<h2>Internal Revenue Code Section 1031</h2>

<p><a aria-label="IRC Section 1031" href="/resources/internal-revenue-code-section-1031" title="IRC Section 1031">Internal Revenue Code (IRC) Section 1031</a>, which pertains to tax deferral for like-kind exchanges of assets, has been a mainstay of the tax code since 1921.&nbsp; Originally is was thought that exchanges had to be simultaneous and that the taxpayer had to give up the existing property, the “relinquished property,” and receive the new “replacement property” from the buyer of the relinquished property.&nbsp; The landmark legal decision in Starker v. U.S. held that exchanges did not have to be simultaneous and <a aria-label="IRS Regulations section 1031" href="/resources/internal-revenue-service-regulations-irc-ss1031" title="IRS Regulations section 1031">Internal Revenue Service Regulations: IRC§1031</a> published in 1991 provided a technique whereby the taxpayer did not have to receive the replacement property from the buyer. In fact, neither the taxpayer’s buyer nor seller need to provide their cooperation in order for the taxpayer to execute an exchange.</p>

<h2>What assets are like-kind to one another?</h2>

<p>Determining that assets are like-kind is generally more broad when dealing with real estate than when dealing with personal property.&nbsp; A regular owning of real estate is known as a fee interest.&nbsp; Any type of real estate is like-kind to any other type of real estate.&nbsp; So a parcel of vacant land held for investment would be like-kind to a commercial building, a condominium held for rent is like-kind to an industrial building, and so on.&nbsp;</p>

<p>Some non-traditional asset holdings have also been found to be like-kind to a real estate fee interest such as options, timber and water rights, installment sale agreements, oil and gas rights, co-ops, improvements made upon real estate, and lessee’s interests under long term leases and easements.</p>

<h2>Is a landowner’s income stream from a cell phone tower lease exchangeable?</h2>

<p>A lessee’s interest in a long term lease (30 or more years) including options has been considered like-kind to real estate for a long time.&nbsp; The same cannot be said about a property owner’s interest, as lessor, in a lease or long term lease. The value of an ongoing stream of income from a lease, including a cell phone tower lease, is considered rent and not a real estate interest.&nbsp; However, a private letter ruling (PLR 201149003) put out by the IRS in 2011 suggested a way to effectively convert that stream of income to an interest in real estate that would become like-kind to any other fee interest in real estate.&nbsp;</p>

<h2>How may cell towers be included in a 1031 exchange?</h2>

<p><img alt="cell tower disguised as a pine tree" src="/sites/default/files/files/private/cell-tower-pine-tree-cropped.jpg" style="width:300px; height:450px; margin:5px; float:right" />As noted above, there is a lot of authority that easements are like-kind to real estate.&nbsp; Under the PLR, if a cell tower is part of a permanent easement and the value of the easement is based upon the value of the cell tower lease, then a sale of the easement can be exchanged for other fee interests in real estate. Even if the cell phone tower is not located on an easement, the taxpayer may create the easement prior to the sale of the cell tower and effectively sell the cell tower by selling that easement.&nbsp;</p>

<p>Easements generally can be of a limited term or a perpetual term.&nbsp; The private letter ruling referred to above was based upon a perpetual term easement.&nbsp; Easements can be used for various purposes, such as granting access to property or granting possessory rights in property.&nbsp; It is possible that the IRS would look at the nature of a particular easement to determine whether, if it were long term, it would be like-kind to a fee interest in real estate.&nbsp; It may be that a possessory-type, long-term easement would receive the same tax treatment as a permanent easement, but this was not dealt with in the PLR (See also <em><a href="https://law.justia.com/cases/federal/district-courts/FSupp2/228/1080/24…; target="_blank">Wiechens vs. US, 228 F. Supp. 2d 1080</a></em>). Also, it must be kept in mind that, technically, only taxpayers to whom the PLR is provided may rely upon it, though it is very common for other taxpayers to feel a sense of comfort in reading a favorable PLR on a subject with which they are involved.</p>

<h2>Retaining the Services of a Qualified Intermediary</h2>

<p>A qualified intermediary (QI) is necessary for non-simultaneous exchanges, and the use of one provides a safe harbor for structuring the transaction.&nbsp; The regulations are purposely liberal on the mechanics of transferring the relinquished property to the QI and receiving title to the replacement property back from the QI.&nbsp; One such permitted method, which is the industry standard, is to assign rights in the sale and purchase agreements to the QI.&nbsp; <em>For tax purposes</em>, the QI’s right to receive the property resulting from the assignment of rights is the same as if the QI took title from the taxpayer on the relinquished property and transferred title to the taxpayer on the replacement property.&nbsp; The taxpayer can still “direct deed” the property to the buyer and receive a deed from the seller.&nbsp; There are a few other requirements as well to meet this safe harbor.</p>

<p>Prior to the 1991 regulations, if the taxpayer received and held the sale proceeds, the taxpayer was deemed to have made a taxable sale, regardless of whether replacement property was purchased within the 180 day time period.&nbsp; For a variety of reasons, the other option — allowing the buyer to hold the proceeds until the taxpayer needed to have them applied to the purchase of the replacement property — was a risky proposition.&nbsp; So the regulations provided an additional safe harbor by allowing the QI to hold the funds or for the funds to be placed into an escrow or trust account.&nbsp;</p>

<h2>Current Requirements of a 1031 Exchange</h2>

<p>The 1991 regulations still cover how to complete an exchange to this day.&nbsp; The following documents are common to exchanges in which a Qualified Intermediary is used:</p>

<ul>
<li>Tax Deferred Exchange Agreement</li>
<li>W-9</li>
<li>Assignment of Contract Rights to Sell Relinquished Property</li>
<li>Designation Notice from taxpayer to QI within 45 days of the sale of the Relinquished Property identifying up to three properties the taxpayer may elect to acquire (additional designation rules may be applicable)</li>
<li>Assignment of Contract Rights to Acquire the Replacement Property</li>
</ul>

<h2>Summary</h2>

<p>Not only have tax deferred exchanges been permissible by the IRS since 1921, the ability to effect an exchange has been made much easier as a result of the decision in the Starker case and the regulations that followed.&nbsp; Those regulations, among other things, provide safe harbors for engaging the services of a QI, with whom the taxpayer completes the exchange and who arranges for the funds to be held securely outside the control of the taxpayer.&nbsp;</p>

<p>There is an active market in the buying and selling of cell phone towers, and the ability to sell a cell phone tower and receive total tax deferral by trading into a fee interest in real estate is a valuable tool to prospective sellers.&nbsp; Although the value of the cell phone tower may be the stream of income under the cell phone tower lease, one cannot exchange that income for a direct interest in real estate.&nbsp; However, if the cell phone tower is situated on a permanent easement, the seller may trade an interest in real estate for a new interest in real estate.&nbsp; Even if there is no preexisting easement, the taxpayer may create one prior to the intended sale of the cell tower lease.&nbsp; The 1031 exchange procedures are very form-oriented, and as long as the taxpayer, with the help of a QI, strictly follows the procedures, tax deferral upon the sale of the easement can be realized.</p>

<h2><em>Franchise Assets are no longer eligible for a 1031 Exchange due to the <a href="Tax Cuts and Jobs Act of 2017" title="/blog/tax-cuts-and-jobs-act-2017-and-its-effects-1031-exchanges">Tax Cuts and Jobs Act of 2017.</a></em></h2>

<h2>&nbsp;</h2>

<h2>Can Franchise Assets be Exchanged?</h2>

<p>People tend to equate tax deferred exchanges with real estate but exchanges can be equally advantageous when selling and buying franchises. In 1991 the tax deferred exchange regulations (<a href="/exchange-library/internal-revenue-service-regulations-irc-%C2%A71031">Internal Revenue Service Regulations: IRC§1031</a>) took effect, making completing an exchange easier and simpler than ever before.&nbsp; These regulations allowed for the removal of the buyer of the old property and the seller of the new property as participants in a taxpayer's exchange, with the addition of the qualified intermediary (QI).&nbsp; Also, as part of these new regulations, the asset sale and asset purchase that comprised an exchange could be separated by up to 180 days.&nbsp; Before that it was generally understood that the sale of an asset and the purchase of an another had to take place simultaneously.</p>

<p>It wasn't long before many owners of real estate began exchanging using the safe harbor procedures set forth in the regulations.&nbsp; Although personal property exchanges were covered in depth in the regulations, generally taxpayers' use of the exchange rules to do personal property exchanges lagged behind the use for real estate transactions.&nbsp; Even as personal property exchanges of machinery, equipment, vehicles, etc. gained traction, exchanges of certain intangible personal property interests such as franchise rights continued to be very underutilized.&nbsp; Neither owner-operators nor their professional advisors picked up on the fact that sales and purchases of franchises could be structured to defer taxes.</p>

<p>Since becoming law in 1921, the rationale for the inclusion of tax deferred exchanges in the IRS code, has been that a taxpayer who is vested with an asset (such as a franchise) and who receives in exchange other like-kind assets (such as of a similar franchise or franchises in a different location), and no cash, there is a continuity of holding the same or similar assets.&nbsp; Since the same kind of assets were sold and bought and the taxpayer pocketed no cash, the transaction isn't seen as a taxable event.&nbsp; The gain on the sale of the first franchise assets, the relinquished property, is deferred until the acquired like-kind franchise assets, the replacement property, are sold without a further exchange.</p>

<h2>What Qualifies for Tax Deferral upon the Sale of a Franchise?</h2>

<p>Perhaps the most common franchise exchanges are those that involve fast food restaurants.&nbsp; An owner might have one or more franchise locations that have greatly increased in value over time, value that the owner would like to parlay into additional restaurants.&nbsp; The exchange of such a business was formerly a more straightforward matter, because the IRS regarded the business as a whole entity that included the value of any underlying assets. This changed shortly before 1991's exchange regulations, and now the IRS requires that each underlying asset be seperated and valued individually.</p>

<p>For franchise exchanges this means that the value of the franchise rights are separate from the value of the furniture, fixtures and equipment (FF&amp;E). If a restaurant franchise, valued at $300,000 for the franchise rights and $200,000 for the FF&amp;E, is exchanged for another restaurant franchise with rights valued at $200,000 and FF&amp;E valued at $300,000, the $100,000 difference between the franchise rights sold and those bought would be taxed, even though, taken as whole entities, the two businesses are of equal value.</p>

<p>It's worth noting that any value associated with goodwill, including trademarks and trade names, is not capable of being exchanged, because the regulations state that goodwill is "inherently unique and inseparable from the business."&nbsp; For this reason, sellers of businesses may wish to minimize the value of the goodwill and increase another component asset of the sale which will be capable of receiving like-kind exchange treatment.&nbsp; Inventory and cash-on-hand are also not part of a franchise exchange since, unlike equipment, these assets are not held for use in a business or trade.</p>

<h2>Retaining the Services of a Qualified Intermediary</h2>

<p>A qualified intermediary (QI) is necessary for most exchanges in which the relinquished assets are sold to a buyer and the replacement assets are being acquired from a seller, who is not the same as the buyer of the relinquished assets. The taxpayer essentially sells the relinquished assets to the QI, who in turn sells them to the buyer. Similarly, the taxpayer purchases the replacement assets from the QI, who acquires those assets from the seller.&nbsp; In effect, the taxpayer completes an exchange with the QI.&nbsp;</p>

<p>The regulations are purposely liberal on the mechanics of transferring the relinquished and replacement assets to and from the QI.&nbsp; The standard practice is for the taxpayer to "assign rights," in the sale and purchase agreements, to the QI.&nbsp; For tax purposes, this means that the QI's right to receive the property is the same as if the QI took title from the taxpayer to the relinquished property and transferred title of the replacement property to the taxpayer.&nbsp; Notwithstanding the assignment of rights to the QI, the taxpayer is permitted to make a direct transfer of the assets by bill of sale, or otherwise, of the relinquished assets to the buyer and receive the replacement assets by direct transfer from the seller. There are a few other requirements as well to meet this safe harbor.</p>

<p>The basics of like-kind exchanges are fairly easy to grasp. Generally speaking, most deferred 1031 exchanges are document driven processes involving a distinct set of forms, including:</p>

<ul>
<li>Exchange agreement</li>
<li>Assignment agreements</li>
<li>Notifications of assignment</li>
<li>Formal identification forms</li>
</ul>

<p>Beyond these required documents, correctly structured like-kind exchanges also demand that taxpayers adhere to a strict set of rules that include meeting stringent deadline requirements. These deadline requirements are generally absolute and no good faith exceptions exist if they are not met .¹ Let's explore the 1031 exchange deadlines, what triggers them, and whether or not extensions exist for taxpayers who might have trouble meeting them.</p>

<p>These deadlines are clearly defined within Internal Revenue Code section 1031 ("Section 1031") underlying regulations which, in summary, state that <strong>in every like-kind exchange of property, the replacement property will be treated as like-kind to the relinquished property, IF the replacement property is both identified within the identification period and received by the end of the exchange period</strong> .² These very same regulations go on to define the two stages/periods involved in every deferred exchange, known as the "identification period" and the "exchange period."</p>

<h2>Identification Period</h2>

<p>The identification period, more commonly known as the "45 Day ID period," starts on the day the relinquished property is transferred from the taxpayer to the buyer (the day the benefits and burdens of ownership transfer to the buyer) and ends at midnight on the 45th calendar day after that transfer.³ It's critical to understand exactly when the 45 day identification period begins and ends, as it will determine the exact date by which a taxpayer must complete and deliver, in writing, the identification of their planned replacement property.</p>

<h2>Exchange Period</h2>

<p>The exchange period, also known as the "180 day completion period," is generally known to begin on the day the legal ownership of the relinquished property is transferred from the seller to the buyer and end at midnight, 180 calendar days thereafter.&nbsp; This general understanding is only half correct, as Section 1031's underlying regulations describe a more nuanced end date to this deadline.</p>

<p>In reality, the exchange period does indeed begin on the same date as the identification period and they run concurrently. However, the exchange period ends at midnight upon the earlier of 180 calendar days after the transfer of the relinquished property or the due date of the exchanger's tax return (with extension) as "imposed by chapter 1 of subtitle A of the Code for the taxable year in which the transfer of the relinquished property occurs." ⁴</p>

<blockquote>The bottom line is if you begin a 1031 exchange in the latter part of your tax year, you may not have the full 180 calendar days to complete the exchange. So, be sure to extend your tax return filing deadline to ensure that you have the opportunity to maximize the length exchange period.</blockquote>

<h2>Extension of the Identification and Exchange Periods</h2>

<p>Extensions of time do exist for date driven acts within the Internal Revenue Code.⁵ These extensions are available for taxpayers affected by:</p>

<ul>
<li>Federally declared disasters</li>
<li>Acts of terrorism</li>
<li>Military actions</li>
</ul>

<p>Specifically related to deferred like-kind exchanges, Revenue Procedure 2007-56 allows extensions of both the 45-day identification and the 180-day completion deadlines. Taxpayers conducting like-kind exchanges are only allowed extensions if the Internal Revenue Service issues guidance or publishes notifications related to the three items listed above. The notice/guidance issued by the Internal Revenue Service will:</p>

<ul>
<li>Define affected taxpayers</li>
<li>Detail what acts can be extended/postponed</li>
<li>Describe the length of the extension</li>
<li>Define the location of the disaster area</li>
</ul>

<h2>Summary</h2>

<p>Whether you're just considering a like-kind exchange or you are currently in the middle of one, it's critical to understand the exchange deadlines. As always, be sure to consult with your tax advisor and confirm your understanding of the like-kind exchange stages, their beginning and end dates and any potential extensions of time that might be available to you.</p>

<p>&nbsp;</p>

<p><span style="font-size:10px;">¹ Knight v. C.I.R., T.C. Memo. 1998-107<br />
² Reg. Section 1.1031(k)-1(b)(1)(ii)<br />
³ Reg. Section 1.1031(k)-1(b)(1)(i)<br />
⁴Reg. Section 1.1031(k)-1(b)(2)(i)(ii)<br />
Long, Jeremiah and Foster, Mary. Tax-Free Exchanges under §1031. Thompson Reuters: used as a critical source in the creation of this post.<br />
⁵I.R.C. Section 7508A</span></p>

<p>As Politico noted in a recent report on The Center for American Progress study, <a href="http://cdn.americanprogress.org/wp-content/uploads/2014/09/SteinTaxRefo…; target="_blank">“The Growing Consensus to Improve Our Tax Code,”</a> there are&nbsp; more than 20 tax “proposals that could be areas of common ground. It argues that there are opportunities throughout the tax code for bipartisan action even if comprehensive reform isn't an option.”</p>

<p>The underlying tone of this study is the desire to create a “simpler and fairer tax code.” Wouldn’t that be nice?&nbsp; However, I’m struggling to recall ever having seen Congress make anything simple. &nbsp;"Fair" would take an even greater leap of faith.&nbsp; As business owners, we know better.&nbsp; Simpler to whom?&nbsp; Fairer to whom?&nbsp; Remember my comments in a previous post about a <a href="/blog/why-contribute-political-action-committee">zero-sum game</a>?</p>

<p>The study reports that business tax changes account for nearly two-thirds of the potential reform areas. They include depreciation and expensing, LIFO, 1031 exchanges, carried interest and passive loss limitations related to oil and gas investments.</p>

<p>The <a href="https://www.1031taxreform.com/1031repealissue-2/">Federation of Exchange Accommodators (FEA) recently responded directly to this report</a>, clarifying inaccuracies, myths and misstatements of the legislative history that were noted to justify repeal of Internal Revenue Code section 1031 ("Section 1031") (see page 28 in <a href="http://cdn.americanprogress.org/wp-content/uploads/2014/09/SteinTaxRefo… report</a>).&nbsp; While we all support the goal of making the “tax code work better for everyone – not just the wealthy and well connected,” many disagree that repeal or limitation of Section 1031 would further tax reform goals.&nbsp;&nbsp; Merely deleting code sections in our tax code does not make it simpler or fairer. On the contrary, removing the benefits of like-kind exchanges encourages effectively penalizes business owners who have limited access to capital while hoping to grow operations and maintain their workforce.<br />
&nbsp;<br />
Lawmakers often rely on sources or themes that might promote good political policy but result in decisions that promote bad economic policies. In order to fully understand why Section 1031 like-kind exchanges create good political, tax and economic policy, let’s review some of the myths surrounding the code section’s original intent noted by the FEA in a formal response.</p>

<h2>Myth 1: The Congressional purpose for Section 1031 is no longer relevant</h2>

<p><strong>Truth:&nbsp;</strong><strong>Section 1031 was enacted in 1921 for three primary purposes, two of which are even more relevant today in our global economy</strong><strong>.</strong></p>

<ol>
<li><strong>Avoiding unfair taxation of ongoing investments</strong> to allow taxpayers to maintain investments in property without being taxed on theoretical (i.e. “paper”) gains and losses during the course of a continuous investment.</li>
<li><strong>Encouraging active reinvestment</strong>, which encourages the tax-deferred exchange of property, thus promoting transactional activity.</li>
</ol>

<p>The third primary purpose of the 1921 law had to do with "administrative convenience," which referred to "the difficulty of valuing exchanged property." Three years later in 1924, Congress scrapped administrative convenience as a purpose for Section 1031 as being too vague, however this long-defunct third purpose, which the U.S. Treasury Department acknowledges is no longer true, is curiously the only rationale cited by the Treasury for repeal.</p>

<h2>Myth 2: The absence of a precise definition of “like-kind” is administratively difficult for the IRS and creates the opportunity for abuse.</h2>

<p><strong>Truth: The definition of “like-kind” is well understood. Section 1031 is neither administratively difficult for either the IRS or taxpayers, nor is it abused.</strong></p>

<p>The study, citing the Tax Reform Act of 2014, states that “the current rules have no precise definition of ‘like-kind,’ which often leads to controversy within the IRS and provides significant opportunities for abuse.”</p>

<p><a href="/exchange-library/internal-revenue-service-regulations-irc-%C2%A71031">Treasury Regulations</a>&nbsp;in effect since 1991 provide specific frameworks for determining whether assets are “like-kind.” Like-kind exchanges conducted within the regulatory safe harbors under Section 1031 using professional qualified intermediaries are straightforward transactions that follow a well understood set of rules, procedures and documents. Taxpayers claiming tax-deferral treatment must report certain information on IRS Form 8824 with their tax returns. Determination of whether the rules have been complied with is not complicated. Furthermore, professional qualified intermediaries promote compliance, and are subject matter experts who simplify Section 1031 transactions by guiding clients and their tax advisors through the process, providing proper documentation, holding funds and offering other services.</p>

<h2>Myth 3: Section 1031 allows taxpayers to avoid capital gains taxes (taxation), and to defer gain indefinitely until the gain and related tax are eliminated at death.</h2>

<p><strong>Truth: Under Section 1031, taxes are deferred - not eliminated. At some point the tax gets paid.</strong></p>

<p>The study states that Ways and Means Committee Chairman Dave Camp's (R-MI) staff “caution that the rules enable investors to defer capital gains taxes for decades or avoid them entirely if the owner of the property dies before realizing their gain for tax purposes.” Citing a journal article, the study also asserts that Section 1031 rules are frequently used to “avoid capital gains taxes on real estate investments.”&nbsp;</p>

<p>Section 1031 exchanges structured under the IRS regulatory safe harbors using professional qualified intermediaries are neither tax savings vehicles nor “abusive tax avoidance schemes.” Rather, they are legitimate transactions utilizing an important tax planning tool.</p>

<p><strong>Payment of tax occurs</strong>:</p>

<ol>
<li><strong>upon sale</strong> of the replacement asset;</li>
<li>incrementally, <strong>through increased income tax due to foregone depreciation</strong>; or</li>
<li>by <strong>inclusion in a decedent’s taxable estate</strong>,</li>
</ol>

<p>at which time the value of the replacement asset could be <strong>subject to estate tax at a rate more than double the capital gains tax rate</strong>. It should also be noted that taxpayers utilizing Section 1031 exchanges include corporations and other business entities that cannot “take the gain to the grave.”</p>

<h2>Myth 4: Like-kind exchanges are used only by the wealthy or well connected.&nbsp;</h2>

<p><strong>Truth: Like-kind exchanges are fair and working well for a broad spectrum of taxpayers at all levels.</strong></p>

<p>Section 1031 is fair, benefiting taxpayers of all sizes, from individuals of modest means to high net worth taxpayers and from small businesses to large entities. Transactions represent taxpayers at all levels, in all lines of business, including individuals, partnerships, limited liability companies, and corporations. An industry survey showed that 60% of exchanges involved properties worth less than $1 million, and more than a third were worth less than $500,000. Exchanged properties include real estate, construction and agricultural equipment, railcars, vehicles, shipping vessels and other investment and business-use assets.&nbsp; Tax deferral benefits are only available if the taxpayer continues their investment by acquiring like-kind replacement property.&nbsp; This restriction retains value and stimulates activity within an economic sector that has a positive ripple effect.&nbsp; Thus, even the relatively rare exchanges of art and classic cars stimulate business for auction houses, galleries, artists, framers, insurers, auto dealers, mechanics, body shops and the like.</p>

<h2>Myth 5: Elimination of Section 1031 like-kind exchanges will raise significant revenue.</h2>

<p><strong>Truth: When the impacts of the economic stimulus effect of Section &nbsp;1031 and the effect of depreciation are taken into account, any Treasury revenue raised from elimination of Section 1031 would be negligible.</strong></p>

<p>The study cites the Joint Committee on Taxation’s assertion that the elimination of Section 1031 will raise approximately $41 billion over 10 years.</p>

<p>This ignores the fact that like-kind exchanges are a powerful economic stimulator, encouraging investment in small and medium sized growing businesses and thereby promoting U.S. job growth. Section 1031 exchanges contribute to the velocity of the economy by stimulating a broad spectrum of transactions which, in turn, generate jobs and taxable income through business profits, wages, commissions, insurance premiums, financial services, and discretionary spending by gainfully employed workers.&nbsp; This transactional activity raises state, local and federal tax revenue through transfer, sales and use taxes and increased property taxes. The loss of this economic stimulus would be costly to the U.S. economy, creating a chilling effect on real estate transactions, reduced demand for manufactured goods and job loss, as many transactions would be abandoned or delayed by taxpayers unwilling or unable to withstand an effective tax on their working cash flow.</p>

<p>With respect to depreciable assets, like-kind exchanges are essentially revenue-neutral because gain deferred is directly offset by a reduction in future depreciation deductions available for assets acquired through an exchange. The tax basis of newly acquired replacement property is reduced by the amount of the gain not recognized due to the exchange of the sold property. Consequently, the taxpayer forgoes an equal dollar amount of future depreciation deductions on the replacement property, resulting in increased annual taxable income over time, taxed at ordinary income tax rates.</p>

<h2>Conclusion</h2>

<p>We generally all support the goals of tax reform: to achieve a simpler, fairer and flatter tax code that is more efficient and results in a broader tax base, minimized economic distortion, greater financial growth, job creation and a strengthened economy. However, effective reform requires well-reasoned change.&nbsp; Achieving meaningful reform starts with preserving existing incentives for investment that are proven tools used to spur economic growth and productivity within the United States.</p>

<p>Don’t forget to share your thoughts at <a href="https://www.1031taxreform.com">www.1031taxreform.com</a>.</p&gt;

<h2>When to Use the Services of a Tax Deferred Exchange Company?</h2>

<p>Many people and companies sell appreciated assets, such as real estate, and wish to acquire similar replacement assets without being subject to capital gain tax. Also at times, taxpayers will sell an asset that has been depreciated and do not wish to incur tax caused by the recapture of that depreciation.&nbsp; Almost always the sale and purchase are separated in time and the buyer of the old asset is not the seller of the new asset.&nbsp; The ability to defer these tax consequences can be accomplished by the use of an Internal Revenue Code (IRC) §1031 tax deferred exchange or 1031 exchange.</p>

<p>As discussed in my recent blog post, “<a href="/blog/are-1031-reverse-tax-deferred-exchanges-real-estate-approved-irs">Are Tax Deferred Exchanges of Real Estate Approved by the IRS</a> ”, in 1991, the IRS issued <a href="/exchange-library/internal-revenue-service-regulations-irc-%C2%A71031">regulations</a> governing these types of transaction.&nbsp; Several of the key components of these regulations are the use of an intermediary to tie the sale and purchase together and as a party who can hold the sale proceeds until used to purchase replacement property from the taxpayer’s seller.&nbsp; By using an intermediary the taxpayer is deemed to have sold the old property to the intermediary and through the intermediary to the buyer and to have the intermediary acquire the new property from the seller and transfer it to the taxpayer.&nbsp; The taxpayer is deemed to have concluded an exchange with the intermediary.&nbsp; The taxpayer can have up to 180 days to complete a purchase made after the sale.&nbsp; Consistent with the fact that the transfer of the old asset is not a sale, but rather the first leg of an exchange, the taxpayer cannot receive the proceeds of the sale.&nbsp; Instead the proceeds are held by the intermediary with or without the use of a trust or escrow arrangement.</p>

<h2>Are All Exchange Companies Who Follow the Same IRS Rules Equal?</h2>

<p>We know that the Declaration of Independence states that all persons are created equal.&nbsp; Due to the U.S. Supreme Court’s recent holding in the Citizens United case, we also know that companies are persons too.&nbsp; Does this mean that all exchange companies are equal?&nbsp; No, they most definitely are not equal.&nbsp; The recent South Dakota Supreme Court decision in Kreisers Inc. v. First Dakota Title Limited Partnership is a classic example of what can go wrong using exchange services from a company whose main business is something other than facilitating like-kind exchanges.</p>

<h2>The Case of Kreisers Inc. v. First Dakota Title Limited Partnership</h2>

<p>In the case of Kreisers Inc. v. First Dakota Title, the taxpayer was selling a property and intended to acquire a new property and use some of the proceeds from the exchange to pay for building a new warehouse.&nbsp; These types of exchanges are somewhat complicated since the IRS will not allow the taxpayer to include in the value of the replacement property any money that the taxpayer puts into the property in the form of improvements once the taxpayer takes ownership of the property.&nbsp; Rather, once ownership is taken, money spent for improvements is considered to be the payment of contractor services and the purchase of materials.&nbsp; As such these costs are not like-kind to the sale of real estate.&nbsp; The IRS approved safe harbor work around requires the exchange facilitator to take title to the property on behalf of the taxpayer and causing the desired improvements to be made using the exchange funds.&nbsp; Once the taxpayer takes title to the property, the taxpayer is deemed to be acquiring improved real estate rather than paying directly for labor and materials.&nbsp;</p>

<p>In regard to the Kreiser’s case, as is frequently the case, persons involved on the title insurance side of the transaction held out that they could also provide §1031 exchange services.&nbsp; There was no representation that the title company did not provide any exchange services other than simple, forward exchanges, which are paper transactions and do not involve the facilitator taking title to the property.&nbsp; An attorney at First Dakota, who was also the manager of its title department, did double duty at First Dakota by facilitating exchanges.&nbsp; Apparently there was very little dialog between Kreisers and the exchange representative.&nbsp; The exchange documents were also sent to First Dakota’s outside counsel to review but no questions were asked by outside counsel to Kreisers.&nbsp; Kreisers requested by phone that the title company representative call Kreisers’ local tax advisors presumably to get more information on the planned transaction.&nbsp; According to testimony, that call was never made.&nbsp; At closing, the closing agent at First Dakota briefly summarized the exchange documents and suggested that Kreisers sign a blank new property designation form, which would be filled in later by her to identify the replacement property.&nbsp; Later, Kreisers acquired the new property and requested that First Dakota begin paying for the normal costs of a build out.&nbsp; First Dakota declined based upon the fact that the exchange transaction was not set up as a typical exchange involving new construction.&nbsp; Kreisers filed suit for negligence resulting in the loss of the tax deferral benefit.&nbsp; They prevailed in the lower court and the matter was appealed to the state Supreme Court.</p>

<h2>The South Dakota Supreme Court Decision</h2>

<p>The court upheld the circuit court’s decision noting “The circuit court determined that First Dakota owed Kreisers a common law duty of care when First Dakota held itself out as being qualified to handle §1031 exchanges. First Dakota agreed to provide these services prior to signing any contract with Kreisers”.&nbsp; Therefore, the circuit court concluded that “First Dakota had a common law duty to exercise reasonable and proper care in the handling of the §1031 exchange, including the drafting of the closing documents.” The Supreme Court decision went on to state</p>

<blockquote>“Moreover, as the circuit court highlighted, Kreisers already believed that it had an expert in §1031 exchanges in First Dakota, which never informed Kreisers that its work was limited to forward exchanges.&nbsp; It is important to once again note the complexity of these exchanges.&nbsp; There is no evidence that anyone at Kreisers had any expertise in §1031 exchanges.&nbsp; Kreisers was putting faith in First Dakota to properly exercise its knowledge and expertise to facilitate the §1031 exchange.&nbsp; The circuit court’s finding that Kreisers was not negligent in not clear error”.</blockquote>

<h2>What Can be Taken Away from the Decision in the Kreisers’ Case?</h2>

<p>Sometimes it is best to stick with what you know best, not trying to be all things to all people.&nbsp;&nbsp; There are many companies whose primary business is facilitating §1031 exchanges, yet they do not have a secondary business acting as a title insurance company.&nbsp; A taxpayer should do some due diligence before selecting an exchange services provider such as asking:</p>

<ul>
<li>Are you a member of the Federation of Exchange Accommodators?</li>
<li>Are you compliant with all state required regulations of exchange facilitors?</li>
<li>Do you have Certified Exchange Specialists® on staff?</li>
<li>What types of exchange services are provided by your company?</li>
<li>How many exchanges do you conduct annually?</li>
<li>Do you have a list of client references available?</li>
<li>Do you maintain a fidelity bond?</li>
<li>Are client funds put into a escrow or trust account?</li>
</ul>

<p>It is important to make sure that if all pertinent facts are not given by the taxpayer, an experienced, dedicated exchange facilitator will know what questions to ask to solicit all things relevant.&nbsp; Remember, not all intermediaries are created equal.</p>

<p>As defined by Merriam-Webster: A Political Action Committee or PAC is a group formed (as by an industry or an issue-oriented organization) to raise and contribute money to the campaigns of candidates likely to advance the group's interests.</p>

<p>Being a business owner of a small or medium size company, how can you gain access to those who sometimes determine the fate of your business?&nbsp; Calling on PAC funds at the appropriate time provides a path to meet directly with representatives who, even though they may or may not understand your industry, could close your business or dramatically disrupt the market with a simple “aye or nay” from their lips on the House or Senate floor.&nbsp;&nbsp; So why should you play the D.C. game<em>? </em>And let’s be clear. It is a “game” – a zero-sum game! Someone will win and someone will lose. Why not increase your odds by playing by the Washington D.C. rules to advance your agenda?</p>

<p>Contributing to this access gives you the opportunity to discuss industry issues with those who receive your support.&nbsp; Laying out the industry’s top concerns by simply explaining how a certain regulation could (or does) impact your employees and customers helps the representative better understand potential laws being introduced.&nbsp;</p>

<h2>PACs are Only Funded by Special Interest</h2>

<p>I speak all over the country on the topic of legislative issues specifically related to IRC 1031 like-kind exchanges.&nbsp; When I reference our industry’s PAC, at times, I receive considerable resistance. I simply ask doubters, how do you think our industry is able to pierce disinterested first-level staffers or grab enough attention by the decision makers to ensure our concerns are at least considered?&nbsp; Would you prefer to leave it to the uninformed representatives to determine the fate of your industry or your job?&nbsp; Simply put, PACs contributors are <em>interested</em> in having the opportunity to state their case, support their cause, and yes, express their special interest.&nbsp; If you don’t like the game, that’s OK.&nbsp; But just don’t be upset if you lose.</p>

<p>Representatives simply don’t have the time to read, much less understand the consequences of any <em>one</em> bill.&nbsp; That is where strategically utilizing PAC funds is a very powerful avenue to grab a representative’s attention.&nbsp; It's one way to ensure representatives hear industry concerns. Once an industry's PAC chooses to allocate funds to a certain Senator or Congressman, they have an opportunity to ensure key points are communicated.</p>

<h2>PAC Fund Restrictions</h2>

<p>Political Action Committees have some very specific rules that must be followed so that both you and your selected candidate don’t get entangled in the laws that surround the management of PAC monies.</p>

<ul>
<li>Only individual employees or connected associates can contribute to a PAC. Funds directly from the company are not allowed.</li>
<li>Permission must first be given from an employer prior to the PAC soliciting monies from employees.</li>
<li>Maximum contribution levels need to be monitored.</li>
</ul>

<p>So, the next time you are approached about contributing to a PAC.&nbsp; Ask yourself does this PAC represent my interest?&nbsp; Are those in charge of the PAC able to express the concerns that best represent your interest?&nbsp; Is the PAC targeting the right representatives?&nbsp; As with so much in politics, it is easy to look the other way and simply rely on the ongoing inability of Congress to move anything forward.&nbsp; But, eventually a bill or just a small sentence buried deep within a bill could severely impact an entire industry.&nbsp; As I have said before, “If you are not at the table, then you are most likely on the menu."&nbsp; So consider if your PAC can get a chair at the table.&nbsp; And if so, then do your part to support the seat.</p>

<p><a href="http://www.fea1031pac.org/"><em>Learn more on the official 1031 PAC website</em></a>.</p>

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