<p>The <a href="https://www.accruit.com/exchange-library/internal-revenue-service-regul…; target="_blank">IRC Section 1031 regulations</a> have at their core a rule against the taxpayer being in actual or constructive receipt of exchange proceeds.&nbsp; This rule covers the period of time from the point of sale of relinquished property to the purchase of replacement property.&nbsp; Of course, once the 180-day exchange period lapses the ability to do a delayed exchange is over and the funds can be returned to the taxpayer. The reason for this requirement is based upon the underpinnings of the delayed exchange regulations themselves.&nbsp;</p>

<h2>Safe Harbor Exchange</h2>

<p>Prior to the issuance of the 1031 regulations in 1991, it was thought that for a valid exchange the taxpayer needed to sell relinquished property and acquire replacement property simultaneously.&nbsp; The replacement property could come from the buyer of the relinquished property or from a third party joining in the closing.&nbsp; For the first time, in 1991, the IRS provided a “safe harbor” mechanism to allow a delay of up to 180 days from the sale to the purchase.</p>

<p>The safe harbor mechanism allowed the exchanging taxpayer to direct the proceeds from the disposition of the relinquished property to a special account. The funds in the special account are held there until they can be used to acquire the replacement property that the taxpayer has designated to complete his exchange. The funds can be distributed to the seller after certain time periods if the taxpayer is unable to acquire suitable replacement property.</p>

<p>The special account can be one in which the exchange company (a qualified intermediary such as Accruit) is holding the funds on behalf of the taxpayer, or it may take the form of an escrow or trust account.&nbsp; &nbsp;In each case, consistent with the concept that the proceeds from the sale of the relinquished property were not received by the taxpayer but that the taxpayer is receiving like-kind property instead, the taxpayer is not permitted to take possession of or otherwise use the funds until they are used to acquire replacement property. &nbsp;Should the taxpayer have actual or constructive receipt of the funds, he is deemed to have sold the property and any subsequent purchase would not constitute a valid exchange; rather it would be considered like any other sale and purchase for cash, and there would be no tax deferral.</p>

<h2>Examples of Actual or Constructive Receipt</h2>

<p>There are times when a taxpayer sells relinquished property and has the bona fide intention to do an exchange.&nbsp; The taxpayer leaves the closing with a check payable to him in hand, arrives home and calls an exchange company to discuss next steps.&nbsp; Even though he has not deposited the check and has every good faith intention of doing an exchange, his receipt of the check puts him in actual receipt thereby negating the possibility of an exchange.&nbsp;</p>

<p>Constructive receipt is similar.&nbsp; Let’s say at the end of a closing, the taxpayer’s lawyer puts the proceeds in the lawyer’s clients’ funds account. The lawyer’s possession of the funds is imputed to the taxpayer. The lawyer, an agent of the taxpayer, causes the taxpayer to lose the opportunity to do a delayed exchange under the applicable safe harbor.&nbsp;</p>

<h2>The (g)(6) Provisions of the Regulations</h2>

<p>The actual rule disallowing any exchange where the taxpayer has actual or constructive receipt is generally referred to as the “(g)(6)” rule:</p>

<blockquote>
<p>“(6) ADDITIONAL RESTRICTIONS ON SAFE HARBORS UNDER PARAGRAPHS (g)(3) THROUGH (g)(5). (i) An agreement limits a taxpayer's rights as provided in this paragraph (g)(6) only if the agreement provides that the taxpayer has no rights, except as provided in paragraphs (g)(6)(ii) and (g)(6)(iii) of this section, to receive, pledge, borrow, or otherwise obtain the benefits of money or other property before the end of the exchange period.”</p>
</blockquote>

<h2>Lender Issues and the (g)(6) Provisions</h2>

<p>Quite often a taxpayer’s real estate is used to secure other loans that a taxpayer receives.&nbsp; For example, a taxpayer may give a mortgage on its building to its bank to secure a business line of credit.&nbsp; When the taxpayer sells the building, the mortgage will be released and the bank may be under-secured on the business line of credit.&nbsp; To protect itself, the bank may want to take a pledge of the funds in the exchange account pending the purchase of a new building in which the bank might take a new mortgage. However under the (g)(6) provisions, the taxpayer cannot “pledge, borrow, or otherwise obtain the benefits of money” in the exchange account in order to maintain the necessary loan collateral.&nbsp; Thus, the exchange account <em>cannot</em> be pledged to back up the line of credit. This tends to be a common problem.&nbsp;</p>

<p>If the lender is willing to be flexible, there are some potential work-arounds for this problem. Michael Tuchman, a tax and transactional lawyer at the Chicago law firm of Levenfeld Pearlstein who represents various exchange companies, lenders and taxpayers doing exchanges, has written a short memo on some of the <a href="/sites/default/files/1031-g6-restrictions-lenders-tuchman.pdf" target="_blank">techniques that can give the lender a reasonable degree of comfort without necessarily violating the (g)(6) provisions</a>. Taxpayers should, of course, consult their own tax advisors for situation-specific advice. &nbsp;</p>

<h2>Summary</h2>

<p>The ability to defer tax under IRC Section 1031 and the associated regulations can be very valuable to taxpayers.&nbsp; However, in order to benefit from this tax deferral, strict adherence to the 1031 rules is required.&nbsp; One key rule is ensuring that the seller/taxpayer does not assert any ownership of the sale proceeds during the pendency of the transaction.&nbsp; Actual or constructive receipt of funds evidences an ownership interest and violates the exchange rules.&nbsp;</p>

<p>Any attempt to pledge exchange funds during the exchange would constitute evidence of an interest in the funds and is specifically disallowed.&nbsp; In certain situations, this lack of the ability to pledge causes significant issues to lenders who need to make sure they have sufficient collateral while not wanting to cause a breach of the taxpayer’s transaction.&nbsp; There are a few measures that can ameliorate this problem by allowing some degree of protection to the lender without rising to the level of pledging the funds.</p>

<p>&nbsp;</p>

<p><em>There is a <a href="https://www.accruit.com/blog/reporting-1031-exchange-irs-form-8824&quot; target="_self">newer version</a> of this post.</em></p>

<p>With the first quarter of 2016 nearly over, owners of heavy equipment are busy finalizing their 2015 financial statements.&nbsp; Once those financial statements are complete, accountants will be busy preparing the related tax returns.&nbsp; For those owners who have completed a 1031 like-kind exchange, a <a href="https://www.irs.gov/pub/irs-access/f8824_accessible.pdf&quot; target="_blank">Form 8824</a> will need to be prepared and filed with the Internal Revenue Service (IRS).</p>

<h2>What is Form 8824?</h2>

<p>Titled, “Like-Kind Exchanges (and section 1043 conflict-of-interest sales)," Form 8824 serves two primary purposes:</p>

<ul>
<li>To allow business owners to report the deferral of gains through Section 1031 tax deferred exchange transactions</li>
<li>To allow certain members of the Federal Government to report the deferral of gain through conflict-of-interest sales</li>
</ul>

<p>The form is divided into four distinct parts, including:</p>

<ul>
<li>Part I – Information on the like-kind exchange</li>
<li>Part II – Related Party Exchange Information</li>
<li>Part III - Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received</li>
<li>Part IV – Deferral of Gain From Section 1043 Conflict-of-Interest Sales</li>
</ul>

<p>For the purposes of reporting any like-kind exchange activity, equipment owners need only be concerned with the first three parts of the form.&nbsp; Part IV is simply not required for someone that isn’t a member of the Federal Government’s executive branch, or are considered judicial officers under the same.</p>

<h2>Part I – Information on the Like-Kind Exchange</h2>

<p>This section covers the basics of the 1031 exchange, including:</p>

<ul>
<li>Description of the relinquished property (property sold)</li>
<li>Description of the replacement property (property acquired)</li>
<li>Date the property given up was originally acquired</li>
<li>Date the property replacement property was actually received</li>
</ul>

<p>Part one also asks if any like-kind property was either sold to, or purchased from a related party.&nbsp; If the answer is yes, then the form’s preparer must complete Part II.&nbsp; If the answer is no, then the preparer may skip Part II and move on to complete Part III.</p>

<h2>Part II – Related Party Information</h2>

<p>It’s interesting to note, this section does not require any calculations.&nbsp; It simply asks for some basic information about the related party transaction, including:</p>

<ul>
<li>The related party’s name, address and relationship</li>
<li>Timing of any dispositions (by the related party) of the property received from the equipment owner</li>
<li>Timing of dispositions related to the property acquired by the equipment owner</li>
</ul>

<h2>Background on Related Parties</h2>

<p>Part II addresses very specific concerns regarding what is known as basis shifting.&nbsp; In these transactions, <a href="/blog/1031-tax-deferred-exchanges-between-related-parties">related parties were working together by exchanging low basis property for high basis property</a> with the immediate plans to sell, at a gain, the lower basis property.&nbsp; By following this strategy, related taxpayers were effectively reducing the gain on the sale of the low basis property.&nbsp; For like-kind exchange purposes, related parties are defined under Internal Revenue Code Section 267(b) or 707(b)(1) and can include:</p>

<ul>
<li>Family members, including brothers and sisters, husbands and wives, lineal descendants, ancestors</li>
<li>Individuals and corporations, where more than 50% of the value of the stock is owned directly or indirectly by or for the individual</li>
<li>A corporation and a partnership if the same persons own more than 50% in the value of the outstanding stock of the corporation and more than 50% of the capital interest or profits interest in the partnership.</li>
</ul>

<h2>Part III – Realized Gain or Loss, Recognized Gain, and Basis of Like-Kind Property Received</h2>

<p>This entire section is dedicated to determining the results of the like-kind exchange.&nbsp; Of the 14 total lines contained within this section, eight are simple addition and subtraction fields.&nbsp; This leaves the form’s preparer with some additional work to gather the data for the remaining six fields.&nbsp; It’s critical to avoid being fooled by the form’s apparent simplicity.&nbsp; The tax preparer must understand the precise meaning of this section’s terminology and each line’s requirement in order to complete the form correctly.&nbsp; Amongst other things, Part III will require the following:</p>

<ul>
<li>Fair market value and adjusted basis of other property given up</li>
<li>Cash received and fair market value of other property received</li>
<li>Net liabilities received by the other party</li>
</ul>

<h2>Summary</h2>

<p>For the vast majority of exchanging equipment owners part four of Form 8824 will simply not apply, and as such it can be ignored.&nbsp; However, equipment owners should carefully report each and every exchange of like-kind property using the first three parts of this form.&nbsp; In doing so, equipment owners can effectively communicate to the IRS why the disposition(s) of their equipment, should not trigger any income taxation.&nbsp;</p>

<p>&nbsp;</p>

<p>When selling or purchasing an investment property in a <a href="https://www.accruit.com/property-owners/1031-exchange-explained&quot; title="1031 Exchange Explained">1031 exchange process</a>, certain selling expenses paid out of the sales or <a href="/services/1031-exchange">1031 exchange</a> proceeds will result in a taxable event for the exchanger. Routine selling expenses such as broker commissions or title closing fees will not create a tax liability. Operating expenses paid at closing from 1031 proceeds will create a tax liability for the exchanger.</p>

<p>The IRS, through various revenue rulings has provided guidelines for allowable and unallowable closing and settlement costs based on common geographical practices and standards.</p>

<h2>Allowable closing expenses for <a href="https://www.accruit.com/blog/complex-issues-concerning-section-1031-tax…; title="irs 1031 exchange">IRS 1031 exchange</a> purposes are:</h2>

<ul>
<li>Real estate broker’s commissions, finder or referral fees</li>
<li>Owner’s title insurance premiums</li>
<li>Closing agent fees (title, escrow or attorney closing fees)</li>
<li>Attorney or tax advisor fees related to the sale or the purchase of the property</li>
<li>Recording and filing fees, documentary or transfer tax fees</li>
</ul>

<h2>Closing expenses which result in a taxable event are:</h2>

<ul>
<li>Pro-rated rents</li>
<li>Security deposits</li>
<li>Utility payments</li>
<li>Property taxes and insurance</li>
<li>Associations dues</li>
<li>Repairs and maintenance costs</li>
<li>Insurance premiums</li>
<li>Loan acquisition fees: points, appraisals, mortgage insurance, lenders title insurance, inspections and other loan processing fees and costs</li>
</ul>

<p>To reduce the taxable consequences of these operating, financing and other closing fees, try to:</p>

<ul>
<li>Pay security deposits, pro-rated rents and any repair or maintenance costs outside of closing, or deposit these amounts in escrow with the closing agent.</li>
<li>Treat accrued interest, prorated property tax payments or security deposits as non-recourse debt that the exchanger is relieved of on the sale of their old property, which could be offset against the debt assumed on the replacement property. Note: this would only work if mortgage debt is obtained on the replacement property purchase that exceeds the mortgage debt paid off on the sale of the relinquished property.</li>
<li>Match any prepaid taxes or association dues credited to the investor against the unallowable closing expenses listed on the settlement statement.</li>
</ul>

<p>Check with your tax advisor prior to the closing to review the closing settlement statements to determine if there is an opportunity to <a href="https://www.accruit.com/blog/primer-1031-exchanges-and-related-types-ex…; title="Avoid a taxable transaction in your 1031 exchange">avoid a taxable transaction in your 1031 exchange</a>. It’s possible that an exchanger has a long term loss carry forward or non-recognized passive operating losses that could offset the taxable amount.</p>

<p>Please note that all material provided in this newsletter is for informational purposes only and the author is not providing legal, tax accounting or other professional services. The accuracy of the information provided as it pertains to your situation is not guaranteed. Please seek professional consultation if legal, tax accounting or other expert assistance is required.</p>

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<p>In 2007, Michael Bay directed the film <em>Transformers</em>, which some might argue was his greatest film to-date. <em>Transformers </em>follows a young man who gets tossed into an alien war between the Autobots and the Decepticons, both of whom are on Earth disguised as different motor vehicles but can transform into huge warring robots in a moment. It was way back in 1984 when Hasbro launched the Transformer line of toys that inspired the recent films. Toys that had kids around the world singing the refrain, <em>Transformers! More than meets the eye!</em></p>

<p>Qualified intermediaries (QIs) are more than meets the eye as well. No, they don't transform into vehicles or robots, but they are often seen in a limited light. You’re likely aware of the QI's primary duties in a 1031 exchange:</p>

<ul>
<li>Structuring the 1031 exchange</li>
<li>Preparing the related documentation</li>
<li>Safeguarding proceeds from the sale of the relinquished property(ies)</li>
<li>Continuous monitoring and advising to ensure compliance with federal and state 1031 and QI requirements</li>
</ul>

<p>While these are important responsibilities, a QI can add value in the following areas, as well:</p>

<ul>
<li>Exchange related information and expertise</li>
<li>Speaking commitments</li>
<li>Co-sponsoring events</li>
<li>Continuing education courses</li>
<li>Participating in client-facing meetings</li>
</ul>

<h2>Qualified intermediaries provide 1031 exchange-related information and expertise.</h2>

<p>A common phrase heard among QIs is they do not provide tax advice. However, what they can provide is detailed exchange information. How many times does a like-kind exchange (LKE) fail to get off the ground because the exchanger does not have the right information and decides to back out of the LKE? If a person or company has the chance to save 30-40% by conducting an exchange, having a free conversation with a 1031 exchange expert on potential options makes a lot of sense. Paying taxes is never pleasant, but paying unnecessary taxes is ill-advised.</p>

<h2>Qualified intermediaries are available as speakers.</h2>

<p>Throughout the year brokers, bankers, CPAs, and other industry groups organize speaking engagements at conferences and company parties, in front of clients and prospects. QIs, as speakers, are often available to present at such occasions, providing educational value free of charge.</p>

<h2>Qualified intermediaries will often co-sponsor events.</h2>

<p>Similarly, QIs can also help by co-sponsoring events. The real estate industry puts on many events that draw a variety of professionals (title closers, escrow agents, and realtors). QIs are in a position to benefit from shared relationships or contact with new groups of professionals and therefore are often interested in co-sponsoring such events.</p>

<h2>Qualified intermediaries are great sources of continuing education.</h2>

<p>The opportunity to provide training to individuals in need of credit hours remains an effective use of the qualified intermediary’s expertise and time.&nbsp; Realtors, brokers, accountants, and lawyers are among the professionals who require continuing education hours on an annual basis, and many QIs can provide webinar or in-person training to meet those needs. QIs enjoy this opportunity because it allows the QI to introduce themselves and their companies to a new and focused group.</p>

<h2>Qualified intermediaries are available for client-facing meetings.</h2>

<p>Tax topics can make anyone cringe, so it is no wonder that realtors, brokers, and other advisors do not enjoy diving into the details when faced with a client interested in a 1031 exchange. Frequently, a QI is brought in to speak directly with the client, explain the process, and answer their questions.</p>

<h2>Summary</h2>

<p>Your qualified intermediary will structure the 1031 exchange, prepare the related documentation, and safeguard the proceeds from the sale of the relinquished property. The QI will also monitor and advise throughout the exchange to ensure compliance. But there is much more a QI can do to advise, educate, and partner with those interested in learning more about the 1031 exchange process.</p>

<p>In today’s economy any proper advantage should be pursued, whether that is a marketing strategy, discounted pricing, or a tax benefit like a 1031 exchange. When working with a QI, remember to take advantage of their expertise. Qualified intermediaries may have yet to master the art of transforming into robots or vehicles, but they are indeed <em>more than meets the eye</em>.</p>

<p>Photo: <a href="https://www.flickr.com/photos/jquiz/543625766&quot; target="_blank">Jesus Q,</a></p>

<p>The reinvestment goal of any 1031 tax deferred exchange should be to buy replacement property of equal or greater value and to use up all the exchange proceeds in the closing of the replacement property without getting any cash back.&nbsp; Receiving cash, sometimes called boot, won’t generally terminate the like-kind exchange, however, it will likely trigger a taxable event for the taxpayer, and should be avoided.</p>

<p>Sometimes, the taxpayer receives their replacement property settlement statement, and it shows that they are getting cash back.&nbsp; What possibly could have caused this?&nbsp; Below are a few examples of what may have caused the cash back scenario and what can be done to fix the settlement statement prior to the closing in order to avoid the cash boot:</p>

<ul>
<li>Other credits may appear on the settlement statement</li>
<li>Taxpayer loan terms may need to be adjusted</li>
<li>Taxpayer may be purchasing other properties</li>
</ul>

<h2><strong>Credits on the Settlement Statement Contributing to Cash Boot</strong></h2>

<p>If the settlement statement has a credit for earnest money that the taxpayer paid out of pocket, the settlement agent can show an offsetting debit line item and title it “Reimbursement of prepaid earnest money to the buyer.” However, if the qualified intermediary was instructed to pay the earnest money out of the exchange proceeds prior to closing, this offsetting debit is not an option because the taxpayer can’t be reimbursed for an item that they did not prepay out of their pocket.</p>

<p>If the other credits include a credit for property taxes, rent, or security deposit prorations, the taxpayer should consider asking the seller to pay these items to the taxpayer outside of closing or to ask the closer to show these items as paid outside of closing and not as a credit line item.&nbsp; Even though these non-exchange items are customarily shown as a credit, it is best if they are handled outside of the closing.&nbsp;</p>

<h2><strong>Adjusting Loan Terms to Avoid Cash Boot</strong></h2>

<p>If a taxpayer is buying replacement property and is obtaining a loan as a part of the purchase, care must be taken to ensure that all of the exchange proceeds are reinvested into its acquisition.&nbsp; There have been lenders who have advised clients to combine exchange proceeds with a high balance loan, allowing the taxpayers to receive excess cash back in the closing process.&nbsp; In their opinion, the cash back is related to the loan proceeds rather than the exchange proceeds.&nbsp; Unfortunately, the Internal Revenue Service (IRS) does not interpret cash back through the closing that way.&nbsp; From the IRS’s perspective, the taxpayer is tapping equity through the exchange, and the equity (cash) received will be considered taxable boot if it is done through the closing.&nbsp; A better route would be to:</p>

<ul>
<li>Lower the loan amount or</li>
<li>Consider a principle reduction on the settlement statement for the amount of the excess cash back</li>
</ul>

<p>If the goal is to get some cash back without triggering taxation, one can refinance the relinquished property prior to starting an exchange or refinance the replacement property after the exchange is complete.&nbsp; Refinancing the relinquished property prior to selling is generally discouraged unless you can argue that the refinance was not in anticipation of the upcoming exchange or it was for independent business reasons.&nbsp; The preferred method is to refinance the replacement property after the exchange is complete.</p>

<h2><strong>Purchasing Additional Properties to Avoid Cash Boot</strong></h2>

<p>If cash remains after the measures above are taken, there is a chance the taxpayer has the intent to purchase more than one replacement property.&nbsp; If that is the case, the closer should only credit the buyer for proceeds needed to purchase the property, without sending cash back to the buyer.&nbsp; The remaining proceeds will be held by the qualified intermediary pending further purchase transactions.</p>

<p>If the taxpayer is struggling to find properties to consume their remaining exchange proceeds and still within the 45-day identification period, they should call their qualified intermediary or counsel to discuss alternative forms of investment.&nbsp; Many taxpayers do not realize that investing in certain <a href="/blog/interview-energy-1031-specialist-wolf-hanschen">energy royalty interests</a>, water rights, or <a href="/blog/fractional-ownership-real-estate">passive fractional interests (Delaware Statutory Trusts)</a> may qualify as like-kind under the 1031 rules and allow them to further their tax deferred reinvestment goals.</p>

<p>Photo: <a href="https://www.flickr.com/photos/teegardin/5912877757&quot; target="_blank">Ken Teegardin</a></p>

<p>A basic premise of the 1031 like-kind exchange is that the relinquished property and the replacement property have to be like-kind to one another.&nbsp; But what constitutes like-kind in the context of real estate exchanges is probably not what you might suppose it to be.&nbsp; Here, I will examine types of property interests that are considered like-kind to a conventional interest in real estate.</p>

<h2>Where is "like-kind" defined?</h2>

<p>The question of what like-kind is when exchanging real estate is very broad.&nbsp; This is not defined in the tax code or in the <a href="/exchange-library/internal-revenue-service-regulations-irc-%C2%A71031">1031 exchange regulations</a>, rather it follows case law history, sometimes going back to English Common Law and IRS rulings. For real estate, any type of real estate is like-kind to any other type. For example, an investment condominium would be like-kind to vacant land bought for appreciation.&nbsp;</p>

<h2>What are some other real estate property interests?</h2>

<p>The fullest and most complete ownership in land is known as a fee simple, or a fee interest.&nbsp; A fee simple ownership can pertain to a taxpayer’s relinquished property or the replacement property.&nbsp; This is also the most common interest that people own in real estate.&nbsp; However there are many additional types of property ownership that are considered as like-kind to a fee interest and like-kind to each other.&nbsp; Such property interests include:</p>

<ul>
<li>Installment Agreement for Deed (buying on contract)</li>
<li>Easements on real estate</li>
<li>Long term lease interest</li>
<li>Cooperative apartments</li>
<li>Certain oil, gas and mineral interests</li>
<li>Water rights not limited in term or amount</li>
<li>Certain option agreements for real estate purchase</li>
<li>Improvements made on real estate</li>
</ul>

<p>Let’s look more closely at a few of these other real estate interests.&nbsp;</p>

<h2>Installment Contracts for Deed</h2>

<p>In the case of a person’s interest as a purchaser under an Installment Agreement for Deed, also known as Articles of Agreement for Deed, due to the legal principle of equitable conversion, the purchaser under the contract is considered to own the real estate even though the purchaser does not receive a deed until all payments due under the Agreement for Deed are made.&nbsp; As such, the purchaser could sell his or her interest under the contract and buy something outright like a fee interest in real estate.</p>

<h2>Easements</h2>

<p>An easement is another real property ownership interest that can be exchanged for a fee interest in real estate.&nbsp; For example an owner of land which contains a cell tower can sell that interest by conveying the buyer an easement on the portion of land where the cell tower is situated.&nbsp; This often includes the assignment of the cell tower lease to the easement purchaser as well.&nbsp; Although the lessor’s interest in the lease cannot be the subject of a real estate exchange, the value of the rental income under the lease can affect the value of the easement being transferred.</p>

<h2>Leases</h2>

<p>A lessee’s interest under a long-term lease has long been considered by the courts and the IRS to constitute a real estate interest.&nbsp; As such it may be exchanged for a fee interest.&nbsp; To distinguish a long-term lease from anything less, the lease has to have 30 years or more to run as of the time of sale of the lease interest.&nbsp; Although the remaining term of the lease may be of some lesser term at the time of sale, for determining whether it is long-term includes the time of any option periods under the lease.&nbsp; As an example, if at the time of the sale of the lease, it has ten years to run, but it also includes two ten-year renewal options, that would be considered a lease of thirty years or more.&nbsp; As such it could be exchanged for a fee interest.</p>

<h2>Cooperative Apartments and Land Trusts</h2>

<p>Cooperative apartments, known as co-ops, are generally owned by unit owners as holders of stock in the corporation which holds title to the property.&nbsp; In addition, the unit owner usually gets a lease to his or her unit.&nbsp; Although exchanges of stock are not allowed under the tax code, the IRS has issued several letter rulings confirming for 1031 exchange purposes, the interest of a taxpayer in a co-op can be exchanged for other interests in real estate.&nbsp;</p>

<p>Illinois-type land trusts (found in various other states as well) are similar. The land trust company, the trustee, holds legal title to the real estate on behalf of its customer, the land trust beneficiary.&nbsp; Sales of certificates of trust or beneficial interest are not permitted under the exchange rules, but the nature of the beneficiary’s ownership in a land trust is so much like any direct real property interest that the IRS allows the trustee’s sale of the trust’s interest or a taxpayer selling the beneficial interest in the trust to be treated as like-kind to a fee interest as replacement property.</p>

<h2>Mineral Rights</h2>

<p>Oil, gas and other mineral rights have become increasingly popular as replacement property for taxpayers. These royalty interests provide the taxpayer with an investment where there are no management headaches, and the rates of return are often higher than a conventional real estate “armchair” investment.&nbsp; These royalty interests give the holder a percentage of the mineral interest taken from the property and are considered like-kind ownership trading from a direct real estate investment or trading from a mineral interest into a fee interest.</p>

<h2>Property Improvements</h2>

<p>As a general matter, a person or entity owning land also owns whatever property improvements are situated on the land.&nbsp; But it is possible to separate the improvements from the underlying land.&nbsp; A party can convey improvements to another party without conveying the underlying property.&nbsp; It is also quite common for the owner of land to lease the land to a party who would erect and own improvements.&nbsp; This is done via a ground lease. This lease technique can be particularly helpful to certain taxpayers who want to use proceeds of sale of a relinquished property to build on property owned by an entity that is related to the taxpayer.</p>

<p>Under IRS rules, a taxpayer cannot build on property the taxpayer already owns.&nbsp; Nor can the taxpayer acquire replacement property from a related party.&nbsp; However, should the taxpayer’s exchange facilitator enter into a ground lease with the related party property owner, build the improvements per the plans and specs of the taxpayer and later turn the improvements over to the taxpayer, the taxpayer is not deemed to have built on property owned by a related party.&nbsp; The reason for this is because the property owner owns the fee which is separate from the lease interest of the facilitator, and consequently the taxpayer is not receiving any replacement property from a related party.</p>

<h2>Summary</h2>

<p>While all 1031 tax-deferred exchanges require the relinquished and replacement property to be like-kind, with real estate exchanges the definition of like-kind is very broad.&nbsp; The real estate does not have to be similar in use.&nbsp; While at first glance there are various interests in real estate that may not appear to be like-kind, upon further analysis, many types of less ordinary real estate interests are like-kind.</p>