<p>Accruit Client Service Manager Asher Azim joins fellow 1031 professionals at the Jeremiah Long Memorial National Conference on Like-Kind Exchanges for in-depth discussion on topics pertaining to Section 1031, including:</p>

<ul>
<li>Current Thinking on What is Real Property</li>
<li>Handling Personal Property in Real Estate Transactions</li>
<li>Critical Analysis of Current DST Offering Paradigms</li>
<li>State Law Issues Affecting Exchanges</li>
<li>Ethical Questions for QIs and Advisors in Like-Kind Exchanges</li>
</ul>

<p>Learn more about the <a href="http://www.1031advancedseminar.com/national-conference&quot; target="_blank">Jeremiah Long Memorial National Conference on Like-Kind Exchanges</a>.</p>

<p>Today, Accruit Associate General Counsel Jordan Born joins scholars, practitioners and other industry professionals at the <a href="https://email.jmls.edu/real-estate/2018/kratovil/1/email.html&quot; target="_blank">16th Kratovil Conference on Real Estate Law &amp; Practice</a> at The John Marshall Law School to discuss potential changes in land use to meet the needs of the commercial real estate industry.</p>

<p>From the conference titled, <em>An Inflection Point in Land Development? Private &amp; Public Conditions Considered</em>:</p>

<blockquote>
<p>Privately created restrictions on use and affirmative responsibilities—those covenants running with the land—structure condominiums and homeowner associations, retail shopping centers, and other real property in such a way that the rights and duties of owners and users stand in the way of the future needs of society. Likewise in the public sector, established land development conditions—exactions, impact fees, in-lieu fees—that may have once made sense may no longer support today's land-use goals and policies.</p>
</blockquote>

<p>Two terms common to the sale and purchase of real estate are “earnest money” and “down payment.” In this blog post, I will review the definitions of each of these terms and how they are used in the context of real estate and escrow. &nbsp;</p>

<h2>What is Earnest Money?</h2>

<p>According to Merriam-Webster, earnest money has various definitions, including:</p>

<blockquote>
<ul>
<li>a serious and intent mental state</li>
<li>something of value given by a buyer to a seller to bind a bargain</li>
<li>a token of what is to come</li>
</ul>
</blockquote>

<p>Earnest money is exactly these things.&nbsp; In the purchase of an asset, it represents an advance deposit made by the purchaser toward the final purchase price.&nbsp; Earnest money establishes the purchaser’s intent to acquire, through the contribution of value as a “token of what is to come.”&nbsp; These dollars are frequently held by a third-party escrow agent, in trust, until conditions for release have been met.</p>

<p>Conditions for release of these funds are negotiated between the seller and purchaser, and the earnest money can be applied against the purchase price of the asset after certain conditions are met, such as:</p>

<ul>
<li>Completion of inspection(s) or testing</li>
<li>Completions of due diligence</li>
<li>Purchaser’s procurement of additional financing</li>
</ul>

<p>The terms of the purchase or sale contract will determine whether the earnest money is refunded to the purchaser or retained by the seller.&nbsp; Ultimately, earnest money can effectively be used to protect both parties.&nbsp; If the purchaser is unable to fulfill certain contracted obligations, then the seller may retain the funds and avoid the burden of a settlement through the court system.&nbsp; On the flip side, the purchaser is protected and can get funds back if the seller terminates the agreement or if inspections or due diligence produce a failing event.</p>

<h2>What is a Down Payment?</h2>

<p>Back to Merriam-Webster for the definition of a down payment:</p>

<blockquote>
<p>a part of the full price paid at the time of purchase or delivery with the balance to be paid later</p>
</blockquote>

<p>A down payment differs from earnest money in that, in the case of a down payment, the purchaser and the seller have moved successfully through contracted requirements and have arrived at a lender requirement for the purchaser to place a certain amount of their own money toward the acquisition price of the asset.<br />
&nbsp;<br />
Down payments can vary in amount, depending upon lender requirements and how much the purchaser can reasonably afford.&nbsp; As a general rule, the more the purchaser can apply as a down payment, the better, as the larger amount can make:</p>

<ul>
<li>the loan approval process easier,</li>
<li>the amount of the loan smaller, and</li>
<li>the resulting payments and interest costs lower.</li>
</ul>

<h2>Summary</h2>

<p>While different, earnest money and down payments are a very important part of the sale and purchase process.&nbsp; As stated above, the more a purchaser can apply as earnest money or as a down payment, the better.&nbsp; Large earnest money deposits can encourage the seller toward temporarily taking the asset off the market and accepting the purchaser’s offer.&nbsp; In highly competitive scenarios, earnest money is a powerful tool for the purchaser.&nbsp; Down payments represent another powerful tool for the purchaser, as they indicate a strong commitment to the lender regarding shared risk in the investment.&nbsp;</p>

<p>In a sale of real estate, it’s common for the seller, the taxpayer in a <a href="/services/1031-exchange">1031 exchange</a>, to receive money down from the buyer in the sale and to carry a note for the additional sum due. The taxpayer facilitates financing for the buyer in this way to make the transaction happen. Sometimes this arrangement is entered into because both parties wish to close, but the buyer’s conventional financing is taking more time than expected. If the buyer can procure the financing from the institutional lender before the taxpayer closes on their replacement property, the note may simply be substituted for cash from the buyer’s loan. Regardless of the circumstance for seller financing, without further steps, the taxpayer’s use of the value of the note toward the purchase of the replacement property will be taxable.</p>

<p>In a non-exchange context there is no problem in the taxpayer carrying back a note from the buyer. However, under the exchange regulations, the actual or constructive receipt of the note would run afoul of <a href="https://www.accruit.com/blog/understanding-like-kind-requirement-1031-e…; title="1031 like-kind exchange">1031 like-kind exchange</a> rules. More specifically, as stated in the regulations:</p>

<blockquote>
<p>“If the taxpayer actually or constructively receives money or other property in…. consideration for the relinquished property before the taxpayer actually receives like-kind replacement property, the transaction will constitute a sale and not a deferred exchange, even though the taxpayer may ultimately receive like-kind replacement property.”</p>
</blockquote>

<p>The taxpayer’s receipt of the note would constitute “other property,” and the amount of the note would constitute “boot” and would be taxable. However, there are <u>two ways</u> to work around this adverse consequence, both of which require the note (and instrument securing the note) to be <a href="/blog/safe-harbors-core-section-1031-treasury-regulations">issued in the name of the qualified intermediary f/b/o taxpayer’s name</a>.</p>

<h2>Relinquished Property Buyer’s Note is Used to Purchase Replacement Property</h2>

<p>Once issued in the qualified intermediary’s name, the trick then is to use the note or its value to purchase, in whole or in part, the replacement property. Under certain limited circumstances, the seller of the replacement property may be willing to take the note as part of the payment for the replacement property. Typically, the instrument securing the note would also be transferred to the replacement property’s seller. Although not legally required, the taxpayer would typically be expected to add his guaranty to the note to further enhance the third party seller’s degree of security. The third party seller’s receipt of the note would also allow that party to report the gain on the sale on an installment basis which is beneficial assuming that this party is not also doing his or her own exchange. However, in the real world, it is a bit difficult to expect the seller to agree to accept the note as part of the purchase price.</p>

<h2>Note Buyout by Taxpayer Prior to Replacement Property Purchase</h2>

<p>A solution is for the taxpayer to “buy” or redeem his own note from his exchange account with fresh cash. These funds can be cash that the taxpayer already has available, such as from a home equity line, or it can be from a loan that the taxpayer takes out to buy the note. Essentially, this enables the taxpayer to advance those personal funds into the replacement property even though not receiving the equivalent amount of cash from the buyer at that time. The benefit to the note buyout is that the future principal payments (but not interest) received by the taxpayer over time will be fully tax-deferred.</p>

<p>In the example above, care should be taken during the negotiations with the buyer of the relinquished property to assure that the taxpayer will be receiving sufficient interest on the buyer’s note to offset the costs of any loan taken out by the taxpayer or the time value of the taxpayer’s personal funds used to acquire the note from the <a href="https://www.accruit.com/qi-services&quot; title="qualified intermediary">qualified intermediary</a>.</p>

<p>The taxpayer and qualified intermediary should also be careful in timing when the note is assigned to the taxpayer. There is a natural tendency to pass the note simultaneously upon receipt by the qualified intermediary of the equivalent amount of cash. After all, the client is putting into the exchange account the exact same value that is being taken out. However, because the regulations prohibit the taxpayer from the “right to receive money or other property” during the pendency of the exchange transaction, it is probably a safer practice to to assign the note to the seller simultaneously with the acquisition of the replacement property or after the replacement property has been acquired. Some qualified intermediaries will provide a form they will sign acknowledging the substitution of cash for the note with a promise to distribute the note upon the closing of the exchange account.</p>

<p>For more information about 1031 exchanges, contact Accruit by calling&nbsp;<a href="tel:8002371031" tabindex="-1">(800) 237-1031</a>&nbsp;or emailing <a href="mailto: info@accruit.com" title="info@accruit.com">info@accruit.com</a> today!&nbsp;</p>

<hr />
<p>&nbsp;</p>
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<p>The Tax Cuts and Jobs Act of 2017 (TCJA) that took effect on January 1, 2018 was a major overhaul of the Internal Revenue Code. Late in 2017, while changes to Section 1031 were being contemplated by Congress, Accruit posted <a href="https://www.accruit.com/blog/what-are-effects-tax-reform-1031-tax-defer… blog article concerning some of the proposed amendments or even total repeal of Section 1031</a> being contemplated in Washington, D.C. and the potential adverse effects on tax deferred exchanges.</p>

<p>Fortunately, the TCJA passed by Congress and signed into law by the President generally preserved like-kind exchanges under Section 1031 of the Code. Although Section 1031 has been around for nearly one hundred years, the TCJA now limits the non-recognition treatment to only like-kind exchanges of real estate. While 1031 exchanges relating to real property remain unchanged, the TCJA completely eliminates the ability of a taxpayer to defer the gain on all types of personal property assets after January 1, 2018, such as:</p>

<ul>
<li>Aircraft</li>
<li>Railcars</li>
<li>Franchise and dealership rights</li>
<li>Art and other collectibles</li>
<li>Equipment and machinery</li>
<li>Off-lease assets</li>
<li>Patents and other intellectual property</li>
<li>Vehicles, trucks and trailers</li>
</ul>

<p><br />
As a result of personal property now being excluded from Section 1031 exchanges under the Code, the taxpayer could realize a sizable gain in exchanges of real property that include a significant amount of personal property. For example, transactions involving multi-unit apartment buildings, hotels and restaurants may include substantial personal property to be conveyed in addition to the real estate.</p>

<p>Although the real property may qualify for a 1031 like-kind exchange, the personal property transferred with the real estate cannot be simply disregarded under the TCJA. The taxpayer will need to allocate the portions of purchase price attributable to the real estate and personal property. Unfortunately, the personal property included would likely be considered taxable “boot” in the real property exchange. In such instances the taxpayer should consider the TCJA bonus depreciation and immediate expensing provisions. The accelerated depreciation rules can take much of the sting out to the inability to do an exchange for personal property</p>

<p>Interestingly, the changes implemented by the TCJA also materially affect the world of professional sports. Pro sports teams that trade players are seen as effectively trading those players’ contracts which are regarded as assets for tax purposes. Consequently, it is possible that sports franchises may seek to trade fewer players now that they can no longer use Section 1031 for like-kind exchanges to make player trades on a tax-deferred basis and have to pay taxes each time they make a trade.</p>

<p>Congress enacted significant changes to the like-kind exchange rules under Section 1031 by way of the TCJA. The removal of personal property from like-kind exchanges has adversely affected many taxpayers and greatly impacted other industries. There are no guarantees that will not revisit the notion of repealing Section 1031 exchanges altogether. It is more important than ever before to consult with your legal and tax professionals, as well as the professionals at Accruit, as soon as possible concerning the new law and its impact on your next like-kind exchange of real estate.</p>

<p>In the event of a federally-declared disaster, the IRS will provide relief to taxpayers in the form of extensions on the 180-day exchange period and 45-day identification period rules. Notice of such relief is posted on this IRS web page:</p>

<p><a href="https://www.irs.gov/newsroom/tax-relief-in-disaster-situations&quot; target="_blank">Tax Relief in Disaster Situations</a></p>

<p>Specifics of the tax relief being provided for victims of Hurricane Florence can be found here:</p>

<p><a href="https://www.irs.gov/newsroom/help-for-victims-of-hurricane-florence&quot; target="_blank">www.irs.gov/newsroom/help-for-victims-of-hurricane-florence</a></p&gt;