Workshop presentation on 1031 Exc

1. Section 1031 Exchanges in the 21st Century –
Regulatory Changes and Case Law Impact
Presented by:
Citibank Financial Intermediaries Group
David M. Gorenberg, Esquire
Certified Exchange Specialist®
Presented:

2. Please Turn Cell Phones and Pagers to Silent or Off.
Thank you.
2 Section 1031 Exchanges in the 21st Century

3. 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.
3 Section 1031 Exchanges in the 21st Century

4. Agenda
• 1031 Exchanges – Case Law and Regulatory Update
– The Good
• What is “Like-Kind” Property
– Real Property
– Personal Property
• Regulatory Review
– The Bad
• QI Fraud
• QI Bankruptcy
– The Ugly
• Choosing a QI
– Ethical Considerations
4 Section 1031 Exchanges in the 21st Century

5. “The Good”
5

6. Overview of the Statute and Regulations
6 Section 1031 Exchanges in the 21st Century

7. Why Exchange?
- smaller property
7 Section 1031 Exchanges in the 21st Century

8. Why Exchange?
- larger property
8 Section 1031 Exchanges in the 21st Century

9. 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.
9 Section 1031 Exchanges in the 21st Century

10. 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.
10 Section 1031 Exchanges in the 21st Century

11. Like-kind Property
Foreign real property is not like-kind to U.S. real property.
11 Section 1031 Exchanges in the 21st Century

12. 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)
12 Section 1031 Exchanges in the 21st Century

13. 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
13 Section 1031 Exchanges in the 21st Century

14. Common Less-Than-Fee Exchanges
• Timber Rights
• Mineral Rights
• Oil Rights
• Riparian Rights
• Tenants in Common
• Transferrable Development Rights
• Others
14 Section 1031 Exchanges in the 21st Century

15. 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
15 Section 1031 Exchanges in the 21st Century

16. Common Personal Property Exchanges
• Aircraft
• Artwork
• Collectibles
• Equipment
• Fleet Vehicles
• Intellectual Property
– Licenses, Franchises, Patents, Trademarks
• Livestock
• Others
16 Section 1031 Exchanges in the 21st Century

17. Common Personal Property Exchanges
- Franchises Often Sold With Real Estate
• Franchises may be exchanged for
other franchises
• Nature of the franchise must also be
like-kind
• Lexus is not like-kind to Ramada
• Lexus is like-kind to Ford
17 Section 1031 Exchanges in the 21st Century

18. Common Multi-Asset Exchanges
- Personal Property Often Sold With Real Estate
• Personal Property for Personal Property
• Real Property for Real Property
18 Section 1031 Exchanges in the 21st Century

19. §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
19 Section 1031 Exchanges in the 21st Century

20. Time Restrictions
• 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
Identification
Period
Exchange
Period
Day 0 Day 45 Day 180
Section 1031 Exchanges in the 21st Century
20

21. 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
21 Section 1031 Exchanges in the 21st Century

22. 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
22 Section 1031 Exchanges in the 21st Century

23. 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.
Section 1031 Exchanges in the 21st Century
23

24. 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.
Section 1031 Exchanges in the 21st Century
24

25. Treasury Inspector General for
Tax Administration
25 Section 1031 Exchanges in the 21st Century

26. 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.”
Section 1031 Exchanges in the 21st Century
26

27. Regulations under Sections 468B and 7872
27 Section 1031 Exchanges in the 21st Century

28. 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.
Section 1031 Exchanges in the 21st Century
28

29. 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
Section 1031 Exchanges in the 21st Century
29

30. “The Bad”
Section 1031 Exchanges in the 21st Century
30

31. 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.
31 Section 1031 Exchanges in the 21st Century

32. 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”
32 Section 1031 Exchanges in the 21st Century

33. 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)
Section 1031 Exchanges in the 21st Century
33

34. QI Bankruptcy
• Southwest Exchange $ 97.5 Million
• 1031 Tax Group $151 Million
• LandAmerica Exchange Services $424 Million
Total $672.5 Million
Section 1031 Exchanges in the 21st Century

35. State Regulation of Qualified Intermediaries
• Enacted • Pending
– California – Arizona
– Colorado – Oklahoma
– Idaho – Texas ≈ Bill Died
– Maine
– Nevada
– Oregon
– Virginia
– Washington
Section 1031 Exchanges in the 21st Century
35

36. “The Ugly”?
Section 1031 Exchanges in the 21st Century
36

37. 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
Section 1031 Exchanges in the 21st Century
37

38. Your Questions
38 Section 1031 Exchanges in the 21st Century

39. On the Web:
39 Section 1031 Exchanges in the 21st Century

40. Contact Information
David Gorenberg, Esquire
Certified Exchange Specialist®
Senior Vice President, 1031 Exchange Services
Citibank, N.A.
1650 Market Street, Suite 3550
Philadelphia, PA 19103
Office: 267.385.3624
Fax: 866.767.8201
Mobile: 610.883.2181
E-mail: david.gorenberg@citi.com
THANK YOU!
40 Section 1031 Exchanges in the 21st Century