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

<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 and who receives in exchange other like-kind assets, and no cash, there is a continuity of holding the same or similar assets. 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. The gain on the sale of the first assets, the relinquished property , is deferred until the acquired like-kind assets, the replacement property , are sold without a further exchange.</p>

<p>Upon the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the types of assets qualifying for tax deferral through an exchange changed dramatically. Tax deferral through 1031 exchanges would only be allowed for what is considered real property (land, buildings, etc.) and not for personal property (heavy equipment, cars, franchises. Therefore, since the passage of the TCJA, the actual franchise rights no longer qualify for a like kind exchange to defer taxes on gains. However, should the investor own the underlying real property where the Franchise resides the investor still could qualify for an exchange on the underlying land/building.</p>

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

<p>Perhaps the most common inquiries around franchise exchanges are those that involve fast food restaurants. 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. 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 separated and valued individually.</p>

<p>For owners/investors of franchises this means that the value of the franchise rights are separate from the value of land, buildings and furniture, fixtures and equipment (FF&amp;E). A restaurant franchise valued at $300,000 for the franchise rights and $750,000 for the land/building can separate the sale of the land/building from the sale of the franchise rights. The land/building would then qualify for a like-kind exchange into land/building for a new franchise or a multitude of other real property deemed like-kind such as a multi-family rental building or farmland.</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." 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. 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. In effect, the taxpayer completes an exchange with the QI. Selecting the correct QI is a decision that should not be taken lightly. Read on to learn more about the considerations for <a href="https://www.accruit.com/blog/1031-exchange-tips-selecting-right-qi&quot; target="_blank">choosing the right QI for your transaction</a>.</p>

<p>Join Roy Pfleger of RVP II Consulting, and David Gorenberg, Managing Director of Accruit, as they discuss the basics of 1031 exchanges, and replacement property options including NNN, TICs, DSTs and more.</p>

<p>Date: Tuesday, December 15th, 2020</p>

<p>Time: 11:00 AM-12:00 PM EST<br />
Location: Online</p>

<p>&nbsp;</p>

<p>&nbsp;</p>

<p>In this 1-hour webinar, you'll:&nbsp;</p>

<ul>
<li>Learn the basics of 1031 exchange, including the process and different types of exchanges</li>
<li>Know how and why to leverage the benefits of 1031 exchange as it relates to various replacement property options, including NNN, TIC, DST, and oil and gas royalties.</li>
</ul>

<p>This webinar is presented in collaboration with RVP II Consulting</p>
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<h2>About the Speakers:&nbsp;</h2>

<h3>Roy Pfleger II, Financial Consultant</h3>

<p><img alt="" src="/sites/default/files/files/Roy%20Pfleger%20Headshot.png" style="margin-left:30px; margin-right:30px; width:100px; height:140px; float:left" />Roy&nbsp;has spent his entire career within the financial services sector. He began his journey at one of the country’s top John Hancock agencies as an intern. During his tenure at John Hancock and over the course of his career, Roy gained vast experience in financial services and excelled in management. Roy oversaw multiple branch offices locally and around the country. He had responsibilities in compliance, supervision, marketing, recruiting, day-to-day operations, administration, life insurance case management, business and investment processing, transitioning books of business and client accounts, and technology implementation.</p>

<p>As the President and Owner of RVPII Consulting, Roy Pfleger&nbsp;set out to break the boundaries of the traditional financial services experience by incorporating his managerial and operational background. By using his knowledge and expertise, Roy focuses on guidance, accountability, and implementation of strategies, to share with his clients along their financial planning journey.</p>

<p>&nbsp;</p>

<h3>David Gorenberg, Esq., CES ®, Managing Director, Accruit</h3>

<p><img alt="" src="/sites/default/files/files/David%20Gorenberg%20Headshot.jpg" style="margin-left:30px; margin-right:30px; width:100px; height:150px; float:left" />A dedicated and successful professional, David Gorenberg has over twenty years of experience in business development and public speaking. His dynamic personality enables him to make effective presentations to groups both large and small, at all professional levels. David has written and spoken extensively on&nbsp;1031 Exchange&nbsp;transactions pursuant to Section 1031 of the&nbsp;Internal Revenue Code&nbsp;, and Tenant-In-Common (TIC) and Delaware Statutory Trust (DST) investment properties as&nbsp;like-kind&nbsp;replacement property&nbsp;solutions for 1031 Exchange transactions pursuant to IRS Revenue Procedure 2002-22 and Revenue Ruling 2004-86.</p>

<p>Prior to joining Accruit, he was with Wilmington Trust, where he served as the Vice President and Product Leader for Wilmington Trust 1031 Exchange, LLC out of Wilmington, DE. Prior to that, he spent six years with Citibank’s 1031 operations, where he built their 1031 Exchange service from the ground up, ultimately generating over $850 million in annual deposits for the bank. In addition he has held leadership positions with three other national Qualified Intermediaries (Accommodators). Prior to becoming a full time&nbsp;Qualified Intermediary&nbsp;, David managed a successful law practice, where he was involved in business and real estate transactions. In that capacity, David has guided his clients through 1031 Exchange transactions since 1992.</p>

<p>&nbsp;</p>

<p>1031 like-kind exchanges or tax deferred exchanges have been part of the United States tax code since 1921, yet they continue to be the subject of a number of misconceptions, some of which are addressed below.</p>

<h2>Myth: 1031 like-kind exchanges are only for the wealthy</h2>

<p>This misconception arises from the visibility that high-profile companies or individuals have when exchanging a large office building or rental property and deferring the tax on the sale of that property. What is being missed is that average everyday people are utilizing like-kind exchanges as well.</p>

<p>A small business owner who owns his 25,000 sq ft warehouse can defer gain on the sale of that space when he uses the proceeds to purchase another building or even a piece of land. An individual who defers tax on selling a small rental property when she buys a replacement property is also taking advantage of Section 1031 of the tax code. These sorts of transactions made by small businesses and middle class investors are frequent, even if they don’t make the headlines.</p>

<p>I had the opportunity to meet a teacher recently in Denver, Colorado who, upon learning about our company, related her own like-kind exchange story. She had purchased a rental home four years ago for a terrific price, and when the market went up, she was able to enter into a contract to sell it for a profit. She was lucky to have a smart accountant who advised her to structure the transaction as an exchange with a qualified intermediary enabling her to reinvest all of the proceeds in another rental, thereby deferring tax on the sale. She did so and has now profited enough to secure a down payment on three rental properties, about which she remarked, “On a teacher’s salary, without 1031s, I would never have been able to own three rentals.”</p>

<h2>Myth: A 1031 exchange must be simultaneous</h2>

<p>When the tax code was first added in 1921, all exchanges were simultaneous. Over time, the <a href="https://www.accruit.com/blog/1031-exchange-any-other-name&quot; target="_blank">two-party simultaneous exchange</a> was expanded a bit in order to provide greater opportunity to complete an exchange.&nbsp;The most common type of 1031 exchange is a forward exchange, in which the proceeds from the sale of one asset is used to purchase an asset considered to be like-kind within 180 days.</p>

<p>There are other <a href="https://www.accruit.com/blog/what-are-1031-exchange-deadlines&quot; target="_blank">1031 exchange deadlines</a>, but the 180-day completion period allows for non-simultaneous exchanges. It is even possible, in a <a href="https://www.accruit.com/blog/are-1031-reverse-tax-deferred-exchanges-re…; target="_blank">reverse exchange</a>, to purchase replacement property up to 180 days prior to selling the relinquished property.&nbsp;</p>

<h2>Myth: The relinquished property must be exactly the same as the replacement property in order to be “like-kind”</h2>

<p>In real estate, the term “like-kind” is remarkably broad. In fact, all real estate property is considered “like-kind.” Land can exchange into an office building; a rental home can exchange into a Delaware Statutory Trust (DST); a multi-family complex can exchange into twenty rental homes. The list could go on, but the point is that there are many options in real estate when doing an exchange.&nbsp;</p>

<h2>Myth: 1031 exchanges are a tax loophole</h2>

<p>Congress established 1031 like-kind exchanges as part of the Internal Revenue Code in 1921 with two primary purposes:</p>

<ul>
<li>To avoid unfair taxation of ongoing investments</li>
<li>To encourage active reinvestment</li>
</ul>

<p>Nearly 100 years later, like-kind exchanges continue to support sales and purchases of real estate and business assets, encourage business expansion, and <a href="https://www.accruit.com/blog/1031-like-kind-exchange-impact-study-resul…; target="_blank">stimulate economic growth</a>. They are an <a href="https://www.accruit.com/blog/preserving-section-1031&quot; target="_blank">intentional and integral aspect of United States tax law</a>, not a tax avoidance strategy. In fact, about 88% of properties acquired through an exchange are later sold through a taxable event.</p>

<h2>Conclusion</h2>

<p>Clearing up the misconceptions about what 1031 like-kind exchanges are and how they work continues to be part of Accruit’s mission, since the first step to employing like-kind exchanges is understanding them. If there’s any audience to whom the use of 1031s is limited, it’s the informed.</p>

<p>Choosing a local Qualified Intermediary (QI) is an important decision, and as such, the process shouldn't be taken lightly. After all, your QI will be guiding you through a maze of federal and state requirements as well as safeguarding the proceeds from the sale of your relinquished property. Given the potential tax consequences involved with an improperly structured exchange and the safety issues related to your proceeds, a true due diligence approach should be taken before committing to a QI.</p>

<p>To begin, let's take a quick look at some of the QI's responsibilities:</p>

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

<p>It's important to note that there is currently no federal regulation of qualified intermediaries. However, with the help of the Federation of Exchange Accommodators (FEA), a number of states, including Colorado, have begun taking the lead in assuring higher professional standards for QIs. Some of the newly enacted requirements (which can vary from state to state) include:</p>

<ul>
<li>Qualified escrow and/or trust accounts for client funds</li>
<li>Minimum bond and insurance requirements</li>
<li>Fund withdrawal authorization requirements</li>
<li>Registration and licensing requirements for QIs</li>
<li>Investment limitations on exchange proceeds</li>
</ul>

<p>These are just some of the new state level regulatory requirements for QIs, and Accruit has taken a leadership role in making sure that legislators are fully informed in order to properly protect exchangers. However, our responsibility to inform doesn't stop there. It also includes educating the marketplace to ensure the right due diligence is performed prior to choosing a QI. Items we advise businesses to research include:</p>

<ul>
<li>The QI's technical expertise and experience</li>
<li>Banking processes and guidelines</li>
<li>Certified Exchange Specialist® (CES®) on staff</li>
<li>Quality control</li>
<li>Insurance and bonding coverage</li>
<li>Employee recruitment (including background checks with continuous monitoring)</li>
<li>Membership in the FEA</li>
<li>Applicability and QI's status related to relevant state regulatory requirements</li>
<li>References</li>
</ul>

<p>This article is merely intended to start a discussion regarding the importance of choosing the right QI locally. In practical terms, the process should be far more in-depth and you should include a trusted tax advisor as part of your decision team.</p>

<p>Working with an independent Qualified Intermediary provides benefits you may not have considered. Learn why working with Accruit is different than QI's who are a part of a larger entity.&nbsp;</p>
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<p>&nbsp;</p>

<p>&nbsp;</p>

<p>Most people are aware that the federal tax law changed at the beginning of 2018 due to the passage of the Tax Cuts &amp; Jobs Act. Some of the significant changes included reducing the capital gain rates and lowering tax rates on corporations. Among other things&nbsp;<a href="https://www.accruit.com/blog/tax-cuts-and-jobs-act-2017-and-its-effects…; target="_blank">the Act eliminated personal property from the tax deferral provisions of IRC §1031</a>, leaving only real estate as an asset eligible for such deferral. This was a significant departure from how §1031 was utilized by taxpayers since its inception in 1921.</p>

<p>Many types of real estate include machinery, equipment and other components that may or may not be considered part of the real estate. Before the change in the law, it was not quite as significant whether those items were so inherently a part of the real estate that they were deemed real estate itself. If they were determined to be personal property and it was likely the trade would include like kind replacement personal property, then the character would not matter much; the real estate portion would be deferred as would the personal property portion.</p>

<p>In order to add clarity to these determinations as to what constituted real estate in this context, in <a href="https://www.accruit.com/blog/proposed-regulations-1031-exchange&quot; target="_blank">June of 2020, the IRS put out proposed regulations</a> on the subject. Essentially, each component had to be analyzed separately to determine whether it was land, an inherently permanent structure, or a structural component of an inherently permanent structure. Land was rather clear but some of the other determinations were difficult to make. For instance, in regard to a component of a structure, the determination was largely based upon function. An example in the regulations referenced different treatment for a gas line that serviced the property generally for heating purposes,&nbsp;compared to a gas line that was used for cooking food that was served by the business. The former was considered part of the real estate for exchange purposes and the latter being used towards the “production of income” and therefore not so. Furthermore, the proposed regulations suggested that reference to local law characterization would not be taken into consideration. This was a departure from prior analyses where local law was a significant part of the determination.</p>

<p>In any event, the IRS took into consideration the significant amount of feedback received and changed the final regulations in favorable ways. Under the final regulations, the asset is considered real estate if (i) it is specifically listed as such in the regulations or (ii) if it is real estate under state or local law and last (iii) if it is “considered real property based on all the facts and circumstances under the various factors provided in the final regulations.”</p>

<p><em>It should be worth noting that the classification of an asset for exchange purposes is not determinative of its classification for other purposes such as taking of depreciation. The asset can be considered real estate for one purpose and personal property for another.</em></p>

<p>The final regulations introduced another favorable rule. After personal property exchanges were disallowed, if exchange funds were directed to a closing for the purchase of replacement property whose purchase price included a personal property component, the exchange could be put at risk. This was seen as an unpermitted use of exchange funds on the part of the taxpayer which, in turn, violated the entire exchange. To provide a solution to this dilemma, the service borrowed on a provision from the original exchange regulations regarding the identification of personal property that was typically incidental to the real property. Examples are office furnishings in the purchase of an office building or hotel furnishings with the purchase of the hotel. This rule, known as the “incidental property rule” states that the personal property did not have to be separately identified from the real property but must be incidental to the real replacement property, having an aggregate fair market value not greater than 15% of the fair market value of the real estate, and must typically be transferred with the real property in a standard commercial transaction. Under the final regulations should part of the purchase price of the real estate include the value of personal property fitting this definition, it will not be considered “actual or constructive” receipt of the funds by the taxpayer otherwise compromising the exchange.</p>

<p>Again, it should be noted that this rule pertains to avoiding a taxpayer getting boxed in when a real estate purchase includes some customary personal property that is not being paid for separately. However, that is not to say that it is disregarded nor considered part of the real estate for gain purposes. It still retains its character as non like-kind property compared to the original sale of real estate.</p>

<p>If you have questions about an exchange that includes property as described above, please&nbsp;get in touch with one of our subject matter experts to discuss your situation specifically.</p>

<p>&nbsp;</p>
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<p>Accruit has previously provided a summary of the rules pertaining to extensions of exchange transactions <a href="https://www.accruit.com/blog/how-federally-declared-disasters-affect-10…; target="_blank">due to federally declared disasters</a>.</p>

<p>The IRS has recently issued extensions&nbsp;for Section 1031 filing deadlines related to real estate located within certain counties in California, Florida,&nbsp;and Louisiana.</p>

<p>In California, the IRS issued extensions for&nbsp;Fresno, Los Angeles, Madera, Mendocino, Napa, San Bernardino, San Diego, Shasta,&nbsp;Siskiyou, and Sonoma counties <a href="https://www.irs.gov/newsroom/irs-announces-tax-relief-for-september-cal…; target="_blank">for wildfires that began on September 4, 2020</a>.</p>

<p>In Florida, the IRS issued extensions&nbsp;Bay, Escambia, Okaloosa, Santa Rosa, and Walton counties&nbsp;<a href="https://www.irs.gov/newsroom/irs-announces-tax-relief-for-hurricane-sal…; target="_blank">for hurricane Salley that began on September 14, 2020</a>.</p>

<p>In Louisiana, the IRS issued extensions for Acadia, Beauregard, Calcasieu, Cameron, Jefferson Davis, Lafayette, Rapides, St. Landry, St. Martin and Vermilion parishes <a href="https://www.irs.gov/newsroom/irs-announces-tax-relief-for-hurricane-del… hurricane Delta that began on October 6, 2020</a>. Extensions were also issued for&nbsp;Acadia, Allen, Beauregard, Bienville, Bossier, Caddo, Calcasieu, Cameron, Catahoula, Claiborne, Evangeline, Grant, Jackson, Jefferson Davis, Lafayette, La Salle, Lincoln, Morehouse, Natchitoches, Ouachita, Pointe Coupee, Rapides, Sabine, St. Landry, St. Martin, St. Mary, Union, Vermilion, Vernon, Webster, West Feliciana, and Winn parishes <a href="https://www.irs.gov/newsroom/irs-announces-tax-relief-for-hurricane-lau…; target="_blank">for hurricane Laura that began on August 22, 2020</a>.</p>

<p>Accruit suggests that affected taxpayers consult with their tax and legal professionals as well as confirm on IRS website for any updates.</p>