Identify property that qualifies for IRC 1031 exchanges Calculate basis of property acquired in a like kind exchange Understand how boot can cause

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1 Pages 40-67

2 Identify property that qualifies for IRC 1031 exchanges Calculate basis of property acquired in a like kind exchange Understand how boot can cause recognition of gain or loss Advise a client about the mechanics of a deferred or reversed exchange Understand the special rules that apply with related parties Personal residence and like-kind exchange

3 Identify other real property interests that may qualify for a like-kind exchange Report a like-kind exchange Structure a transaction to not qualify as a like kind exchange

4 (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

5 Both relinquished and acquired property must be Investment property or Protective use in a trade or business Not Property primarily held for sale Securities, certificates of trust, beneficial interest Partnership interests, evidences of indebtedness or Personal use assets

6 Real Property Any real estate for any other real estate (used in a trade or business or held for investment)

7 Like kind or Like class Depreciable Tangible Property Like class Same general asset class or same product class Product class- NAICS (North America Industry Classification System)

8 Defined by Treasury Regs (a)2(b)(2) and Rev. Proc C.B Office furniture, fixtures, and equipment 2. Information systems (computers and peripheral equipment) 3. Data handling equipment, except computers 4. Airplanes (airframes and engines), except those used in commercial or contract carrying of passengers or freight, and all helicopters (airframes and engines) 5. Automobiles and taxis 6. Buses

9 7. Light general-purpose trucks 8. Heavy general-purpose trucks 9. Railroad cars and locomotives, except those owned by railroad transportation companies 10. Tractor units for use over-the-road 11. Trailers and trailer-mounted containers 12. Vessels, barges, tugs, and similar water transportation equipment, except those used in marine construction

10 Depreciable Tangible Personal Property NAICS same 6 digit class = Like Kind /naics for a copy of the NAICS manual The North American Industry Classification System (NAICS) is the standard used by Federal statistical agencies in classifying business establishments for the purpose of collecting, analyzing, and publishing statistical data related to the U.S. business economy

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14 Bob Builder transfers a grader to Frank Farmer in exchange for a scraper. Neither property is within any of the general asset classes. However, both properties are within the same product class (NAICS code ). The grader and scraper are of a like class and are like-kind for purposes of section 1031

15 Qualify for IRC 1031 like kind property Exchanged properties must be like kind No like class exchanges qualify Intangible Personable Property Nature or Character of the rights exchanged Nature or Character of the underlying property exchanged

16 Basis of the replacement property = Basis of the relinquished property: Increased by any costs incurred Increased by any additional consideration paid (Boot) Basis of acquired property = Carryover basis Increased by any gain recognized Decrease by any Boot received Decreased by any loss recognized

17 Basis of Replacement property = Basis of Relinquished property + any fees Carryover basis + any transaction fees + gain recognized Adjusted basis of Aaron s truck $2,500 Less Boot (cash) received Add Gain recognized Basis of Aaron s acquired truck $2,400

18 I have one truck that I use for my Beekeeping business and my family uses for recreational use Can I still exchange my truck in a like-kind transaction and postpone any gain on the transaction? If so, how?

19 July 15, 2017, Merrill traded in a pickup truck he basis of $28,000 Placed in service on June 30, 2015 He used the pickup 75% of the time in his beekeeping business 25% for personal use

20 Year Depreciation Calculation Depreciation Allowable 100% Business Use 75% Business Use 2015 $28, % = $ 4,200 $3, $28, % = $ 7,140 5, $28, % ½ = 2,499 1,874 Total $13,839 $ 10,379

21 Cost of relinquished pickup $28,000 Accumulated depreciation using 100% business use (13,839) Exchange basis $14,161 Cash boot paid (10,000) Adjusted basis of new pickup for depreciation $24,161 Cost of relinquished pickup $28,000 Accumulated depreciation for business use (10,379) Exchange basis $17,621 Cash boot paid 10,000 Adjusted basis of new pickup for gain or loss $27,621

22 Rather than trade in his truck Merrill gifts it to his son Truck FMV $20,000 Carryover basis 17,621 If son trades gifted truck in for new truck (plus $10K cash) Son s basis in new truck is $27,621 Any IRC 1245 recapture in old truck carries over to new truck

23 Boot is generally cash but may be any other non like-kind asset Could be a transfer of liabilities (net) Could result in a gain If not like kind boot is transferred could result in a loss How does boot effects basis?

24 Two possible effects on the basis of property received Increases basis by the amount of gain recognized.or Decreases basis by total FMV of boot received If the FMV of boot is = or less than gain no adjustment to basis

25 W.W exchanges delivery van (FMV $3K & adj. basis $5K) + $800 cash Pick-up truck (FMV of $4,200) Both vehicles used 100% business Both are like class per (#7 page 41) light general purpose truck What is W.W. s gain on the transaction Received $4,200 + $800 = $5,000 Relinquished (basis) $3,000 Gain realized $2,000

26 W.W. receives pick-up truck (FMV $2,800 & $2,200 cash) $5,000 Relinquishes van ($3,000 basis) Gain realized 2,000 Gain recognized 2,000 Basis in truck $3,000 (basis in van) + 2,000 gain recognized - 2,200 boot received = $2,800 new basis & no deferred gain

27 Dan apartment building $400K basis, $800 FMV, $320K mortgage Elene apartment building $700 basis, $1M FMV, $660 mortgage Dan relinquishes his apartment + $160K cash Does Dan have a gain and if so how much?

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29 Dan Elene Adjusted basis of property transferred $400,000 $700,000 Cash paid 0 160,000 Liability on property received 600, ,000 Cash received (160,000) 0 Liability on property transferred (320,000) (600,000) Gain recognized $160,000 $120,000

30 Dan Elene Adjusted basis of property transferred $400,000 $700,000 Cash paid 0 160,000 Cash received (160,000) -0- Net debt transferred 280, ,000 Gain recognized 160, ,000 Basis in property acquired $680,000 $700,000

31 Dan sells property for $880,000 Pays off mortgage of 320,000 Net proceeds 560,000 Proceeds held in escrow by a qualified intermediary Dan purchases Elene s property for $ 1,000,000 Finances 440,000 Realized gain 480,000 Recognized gain $ - 0 -

32 Taxpayer may have to report ordinary income If the taxpayer receives boot Limited to lesser of The recomputed basis of the property or The excess of the amount realized on the disposition over the adjusted basis of the property

33 Like-kind personal property is section 1245 property in most cases, which means that the relinquished property and the replacement property are subject to the same recapture rules. In some cases, section 1245 real property and property that is not section 1245 real property are like-kind even though subject to differing recapture provisions. In those cases, the section 1245 recapture rules can cause gain to be recognized as ordinary income at the time of the like-kind exchange even though the gain would not have to be recognized under the section 1031 like-kind exchange rules for qualifying real property.

34 Vickie purchased a new machine - cash $3,400 + old machine - dealer allowance 1,360 Original cost of $5,000 Depreciation 3,950 Adj. basis $1,050 Realized gain 310 Recognized gain $ -0- Why?

35 2017 Mike traded tractor #1 FMV $30,000 For tractor #2 FMV 25,000 Received cash 5,000 #1 cost $50,000 Depreciation 30,800 Adj. basis $19,200 Realized IRC 1245 gain 10,800 Gain realized boot 5,000 Deferred IRC 1245 recapture $5,800

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37 Penelope exchange a warehouse for land & dep. real property FMV - warehouse $112,000 Depreciation 20,000 Basis 92,000 Land FMV 95,000 Other depreciable real property 15,000 Recognized gain $5,000 Greater of: $2,000 (112, ,000) $5,000 (20,000 addt. depreciation - $15,000)

38 Seller disposes of property first Hope to find replacement property later Potential drawback no replacement property available Timing constraints within Treas. Regs. Requires a qualified intermediary to hold funds Property for property No constructive receipt of funds

39 In a deferred exchange, the replacement property must be 1. Identified within 45 days after the taxpayer relinquishes the exchanged property, and 2. Received by the earlier of 180 days after the date the taxpayer relinquishes the exchanged property or the due date of the taxpayer s return for the tax year in which the relinquishment occurs

40 Exchange one for two

41 A Qualified Intermediary ( QI ) is a person who: Is not the taxpayer or a disqualified person; Enters into a written agreement with the taxpayer (the exchange agreement) under which the qualified intermediary: Acquires the relinquished property from the taxpayer; Transfers the relinquished property to the buyer; Acquires the replacement property from the seller; Transfers the replacement property to the taxpayer. The exchange agreement must expressly limit the taxpayer s rights to receive, pledge, borrow, or otherwise obtain benefits of money or other property held by the qualified intermediary

42 Taxpayer s agent Employee Accountant Attorney Banker Broker Real estate agent (within a 2 year period of the transfer) Related party IRC 267(b) or 707(b)

43 (b)relationships The persons referred to in subsection (a) are:(1)members of a family, as defined in subsection (c)(4); (2)An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; (3)Two corporations which are members of the same controlled group (4)A grantor and a fiduciary of any trust; (5)A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts; (6)A fiduciary of a trust and a beneficiary of such trust; (7)A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts; (8)A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly (9)A person and an organization to which section 501

44 Fred Wants out of farming - Farm $800,000 FMV George Wants to build mansion on Fred s property George Has no property to exchange with Fred Fred hires a qualified intermediary facilitates sale to George Fred finds a beach house ($800,000) rental property within 45 days Fred recognizes no gain on the exchange as long as the transaction is completed within the earlier of 180 days or due date of return

45 Can we do this backwards? First - Purchase the replacement property Than - Dispose of the existing property Rev. Proc , provide a Safe Harbor Property must be held in a QEAA Qualified Exchange Accommodation Arrangement Six additional requirements need to be met

46 1. Title to the property is held by an exchange accommodation titleholder who is not the taxpayer or a disqualified person and who is subject to federal income tax for the entire period from the date the titleholder acquires the property until it is transferred again to complete the exchange. 2. At the time the ownership of the property is transferred to the titleholder, the taxpayer has a bona fide intent that the property held by the titleholder represents either replacement property or relinquished property in an exchange that qualifies for nonrecognition of gain under section 1031.

47 3. No later than 5 business days after the title is transferred, the taxpayer and the titleholder enter into a written agreement that the property is being held to facilitate a section 1031 exchange, and that the taxpayer and the titleholder agree to report the acquisition, holding, and disposition of the property as specified in Rev. Proc No later than 45 days after the taxpayer transfers the replacement property to the titleholder, the taxpayer identifies the relinquished property (the taxpayer can identify alternative and multiple properties under the rules previously discussed).

48 5. No later than 180 days after the title is transferred to the titleholder, the property is transferred as either replacement or relinquished property. 6. The combined time period that the relinquished property and the replacement property are held in the QEAA does not exceed 180 days.

49 Lana owns parcel A and wants parcel B before it gets sold Lana would like to postpone the gain on the sale of parcel Lana has not yet found a buyer for parcel A, but believes it will sell Can she purchase parcel B purchased first and still postpone the gain under IRC 1031 and if so how?

50 Lana can utilize the services of a QEAA The QEAA can acquire the property on the TP s behalf Title actually will be in the name of the TP It would be difficult to get financing otherwise Lina would need to either get a bridge loan or self-finance The QEAA than disposes of parcel A

51 Related parties can exchange property and defer gain under IRC 1031 A subsequent disposition within two years can cause the recognition of that gain Who are related parties? Once again defined by IRC 267(b) & 707(b)(1) Additional requirement Filing Form 8824 for the year of sale and for the following two years

52 July 2016, Emily exchanges properties with her son Arthur Both properties were help for investment Emily property has a FMV of $100,000 and basis of $60,000 Arthur s property has a FMV of $100,000 and basis of $80,000 The exchange qualified as a like-kind exchange April 2017, Arthur sells property to an unrelated party for $102,000

53 Arthur must recognize a gain on the sale of: Adjusted basis $80,000 Sales price 102,000 Gain $22,000 Emily as a result of the subsequent sale also must report her deferred gain of: Adjusted basis $100,000 ($60,000 + $40,000 deferred gain) Basis 60,000 Gain $40,000

54 If the disposition was a nonrecognition transaction The related parties derived no tax advantage from shifting basis between the exchanged properties, or An exchange of undivided interests in different properties resulted in each related party holding either the entire interest in a single property or a larger undivided interest in any of the properties.

55 Generally not allowed for like-kind exchange If you sold your home for a loss could you deduct it? Courts have held that the hope that your residences increases in value does not make it an investment property There is a Safe Harbor difficult standard to meet Same rules under IRC 280 personal use test Includes the 14 day or 10% personal use test

56 TP can relinquish/exchange investment property (land and or building) Receive rental property or land Convert the rental or build a residence TP must hold (as a residence) for 5 years to qualify for IRC 121

57 Ownership in a trust (very limited circumstances) Easements (not personal property) Timberland only timberland for raw land Leasehold interests Must be 30 year or more for other real estate Fractional interest Must be tenants in common not for a share of a stock or partnership interest recent court case

58 Tenants in common - are co-owners who each own a separate and undivided interest in the same real property and have an equal right to the possession and use of the property. They each have an Undivided Fractional Interest. Not a partnership Joint ownership Two friends get together and purchase rental property One can exchange his/her interest for another rental property

59 Rev. Proc spells out conditions that must be met Requires IRS Letter Ruling 15 required conditions that must be met

60 Form 8824 Like-Kind exchange Form 6252 Installment sale (like-kind exchange) Several examples in the book

61 Carl owns a 500 unit apartment & a JD tractor used on the property Carl wants a larger tractor- cost of $20,000 Current tractor FMV $5,000 & $-0- basis Option 1- Sell tractor for $5,000 and recognize $5,000 ord. income Option 2 trade-in old tractor + $15,000 cash (gain is deferred) Basis in new tractor: Option 1 = $20,000 Basis in new tractor: Option 2 = $15,000

62 Ima wants to sell her 1000 acre farm in Iowa (no structures) FMV is $2,000,000 Basis in farm - $100,000 Wants to avoid paying tax on the sale/gain Finds a motel in Alabama FMV $1,500,000 Both parties agree to the exchange + $500,000 cash to Ima Additional transfer tax of $7,500 due (from Ima) Ima has a gain equal to the boot less the addt. cost = $492,500 Files Form 8824 Like-kind exchange Form 4797 Sale of business property and Schedule D (Form 1040)

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64 What would happen if (in the prior example) the motel owner did not have the $500,000 cash (Boot) to balance the transaction? Another option could be a like-kind exchange with an installment sale agreement This would also have the effect of spreading out Ima s gain over multi years Interest would be charged on the installment balance and Ima would have a source of yearly cash to keep her bad business decision going Ima files Form 8824 & Form 6252

65 I want to pay the tax now Why???? I have a NOL carry forward I am in a low tax bracket (now & it s going up) I have other capital losses to offset Higher basis in new property (IRC 179, bonus depreciation spread the cost over a period of time) Reduce SE tax (additional depreciation) I like paying taxes ( or I never did it before)

66 Sell the currently owned asset Receive the payment directly from the buyer Purchas the new asset Keep the transactions separated Difficult to do with a dealer (car, equipment,) IRS may challenge and re-characterize as a like-kind exchange

67 If basis of old property exceeds FMV in a like-kind exchange losses are postponed Better off selling property and recognizing loss, unless you don t need the loss now Have an NOL Have carryover capital losses In a low tax bracket

68 Any Questions??????????????