find an exchange company experienced in all the nuances of structuring such transactions to provide the best chance to pass muster if ever scrutinized by the IRS.</p>
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<p>Delaware Statutory Trust Investments (DSTs) have flourished as real estate investments over the past decade. They are an outgrowth of the older Tenant-in-Common (TIC) investments but don’t have some of the burdensome requirements of a TIC investment. In particular, TIC investments require the unanimity of all the co-investors to agree on any actions and that is often difficult to achieve.</p>

<h2>What is a Delaware Statutory Trust?</h2>

<p>The reference to the term DST does little to describe such an investment. Rather, the term describes a simple mini-type trust that is available to establish in the business-friendly state where it originated. The use of the DST structure helps keep title clean in connection with ownership by many co-investors. It separates the investor holding title individually to holding in a new trust where the investor is the beneficial owner. The trustee of the trust can take actions on behalf of the trust beneficiaries (i.e. the DST investors/owners) which does not require agreement by all. One challenge of a DST structure is that the property cannot be refinanced after the initial loan is in place nor can a lease be revised for a single tenant property. These factors are usually dealt with before the DST formation but sometimes the issues may arise later. If so, solutions can be complicated.</p>

<h2>Why invest in a DST?</h2>

<p>A DST is attractive to an investor who desires access to a single property or portfolio of high value, high quality real estate asset(s) that may not otherwise be available to them due to size or service constraints. The investor receives a deeded fractional ownership in the property in a percentage based upon the equity invested. It has some characteristics of a REIT or Real Estate Investment Trust but is different, including the fact that it is often, but not always, just a single property. In addition, the owner of REIT shares holds a partnership interest in the underlying real estate investment. Partnership investments do not qualify for 1031 exchange investments, even if the underlying asset consists of real estate.</p>

<p>These investments generally pay quarterly an amount based upon the excess rent over the property expenses, including any mortgage payments. The rate of return varies from deal to deal based on the specifics of the property and financing. Typically, the sponsor knows the net rent that can be expected and can give the investor the anticipated return for the term of the investment. The holding period of the asset is usually 5-7 years and the investor shares in the same percentage basis the appreciation in value upon sale of the property. This can increase the overall annualized return a couple of percentage points.</p>

<p>The manner in which DSTs are marketed to the public have a lot of characteristics of sales of securities. Over time, the SEC decided to regulate them as actual sales of securities. So, although a DST interest retains the nature of real estate ownership, with some exceptions, they are regulated. They are typically brought to market for syndication by large well-known sponsors, although they have to be acquired through a Broker, Registered Investment Advisor or a licensed Financial Advisor. If a consumer does not have one, the sponsor will usually refer him or her to a few to work with. The broker or advisor must have an agreement in place with the sponsor and not all brokers or advisors have agreements with all sponsors. Typically, the broker or advisor will vet all offerings of the sponsors with whom they have an agreement and that level of due diligence is a benefit to the investor who is unlikely to have the wherewithal to review the investment as closely. All fees are paid by the sponsor and not the investor.</p>

<h2>Delaware Statutory Trust Pros and Cons</h2>

<p>DSTs are popular to people in general who generally wish to have some diversity in their investment portfolio by introducing some real estate component. People like being able to count on the specific return and appreciate not having to deal directly with tenants. They are also extremely popular with 1031 exchange investors for the same reasons but also due to the fact that it can be difficult to identify replacement property within 45 days of sale of their relinquished property and they have certainty of a closing within the applicable 180-day window. Most investments include picking up a pro-rata amount of underlying debt on the property, an important factor for 1031 exchange investors. The debt is non-recourse to the investor but allows the investor to hold new debt equal to or greater than the debt retired upon sale of the relinquished property. A DST or two make this very easy. Exchange investors also sometimes use a DST as a backup in case the primary identified property falls through or the primary property acquisition does utilizethe entire exchange value. The DST purchase can absorb the balance.</p>

<p>Like any investment, DSTs have risks associated with them. The sponsor does due diligence as does the back office of the broker or adviser’s firm, but so should the investor. The prospectus typically does a good job in pointing out other risks of each such individual investment. Also, they are somewhat illiquid once acquired, so the investor should be prepared to stay invested for the term of the deal.</p>

<p>Often times, a 1031 qualified intermediary (QI) will receive a panicked phone call from a taxpayer who closed the sale of their relinquished property, received the sale proceeds and then realized they could have deferred substantial taxes in a Section 1031 exchange. In many of these instances there may not be an opportunity to revive the exchange, however, in some cases, the taxpayer may be able to breathe new life into what was thought to be a lost cause.</p>

<h2>Can you do a 1031 exchange after closing?</h2>

<p>The use of rescission has long been recognized in law generally in connection with transactions not related to 1031 exchanges. However, the Internal Revenue Service (“IRS”) has allowed the use of rescission to correct a problem with an exchange transaction. “Rescission” is not defined in the Internal Revenue Code or the Treasury Regulations, which are the source of most rules used to advise taxpayers. Rather, rescission is a concept which some courts have allowed, and the IRS has blessed, specifically in <a href="https://www.irs.gov/pub/irs-wd/0843001.pdf&quot; target="_blank">Revenue Ruling 80-58</a>, 1980-1 C.B. 1156. The IRS has also issued private letter rulings in the past for taxpayers in specific fact patterns. There is other general authority for rescission in the case of <a href="https://scholar.google.com/scholar_case?case=741284234833876900&amp;hl=…; target="_blank">Penn v. Robertson</a>, 115 F2d 167, 40-2 U.S. Tax Cas. (CCH) P. 9707 (CCA 4th Cir. 1940).</p>

<p>As an example, consider an individual taxpayer closes the sale of a parcel of land in February 2020 for a sizable gain. The taxpayer receives the sale proceeds but later finds out they could have deferred substantial tax liability by doing a 1031 exchange. As long as the taxpayer makes the decision to rescind the transaction in the same tax-reporting period–in this example before 2020 year-end–the taxpayer can contact the buyer and they can agree to rescind the transaction. Of course, should the buyer not be willing to cooperate, or should there be a buyer’s lender who does not wish to participate, this process may not be feasible.</p>

<h2>Seller and buyer agree to rescind. What happens next?</h2>

<p>When a rescission is properly completed, the IRS treats the sale as if it never happened, as long as the taxpayer receives the property back from the buyer and the buyer receives the full purchase price back from the taxpayer on or before the end of the tax reporting period for the taxpayer. The parties may agree they were laboring under mutual mistake of fact or some other reason for the decision to rescind. Another important consideration is when the rescission of the transaction is complete, the parties should have no further obligations to each other to take any further action. If these criteria are met, pursuant to the authorities cited above, the parties are in the exact position they were prior to the sale. The taxpayer and the buyer can then undertake another sale and purchase transaction and close the transaction with the participation of a QI company, like Accruit,&nbsp;receiving the exchange proceeds so it can help process the taxpayer’s 1031 exchange. In order to ease the burden on the buyer during rescission, it may be helpful if the taxpayer agrees to pay for any buyer expenses incurred in accommodating the taxpayer.</p>

<p>Typically, the QI company is not in a position to provide legal advice regarding the rescission process or provide any rescission agreement. There are numerous attorneys and CPA’s nationwide who are knowledgeable in this area of the law and who can help advise the taxpayer.</p>

<p>Do you have an uncommon situation that you have questions about? <a href="https://www.accruit.com/contact-us">Ask our experts</a>.&nbsp;</p>

<p>&nbsp;</p>
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