Nh Accounting Workbook 8.4.09

Flawless Section 1031 Exchanges for Over 27 Years

Section 1031

For

Accounting

Professionals

Edmund & Wheeler, Inc. QI
It is estimated that 20-25% of the nearly
567 Cottage Street $200B in annual real estate transactions
Littleton, NH 0561 could benefit from a Section 1031
Exchange, and that only 3% take
603-444-0020 advantage of this powerful tool.

Edmund & Wheeler, as a Qualified
www.section1031.com Intermediary (QI), has been facilitating
exchange@section1031.com Section 1031 Exchanges for over 27 years.
We have developed “The Power of Section
1031” to provide a solid understanding of
Section 1031 basics and the strategic ways
in which Section 1031 can be utilized and to
assist accounting professionals in
recognizing opportunities for their clients.

© 2008 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for educational purposes only
and do not constitute tax, accounting, legal or investment advice.

Welcome To Section 1031 for Accounting Professionals. This workbook has been designed to assist you
during the course, and to provide a reference tool for you in the future. The session is broken down into three
sections as described below.

Web references have been made throughout the document so that you can do further topical research as
required. Web references are indicated with a grey arrow. www.section1031.com

If you have additional questions or concerns after you complete this course, Edmund & Wheeler is always
available by email at exchange@section1031.com, by phone at 603-444-0020, or on the Web at
www.section1031.com. Our practice provides accounting professionals with Section 1031 consulting at no
charge!

Section 1 provides you with an outline of this course, an introduction
Section
to the Section 1031 Exchange and the essential elements required for
1&1a successful exchanges. Section 1a provides specific information
required for accounting professionals.
Introduction &
1031 Basics
This section lasts approximately 2 hours and begins on Page 3.

Section 2 contains case studies of the various types of Exchanges as
Section well as real‐life examples of actual transactions that will assist you in
developing your own Section 1031 strategies.
2

Case Studies &
Real-life Examples This section lasts approximately 1 hour and begins on Page 35.

Section 3 outlines the viable alternatives for Exchanges that can be
Section
used for diversification, relocation or the desire of a client wishing to
3 exit from the real estate investment class.

Alternate Exchange
Opportunities This section lasts approximately 1 hour and begins on Page 55.

1 Page Course Summary – “Must Have Section 1031 Concepts”
Summary Commonly used phrases and Section 1031 definitions.
45/180 Calculation Charts
Section 1031
Glossary This section begins on Page 72.

© 2009 Edmund & Wheeler, Inc. All rights reserved. The enclosed materials and hypothetical examples are provided for
educational purposes only and do not constitute tax, accounting, legal or investment advice. 2

Section

1
Introduction &
1031 Basics

Contents
Introduction ...................................................................................................................................................5

About Edmund & Wheeler, Inc......................................................................................................................6

Primary Objectives of This Course ...............................................................................................................7

What Is A Section 1031 Exchange ...............................................................................................................8

The Five Critical Elements of an Exchange ..................................................................................................8

The Regulation .............................................................................................................................................8

An Exchange at a glance ..............................................................................................................................9

Section 1031 (a)(1) IRS Code.......................................................................................................................9

Exceptions to Section 1031 ..........................................................................................................................13

Investment Purpose and the Benefits of an Exchange .................................................................................14

The Essential Elements ................................................................................................................................14

Replacement Property Rules ........................................................................................................................15

Real Property (What is Like Kind?) ...............................................................................................................16

Examples of Like-kind ...................................................................................................................................17

Personal Property .........................................................................................................................................18

Timing Is Everything .....................................................................................................................................18

Can Anyone Handle an Exchange? ..............................................................................................................19

Who Qualifies for an Exchange? ..................................................................................................................19

The Qualification Tool ...................................................................................................................................20

The Five Most Common Section 1031 Misconceptions ................................................................................22


Section

1a
Section 1031 &
Accounting

Contents
How the Different States Approach Section 1031 .........................................................................................24

Reporting an Exchange to the IRS ...............................................................................................................25

Form 8824 ....................................................................................................................................................26

Completing Form 8824 (Part I) .....................................................................................................................28

Completing Form 8824 (Part II) ....................................................................................................................29

Completing Form 8824 (Part III) ...................................................................................................................30

What is Boot? ...............................................................................................................................................31

What is New Money? ....................................................................................................................................31

Exchanges That Cross Two Tax Years ........................................................................................................31

Can a Failed Exchange Be Fixed? ...............................................................................................................32

Section 1031 and Partnerships .....................................................................................................................33

Section 1031 or Section 1033? .....................................................................................................................34


Too many professionals get caught up in the belief that
Section 1031 is only about deferring capital gains. While it
is one of the remaining tax deferral tools available, it’s
actually a LOT about leverage. Clients using what they
would have paid immediately in capital gains taxes to
improve the quality and value of their holdings and plan
for their financial future, is REALLY what Section 1031 is
all about.  Section 1031 has been a part of the Internal
Revenue Service Code since 1921!

Look at it as a gift from Uncle Sam, but don’t tell anyone.

Ok, let’s do the math. These numbers suggest that
investors paid the Government over $5B in capital gains
taxes when in fact, they could have used this money in
their own portfolios, interest free, for as long as they
would like. Wait a minute…

Why is this so? We have found that many professionals
that we deal with on a day‐to‐day basis are unclear of the
many strategic uses of Section 1031. Unfortunately, there
are still many that don’t even know of its existence, and
fail to recognize even its most basic uses.

Don’t let your clients find out you didn’t tell them they
could have used this powerful tool.

As accounting professionals, you have a certain
responsibility to your clients regarding the tax
ramifications of their transactions.  Holders of investment
real estate should be made aware of the tools that are
available to help them strengthen their real estate
portfolios. Section 1031 is one of the more powerful tools.

We hear over and over again from accounting
professionals how thankful their clients were that they
understood Section 1031 and helped them to explore the
possibilities. Indeed, many of our accounting partners
have saved their clients hundreds of thousands of dollars
in capital gain expense, giving them more money to
invest.


In 1981, Mr. George Foss, III, our founder and co‐principal was a prominent real estate
broker in Northern New Hampshire. After reading about the concept of a Section 1031
Exchange, he was immediately intrigued, and saw the opportunity to add an interesting twist
to his real estate deals by helping clients to take advantage of this virtually unknown gift
from Uncle Sam.

27 years and thousands of successful exchanges later, George Edmund & Wheeler remains
the foremost authorities on Section 1031 in the New England states, and have completed
exchanges with clients in 48 of 50 states.

The firm has provided Section 1031 education and consulting to hundreds of New England
real estate professionals and has helped them to save their clients over $100 Million in
capital gains taxes.

George Foss, QI John Hamrick, Instructor


Today will begin by providing you with some of
the very important basic aspects of Section
1031. We find that may investors absolutely
qualify for 1031 treatment, but their advisors
are sometimes lacking in this basic
understanding.

We will then be exploring Section 1031 from
and accountants viewpoint, going through some
real live examples and relating some
information on alternative exchange strategies.

This course has been designed to assist you in
becoming proficient in the basics of a Section
1031 Exchange.

An Exchange can be a very complex and time‐
consuming endeavor. As QI’s, we understand all
of the mechanics and the myriad of rules and
regulations surrounding an Exchange. Our goal
for this session is to provide you the knowledge
and tools required to assist your clients in
recognizing the tremendous opportunities
provided by Section 1031.

Section 1031 is not just a tax deferral vehicle. It
is a powerful part of your client’s overall
investment strategy, their exit strategy from a
business, and an integral part of their estate
planning.

Bottom line is that the taxes that are deferred
can be used to leverage larger investments,
diversify portfolios and substantially increase
wealth.


Section 1031 is fundamentally about the relocation and
reallocation of your client’s real estate assets, all without
paying capital gains taxes. Relocation could be across the
street, or across the nation. Clients can relocate their
holdings to several markets, creating geographical
diversity. They can also reallocate holdings by combining
multiple holdings into one more valuable property. They
can sell apartment buildings and Exchange for single‐
family housing units, or they can opt for one of the
passive real estate investments available and leave the
day‐to‐day management of real estate to a professional
property management team.

Section 1031 exchanges are reported on Form  8824,
attached to the Form 1040 Tax Return.  It is important
that all of the documentation leading up to and used
during the exchange explicitly states that an exchange is
taking place and not an ordinary sale.  The taxpayer
cannot touch the funds or it will trigger the tax.  The
Relinquished Property and the Replacement property
must be investment/business use property in the
taxpayer’s hands.  All exchanges must be concluded
within 180 days, as may be reduced by the initial due date
of the Federal Tax Return.

An exchange is handled in the same manner as a regular
sale with the exception that a third party, the Qualified
Intermediary (QI), provides documentation, acts as
Escrow Agent, and handles all funds.


www.section1031.com/PDFs/New PDFs/IRC1031.pdf

Section 1031

(a) Nonrecognition of gain or loss from exchanges solely in kind

(1) In general

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business
or for investment if such property is exchanged solely for property of like kind which is to be held either for
productive use in a trade or business or for investment.

(2) Exception

This subsection shall not apply to any exchange of—

(A) stock in trade or other property held primarily for sale,

(B) stocks, bonds, or notes,

(C) other securities or evidences of indebtedness or interest,

(D) interests in a partnership,

(E) certificates of trust or beneficial interests, or

(F) choses in action.

For purposes of this section, an interest in a partnership which has in effect a valid election under section

761(a) to be excluded from the application of all of subchapter K shall be treated as an interest in each of the
assets of such partnership and not as an interest in a partnership.


(3) Requirement that property be identified and that exchange be completed not more than 180 days after
transfer of exchanged property

For purposes of this subsection, any property received by the taxpayer shall be treated as property which is not
like-kind property if—

(A) such property is not identified as property to be received in the exchange on or before the day which is 45
days after the date on which the taxpayer transfers the property relinquished in the exchange, or

(B) such property is received after the earlier of—

(i) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the
exchange, or

(ii) the due date (determined with regard to extension) for the transferor’s return of the tax imposed by this
chapter for the taxable year in which the transfer of the relinquished property occurs.

(b) Gain from exchanges not solely in kind

If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of
section 1037(a), if it were not for the fact that the property received in exchange consists not only of property
permitted by such provisions to be received without the recognition of gain, but also of other property or money,
then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such
money and the fair market value of such other property.

(c) Loss from exchanges not solely in kind

If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of
section 1037(a), if it were not for the fact that the property received in exchange consists not only of property
permitted by such provisions to be received without the recognition of gain or loss, but also of other property or
money, then no loss from the exchange shall be recognized.

(d) Basis

If property was acquired on an exchange described in this section, section 1035 (a), section 1036(a), or section
1037 (a), then the basis shall be the same as that of the property exchanged, decreased in the amount of any
money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the
taxpayer that was recognized on such exchange. If the property so acquired consisted in part of the type of
property permitted by this section, section 1035 (a), section 1036(a), or section 1037 (a), to be received without
the recognition of gain or loss, and in part of other property, the basis provided in this subsection shall be
allocated between the properties (other than money) received, and for the purpose of the allocation there shall be
assigned to such other property an amount equivalent to its fair market value at the date of the exchange. For
purposes of this section, section 1035 (a), and section 1036 (a), where as part of the consideration to the
taxpayer another party to the exchange assumed (as determined under section 357 (d)) a liability of the taxpayer,
such assumption shall be considered as money received by the taxpayer on the exchange.

(e) Exchanges of livestock of different sexes
For purposes of this section, livestock of different sexes are not property of a like kind.


(f) Special rules for exchanges between related persons

(1) In general

If—

(A) a taxpayer exchanges property with a related person,

(B) there is non-recognition of gain or loss to the taxpayer under this section with respect to the exchange of such
property (determined without regard to this subsection), and

(C) before the date 2 years after the date of the last transfer which was part of such exchange—

(i) the related person disposes of such property, or

(ii) the taxpayer disposes of the property received in the exchange from the related person which was of like kind
to the property transferred by the taxpayer,

there shall be no non-recognition of gain or loss under this section to the taxpayer with respect to such exchange;
except that any gain or loss recognized by the taxpayer by reason of this subsection shall be taken into account
as of the date on which the disposition referred to in subparagraph (C) occurs.

(2) Certain dispositions not taken into account

For purposes of paragraph (1)(C), there shall not be taken into account any disposition—

(A) after the earlier of the death of the taxpayer or the death of the related person,

(B) in a compulsory or involuntary conversion (within the meaning of section 1033) if the exchange occurred
before the threat or imminence of such conversion, or

(C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such
disposition had as one of its principal purposes the avoidance of Federal income tax.

(3) Related person

For purposes of this subsection, the term “related person” means any person bearing a relationship to the
taxpayer described in section 267 (b) or 707 (b)(1).

(4) Treatment of certain transactions

This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to
avoid the purposes of this subsection.

(g) Special rule where substantial diminution of risk

(1) In general

If paragraph (2) applies to any property for any period, the running of the period set forth in subsection (f)(1)(C)
with respect to such property shall be suspended during such period.

(2) Property to which subsection applies

This paragraph shall apply to any property for any period during which the holder’s risk of loss with respect to the

property is substantially diminished by—


(A) the holding of a put with respect to such property,

(B) the holding by another person of a right to acquire such property, or

(C) a short sale or any other transaction.

(h) Special rules for foreign real and personal property

For purposes of this section—

(1) Real property

Real property located in the United States and real property located outside the United States are not property of
a like kind.

(2) Personal property

(A) In general

Personal property used predominantly within the United States and personal property used predominantly
outside the United States are not property of a like kind.

(B) Predominant use

Except as provided in subparagraphs (C) and (D), the predominant use of any property shall be determined
based on—

(i) in the case of the property relinquished in the exchange, the 2-year period ending on the date of such
relinquishment, and

(ii) in the case of the property acquired in the exchange, the 2-year period beginning on the date of such
acquisition.

(C) Property held for less than 2 years

Except in the case of an exchange which is part of a transaction (or series of transactions) structured to avoid
the purposes of this subsection—

(i) only the periods the property was held by the person relinquishing the property (or any related person) shall
be taken into account under subparagraph (B)(i), and

(ii) only the periods the property was held by the person acquiring the property (or any related person) shall be
taken into account under subparagraph (B)(ii).

(D) Special rule for certain property

Property described in any subparagraph of section 168 (g)(4) shall be treated as used predominantly in the
United States.


As can be seen from the Section 1031 statute language, at #2:

2) Exception

This subsection shall not apply to any exchange of—

(A) stock in trade or other property held primarily for sale,

(B) stocks, bonds, or notes,

(C) other securities or evidences of indebtedness or interest,

(D) interests in a partnership,

(E) certificates of trust or beneficial interests, or

(F) choses in action.

So these things cannot be exchanged under Section 1031.  This was not always the case.

The original statute was passed on March 8, 1921, and was silent on the items named
above, especially (B) stocks, bonds, or notes.  It didn’t take Roaring 20’s Investors long to
figure out that they could sell shares with losses and exchange shares with gains.  Two
years later, in 1923, the party was over, and all of the exceptions except (D) were added;
(D) came along in 1984.


It’s important to understand the difference
between investment property and property
“held for sale.”  Property that is held for sale is
technically inventory in the hands of the
taxpayer and is therefore not eligible for Section
1031 treatment.

Section 1031 Exchanges can be used as a
strategy to achieve tax deferral while changing
the location and the type of property held.  As a
tax‐planning tool, it will achieve greater net
equity over time and increased cash flow.

Section 1031 can also unravel partnership issues
and allow investors to exchange from active to
passive real estate holdings.

The Exchange Agreement created by the
Qualified Intermediary gives the QI legal
standing by way of an assignment of the
Contract Rights in both the old property and the
new property.  From the Exchangor’s
perspective, a sale does not occur, but rather an
exchange of properties.  Both must be used by
the taxpayer for investment or productive use.
The “Like‐Kind” Test must be satisfied.


There are three separate rules for identifying Replacement property.  The most common
rule is termed the “3 Property Rule.”  It doesn’t matter how many properties were sold
in an exchange, it is a cap on the number of choices of limitless value.  Identifying three
properties within the 45‐day deadline will be challenging.  Three, two, or even one
property can be selected, but it’s a good policy to identify more than one so a backup
property is available.  More than one can be purchased.

The 200% Rule is available to taxpayers who want to identify and/or acquire more than
three properties.  The limitation in using the 200% Rule is that the total value of what is
identified cannot exceed twice the value (or 200%) of the Relinquished Property.  This
rule works well for larger dollar transactions when the taxpayer wants to diversify the
investment into multiple properties.

The 95% Rule is the most perilous choice.  It will allow the taxpayer to ignore the value
and the number of choices with the requirement that once the properties are identified,
the taxpayer MUST acquire 95% of them (by value).   In nearly 30 years of practice this
rule has been used by a client in only one instance.

NOTE:  Now is your only opportunity to add an Alternative Investment such as a Tenant‐
in‐Common (TIC) property; an UP‐REIT; or an Oil & Gas Lease to one of these lists.  Only
Structured Sales, which convert all or what’s left of a Section 1031 Exchange to a Section
453 Installment Sale, can be elected later, after the 45th day.   More on this later…….


The point to remember is that it does not matter the type of real estate that the taxpayer owns, it is how the property is used
in their hands. It must be for investment, commercial or business use. A single‐family residence is like kind to every other kind
of real property as long as the single‐family residence is NOT Personal Use or Dealer Property.

These are ALL Like Kind!


Question:

“Can you do a 1031 exchange when selling and assigning the rights under a long
term cell tower lease valued based upon anticipated income from rent?”

Answer:

A cell tower lease is typically on a patch of land on which the tower is erected, and a
right‐of‐way access to the site.  The Landlord owns the land & easement which is leased,
and the tenant owns, and must later remove the improvements.  The lease would
describe all of this, and state an initial term plus a number of options to renew.

If you can add the number of years remaining in the initial term and in all of the options
to renew together and get a result that equals or exceeds 30 years, then the leasehold is
exchangeable for another leasehold of 30 years or more, or for a fee interest in real
estate.  Said another way, the lease must have 30 or more years left to run counting all
options to renew to be exchangeable for a fee.  The underlying properties must be of
Like‐Kind.  IRS Regs 1.1031(a)‐1(c).

The income from the lease has no bearing on the exchangeability of the asset; it's
only that the lease pertains to real property and that it has a remaining term that
qualifies, as above.  However, the income does play a part in the valuation of the lease, as
to be completely tax‐deferred; the Replacement Property must be valued equal to or
greater than the Relinquished Property.  So, the payments to be made under the lease in
the future have to be given a Present Value.




When Section 1031 was first codified in 1921, it was for the benefit of farmers who
objected to paying a two (2%) percent capital gains tax on their farm property, both real
and personal.   Certain items of personal property are exchangeable as long as they fall
into the same asset class or product code.   All aircraft is like‐kind to all other aircraft for
instance, but is not like kind to other items of machinery.

The North American Industry Classification System for Sectors 31‐33 is the best sources for
determining like kind for personal property.

www.census.gov/naics
(for a complete description of the allowable categories)

The Exchange will begin on the day the deed is
conveyed to the purchaser.  The 45 day and 180 day
clocks will begin the following day.  Contracts for sale
and purchase do not trigger the beginning on an
exchange, it always happens on the day of the first
leg of the transaction.  This is also true for reverse
exchanges.

Only Presidentially declared disasters would provide
for extension of these time sensitive dates.


A “Qualified Intermediary” is one who is not
“Disqualified.”  The Regulations are specific in stating
that one who has served the Taxpayer in almost any
capacity in the past 2 years is disqualified to be the Q.I.

Trusted friends and non‐relatives (cousins, in‐laws, etc.)
can technically serve, but one wants a Qualified
Intermediary with a thorough knowledge of the Code
and the Regulations.

The Exchange Agreement must have this statutory
language included that prohibits the taxpayer from any
type of use of the funds prior to the end of the
Exchange period.

The first step is to engage the Qualified Intermediary to
create a written Exchange Agreement.   The QI is
required to have standing in the exchange and this will
be accomplished with an assignment of the contracts.
Specific guidance will be provided to the Settlement
Agent and the funds will be directed to the QI for the
acquisition of the new property.   Most importantly, the
QI will provide guidance to the taxpayer to avoid the
pitfalls.  Transactions with related parties are
prohibited unless other rules are followed.

Exchanges can be conducted regardless of whether the
taxpayer is an individual or some form of other entity.
It is important to remember that the same taxpayer
must sell and then buy.  The IRS is tracking the taxpayer
identification number (EIN).  Single member LLC’s and
revocable trusts (disregarded for tax purposes) may
also exchange property.


DOES YOUR SITUATION QUALIFY FOR A SECTION 1031 EXCHANGE
This tool has been developed to help you quickly identify Section 1031 opportunities?

www.section1031.com/PDFs/New PDFs/WhatQualifies.htm

Plans for the Money
The greatest benefit from capital gains
deferral will be obtained by reinvesting the
entire price (less costs) from the sale of
investment  property. It is possible to extract
cash at closing; however, the amount you take
will be subject to tax.

Amount Invested
How was the property acquired and how long
has it been owned?  Was it purchased, was it
exchange into it, was it given or inherited by
the taxpayer?

The answers to these and other questions will
determine whether the cost basis, and what
the exposure is to Capital Gains Tax.  If the
gain exceeds $20,000 then an Exchange should
be considered (Rule of thumb).

Mortgage Balance
The outstanding mortgage debt is paid off at closing in the same manner as any other closing; and debt paid off must be
replaced when the new property is acquired or new cash added to offset any difference. Any debt relief not offset by new cash
will result in taxable boot.

On Last Two Tax Returns or Vacant Land
A taxpayer’s return provides the IRS with an audit trail of past activity.  Rental property must have appeared on Schedule “E” of
the return (or the corporate equivalent) if the property is portrayed as held for investment or for use Trade or Business. The
only exception will be vacant land.

How Long Owned
Dealers are not permitted to use Section 1031; generally their assets are “held for sale”, not “held for investment”. In order for
a property to be considered for long‐term capital gain treatment, it must have been owned by the taxpayer for at least one
year, preferably two.

Type of Replacement Property
Section 1031 requires that the property be “like‐kind”; all real property is like‐kind to all other real property.  The Like‐kind test
is more stringent for personal property


Choices of Replacement Property
Under the simple rules, taxpayers may
select up to three potential new properties
and can buy any one, two or all three of
them.

More choices are available; however, the
dollar value of the choices is capped at
200% of the value of the old property.

Can Meet 45 Day Requirement
After the closing of the old or Relinquished
Property, taxpayers have 45 days to make
formal identification of Replacement
Property choices. No substitutions are
permitted after the 45th day.

Can Meet 180 Day Requirement
After the closing of the old or Relinquished
Property, taxpayers will have 180 days to
acquire the new or Replacement Property.
Exchanges must be accounted for within the same tax year; often it is necessary to extend the due date of the tax return to
accomplish this task and to get the full benefit of 180 days for a year‐end exchange.

Third Party Handling of Money
Receipt of funds by the taxpayer at closing is not permitted in a Section 1031 Exchange. A Qualified Intermediary must be
designated to facilitate this process so that the taxpayer never has Constructive Receipt of the funds.

Relatives and attorneys or accountants that have represented the taxpayer in the last two years are prohibited from acting as
the Qualified Intermediary.

www.section1031.com/PDFs/New PDFs/WhatQualifies.htm

Have qualification questions?

Contact a respected Qualified Intermediary if you have any questions regarding your specific
situation. Many Intermediaries, like Edmund & Wheeler, Inc., provide this consultation free of
charge. A good relationship with a Qualified Intermediary can assist your practice in better
serving it’s clients!


The Five Most Common Section 1031 Misconceptions

Well before delayed exchanges were codified (by IRS) in 1991, all simultaneous exchange transactions of Real
Estate required the actual swapping of deeds plus the simultaneous closing among all parties to a 1031 exchange.
In most cases these types of exchanges were comprised of many of exchanging parties, as well as numerous
exchange real estate properties. Now today, there's no such requirement to swap your own property with
someone else's property, in order to complete an IRS approved exchange. The rules have been refined and ratified
to the point cash rather than the property deeds can be used.

There was a time when all types of exchanges had to be closed on a simultaneous (same day) basis, now they
(1031) are rarely completed this way. As a matter of fact, a majority of the exchanges executed are closed now as
delayed exchanges.

Don’t make this mistake. There is a common misconception that “Like‐Kind” is literal.  There are currently 2 types
of properties that qualify as a 'like‐kind':  Property held for investment and/or Property held for a productive use,
as in a trade or business.

This statement is a perfect example of another 1031 exchanging myth. There are no provisions within either the
IRS Code or the US Treasury Regulations that can restrict the amount and number of real estate properties that
can be involved in an exchange.  Thus, in exchanging out of several properties into one replacement property or
the reverse of this in selling of one property and acquiring several others, are all perfectly acceptable strategies.

You can take cash out of a Section 1031 Exchange; however, the cash that you take out will be immediately taxable.


Section

1a
Section 1031 &
Accounting

Contents

How the Different States Approach Section 1031 .........................................................................................24

Reporting an Exchange to the IRS ...............................................................................................................25

Form 8824 ....................................................................................................................................................26

Completing Form 8824 (Part I) .....................................................................................................................27

Completing Form 8824 (Part II) ....................................................................................................................28

Completing Form 8824 (Part III) ...................................................................................................................29

What is Boot? ...............................................................................................................................................31

What is New Money? ....................................................................................................................................31

Exchanges That Cross Two Tax Years ........................................................................................................31

Can a Failed Exchange Be Fixed? ...............................................................................................................32

Section 1031 and Partnerships .....................................................................................................................33

Section 1031 or Section 1033? .....................................................................................................................34


Why do cash‐strapped states permit Section 1031 Exchanges?

Because by failing to do so, they miss out on investment capital that would have otherwise come to them, and studies have
shown that there are more dollars arriving than leaving on a net basis.  But these dollars have owners, and it’s these owners of
funds that hesitate to invest in locales where they cannot later get their money out.

In recent examples, Georgia, Mississippi, Oregon and South Carolina all had laws on the books that said that a Section 1031
Exchange within the state was fine, but outside the state was not; going outside the state subjected the entire gain (both gain
before the funds arrived and gain while the funds were in‐state) to the state capital gains tax.

Needless to say, billions of dollars that would have otherwise gone to these four states went elsewhere.  Now all four have
repealed these laws, in Georgia’s case, retroactively.  Montana is the most recent state to consider, and then reject an out‐of‐
state limitation on Section 1031.

Pennsylvania, however, doesn’t seem to get it:  Section 1031 is not recognized even in‐state, and PA state tax on all real estate
transfers, sales or exchanges, is due.

New Hampshire follows the Federal Rules very closely (but see below), as does Maine, Vermont and Rhode Island.  In these
latter three states, one must present a Waiver of Withholding to the Settlement Agent or state taxes will be due.  This Waiver
Rule also exists in NJ, NY, MD, SC, GA, CA, OR, HI and in other states.

Vermont has a special rule for its 6‐Year Land Gains Tax:  Both the Relinquished (old) Property and the Replacement (new)
Property must be in‐state, but the Holding Period shifts too, so the New Property starts at a higher point on the 6‐year
Exclusion Ladder.  (For EVEN or UP Exchanges only; for DOWN Exchanges, some of the Land Gains Tax is due.)

New Hampshire Warning:  The name(s) on the deed to the Relinquished Property must exactly match the name(s) on the deed
to the Replacement Property.  The only exception is a revocable (grantor) trust, which New Hampshire (and IRS) ignores.

Do not let your client take the new property in a single‐member LLC (SMLLC) unless the old property was in the same SMLLC;
any change of entity, although it may be disregarded for IRS purposes, is FULLY RECOGNIZED for New Hampshire Business
Profits Tax (BPT) purposes.

This means, for the moment, than Tenant‐in‐Common (TIC) investments are out of bounds for NH taxpayers, because of the
fact that the TIC sponsor insists that the investment be held in a newly created (Delaware) SMLLC.

The state has issued Notices of Assessment to taxpayers for transactions as far back as 2005.  Litigation is pending.  Stay

tuned….


Reporting an Exchange to the IRS

IRS Form 8824, a dual‐use form for reporting Like‐Kind Exchanges and Section 1043
conflict of interest sales.

We are only concerned with Parts I, II, and III.

Part I:  Describes the property sold and bought; the relevant dates; and whether
Related Parties were involved.

Part II:  Related Party Section.  The form is misleading in that it appears to be possible
to be able to buy the Replacement Property from a relative:  You cannot, unless the
Related Party is also exchanging, and the funds are ultimately given to an Un‐Related
Party.  However, you can sell your Relinquished Property to a relative, provided both
you and the relative hold what is received for two years after the conclusion of the
exchange.  Further, you and the Related Party must report to IRS on this form (Parts I &
II only) for the two subsequent tax years that neither you nor the Related Party sold or
otherwise disposed of the property you or they received in the exchange.

Note how a seemingly innocent event in the life of your relative (they sell your old
place) can trigger your tax!  Watch out for this.

Part III:  The numbers.  We will get to this below.


Part I:  Information Section (line by line instructions)

Line 1:  This is a brief description and the address of your Relinquished (old) Property.

Line 2:  This is a brief description and the address of your Replacement (new) Property.

Line 3:  When did you take ownership of your Relinquished (old) Property?  Month/day/year

Line 4:  When did you transfer the Relinquished (old) Property?  Month/day/year

Line 5:  When did you identify the Replacement (new) Property to the QI?  Month/day/year

Line 6:  When did you receive the Replacement (new) Property?  Month/day/year

Line 7:  Was the property given or received made with a Related Party?  Yes/No

Potential Audit Issues:

Does the property described on Line 1 appear on past returns in Schedule E, or is it vacant land or
other investment property?  Will the property described on Line 2 qualify for and be similarly
listed on Schedule E?

Is Line 3 vs. Line 4 more than 1 year (preferably 2)?  Does Line 4 vs. Line 5 exceed the 45 days?
Does Line 4 vs. Line 6 exceed 180 days, as adjusted for due dates of the return for the tax year in
Line 4?

Will the Schedule E filings for this Taxpayer reflect the gaps of ownership indicated by the entries
on Lines 4 & 6?


Part II:  Related Party Section (line by line instructions)

If this Part applies to your situation, question the Taxpayer closely to be sure that it
was the Relinquished Property (and not the Replacement Property) that was acquired
by the Related Party; this is OK, if both the Taxpayer and the Related Party file this
form for this and for the next two tax years.  However, if the Taxpayer purchased his

Replacement (new) property from a Related Party and that person did not also
exchange, then this transaction has failed and the tax is due.  See Revenue Ruling
2003‐83.  See: http://www.unclefed.com/Tax‐Bulls/2002/rr02‐83.pdf

Line 8:  Related Party Information.  Your Relatives can be found in Section 267(b) &
707(b)(1)

Line 9:  Within the last 2 years, did the Relative who bought your (old) property sell it?
Yes/No

Line 10:  Within the last 2 years, did you sell the (new) property?  Yes/No

If either answer is “Yes”, then the Taxpayer must qualify for one of three exceptions:

Line 11(a):  There was a death of either of you.

Line 11(b):  There was an involuntary conversion (Section1033) of either property.

Line 11(c):  If Taxpayer’s new property was provided by a Related Party and that
person also did a Section 1031 Exchange, then the answers to Lines 9 & 10 will be
“No;”  nevertheless, attach an explanation to the return, and identify (with EIN) the
party from whom you bought.


Part III:  Financial Section  (line by line instructions)

Lines 12‐14 pertain to property given up for which no like‐kind property was received.  Tax is recognized

on Line 14.  The term “Other Property” means property of an un‐like kind.

Line 15:  All “Boot” goes on this line.  Any entries on this line fall to Line 23, and are recognized.
Examples are cash received that was not replaced (“Cash Boot”); any decrease in net indebtedness
(“Mortgage Boot”); and the FMV of any Other Property received (such as a vehicle, gemstones, fine art,
etc.) that the parties may have used to balance their transaction.

Line 16:  FMV of the Replacement (new) Property.

Line 17:  Add Line 16 + 15.

Line 18:  Adjusted basis of the Relinquished (old) Property + all net cash that was added + any increase in
net indebtedness + all closing costs & exchange fees.   (Old Basis + “New Money”)

Line 19:  Subtract Line 18 from Line 17.  This is the Realized Gain.

Line 20:  Enter the smaller of Line 19 or Line 15, but not less than $0.00.  Note that any entry on Line 15
is now here.

Line 21:  If the old Property was depreciable, and the new one is not, there will be some depreciation
recapture.  Reduce Line 20 by this amount and report on Form 4797.

Line 22‐23:  This is the Recognized Gain.  If even or up and no boot, this number will be $0.00

Line 24:  This is the deferred gain, the “interest‐free loan” from Uncle Sam.


Boot Netting Rules:

1.  Cash paid to buy New Property offsets cash received
and/or any debt relief in the sale of old property.

2.  Debt assumed or incurred to buy the New Property

offsets any debt relief (but not any Cash received) in the
sale of the Old Property.

“New Money” goes on Form 8824, Line 18:

Net new cash and Net new debt adds to the Adjusted

Basis, however, Other Property added (vehicle, computer,
etc.) does not.  If Other Property is added, pay tax on
these articles on Lines 12‐14.

Strike Price is the selling price of the Relinquished (old)
Property less sales costs.

Set the closing of the Old Property to fall in these
windows to give your Client an election under Reg
1.1031(k)‐1(j) (Coordination of Sec. 1031 & 453):

Provided the Client had a bona‐fide intention to exchange
at the start of the Exchange Period, and the Client
receives Cash Boot in the next Tax Year,  they can elect
which year to pay tax on said boot.  However, tax on
Mortgage Boot must be paid in the year of receipt.


So, if your Client has sold an asset and then learns about Section 1031 after the closing,
they can:

1.Un‐close with the Buyer.  The more time that has passed the harder this will be,
especially if a bank has recorded a mortgage and disbursed funds.  To un‐close, the
Buyer must receive the funds back and your Client must receive the deed back.  Be
prepared for adverse Transfer Tax consequences, but in some cases, Corrective Deeds
have been used.

2.Re‐close with the Buyer properly, using a Q.I.   An Exchange Agreement is prepared

and executed.  Settlement Instructions are issued.  An Escrow Account is established.  A
new deed is prepared, signed with the later date and recorded.  Buyer’s funds now go
through the QI to the Qualified Escrow Account.  The time periods begin.

3.  As a general matter, Rescissions are expensive, and gaining the full cooperation of
the Buyer and their Bank may prove to be impossible.

4.  Must be done in the same tax year; transactions cannot be rescinded after the end of
the tax year.



Partnership interests (or those of any entity) are NOT
EXCHANGEABLE per Section 1031(a)‐2.

“Drop & Swap” is where a partnership distributes to its
partners tenancy‐in‐common interests in its assets;
these people subsequently exchange while the
partnership sells.  The technique can be made to work if
the distributee partners establish separate holding
periods in the assets before the exchange (1 year

minimum, 2 years better).  Gets pretty awkward.

Form 1065, Question 14:  “At any time during the tax
year, did the partnership distribute to any partner a
tenancy‐in‐common or other undivided interest in
partnership property?”

Nor does the “Swap & Drop” technique work either,
where the entire partnership does the exchange and
then distributes some or all of the property it receives to
departing partners.

Again, the issue appears to be one of “holding period;”
the partnership has a holding period in the relinquished
assets, and IRS wants to see a continuation of this
holding period in the replacement assets.

Form 1065, Question 13:  “Check this box if, during the
current or prior tax year, the partnership distributed any
property received in a like‐kind exchange or contributed
such property to another entity (including a disregarded
entity)”

So, what to do?  Preserve the partnership, its holding
period and its EIN # at all costs; remember, to be a
partnership, there must be 2 or more members.

Close on the asset to be sold, and elect to receive some
“boot” at the closing, which will  be cash and some debt
relief; distribute this “boot” to the departing partners.
The rest of the partnership exchanges in the usual way,
and the partnership receives like‐kind replacement
property, which it will keep.

This leaves the answers to both Questions 13 & 14 on
Form 1065 “No.”

Reflect the cash and debt relief distributions (“boot”) on
the K‐1’s of the departing partners.

When faced with a disaster loss or a condemnation, a decision must be made:  Does the taxpayer
stick with the rules of Section 1033 (Involuntary Conversions), or does s/he attempt to comply with
Section 1031?

In a Section 1033 transaction, the taxpayer can handle funds, and has more time (2+ years) to
replace the lost/taken property, but this replacement must be “similar or related in service or use”
to the old property.  IRC 1033(a)‐(1).  So, under these rules, it is impossible to replace an improved
property with an unimproved one, or a dwelling for a warehouse, etc.

However, let’s say that your property is under agreement of sale and it is damaged by fire or storm
prior to closing.  You could either assign the insurance check to the buyer and close as a Section
1031 Exchange, or you could renegotiate the price of your old property, and close as a combined
Section 1031 Exchange (as to the land and the undamaged portion), and as a Section 1033
Involuntary Conversion (as to the insurance proceeds).  You could handle the insurance funds but
not the rest; Section 1031 time periods would have to be observed and the Replacement Property
must be such that you could add the lost improvement to it before the expiration of 2 years.

Another situation is where a governmental taking is being discussed, but the taxpayer has not yet
received a formal “Notice of Eminent Domain.”   Under these conditions, a Section 1031 Exchange
can be set up to receive the proceeds and reinvest them in “Like‐Kind”  (as opposed to “Similar
Kind”) property.  An example of this was a Conservation Easement (“CE”) sold to a Southern New
Hampshire town (which had voted to take it if necessary).  The funds were reinvested in ranchland
and a mountain cabin in Montana, like‐kind to the CE under Section 1031, but definitely not similar
kind to a CE under Section 1033.


Nh Accounting Workbook 8.4.09

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Nh Accounting Workbook 8.4.09