1031 Exchanges David Gorenberg

1031 Exchanges –
The Art & Science of Capital Preservation
Presented by:
Citibank, N.A. – 1031 Exchange Service
David M. Gorenberg, Esquire
Certified Exchange Specialist®

Presented to:

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2 1031 Exchanges: The Art & Science of Capital Preservation

Important Disclosures

This presentation does not constitute legal or tax advice. Citibank and its employees do not provide tax or
legal advice and are not responsible for advising customers on the laws or regulations pertaining to any
1031 exchange transaction. Citibank and its employees will not make any representations regarding the
tax consequences of any 1031 exchange transaction. It is the customer’s responsibility to seek tax and
legal advisors in connection with any 1031 exchange transaction.

IRS Circular 230 Disclosure: To the extent that this material or any attachment concerns tax matters, it is
not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may
be imposed by law.

Citibank, N.A., Member FDIC. Citibank and Arc Design is a registered trademark of Citigroup Inc.


Overview of the Statute and Regulations


Taxation 101

• Generally, all income is taxable,
unless specifically exempted by law.

• Even illegal income, such as stolen
or embezzled funds, must be
reported on Line 21 of Form 1040.

Source: Department of Treasury, Internal Revenue
Service, Publication 525.


IRC Section 1031

• “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 for productive use
in a trade or business or for investment.”

• §1031 provides for deferral of taxes,
not complete elimination.


Like-kind Property

Foreign real property is not like-kind to U.S. real property.


Business or Investment Use

• There are five tax classes of property:
1) property used in taxpayer’s trade or business;
2) property held primarily for sale to customers;
3) property which is used as your principal residence;
4) property held for investment; and
5) property used as a vacation home

• Section 1031 applies to the first and fourth
categories (and perhaps the fifth)


Less than Fee Interests in Real Property that Qualify for
Exchanges

• Leases with at least 30 years remaining, including renewal options

• Vendee’s interest in a land sale contract; not the vendor’s interest

• Undivided interest in one property for an undivided or 100% interest in
another property

• Remainder interest in real property

• Timber rights, riparian rights,
mineral rights
– As determined by state law


Like Kind Personal Property

• Under the regulations, personal depreciable property
used in business or held for investment is exchanged
with like-kind property if exchanged either for property of
a like kind or like class

• Properties are of like class if they are in the same:
– General Asset Class – Rev. Proc. 87-56, or
– Product Class – SIC Manual (4 digits)

• Personal property is like kind if identical


Like Kind Personal Property

• Livestock of the same sex

• Automobiles for automobiles

• Buses for buses

• Manufacturing equipment for manufacturing equipment

• 13 general asset classes; OMB Standard Industrial Classification (SIC)
Manual identifies 4-digit product classes; New North American Industry
Classification System (NAICS) is 1400 pages
– Exchanges within product class


Common Personal Property Exchanges

• Aircraft

• Artwork

• Collectibles

• Equipment

• Fleet Vehicles

• Intellectual Property
– Licenses, Franchises, Patents, Trademarks

• Others


§1031 in a Nutshell

• To obtain complete deferral of capital gains taxes, the
taxpayer should:
– Purchase replacement property that is equal or greater in value to
the relinquished property
– Have equal or greater equity in the
replacement property
– Have equal or greater debt on the
replacement property
– Receive nothing except like-kind property
– Avoid constructive receipt of exchange
proceeds
– Use a qualified intermediary


Why Exchange?


Delayed Exchanges
- Statutory Requirements

• 1984 Congress amends Section 1031
– 45 day identification period
– 180 day exchange period runs concurrent
• Or due date of tax return, whichever is earlier
– Calendar days, not business days
– No extensions
– Exchange starts on date of recording, or when burdens and
benefits of ownership of relinquished property are transferred,
whichever is first


Identification Requirements

• Signed, and in writing

• Delivered
– QI or seller of replacement property

• Unambiguously described
– Legal description
– Street address
– Distinguishable name (e.g., Mayfair Apartment Building)

• May be revoked or amended, with same formality as above


Identification Rules

• 3 Property Rule – up to 3 properties, without regard to FMV;

or

• 200% Rule – any number of properties, so long as aggregate FMV
does not exceed 200% of FMV of relinquished properties;

but

• 95% Exception – if first two rules violated, must acquire 95% of FMV
of all identified properties


Time Restrictions

Identification
Period
Exchange
Period
Day 0 Day 45 Day 180

NOTE: The total exchange period cannot exceed 180
days, under any circumstances.

1031 Exchanges: The Art & Science of Capital Preservation
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Regulations: 1.1031
- safe harbors
• 1.1031(k)-1(g)
– (2) Security or Guarantee Arrangements
• Determination of whether the taxpayer is in actual or constructive receipt of the exchange
funds is made without regard to existence of mortgage, standby letter of credit, third party
guarantee, etc.
– (3) Qualified Escrow Accounts and Qualified Trusts
• Determination of whether the taxpayer is in actual or constructive receipt of the exchange
funds is made without regard to whether the funds are held in a Qualified Escrow Account or
Qualified Trust
– QEA – Escrow holder is not a disqualified person; escrow agreement contains “(g)(6)” limitations
– QT – Trustee is not a disqualified person; trust agreement contains “(g)(6)” limitations
– (4) Qualified Intermediary
– QI is not considered an agent of the taxpayer; is not a disqualified person; QI enters into “exchange
agreement” that contains the “(g)(6)” limitations
– (5) Interest and Growth Factors
• Determination of whether the taxpayer is in actual or constructive receipt of exchange funds is
made without regard to the fact that the taxpayer is or may be entitled to receive any interest
or growth factor with respect to the deferred exchange.

19

Regulations: 1.1031
- (g)(6) Limitations
• (i) An agreement limits a taxpayer's rights as provided in this paragraph (g)(6) only if the
agreement provides that the taxpayer has no rights, except as provided in paragraphs
(g)(6)(ii) and (g)(6)(iii) of this section, to receive, pledge, borrow, or otherwise obtain
the benefits of money or other property before the end of the exchange period.

• (ii) The agreement may provide that if the taxpayer has not identified replacement
property by the end of the identification period, the taxpayer may have rights to receive,
pledge, borrow, or otherwise obtain the benefits of money or other property at any time
after the end of the identification period.

• (iii) The agreement may provide that if the taxpayer has identified replacement property,
the taxpayer may have rights to receive, pledge, borrow, or otherwise obtain the benefits
of money or other property upon or after
– (A) The receipt by the taxpayer of all of the replacement property to which the
taxpayer is entitled under the exchange agreement, or
– (B) The occurrence after the end of the identification period of a material and
substantial contingency that –
• (1) Relates to the deferred exchange,
• (2) Is provided for in writing, and
• (3) Is beyond the control of the taxpayer and of any disqualified person (as
defined in paragraph (k) of this section), other than the person obligated to
transfer the replacement property to the taxpayer.
20

Treasury Inspector General for
Tax Administration


Treasury Inspector General for Tax Administration

• Reference 2008-30-154; August 27, 2008
– “Guidance Could Be Enhanced for Deciding to Use a Qualified
Intermediary in Like-Kind Exchanges”
• “This report presents the results of our review of qualified intermediary
regulations and qualification requirements. The objectives of this review
were to examine transactions subject to Internal Revenue Code Section
1031, assess the qualification requirements for qualified intermediaries,
and determine the legal protections available to taxpayers. We
conducted this review in response to a request by the Chairman of the
United States House of Representatives Committee on Financial
Services.”

22

Regulations under Sections 468B and 7872


Treasury decision 9413
- Regulations Update

• Designated settlement funds – escrow accounts, trusts, and funds used
in deferred like-kind exchanges; loans to exchange facilitators.

• “468-B” Regulations – The regulations provide rules regarding the
taxation of income earned on escrow accounts, trusts, and other funds
used during deferred like-kind exchanges of property

• “7872” Regulations - regarding below-market loans to facilitators of
these exchanges.

• Effective for all transactions commenced on or after October 8, 2008.

24

468-B Regulations

• IF:
– The exchange funds are $2,000,000 or greater; OR
– The exchange funds remain with the QI for 6 months or longer

• THEN:
– All interest earned on the exchange funds must be paid to the
taxpayer
• Applicable Federal Rate
• 91-day (13-week) T-Bill rate

25

Effect of Bankruptcy of Large National
Qualified Intermediaries

26

QI Bankruptcy
- A Tale of Two Cities

• Southwest Exchange
– Henderson, NV; Donald K. McGhan and others in his family
– 2007; 130+ clients; $97.5MM+
– Funds used to acquire breast implant company, 19-passenger jet,
lavish meals, etc.


QI Bankruptcy
- A Tale of Two Cities

• 1031 Tax Group
– Richmond, VA; Edward H. Okun and others in his business
– 2007; 300 +/- open exchanges; $151MM+
– Funds used to acquire jewelry, sports cars, helicopters, shopping
malls and other “toys”


QI Bankruptcy
- The LandAmerica saga
• Millard refrigerated Services v. LandAmerica
– http://www.les1031creditorcommittee.com/76_3147.pdf
– DeGroot v. Exchanged Titles
• 159 B.R. 303 (1993)
– Cook v. Garcia
• 110 F.3d 67 , 1997 WL 143827 (1997)
– In re San Diego Realty Exchange Co., Inc.
• 24 F.3d 249, 1994 WL 161646 (1994)
– Cook v. 1031 Exchange Corp.
• 29 Va. Cir. 302, Not Reported in S.E.2d, 1992 WL 885015 (1992)
– In re. Sale Guaranty Corp.
• 220 B.R. 660 (1998)
– Rechtzigel v. Fidelity National
• 748 N.W. 2d 312 (2008)
29

State Regulation of Qualified Intermediaries

• Enacted • Pending
– California – Arizona
– Colorado – Maine
– Idaho – Oklahoma
– Nevada – Oregon
– Virginia – Texas
– Washington

30

Other Considerations

31

Choosing a Qualified Intermediary

• Phone Book? • Qualifications
– When was firm established
• Internet?
– Primary business, or sideline
• Referrals – How many transactions
completed
– Financial stability
– Security of exchange proceeds
– Fees, and what is included
– FEA
• www.1031.org
– Certified Exchange Specialist®
• www.1031ces.org

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Contact Information

David Gorenberg, Esquire Kristina C. Harshany
Certified Exchange Specialist® Certified Exchange Specialist®
Senior Vice President, 1031 Exchange Services Vice President, 1031 Exchange Services

Citibank, N.A. Citibank, N.A.
1650 Market Street, Suite 3550 1650 Market Street, Suite 3550
Philadelphia, PA 19103 Philadelphia, PA 19103
Office: 267.385.3624 Office: 267.385.3625
Fax: 866.767.8201 Fax: 866.765.8874
Mobile: 610.883.2181 Mobile: 610.883.2181
E-mail: david.gorenberg@citi.com E-mail: kristina.c.harshany@citi.com


1031 Exchanges David Gorenberg

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