Like-Kind Exchange Mechanics 2018

Transcription

1 Like-Kind Exchange Mechanics 2018 Mark A. Vogel Tax Education Services Denver, Colorado (Handouts pages.)

2 1. Questions for the Instructor: Administrative Matters a. LIVE Questions During the Seminar: 1) Voice: ) Typewritten: a) Click: On next to Live Course Link on your Personal Page b) Click: On the Speech Bubble in the bottom right corner of the seminar viewing screen b. Post-Seminar Questions: 1) OR 2. Computer Problems: a. Call the Office: LKEM.18 2 Other Resources BNA Tax Management Portfolio Number 567-5th (Cost $400). Bloomberg Tax Free Exchanges, published by Aspen Publishing. Author s name is Jeremiah Long (Cost $217). Very Good Mowatt Financial Contact Steven M. Wennerstrom if interested in TIC exchange program ( ). Google Tax Services CCH IntelliConnect, Checkpoint Catalyst Series has a good discussion on the requirements for each state, and Parker Publishing. LKEM.18 3

3 Form 8824 Department of the Treasury Internal Revenue Service Name(s) shown on tax return Like-Kind Exchanges (and section 1043 conflict-of-interest sales) Attach to your tax return. Go to for instructions and the latest information. Identifying number OMB No Attachment Sequence No. 109 Part I Information on the Like-Kind Exchange Note: If the property described on line 1 or line 2 is real or personal property located outside the United States, indicate the country. 1 Description of like-kind property given up: 2 Description of like-kind property received: 3 Date like-kind property given up was originally acquired (month, day, year) MM/DD/YYYY 4 Date you actually transferred your property to the other party (month, day, year) MM/DD/YYYY 5 Date like-kind property you received was identified by written notice to another party (month, day, year). See instructions for 45-day written identification requirement MM/DD/YYYY 6 Date you actually received the like-kind property from other party (month, day, year). See instructions 6 MM/DD/YYYY 7 Was the exchange of the property given up or received made with a related party, either directly or indirectly (such as through an intermediary)? See instructions. If Yes, complete Part II. If No, go to Part III... Yes No Note: Do not file this form if a related party sold property into the exchange, directly or indirectly (such as through an intermediary); that property became your replacement property; and none of the exceptions in line 11 applies to the exchange. Instead, report the disposition of the property as if the exchange had been a sale. If one of the exceptions on line 11 applies to the exchange, complete Part II. Part II Related Party Exchange Information 8 Name of related party Relationship to you Related party s identifying number Address (no., street, and apt., room, or suite no., city or town, state, and ZIP code) 9 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did the related party sell or dispose of any part of the like-kind property received from you (or an intermediary) in the exchange? Yes No 10 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did you sell or dispose of any part of the like-kind property you received? Yes No If both lines 9 and 10 are No and this is the year of the exchange, go to Part III. If both lines 9 and 10 are No and this is not the year of the exchange, stop here. If either line 9 or line 10 is Yes, complete Part III and report on this year s tax return the deferred gain or (loss) from line 24 unless one of the exceptions on line 11 applies. 11 If one of the exceptions below applies to the disposition, check the applicable box. a b c The disposition was after the death of either of the related parties. The disposition was an involuntary conversion, and the threat of conversion occurred after the exchange. You can establish to the satisfaction of the IRS that neither the exchange nor the disposition had tax avoidance as one of its principal purposes. If this box is checked, attach an explanation. See instructions. For Paperwork Reduction Act Notice, see the instructions. Cat. No A Form 8824 (2017)

4 Form 8824 (2017) Page 2 Name(s) shown on tax return. Do not enter name and social security number if shown on other side. Part III Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received Your social security number Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property, see Reporting of multi-asset exchanges in the instructions. Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line Fair market value (FMV) of other property given up Adjusted basis of other property given up Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report the gain or (loss) in the same manner as if the exchange had been a sale Caution: If the property given up was used previously or partly as a home, see Property used as home in the instructions. 15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced (but not below zero) by any exchange expenses you incurred. See instructions FMV of like-kind property you received Add lines 15 and Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus any exchange expenses not used on line 15. See instructions Realized gain or (loss). Subtract line 18 from line Enter the smaller of line 15 or line 19, but not less than zero Ordinary income under recapture rules. Enter here and on Form 4797, line 16. See instructions Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form 4797, unless the installment method applies. See instructions Recognized gain. Add lines 21 and Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and Part IV Deferral of Gain From Section 1043 Conflict-of-Interest Sales Note: This part is to be used only by officers or employees of the executive branch of the Federal Government or judicial officers of the Federal Government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property. 26 Enter the number from the upper right corner of your certificate of divestiture. (Do not attach a copy of your certificate. Keep the certificate with your records.) Description of divested property 28 Description of replacement property 29 Date divested property was sold (month, day, year) MM/DD/YYYY 30 Sales price of divested property. See instructions Basis of divested property Realized gain. Subtract line 31 from line Cost of replacement property purchased within 60 days after date of sale Subtract line 33 from line 30. If zero or less, enter Ordinary income under recapture rules. Enter here and on Form 4797, line 10. See instructions Subtract line 35 from line 34. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form See instructions Deferred gain. Subtract the sum of lines 35 and 36 from line Basis of replacement property. Subtract line 37 from line Form 8824 (2017)

5 Tax-Free Exchanges by Jeremiah Long Example: 1. Relinquished property titled in John s name alone and John would like to take title to the Replacement Property in his name and his wife s (Susan s) name as Tenants in Common. What advice? a. For Colorado, see Imel. b. Real life problem is with a third-party lender. Will not provide financing without Susan s name on title and on the debt. Now, what advice? LKEM.18 4 Example: Tax-Free Exchanges by Jeremiah Long 2. Taxpayer sold the Relinquished Property on May 20, 2018 for $2,800,000 (A/B $600,000) using a Starker Exchange. The taxpayer identified the possible Replacement Properties on June 20, 2018 and then the taxpayer died on June 28, The personal representative completed the exchange and purchased the Replacement Property for $3,200,000 on August 15, What is the Estate s basis in the Replacement Property? a. Is the basis: 1) $1,000,000 ($3,200,000 - $2,200,000) Or 2) $3,200,000 (PLR ) LKEM.18 5

6 Course Objectives 1. Learn Something Beginning in 2018, only real property exchanges qualify for Mechanics: HUD Settlement for the property sold and purchased. How long will it take you to figure out L.15 and L.18 on Form 8824? a. Boot & steps to follow in determining the amount of gain to be reported on L.15 and basis on L.18 of Form b. Realized and Recognized Gain c. Debt Rules How much debt is Boot? (See Barker, 74 T.C. 555 (1980).) LKEM.18 6 Course Objectives 2. Mechanics: HUD Settlement for the property sold and purchased. How long will it take you to figure out L.15 and L.18 on Form 8824? d. Closing Costs or Transactional Costs Reduce Boot (Selling expenses & expenses that would capitalize as part of basis) e. Depreciation on Replacement Property (Easy way or thoughtful way) f. Exchange of Principal Residence where portion of relinquished and replacement used as home office. (To avoid depreciation taken since May 6, But not practical. See Rev. Proc ) LKEM.18 7

7 Course Objectives 3. Starker Exchange Sell & purchase replacement property (See P ) a. Qualified intermediary (see & 1) How much will a QI charge? ($450 to $1,200) b. Identification period 45 days c. How many properties? 3 properties LKEM.18 8 Course Objectives 3. Starker Exchange Sell & purchase replacement property d. Exchange or replacement period? 180 days e. Might also recommend TIC exchange program, if client is having a difficult time locating replacement property. (But TIC programs are rarely, if ever, used today. Have been replaced by DSTs) f. How to treat the exchange if QI files for bankruptcy (Rev. Proc ). (Think of the attorney in Breckenridge, CO who fled to South America with QI funds.) LKEM.18 9

8 Course Objectives 4. Reverse Starker Exchange Purchase replacement property & then sell relinquished property a. Use EAT and the typical charge is $4,000 to $5,000. b. See Rev. Proc which sets forth the rules in order for the exchange to qualify under safe-harbor provisions. (Bartell Rev. Proc is only a safe harbor ruling and is not absolute, but IRS will not acquiesce.) LKEM Course Objectives 5. State Law Treatment of Like-Kind Exchanges (See Worksheet 12 in BNA Tax Management Portion th & Checkpoint s Catalyst Series on like-kind exchanges.) a. For example, Pennsylvania treats all like-kind exchanges as taxable. b. Mississippi, Vermont, and Oregon treat like-kind exchanges as taxable if outof-state property is acquired. (Oregon, however, defers the recognition of the gain until the out-of-state property is sold. Colorado also treats the out-ofstate replacement property as Colorado source income.) c. Most states will allow the gain to be deferred until the sale of the replacement property, but the state might impose a mandatory withholding for state income tax purposes if a non-resident is involved. 1) Think of California property for Colorado property or Colorado property for property located in Texas by a Texas resident (FTB 3840). LKEM.18 11

9 Course Objectives 6. Multiple Asset Exchanges Non Real Property for Non Real Property (N/A for 2018 to 2025) a. Exchange group deficiency is boot b. Personal property exchanges c. Automobile leasing exchanges and the LKE Program approved by Rev. Proc d. Exchange Taco Bell for Burger King 7. How many exchange groups if exchange one piece of real property for three different pieces of real property? (ANS: One) LKEM Course Objectives 8. How long has Form 8824 been in use to report like-kind exchanges? How long has the closer of the sale of real property reported the contract price on a Form 1099S? But if exchange relinquished property (FMV $3,000,000) for replacement property (FMV $3,400,000), what appears on the Form 1099S for the relinquished property and where is that amount reported on Form 8824? Can the IRS track the sale of real property? ANS: Yes, w/ Form 1099S, but selling price not on Form LKEM.18 13

10 Statutory Provisions of 1031 (Yes) (a) Non-Recognition of Gain or Loss from Exchanges Solely In Kind. (1) In General. No gain or loss shall be recognized on the exchange of real property held for productive use in a trade of business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment. LKEM.18 14

11 Statutory Provisions of 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 real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment. (2) Exception for Real Property Held for Sale.--This subsection shall not apply to any exchange of real property held primarily for sale. (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) (ii) the day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or 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 VOGEL.SEM/LKEM.18

12 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) (f) Application to Certain Partnerships.--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. Special Rules for Exchanges Between Related Persons.-- (1) In General.--If-- (A) a taxpayer exchanges property with a related person, (B) there is nonrecognition 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) (ii) the related person disposes of such property, or 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 nonrecognition 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 VOGEL.SEM/LKEM.18

13 (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 Property.--Real property located in the United States and real property located outside the United States are not property of a like kind VOGEL.SEM/LKEM.18

14 Statutory Provisions of 1031 (Yes) (a) Non-Recognition of Gain or Loss from Exchanges Solely In Kind. (2) Exception. This subsection shall not apply to any exchange of real property held primarily for sale. LKEM Statutory Provisions of 1031 (a) Non-Recognition of Gain or Loss from Exchanges Solely In Kind. Starker Exchange (3) Requirement That Property be Identified d 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: (i) (ii) 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 Such property is received after the earlier of: (A) The day which is 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, (B) 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. LKEM.18 16

15 Statutory Provisions of 1031 (Yes) (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. LKEM Statutory Provisions of 1031 (Yes) (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. LKEM.18 18

16 Statutory Provisions of 1031 (Yes) (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. LKEM Statutory Provisions of 1031 (Yes) (e) Application to Certain Partnerships.--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. (But see FSA and FSA which precluded the partners from electing out of Subchapter K since it was formally organized as a partnership under state law See also Notice which indicates IRS is reconsidering its position.) If elect to be excluded from the partnership rules, may participate in LKE. See also Rev. Rul , mere co-ownership of property is not a tax partnership. LKEM.18 20

17 Statutory Provisions of 1031 (Yes) (f) Special Rules for Exchanges Between Related Persons. (1) In General.--If (A) a taxpayer exchanges property with a related person, (B) there is nonrecognition 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 nonrecognition 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. LKEM Statutory Provisions of 1031 (Yes) (f) Special Rules for Exchanges Between Related Persons. (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. LKEM.18 22

18 Statutory Provisions of 1031 (Yes) (f) Special Rules for Exchanges Between Related Persons. (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. LKEM Statutory Provisions of 1031 (Yes) (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. LKEM.18 24

19 Statutory Provisions of 1031 (Yes) (g) Special Rule Where Substantial Diminution of Risk. (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. LKEM Statutory Provisions of 1031 (Yes) (h) Special Rules for Foreign Real Property.--Real property located in the United States and real property located outside the United States are not property of a like kind. LKEM.18 26

20 Mandatory (Yes) Section 1031 is mandatory (Reg (b)-1(a)). LKEM.18 27

21 Mandatory 1. Section 1031 is mandatory (Reg (b)-1(a)). Once the requirements are met, either intentionally or accidentally, the taxpayer does not have the election whether to report or to defer the gain or loss otherwise incurred in the transaction. This is true nd regardless of the taxpayer s intent (U.S. v. Vardine, 305 F.2d 60 (2 Cir. 1962); nd Trenton Cotton Oil Co. v. Comm r, 269 F.2d 453 (2 Cir. 1959)). Thus, a taxpayer cannot avoid tax deferred exchange treatment merely by receiving money or other property in addition to like-kind property (Reg (c)-1 and James Godine, Jr., 36 T.C.M (1977)). 2. Section 1031 is not available to a sale and purchase. Reg (d) and Detroit Egg Biscuit & Specialty Co. v. Comm r, 9 B.T.A (1928). a. May a taxpayer sell property today and purchase like-kind property tomorrow? (See Hillyer for what not to do.) b. Does the taxpayer have the right to touch the cash? VOGEL.SEM/LKEM.18

22 Mandatory (Yes) Section 1031 is not available to a sale and purchase. Reg (d) and Detroit Egg Biscuit & Specialty Co. v. Comm r, 9 B.T.A (1928). May a taxpayer sell property today and purchase like-kind property tomorrow?(see Hillyer for what not to do.) Sell the property on Comes to see U on Does the taxpayer have the right to touch the cash? (See North Central Leasing & Rental LLC.) LKEM Taxable Sales & Exchanges (Yes) CASH AMT Realized FMV of Property Face of Debt Relief Less sum of: Adj. Basis & Selling Exp. Real Gain (Loss) Note: Form 8824 does not follow the traditional way to recognize gain (loss) on the sale or exchange of property. LKEM.18 29

23 Taxable Sales & Exchanges CASH AMT Realized FMV of Property Face of Debt Relief Less sum of: Adj. Basis & Selling Exp. Real Gain (Loss) 1031 provides for the nonrecognition of gain Other Nonrecognition sections: (a) exchange of insurance policies and annuity contracts (a) stock for stock in a corporate reorganization (a) exchange of certain U.S. obligations But pay close attention to exchange of real property by someone who is not a resident of the state in which the property is located. The exchange may be subject to state income tax or at least state income withholding. What result if a Colorado resident who owns California property exchanges such property under 1031 for Colorado property? (See CA CRS which requires withholding of 3a% of the total sales price on disposition of CA real estate when the seller has no permanent place of business in California - See CA Form 593. See also CRS which requires withholding of 2% of the sales price.) VOGEL.SEM/LKEM.18

24 Taxable Sales & Exchanges (Yes) 1031 provides for the nonrecognition of gain Other Nonrecognition sections: 1035(a) exchange of insurance policies and annuity contracts 1036(a) stock for stock in a corporate reorganization 1037(a) exchange of certain U.S. obligations LKEM Taxable Sales & Exchanges (Yes) But pay close attention to exchange of real property by someone who is not a resident of the state in which the property is located. The exchange may be subject to state income tax or at least state income withholding. What result if a Colorado resident who owns California property exchanges such property under 1031 for Colorado property? (See CA CRS which requires withholding of 3⅓% of the total sales price on disposition of CA real estate when the seller has no permanent place of business in California See CA FTB See also CRS which requires withholding of 2% of the sales price.) If have access to BNA Tax Mgt Portfolio on LKE, will give you a Worksheet on what the requirement is for a particular state. Checkpoint Catalyst Library is much more inclusive. LKEM.18 31

25 Form 8824 (Yes) L.15 - Steps to determine boot received. How much gain recognized? L.18 - How to determine basis in replacement property. A/B in Replacement Property & then calculate depreciation on the Replacement Property Client brings in two HUD Settlement Sheets. How long will it take U to figure out L.15 and L.18 from the two settlement sheets? Relinquished (Sold) LKEM Replacement (Purchased)

26 Form 8824 Department of the Treasury Internal Revenue Service Name(s) shown on tax return Like-Kind Exchanges (and section 1043 conflict-of-interest sales) Attach to your tax return. Go to for instructions and the latest information. Identifying number OMB No Attachment Sequence No. 109 Part I Information on the Like-Kind Exchange Note: If the property described on line 1 or line 2 is real or personal property located outside the United States, indicate the country. 1 Description of like-kind property given up: 2 Description of like-kind property received: 3 Date like-kind property given up was originally acquired (month, day, year) MM/DD/YYYY 4 Date you actually transferred your property to the other party (month, day, year) MM/DD/YYYY 5 Date like-kind property you received was identified by written notice to another party (month, day, year). See instructions for 45-day written identification requirement MM/DD/YYYY 6 Date you actually received the like-kind property from other party (month, day, year). See instructions 6 MM/DD/YYYY 7 Was the exchange of the property given up or received made with a related party, either directly or indirectly (such as through an intermediary)? See instructions. If Yes, complete Part II. If No, go to Part III... Yes No Note: Do not file this form if a related party sold property into the exchange, directly or indirectly (such as through an intermediary); that property became your replacement property; and none of the exceptions in line 11 applies to the exchange. Instead, report the disposition of the property as if the exchange had been a sale. If one of the exceptions on line 11 applies to the exchange, complete Part II. Part II Related Party Exchange Information 8 Name of related party Relationship to you Related party s identifying number Address (no., street, and apt., room, or suite no., city or town, state, and ZIP code) 9 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did the related party sell or dispose of any part of the like-kind property received from you (or an intermediary) in the exchange? Yes No 10 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did you sell or dispose of any part of the like-kind property you received? Yes No If both lines 9 and 10 are No and this is the year of the exchange, go to Part III. If both lines 9 and 10 are No and this is not the year of the exchange, stop here. If either line 9 or line 10 is Yes, complete Part III and report on this year s tax return the deferred gain or (loss) from line 24 unless one of the exceptions on line 11 applies. 11 If one of the exceptions below applies to the disposition, check the applicable box. a b c The disposition was after the death of either of the related parties. The disposition was an involuntary conversion, and the threat of conversion occurred after the exchange. You can establish to the satisfaction of the IRS that neither the exchange nor the disposition had tax avoidance as one of its principal purposes. If this box is checked, attach an explanation. See instructions. For Paperwork Reduction Act Notice, see the instructions. Cat. No A Form 8824 (2017)

27 Form 8824 (2017) Page 2 Name(s) shown on tax return. Do not enter name and social security number if shown on other side. Part III Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received Your social security number Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property, see Reporting of multi-asset exchanges in the instructions. Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line Fair market value (FMV) of other property given up Adjusted basis of other property given up Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report the gain or (loss) in the same manner as if the exchange had been a sale Caution: If the property given up was used previously or partly as a home, see Property used as home in the instructions. 15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced (but not below zero) by any exchange expenses you incurred. See instructions FMV of like-kind property you received Add lines 15 and Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus any exchange expenses not used on line 15. See instructions Realized gain or (loss). Subtract line 18 from line Enter the smaller of line 15 or line 19, but not less than zero Ordinary income under recapture rules. Enter here and on Form 4797, line 16. See instructions Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form 4797, unless the installment method applies. See instructions Recognized gain. Add lines 21 and Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and Part IV Deferral of Gain From Section 1043 Conflict-of-Interest Sales Note: This part is to be used only by officers or employees of the executive branch of the Federal Government or judicial officers of the Federal Government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property. 26 Enter the number from the upper right corner of your certificate of divestiture. (Do not attach a copy of your certificate. Keep the certificate with your records.) Description of divested property 28 Description of replacement property 29 Date divested property was sold (month, day, year) MM/DD/YYYY 30 Sales price of divested property. See instructions Basis of divested property Realized gain. Subtract line 31 from line Cost of replacement property purchased within 60 days after date of sale Subtract line 33 from line 30. If zero or less, enter Ordinary income under recapture rules. Enter here and on Form 4797, line 10. See instructions Subtract line 35 from line 34. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form See instructions Deferred gain. Subtract the sum of lines 35 and 36 from line Basis of replacement property. Subtract line 37 from line Form 8824 (2017)

28 Boot 1031(b) (Yes) Includes unlike property received Includes cash received Includes debt relief, with special rules applying LKEM.18 33

29 Boot! Includes unlike property received! Includes cash received! Includes debt relief, with special rules applying! A taxpayer may: 1. Give or receive money 2. Give or receive other property which does not meet the requirements of Assume a liability or have the other party assume a liability 4. Acquire property subject to a liability or have the other party take property subject to a debt! How much cash may a client receive without being required to recognize gain? VOGEL.SEM/LKEM.18

30 Boot (Yes) A taxpayer may: Give or receive money Give or receive other property which does not meet the requirements of 1031 Assume a liability or have the other party assume a liability Acquire property subject to a liability or have the other party take property subject to a debt LKEM Boot (Yes) How much cash may a client receive without being required to recognize gain? May cash out to the extent of the exchange expenses. LKEM.18 35

31 Boot and L.15 Three Steps for Line 15 (Yes) Step 1: Compare Net Equity of Relinquished Property (sold) with Net Equity of Replacement Property (purchased). Sold Relinquished Selling Price Less Debt (sold) Equity - Sold (Cash Received) Purchased Replacement Contract Price Less Debt (purchased) Equity Purchased (Cash Paid) If Equity - Sold exceeds Equity - Purchased, then excess is treated as cash received (or Cash Received Cash Paid) (See L.15.) LKEM Step 2: Boot and L.15 Three Steps for Line 15 (Yes) Compare Debt on Relinquished Property (sold) with Debt on Replacement Property (purchased). Sold Relinquished Selling Price Less Debt (sold) Equity - Sold Purchased Replacement Contract Price Less Debt (purchased) Equity - Purchased If the Debt (sold) on Relinquished Property exceeds Debt (purchased) on Replacement Property, then excess is treated as Net Debt Relief and Boot on L.15. LKEM.18 37

32 Boot and L.15 Three Steps for Line 15 (Yes) Step 3: If No. 1 and/or No. 2 are positive, then subtract transaction costs (selling expenses) on the Property Sold (Relinquished) and (expenses that would have capitalized into basis if not a LKE) Property Purchased (Replacement). Transaction Costs (or exchanges expenses) are expenses listed on HUD Settlement Sheet that are classified as selling expenses on the Relinquished Property and costs on the HUD Settlement Sheet for the Replacement Property that are capitalized into the basis of the property. LKEM Add the following: Basis and L.18 Four Steps for Line 18 (Yes) Step 1: A/B of Relinquished Property (Property Sold) Step 2: Add the excess, if any, of the Net Equity on the Replacement (cash paid) in excess of the Net Equity on the Relinquished (cash received). (This is additional cash paid.) Step 3: Add the excess, if any, of the Debt on the Replacement in excess of the Debt on the Relinquished. Step 4: Add any transaction costs that were not used to determine gain on L.15. LKEM.18 39

33 No. 1 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement (Yes) If a taxpayer s liabilities are assumed or taken subject to treated as money received by the taxpayer. (Sold) (Purchased) Relinquished Property Replacement Property FMV $300,000 FMV $200,000 MTGE 100,000 A/B 50, If sold, would have a taxable gain of $250,000. LKEM No. 1 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement If Sold A/R: Cash $200,000 Debt Relief 100,000 Total A/R $300,000 A/B 50,000 Real Gain $250,000 Recognized? LKEM.18 41

34 No. 1 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement LKEM No. 1 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement What are the entries on L.15 & L.18 of Form 8824? Relinquished Property Replacement Property Selling Price $300,000 Contract Price $200,000 Less Debt (100,000) Less Debt (0) (Step 1) Cash Rec d $200,000 (-) Cash Paid $200,000 Line 15: Net Cash Rec d $ 0 + Debt on Relinquished (Step 2) > Debt on Replacement 100,000 ($100,000 0) L.15 $100,000 = LKEM.18 43

35 No. 1 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $200,000 Less Debt (100,000) Less Debt (0) Cash Rec d $200,000 Cash Paid $200,000 Line 18: A/B of Relinquished $50,000 + Cash Paid > + 0 Cash Received + Debt on Replacement > + Debt on Relinquished 0 L.18 $50,000 (FMV $200,000) LKEM No. 2 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished (Yes) (Sold) (Purchased) Relinquished Property Replacement Property FMV $300,000 FMV $450,000 MTGE 100,000 MTGE 250,000 A/B 50,000 If sold, taxable gain of $250,000. A/R: Cash $200,000 Debt 100,000 Total A/R $300,000 Less A/B 50,000 Real Gain $250,000 LKEM.18 45

36 No. 2 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished LKEM No. 2 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished What are the entries on L.15 & L.18 of Form 8824? (Sold) Relinquished Property (Purchased) Replacement Property Selling Price $300,000 Contract Price $450,000 Less Debt (100,000) Less Debt (250,000) Cash Rec d $200,000 (-) Cash Paid $200,000 Line 15: Net Cash Rec d $ 0 + Debt on Relinquished > Debt on Replacement 0 L.15 $ 0 = LKEM.18 47

37 No. 2 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $450,000 Less Debt (100,000) Less Debt (250,000) Cash Rec d $200,000 Cash Paid $200,000 Line 18: A/B of Relinquished $50,000 + Cash Paid > + 0 Cash Received + Debt on Replacement > Debt on Relinquished ($250,000 > 100,000) + 150,000 L.18 $200,000 (FMV $450,000) (O.B. $50,000 & Boot $150,000) LKEM No. 3 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement (No) (Sold) (Purchased) Relinquished Property Replacement Property FMV $300,000 FMV $350,000 MTGE 200,000 MTGE 125,000 A/B 50,000 Pay Boot 125,000 If sold, taxable gain of $250,000. LKEM.18 49

38 No. 3 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement (No) What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $350,000 Less Debt (200,000) Less Debt (125,000) Cash Rec d $100,000 (-) Cash Paid $225,000 = Line 15: Net Cash Rec d $ 0 + Debt on Relinquished > Debt on Replacement ($200,000 $125,000) + 75,000 But Cash paid of $125,000 (But may use cash paid > cash rec d to offset debt relief.) may offset Debt Relief (75,000) Now unused cash of $50,000 L.15 $ 0 ($125,000 $75,000) LKEM No. 3 - Liability and Boot Rules Debt on Relinquished > Debt on Replacement (No) What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $350,000 Less Debt (200,000) Less Debt (125,000) Cash Rec d $100,000 Cash Paid $225,000 Line 18: A/B of Relinquished $ 50,000 + Cash Paid > Cash Received ($125,000 cash paid less cash used to offset Debt Relief of $75,000) + 50,000 + Debt on Replacement > Debt on Relinquished 0 L.18 $100,000 (FMV $350,000) (Gain Defer - $250,000) LKEM.18 51

39 No. 4 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished (Yes) (Sold) (Purchased) Relinquished Property Replacement Property FMV $300,000 FMV $325,000 MTGE 100,000 MTGE 150,000 A/B 50,000 If sold, taxable gain of $250,000. A/R: Cash $200,000 Debt 100,000 Total A/R $300,000 A/B 50,000 Real Gain $250,000 LKEM No. 4 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished (Yes) What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $325,000 Less Debt (100,000) Less Debt (150,000) Cash Rec d $200,000 (-) Cash Paid $175,000 Line 15: Net Cash Rec d $25,000 + Debt on Relinquished > + 0 Debt on Replacement L.15 $25,000 = LKEM.18 53

40 No. 4 - Liability and Boot Rules Debt on Replacement > Debt on Relinquished (Yes) What are the entries on L.15 & L.18 of Form 8824? (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $300,000 Contract Price $325,000 Less Debt (100,000) Less Debt (150,000) Cash Rec d $200,000 Cash Paid $175,000 Line 18: A/B of Relinquished $50,000 + Cash Paid > Cash Received Debt on Replacement > Debt on Relinquished 50,000 L.18 $100,000 (FMV $325,000) (O.B. $50,000 & Boot $50,000) LKEM.18 54

41 LIABILITY AND BOOT RULES 1. If a taxpayer s liabilities are assumed or taken subject to treated as money received by the taxpayer. a. Relinquished Property Replacement Property FMV $300,000 FMV $200,000 MTGE 100,000 A/B 50,000 b. What are the entries on L.15 & L.18 of Form 8824? Relinquished Property Replacement Property Selling Price $300,000 Contract Price $200,000 Less Debt (100,000) Less Debt (0) Cash Rec d $200,000 ( - ) Cash Paid $200,000 = Line 15: Net Cash Rec d $ 0 + Debt on Relinquished > Debt on Replacement 100,000 ($100,000-0) L. 15 $100,000 Line 18: A/B of Relinquished $ 50,000 + Cash Paid > + Cash Received 0 + Debt on Replacement > + Debt on Relinquished 0 L.18 $ 50, Money paid by the taxpayer reduces his amount realized. Money paid includes paying cash, executing a promissory note or assuming a liability VOGEL.SEM/LKEM.18

42 3. Mortgage Boot = Liabilities assumed or taken subject to. If a taxpayer s liability is assumed or taken subject to, taxpayer treated as having received mortgage boot even if the buyer refinances the taxpayer s property as part of the exchange. a. Relinquished Property Replacement Property FMV $300,000 FMV $450,000 MTGE 100,000 MTGE 250,000 A/B 50,000 b. What are the entries on L.15 & L.18 of Form 8824? Relinquished Property Replacement Property Selling Price $300,000 Contract Price $450,000 Less Debt (100,000) Less Debt (250,000) Cash Rec d $200,000 ( - ) Cash Paid $200,000 = Line 15: Net Cash Rec d $ 0 + Debt on Relinquished > + 0 Debt on Replacement L. 15 $ 0 Line 18: A/B of Relinquished $ 50,000 + Cash Paid > + 0 Cash Received + Debt on Replacement > Debt on Relinquished ($250,000 > 100,000) + 150,000 L.18 $200, VOGEL.SEM/LKEM.18

43 4. If you assume or take subject to a debt, you are deemed to have paid mortgage boot. a. Relinquished Property Replacement Property FMV $300,000 FMV $350,000 MTGE 200,000 MTGE 125,000 A/B 50,000 Pay Boot 125,000 b. What are the entries on L.15 & L.18 of Form 8824? Relinquished Property Replacement Property Selling Price $300,000 Contract Price $350,000 Less Debt (200,000) Less Debt (125,000) Cash Rec d $100,000 ( - ) Cash Paid $225,000 = Line 15: Net Cash Rec d $ 0 + Debt on Relinquished > + 0 Debt on Replacement ($200, ,000) + 75,000 But Cash paid of $125,000 may offset Debt Relief (75,000) L. 15 $ 0 Line 18: A/B of Relinquished $ 50,000 + Cash Paid > Cash Received ($125,000 cash paid less cash used to offset Debt Relief of $75,000) + 50,000 + Debt on Replacement > Debt on Relinquished 0 L.18 $100, VOGEL.SEM/LKEM.18

44 5. Cash Boot = Cash and other non-qualifying property (i.e., a secured or unsecured note). a. Relinquished Property Replacement Property FMV $300,000 FMV $325,000 MTGE 100,000 MTGE 150,000 A/B 50,000 Boot Paid 25,000 b. What are the entries on L.15 & L.18 of Form 8824? Relinquished Property Replacement Property Selling Price $300,000 Contract Price $325,000 Less Debt (100,000) Less Debt (150,000) Cash Rec d $200,000 ( - ) Cash Paid $175,000 = Line 15: Net Cash Rec d $ 25,000 + Debt on Relinquished > + 0 Debt on Replacement L. 15 $ 25,000 Line 18: A/B of Relinquished $ 50,000 + Cash Paid > Cash Received Debt on Replacement > Debt on Relinquished $ 50,000 L.18 $100, VOGEL.SEM/LKEM.18

45 6. You can pay or receive cash boot. 7. Boot Netting Rules: a. Cash paid on acquisition of replacement property offsets cash received on disposition of relinquished property. b. Cash paid on acquisition of replacement property offsets debt relief on the disposition of relinquished property. c. Debt assumed (or taken subject to) on the acquisition of replacement property offsets debt relief (or taking subject to) on the disposition of relinquished property. d. Debt assumed (or taken subject to) on the acquisition of replacement property will not offset cash received on the disposition of relinquished property VOGEL.SEM/LKEM.18

46 Boot Netting Rules (Yes) Cash paid on acquisition of replacement property offsets cash received on dispositionofiti relinquished i property. Cash paid on acquisition of replacement property offsets debt relief on the disposition of relinquished property. Debt assumed (or taken subject to) on the acquisition of replacement property offsets debt relief (or taking subject to) on the disposition of relinquished property. (See Barker, 74 T.C. 555 (1980) and PLR ) Debt assumed (or taken subject to) on the acquisition of replacement property will not offset cash received on the disposition of relinquished property. LKEM Non Qualified Property (Yes) Non-qualified property given offsets non-qualified property received (see Biggs vs. Comm r, 632F.2d 1171 (5 th Cir. 1980)), if the taxpayer transfers non-qualified property, gain or loss may be recognized on the non-qualified property given. In effect, only the adjusted basis of the non-qualified property given offsets boot received. Non-Qualified Property: Received Treat FMV as cash received (and Basis is FMV) Transferred Treat FMV as cash paid (& see Part III, Lines 12, 13 & 14) (What happens if exchange property where client used cost segregation to calculate depreciation?) LKEM.18 56

47 Non Qualified Property (Yes) Received Treat FMV as an additional amount received on L.15 of Form Transferred Treat FMV as an additional amount paid on L.18 of Form 8824, but the transfer of the nonqualified property is a taxable sale or exchange where gain or loss is required to be recognized. (See Lines 12, 13 and 14 on Form 8824.) LKEM Rev. Rul and Commissions (Yes) As a result of Rev. Rul , brokerage commissions paid in a 1031 exchange are treated as property boot paid. Consequently, such commissions paid may be offset against mortgage or property boot received. Thus, Rev. Rul provides that otherwise taxable net boot received by the taxpayer may be offset by the taxpayer s transaction costs, including his brokerage commissions. Non-Deductible Closing Costs or Exchange Expenses WhileRev.Rul dealsonlywithcommissions,thereisnoreasonRev. Rul should not apply equally to all other non-deductible transaction costs, so that in either case the net boot received by the taxpayer should be reduced by the amount of such costs and expenses. LKEM.18 58

48 Rev. Rul and Commissions As a result of Rev. Rul , brokerage commissions paid in a 1031 exchange are treated as property boot paid. Consequently, such commissions paid may be offset against mortgage or property boot received. Thus, Rev. Rul provides that otherwise taxable net boot received by the taxpayer may be offset by the taxpayer s transaction costs, including his brokerage commissions. Non-Deductible Closing Costs While Rev. Rul deals only with commissions, there is no reason Rev. Rul should not apply equally to all other non-deductible transaction costs, so that in either case the net boot received by the taxpayer should be reduced by the amount of such costs and expenses. (Deductible items (taxes, interest, commitment fees for loans, prepayment penalty, etc.) do not constitute transaction costs under this rule. However, if the exchangor uses a portion of his exchange equity to pay such normally prorated items, he is treated as having received property (cash) boot to the extent he does not reinvest all of his exchange equity in the acquired property ( 1031; Reg (d)-1, 2).) Conceptually, it is untenable to make a distinction between commissions and other non-deductible transaction costs. Mercantile Trust Company v. Comm r, 32 B.T.A. 82 (1935), however, does provide the needed authority for the netting of property boot against other transaction costs. In Mercantile, the taxpayer traded down from a $300,000 property to a $267,000 property and intentionally provided for $33,000 in property boot. When the taxpayer reported the transaction, he automatically reduced the amount of property boot received by all transaction costs. The concept of the netting was approved by the Court without comment or IRS objection. Therefore, the above offset rules must be modified to the extent that a trade down does not exceed the exchangor s transaction costs. Transaction costs are those expenses in the transaction which are ordinarily capitalized VOGEL.SEM/LKEM.18

49 Trading Down to the Extent of Selling Expenses Example Owner exchanges qualified property having an adjusted basis of $20,000 and subject to a mortgage of $10,000 for qualified property having a fair market value of $30,000 and subject to a mortgage of $8,000 plus $2,000 cash. Owner pays a commission of $4,000 and recognizes no gain calculated as follows: FMV of property received $30,000 Cash received 2,000 Debt on old property 10,000 Total consideration received $42,000 Less: Basis of old property $20,000 Debt on new property 8,000 Commission 4,000 $32,000 Gain realized $10,000 The net mortgage boot received of $2,000 ($10,000 - $8,000) and the property boot received of $2,000 in cash are offset completely by the $4,000 commission which is considered property boot given VOGEL.SEM/LKEM.18

50 Transaction Costs Which May Be Treated as Boot Paid (Exchange Expenses) Brokerage Commissions on Sale Fees to Escrow Agents Title Search and Other Legal Fees Brokerage Commissions on Purchase Advertising Expenses Appraisal Fees on Both Relinquished and Replacement Property Transfer Taxes Recording Fees Title Insurance Surveyor s Fees Other Charges Title Fees Termite Courier Fees Exchange Fees Escrow for Repairs Fees paid for tax advice relating to whether the requirements of 1031 will be satisfied Points are not transaction costs VOGEL.SEM/LKEM.18

51 Not Transaction Costs Prepaids by Seller Condo Fees Taxes Pay-off of Mortgage Principal Pay off Interest Loan Fees Loan Points Insurance Lender Reserves VOGEL.SEM/LKEM.18

52 Transaction Costs Which May Be Treated as Boot Paid (Exchange Expenses) (Yes) Brokerage Commissions on Sale Fees to Escrow Agents Title Search and Other Legal Fees Brokerage Commissions on Purchase Advertising Expenses Appraisal Fees on Both Relinquished and Replacement Property Transfer Taxes LKEM Recording Fees Title Insurance Surveyor s Fees Other Charges Title Fees Termite Courier Fees Exchange Fees Escrow for Repairs Transaction Costs Which May Be Treated as Boot Paid (Exchange Expenses) (Yes) Fees paid for tax advice relating to whether the requirements of 1031 will be satisfied Points are not transaction costs LKEM.18 60

53 Not Transaction Costs (Yes) Prepaids by Seller Condo Fees Taxes Pay-off of Mortgage Principal Pay off Interest Loan Fees Loan Points Insurance Lender Reserves LKEM Transaction Costs (Yes) Is a Transaction Cost (exchange expense) if: On the Property Sold Did T incur the expenses to sell the property (selling expense)? On the Property Purchased Would T have added the cost to basis if not LKE? LKEM.18 62

54 Reporting Exchange (Yes) Form 8824 See Page 1 If a taxpayer has a like-kind exchange, they must file Form 8824, Like-Kind Exchanges, in addition to Schedule D or Form The Form 8824 requests certain information about the exchange including: Descriptions of the properties, Date of disposition of taxpayer s property, Dates of identification and acquisition of the replacement property, and Certain related party information. The balance of the form concerns computations of realized gain or loss, recognized gain, basis of property received, and deferred gain. LKEM.18 63

55 Form 8824 Department of the Treasury Internal Revenue Service Name(s) shown on tax return Like-Kind Exchanges (and section 1043 conflict-of-interest sales) Attach to your tax return. Go to for instructions and the latest information. Identifying number OMB No Attachment Sequence No. 109 Part I Information on the Like-Kind Exchange Note: If the property described on line 1 or line 2 is real or personal property located outside the United States, indicate the country. 1 Description of like-kind property given up: 2 Description of like-kind property received: 3 Date like-kind property given up was originally acquired (month, day, year) MM/DD/YYYY 4 Date you actually transferred your property to the other party (month, day, year) MM/DD/YYYY 5 Date like-kind property you received was identified by written notice to another party (month, day, year). See instructions for 45-day written identification requirement MM/DD/YYYY 6 Date you actually received the like-kind property from other party (month, day, year). See instructions 6 MM/DD/YYYY 7 Was the exchange of the property given up or received made with a related party, either directly or indirectly (such as through an intermediary)? See instructions. If Yes, complete Part II. If No, go to Part III... Yes No Note: Do not file this form if a related party sold property into the exchange, directly or indirectly (such as through an intermediary); that property became your replacement property; and none of the exceptions in line 11 applies to the exchange. Instead, report the disposition of the property as if the exchange had been a sale. If one of the exceptions on line 11 applies to the exchange, complete Part II. Part II Related Party Exchange Information 8 Name of related party Relationship to you Related party s identifying number Address (no., street, and apt., room, or suite no., city or town, state, and ZIP code) 9 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did the related party sell or dispose of any part of the like-kind property received from you (or an intermediary) in the exchange? Yes No 10 During this tax year (and before the date that is 2 years after the last transfer of property that was part of the exchange), did you sell or dispose of any part of the like-kind property you received? Yes No If both lines 9 and 10 are No and this is the year of the exchange, go to Part III. If both lines 9 and 10 are No and this is not the year of the exchange, stop here. If either line 9 or line 10 is Yes, complete Part III and report on this year s tax return the deferred gain or (loss) from line 24 unless one of the exceptions on line 11 applies. 11 If one of the exceptions below applies to the disposition, check the applicable box. a b c The disposition was after the death of either of the related parties. The disposition was an involuntary conversion, and the threat of conversion occurred after the exchange. You can establish to the satisfaction of the IRS that neither the exchange nor the disposition had tax avoidance as one of its principal purposes. If this box is checked, attach an explanation. See instructions. For Paperwork Reduction Act Notice, see the instructions. Cat. No A Form 8824 (2017)

56 Form 8824 (2017) Page 2 Name(s) shown on tax return. Do not enter name and social security number if shown on other side. Part III Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received Your social security number Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property, see Reporting of multi-asset exchanges in the instructions. Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line Fair market value (FMV) of other property given up Adjusted basis of other property given up Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report the gain or (loss) in the same manner as if the exchange had been a sale Caution: If the property given up was used previously or partly as a home, see Property used as home in the instructions. 15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced (but not below zero) by any exchange expenses you incurred. See instructions FMV of like-kind property you received Add lines 15 and Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus any exchange expenses not used on line 15. See instructions Realized gain or (loss). Subtract line 18 from line Enter the smaller of line 15 or line 19, but not less than zero Ordinary income under recapture rules. Enter here and on Form 4797, line 16. See instructions Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form 4797, unless the installment method applies. See instructions Recognized gain. Add lines 21 and Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and Part IV Deferral of Gain From Section 1043 Conflict-of-Interest Sales Note: This part is to be used only by officers or employees of the executive branch of the Federal Government or judicial officers of the Federal Government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property. 26 Enter the number from the upper right corner of your certificate of divestiture. (Do not attach a copy of your certificate. Keep the certificate with your records.) Description of divested property 28 Description of replacement property 29 Date divested property was sold (month, day, year) MM/DD/YYYY 30 Sales price of divested property. See instructions Basis of divested property Realized gain. Subtract line 31 from line Cost of replacement property purchased within 60 days after date of sale Subtract line 33 from line 30. If zero or less, enter Ordinary income under recapture rules. Enter here and on Form 4797, line 10. See instructions Subtract line 35 from line 34. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form See instructions Deferred gain. Subtract the sum of lines 35 and 36 from line Basis of replacement property. Subtract line 37 from line Form 8824 (2017)

57 Form 8824 Example (Yes If Time) Facts: 1. Basis The original basis in the relinquished property is $50,000, and $20,000 of depreciation has been taken. 2. Relinquished Property The relinquished property s contract price is $100,000 and the current debt to be paid off at settlement is $50,000. The exchanger took back a note for $10,000, had $10,000 in exchange expenses and the $30,000 in net proceeds (after payment of the exchange expenses) were placed in qualified escrow account by the Qualified Intermediary. 3. Replacement Property The replacement property was purchased for $120,000 and a new loan was taken out for $100,000. The cash down payment was $20,000 and exchange expenses were $2, How much gain is required to be recognized and what is the basis in the replacement property? LKEM Form 8824 Example If Sold: Or,IfSold: A/R Cash & Note $50,000 A/R Cash & Note $50,000 Debt Relief 50,000 Debt Relief 50,000 Total A/R 100,000 Total A/R 100,000 Less A/B & SE (40,000) LessA/B,SE& Exp on Purch. (42,000) Real Gain $60,000 Real Gain $58,000 Difference is $2,000 of Exchange Expenses on purchase of Replacement Property LKEM.18 65

58 Form 8824 Example LKEM Solution (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $100,000 Contract Price $120,000 Less Debt (50,000) Less Debt (100,000) Cash Rec d $ 50,000 (-) Cash Paid $ 20,000 = Line 15: Net Cash Rec d $ 30,000 + Debt on Relinquished > + 0 Debt on Replacement - Exchange Expenses (12,000) L.15 $ 18,000 Note $10,000 Cash $8,000 LKEM.18 67

59 Solution (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $100,000 Contract Price $120,000 Less Debt (50,000) Less Debt (100,000) Cash Rec d $ 50,000 Cash Paid $ 20,000 Line 18: A/B of Relinquished $30,000 + Cash Paid > Cash Received Debt on Replacement > Debt on Relinquished + 50,000 + Exchange Expenses + 0 L.18 $80,000 LKEM.18 68

60 Form 8824 Example Facts: 1. Basis - The original basis in the relinquished property is $50,000, and $20,000 of depreciation has been taken. 2. Relinquished Property - The relinquished property s contract price is $100,000 and the current debt to be paid off at settlement is $50,000. The exchanger took back a note for $10,000, had $10,000 in exchange expenses and the $30,000 in net proceeds (after payment of the exchange expenses) were placed in qualified escrow account by the Qualified Intermediary. 3. Replacement Property - The replacement property was purchased for $120,000 and a new loan was taken out for $100,000. The cash down payment was $20,000 and exchange expenses were $2, How much gain is required to be recognized and what is the basis in the replacement property? VOGEL.SEM/LKEM.18

61 Relinquished Property Replacement Property Selling Price $100,000 Contract Price $120,000 Less Debt (50,000) Less Debt (100,000) Cash Rec d $ 50,000 ( - ) Cash Paid $ 20,000 = Line 15: Net Cash Rec d $ 30,000 + Debt on Relinquished > + 0 Debt on Replacement - Exchange Expenses (12,000) L. 15 $ 18,000 Note $10,000 Cash $8,000 Line 18: A/B of Relinquished $ 30,000 + Cash Paid > Cash Received Debt on Replacement > Debt on Relinquished + 50,000 + Exchange Expenses + 0 L.18 $ 80, VOGEL.SEM/LKEM.18

62 Gain Realized on Relinquished Property FMV of Relinquished Property (FMV is normally contract price) $100,000 Less Adjusted Basis ($50,000 - $20,000) (30,000) Less Exchange Expenses: Relinquished Property $10,000 Replacement Property 2,000 (12,000) Realized Gain - Line 19 of Form 8824 $ 58,000 Recognized Gain: Debt Relief on Relinquished Property $ 50,000 Less Debt on Replacement Property 100,000 Net Debt Relief $ 0 Plus Cash Down Payment Received 40,000 Less Cash Paid on Replacement Property (20,000) Less Total Exchange Expenses on Relinquished and Replacement Property (12,000) Plus FMV of other Property, Cash & Notes Received 10,000 Less FMV of Other Property Relinquished (0) Net Boot Received & Gain Recognized (Line 23 of Form 8824) $ 18, VOGEL.SEM/LKEM.18

63 Realized Gain Deferred: Realized Gain $ 58,000 Less Gain Recognized (18,000) Realized Gain Deferred (Line 24 of Form 8824) $ 40,000 Basis of Replacement Property: FMV of Replacement Property (Line 16 of Form 8824) $120,000 Less Realized Gain Deferred (40,000) Basis in Replacement Property (Line 25 of Form 8824) $ (80,000) VOGEL.SEM/LKEM.18

64 Example Guide (See Page 69-2.) (Yes) Taxpayer exchanges Relinquished Property (adjusted basis of $787,000 and FMV of $2,060,000, 000 subject to amortgage of $1,341,000) for Replacement Property (FMV of $3,360,000, subject to a mortgage of $2,800,000). The closing statement (containing a variety of transaction costs, prorations, and other items typical of most real estate exchanges) as to the taxpayer is in the Closing Statement on the following page. (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $ 2,060,000 Contract Price $ 3,360,000 MTGE (1,341,000) MTGE (2,800,000) 000) Cash Rec d $ 719,000 Cash Paid $ 560,000 LKEM Net Cash Received $159,000

65 Example Taxpayer exchanges Relinquished Property (adjusted basis of $787,000 and FMV of $2,060,000, subject to a mortgage of $1,341,000) for Replacement Property (FMV of $3,360,000, subject to a mortgage of $2,800,000). The closing statement (containing a variety of transaction costs, prorations, and other items typical of most real estate exchanges) as to the taxpayer is in the Closing Statement on the following page. Relinquished Property Replacement Property Selling Price $2,060,000 Contract Price $3,360,000 MTGE 1,341,000 MTGE 2,800,000 Cash Rec d $ 719,000 Cash Paid $ 560,000 Net Cash Received $159, VOGEL.SEM/LKEM.18

66 Closing Statement (Seller s) (Purchaser s) Relinquished Property Replacement Property Debit Credit Debit Credit FMV of Properties: $2,060,000 $3,360,000 Mortgage Debt: $1,341,000 $2,800,000 Transaction Costs: Commissions 120,000 Title Policy 3,000 3,000 Transfer Tax 4,000 3,000 Recording Fee Escrow Fee 2,000 $145, Forwarding Fee $41,000 Professional Fee 27,000 Reconveyance Fee 15,000 3,000 Processing Charges 2,000 Local Area Assessment 2,000 Prorations: Property Taxes 12,000 7,000 Business License 6,000 Interest Expense 11,000 13,000 Rent 10,000 17,000 Insurance 7,000 Credit for Repairs 14,000 Other: Security Deposits 16,000 Credit for Direct Deposits 109,000 Current Month s Payment 4,000 Initial Good Faith Deposit 3,000 Loan Charges 32,000 Balance Due Taxpayer 12,000 Balance $1,553,000 $2,060,000 $3,457,000 $2,950,000 Properties 1 and 2 Total Debits $5,010,000 Total Credits $5,010,000 Total Transaction Costs $ 186, VOGEL.SEM/LKEM.18

67 Form 8824 (2017) Page 2 Name(s) shown on tax return. Do not enter name and social security number if shown on other side. Part III Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received Your social security number Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property, see Reporting of multi-asset exchanges in the instructions. Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line Fair market value (FMV) of other property given up Adjusted basis of other property given up Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report the gain or (loss) in the same manner as if the exchange had been a sale Caution: If the property given up was used previously or partly as a home, see Property used as home in the instructions. 15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced (but not below zero) by any exchange expenses you incurred. See instructions FMV of like-kind property you received Add lines 15 and Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus any exchange expenses not used on line 15. See instructions Realized gain or (loss). Subtract line 18 from line Enter the smaller of line 15 or line 19, but not less than zero Ordinary income under recapture rules. Enter here and on Form 4797, line 16. See instructions Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form 4797, unless the installment method applies. See instructions Recognized gain. Add lines 21 and Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and Part IV Deferral of Gain From Section 1043 Conflict-of-Interest Sales Note: This part is to be used only by officers or employees of the executive branch of the Federal Government or judicial officers of the Federal Government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property. 26 Enter the number from the upper right corner of your certificate of divestiture. (Do not attach a copy of your certificate. Keep the certificate with your records.) Description of divested property 28 Description of replacement property 29 Date divested property was sold (month, day, year) MM/DD/YYYY 30 Sales price of divested property. See instructions Basis of divested property Realized gain. Subtract line 31 from line Cost of replacement property purchased within 60 days after date of sale Subtract line 33 from line 30. If zero or less, enter Ordinary income under recapture rules. Enter here and on Form 4797, line 10. See instructions Subtract line 35 from line 34. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form See instructions Deferred gain. Subtract the sum of lines 35 and 36 from line Basis of replacement property. Subtract line 37 from line Form 8824 (2017)

68 Seller: Amount Realized: Replacement Property $3,360,000 Debt (Relinquished Property) 1,341,000 Net Cash Received (Transaction costs, proration and other) 719,000 Total Amount Realized $5,420,000 Less: Adjusted Basis $ 787,000 Plus Debt on New Property 2,800,000 * Net Cash Paid (Transaction costs, proration and other) 560,000 4,147,000 Realized Gain (w/o Rev. Rul ) $1,273,000 * Without Rev. Rul , the transactional costs are added to the basis of the replacement property VOGEL.SEM/LKEM.18

69 Seller: Amount Realized: Replacement Property $3,360,000 + Debt (Relinquished Property) 1,341,000 Net Cash Received (Transaction costs, proration and other) 719,000 Total Amount Realized $5,420,000 Less: Adjusted Basis $ 787,000 Plus Debt on New Property 2,800,000 Net Cash Paid (Transaction costs, proration and other) 560,000 * Plus Net Transactional Costs 186,000 4,333,000 Realized Gain (w/ Rev. Rul ) $1,087,000 * With Rev. Rul , the transactional costs which are used to offset boot received are not added to the basis of the replacement property VOGEL.SEM/LKEM.18

70 Recognized Gain: Lesser of Real Gain or Net Boot Received Net Boot Received $159,000 Less Total Transactions Costs Incurred: Relinquished Property $145,000 Replacement Property 41,000 $186,000 Gain Recognized $ 0 But additional money paid of $ 27,000 ($186,000 $159,000) VOGEL.SEM/LKEM.18

71 Basis With Without Rev. Rul Rev. Rul Old Basis $ 787,000 $ 787, Gain Recognized 0 159, Liability Assumed 2,800,000 2,800,000 Debt Relief (1,341,000) (1,341,000) Additional Boot Paid 27, ,000 Basis $2,273,000 $2,432,000 (Gain without 1031 is $1,128 ($2,060 $787 of basis $145 of selling expenses). Gain of $159 is recognized, leaving deferred gain of $969 ($1,128 $159). New purchase price is $3,360 less deferred gain of $969 plus additional acquisition expenses of $41 equals $2,432.) VOGEL.SEM/LKEM.18

72 Form 8824 Line 15: $719,000 ($560,000 + transaction costs of $186,000 (but limited to $159,000)). Line 18: $787,000 + $27,000 transaction costs + ($2,800,000 $1,341,000) VOGEL.SEM/LKEM.18

73 Solution Relinquished Property Replacement Property Selling Price $2,060,000 Contract Price $3,360,000 MTGE 1,341,000 MTGE 2,800,000 Cash Rec d $ 719,000 ( - ) Cash Paid $ 560,000 Line 15: Net Cash Rec d $ 159,000 + Debt on Relinquished > + 0 Debt on Replacement - Exchange Expense ( 159,000) ($186,000) L. 15 $ VOGEL.SEM/LKEM.18

74 Line 18: A/B of Relinquished $ 787,000 + Debt on Replacement > Debt on Relinquished 1,459,000 ($2,800,000 - $1,341,000) + Cash Paid > Cash Received Exchange Expenses 27,000 L.18 $2,273, VOGEL.SEM/LKEM.18

75 Closing Statement (Seller s) ) (Purchaser s) Relinquished Property Replacement Property Transaction Costs: Commissions $120,000 Title Policy 3,000 $ 3,000 Transfer Tax 4,000 3,000 Recording Fee 700 $145, Escrow Fe}}e 2, Forwarding Fee $41,000 Professional Fee 27,000 Reconveyance Fee 15,000 3,000 Processing Charges 2,000 Local Area Assessment 2,000 LKEM Solution SOLD PURCHASED Relinquished Property Replacement Property Selling Price $2,060,000 Contract Price $3,360,000 MTGE 1,341,000 MTGE 2,800,000 Cash Rec d $ 719,000 (-) Cash Paid $ 560,000 Line 15: Step 1: Net Cash Rec d $ 159,000 + Step 2: Debt on Relinquished > + 0 Debt on Replacement - Step 3: Exchange Expenses (159,000) ($186,000) L.15 $ 0 LKEM.18 71

76 Solution Line 18: Step 1: A/B of Relinquished $ 787,000 + Step 2: Debt on Replacement > Debt on Relinquished 1,459,000 ($2,800,000 - $1,341,000) + Step 3: Cash Paid > Cash Received Step 4: Exchange Expenses ($186,000 - $159,000) 27,000 L.18 $2,273,000 O.B. - $787,000 Boot - $1,486,000 LKEM Depreciation (Yes) Now Assume: Relinquished Property placed in service in 2004 as Commercial Property (39-year) and Replacement Property is: Commercial Property (Same) (Easy or thoughtful way) (39 yr to 39 yr) Residential Rental (Shorter) (39 yr to 27.5 yr) Residential Rental to Commercial Property (Longer) (27.5yrto39yr) If adopt the easy way, must make an election under Reg (i)- 6(i) & (j) (See also instructions to Form 4562 Election Made Under Reg (i)-6(i).) LKEM.18 73

77 Depreciation (Yes) Now Assume: Relinquished Property placed in service in 2004 as Commercial Property (39-year) and Replacement Property is: Options Commercial Property (Same) #1 $2,273, years (Easy) (39 to 39) #2 $1,486, years $787, years (Thoughtful) Residential Rental (Shorter) #1 $2,273, years (39 to 27.5) #2 $1,486, years $787, years LKEM Depreciation (Yes) Now assume that Relinquished Property was Residential Rental Property and Replacement Property is: Commercial Property (Longer) 27.5 years to 39 years Residential Rental (Same) LKEM.18 75

78 Depreciation (Yes) Now assume that Relinquished Property was Residential Rental Property and Replacement Property is: Options Commercial Property (Longer) #1 $2,273, years (Easy) (27.5 to 39) #2 $1,486, years $787, years (2004 & 14 yrs) (Thoughtful) Residential Rental (Same) #1 $2,273, years (Easy) (27.5 to 27.5) #2 $1,486, years (Thoughtful) (Then assume 2008) $787, years LKEM Depreciation (Yes) Relinquished Property was Commercial Property (placed in service in 2003) and Replacement Property is Commercial Property. The adjusted basis of the Relinquished Property is $787,000, consisting of land $200,000 and building $587,000. The Replacement Property basis is as follows: If Dep. A/B of Relinquished $ 787, yrs + Add l Debt & Exchange Expenses 1,486, yrs Total $2,273,000 The Replacement Property is worth $5,000,000, with a land value of $1,000,000 and a building value of $4,000,000. What result? LKEM.18 77

79 Depreciation Using the Thoughtful Way Land (20%) Building (80%) $1,486,000 $297,200 $1,188, yrs 787, , ,600 25yrs Total $2,273,000 $454,600 $1,818,400 LKEM Depreciation of Replacement Property (No) Consider how you would calculate depreciation on the Replacement Property if: Relinquished Property Commercial Replacement Property Commercial LKEM.18 79

80 Depreciation of Replacement Property (No) Consider how you would calculate depreciation on the Replacement Property if: Relinquished Property Commercial Replacement Property Residential Rental Residential lrental Commercial LKEM Depreciation of Replacement Property (No) Consider how you would calculate depreciation on the Replacement Property if: Relinquished Property 10-Year Property Replacement Property 7-Year Property 7-Year Property 15-YearProperty Luxury Auto Luxury Auto LKEM.18 81

81 Allocation of Basis (Yes) If the property received in an exchange consists in part of like-kind property and in part of non like-kind property (boot), the total basis of such properties must be allocated between the properties (other than money) received. When such non like-kind property is received, basis must be first allocated to the non like-kind property to the extent of its fair market value. Basis in the non-real property received is its FMV. LKEM Allocation of Basis (Yes) What result if exchange Commercial Property for three separate real property interests? How many exchange groups? ONE Relinquished Replacement Consists of 3 Properties L.15 No Gain L.18 - $2,273,000 A/B $787,000 (25 yrs) A/B $1,486,000 (39 yrs) The gross FMV of Replacement Properties: Basis Basis No. 1 - $1,000,000 1/6 1/6 No. 2-2,000,000 2/6 2/6 No. 3-3,000,000 3/6 3/6 Total $6,000,000 $787,000 $1,486,000 How to allocate $2,273,000 basis among the three properties. LKEM.18 83

82 Holding Period (Yes) Generally Tacking LKEM Principal Residence Exchanges (No) (Skip to Slide 98.) Rev. Proc Taxpayers who exchange property that satisfies the requirements for both the exclusion of gain from the exchange of a principal residence under 121 (the home sale exclusion) and the nonrecognition of gain on the exchange of like-kind properties under 1031 may apply both provisions to an exchange of property by applying the procedures set forth in Rev. Proc (On , convert principal residence to rental property & then on , have a LKE.) Principal residence that is being sold is worth $500,000, 15% of square footage is home office and depreciation of $30,000. The replacement residence will cost $750,000. Can you avoid reorganizing the $30,000 of depreciation? How long must you take home office on the replacement residence? LKEM.18 85

83 Rev. Proc Rev. Proc Taxpayers who exchange property that satisfies the requirements for both the exclusion of gain from the exchange of a principal residence under 121 (the home sale exclusion) and the nonrecognition of gain on the exchange of like-kind properties under 1031 may apply both provisions to an exchange of property by applying the procedures set forth in Rev. Proc a. Rev. Proc provides that 121 must be applied to gain realized before applying b. Although the home sale exclusion does not apply to gain attributable to depreciation deductions for periods after May 6, 1997, claimed with respect to the business or investment portion of a residence, 1031 may apply to that gain. c. In applying 1031, cash or other non-like kind property (boot) received in exchange for property used in the taxpayer s trade or business or held for investment (the relinquished business property), is taken into account only to the extent the boot exceeds the gain excluded under 121 with respect to the relinquished business property. d. In determining the basis of the property received in the exchange to be used in the taxpayer s trade or business or held for investment (the replacement business property), any gain excluded under 121 is treated as gain recognized by the taxpayer. e. Thus, under 1031(d), the basis of the replacement business property is increased by any gain attributable to the relinquished business property that is excluded under 121. f. Rev. Proc is effective January 27, 2005, but taxpayers may apply it in any taxable year for which the period of limitations on refund or credit has not expired VOGEL.SEM/LKEM.18

84 Principal Residence Exchange A buys a house for $210,000 that A uses as A s principal residence from 2013 to From 2017 until 2019, A rents the house to tenants and claims depreciation deductions of $20,000. In 2019, A exchanges the house for $10,000 of cash and a townhouse with a fair market value of $460,000 that A intends to rent to tenants. A realizes gain of $280,000 on the exchange. A s exchange of a principal residence that A rents for less than three years for a townhouse intended for rental and cash satisfies the requirements of both 121 and Section 121 does not require the property to be the taxpayer s principal residence on the sale or exchange date. Because A owns and uses the house as A s principal residence for at least two years during the five-year period before the exchange, A may exclude gain under 121. Because the house is investment property at the time of the exchange, A may defer gain under Section 121 applies to exclude $250,000 of the $280,000 gain before 1031 applies. A may defer the remaining gain of $30,000, including the $20,000 gain attributable to depreciation, under Although A receives $10,000 of cash (boot) in the exchange, A is not required to recognize gain because the boot is taken into account for purposes of 1031(b) only to the extent the boot exceeds the amount of excluded gain. These results are illustrated as follows: Amount realized $470,000 Less: Adjusted basis $190,000 Realized gain $280,000 Less: Gain excluded under 121 $250,000 Gain to be deferred $30,000 A s basis in the replacement property is $430,000, which is equal to the basis of the relinquished property at the time of the exchange ($190,000) increased by the gain excluded under 121 ($250,000), and reduced by the cash A receives ($10,000) VOGEL.SEM/LKEM.18

85 Principal Residence Exchange B buys a property for $210,000. The property consists of two separate dwelling units, a house and a guesthouse. From 2012 until 2017, B uses the house as B s principal residence and uses the guesthouse as an office in B s trade or business. Based on the square footage of the respective parts of the property, B allocates b of the basis of the property to the house and a to the guesthouse. In 2017, B exchanges the entire property for a residence and a separate property that B intends to use as an office. The total fair market value of B s replacement properties is $360,000. The fair market value of the replacement residence is $240,000 and the fair market value of the replacement business property is $120,000, which is equal to the fair market value of the relinquished business property. From 2012 to 2017, B claims depreciation deductions of $30,000 for the business use. What is the tax effect of the exchange? How much must the taxpayer reinvest in a replacement property to defer the recognition of gain? VOGEL.SEM/LKEM.18

86 Principal Residence Exchange Taxpayer C buys a property for $210,000. The property consists of a house that is a single dwelling unit. From 2017 until 2018, C uses b of the house (by square footage) as C s principal residence and uses a of the house as an office in C s trade or business. In 2018, C exchanges the entire property for a residence and a separate property that C intends to use as an office in C s trade or business. The total fair market value of C s replacement properties is $360,000. The fair market value of the replacement residence is $240,000 and the fair market value of the replacement business property is $120,000, which is equal to the fair market value of the business portion of the relinquished property. From 2013 to 2018, C claims depreciation deductions of $30,000 for the business use. What is the tax effect of the exchange? How much must the taxpayer reinvest in a replacement property to defer the recognition of gain and how long must the replacement property be used as a home office? VOGEL.SEM/LKEM.18

87 Principal Residence Exchanges (No) Rev. Proc provides that 121 must be applied to gain realized before applying Although the home sale exclusion does not apply to gain attributable to depreciation deductions for periods after May 6, 1997, claimed with respect to the business or investment portion of a residence, 1031 may apply to that gain. In applying 1031, cash or other non-like kind property (boot) received in exchange for property used in the taxpayer s trade or business or held for investment (the relinquished business property), is taken into account only to the extent the boot exceeds the gain excluded under 121 with respect to the relinquished business property. LKEM Principal Residence Exchanges (No) In determining the basis of the property received in the exchange to be used in the taxpayer s trade or business or held for investment (the replacement business property), any gain excluded under 121 is treated as gain recognized by the taxpayer. Thus, under 1031(d), the basis of the replacement business property is increased by any gain attributable to the relinquished business property that is excluded under 121. Rev. Proc is effective January 27, 2005, but taxpayers may apply it in any taxable year for which the period of limitations on refund or credit has not expired. LKEM.18 87

88 Principal Residence to Rental to LKE (No) A buys a house for $210,000 that A uses as A s principal residence from 2013 to From 2017 until 2019, A rents the house to tenants and claims depreciation deductions of $20,000. In 2019, A exchanges the house for $10,000 of cash and a townhouse with a fair market value of $460,000 that A intends to rent to tenants. A realizes gain of $280,000 on the exchange. LKEM Principal Residence to Rental to LKE (No) A s exchange of a principal residence that A rents for less than three years for a townhouse intended dfor rental and cash satisfies ifi therequirements of both h 121 and Section 121 does not require the property to be the taxpayer s principal residence on the sale or exchange date. Because A owns and uses the house as A s principal residence for at least two years during the five-year period before the exchange, A may exclude gain under 121. Because the house is investment property at the time of the exchange, A may defer gain under Section 121 applies to exclude $250,000 of the $280,000 gain before 1031 applies. A may defer the remaining gain of $30,000, including the $20,000 gain attributable to depreciation, under Although A receives $10,000 of cash (boot) in the exchange, A is not required to recognize gain because the boot is taken into account for purposes of 1031(b) only to the extent the boot exceeds the amount of excluded gain. LKEM.18 89

89 Principal Residence to Rental to LKE (No) These results are illustrated as follows: Amount realized $470,000 Less: Adjusted basis $190,000 Realized gain $280,000 Less: Gain excluded under 121 $250,000 Gain to be deferred $30,000 A s basis in the replacement property is $430,000, which is equal to the basis of the relinquished property at the time of the exchange ($190,000) increased by the gain excluded under 121 ($250,000), and reduced by the cash A receives ($10,000). LKEM Principal Residence Exchange w/ Home Office Rev. Proc (No) Taxpayer C buys a property for $210,000. The property consists of a house that is asingle dwelling unit. From 2013 until 2018, C uses ⅔ of the house (by square footage) as C s principal residence and uses ⅓ of the house as an office in C s trade or business. In 2018, C exchanges the entire property for a residence and a separate property that C intends to use as an office in C s trade or business. The total fair market value of C s replacement properties is $360,000. The fair market value of the replacement residence is $240,000 and the fair market value of the replacement business property is $120,000, which is equal to the fair market value of the business portion of the relinquished property. From 2013 to 2018, C claims depreciation deductions of $30,000 for the business use. What is the tax effect of the exchange and what is the least amount that the taxpayer must reinvest in like-kind property in order to defer the gain on the exchange? LKEM.18 91

90 Principal Residence Exchange w/ Home Office (No) What is the tax effect of the exchange? How much must the taxpayer reinvest in a replacement property to defer the recognition of gain and how long must the replacement property be used as a home office? LKEM Principal Residence Exchanges Total Residential Office Property Portion Portion Total A/R $360,000 $240,000 $120,000 A/B: $210,000 $140,000 $70,000 Dep (30,000) (0) (30,000) A/B (180,000) (140,000) (40,000) Realized Gain $180,000 $100,000 $ 80,000 Gain Excluded Under 121 ($150,000) ($100,000) ($ 50,000) Gain Recognized if no LKE $ 30,000 $ 0 LT 25% $ 30,000 Would have recognized a LT (25%) gain of $30,000 if no LKE. LKEM.18 93

91 Principal Residence Exchanges Like Kind Exchange Office for Office Sold Replacement Selling Price $120,000 Contract Price $120,000 Less Debt 0 Less Debt 0 Received $120,000 Paid $120,000 Net Boot Received $0 Gain $0 Gain excluded $50,000 under 121 Gain deferred $30,000 Also reduces the amount that need to reinvest in another property in order to avoid recognition of gain if LKE. LKEM Principal Residence Exchanges Purchase of Replacement Property: Total Residence Office Cost $360,000 $240,000 $120,000 If LKE (Office for Office) Less Deferred Gain (30,000) (0) (30,000) A/B $330,000 $240,000 $ 90,000 Basis in Replacement Residence: Residence $240,000 Office 90,000 A/B $330,000 LKEM.18 95

92 Principal Residence Exchanges Like Kind Exchange A/B Old Basis $40,000 + Gain Excluded 50,000 Basis $90,000 (FMV $120,000) (Basis $40,000 + Gain. Exc. $50,000) ($30,000 of gain deferred under 1031) LKEM Principal Residence Exchanges Like Kind Exchange How long after the exchange must the taxpayer continue to use the office in his/her trade or business? What tax effect if the taxpayer purchased a new residence for $700,000 and 10% of the square footage of the new residence is allocable to the home office? How much gain if the exchange qualifies under 1031? LKEM.18 97

93 Relinquished Property Two-Party Exchange (Yes) Taxpayer py Buyer Replacement Property How often will you see? NEVER LKEM The Classic Alderson Exchange Buyer Purchases Replacement Property (Yes) Replacement Property SELLER Step 1 Relinquished Property $ Taxpayer Step 2 Buyer How often will you see? - NEVER LKEM.18 99

94 The Classic Baird Exchange Seller Purchases Replacement Property (Yes) Replacement Property SELLER Rli Relinquished ihdproperty Step 1 Step 2 Relinquished Property TAXPAYER BUYER How often will you see? - NEVER LKEM Direct Deeding (3 Party) (Yes) Replacement Property SELLER Replacement Property $ Relinquished Property Relinquished Property TAXPAYER BUYER Authority is Rev. Rul , C.B. 154.* LKEM

95 Simultaneous Three Party Exchange With Assisting Intermediary (Yes) Replacement Property SELLER Replacement Property $ #4 Relinquished #3 Property TITLE Cash TAXPAYER INTERMEDIARY Starker How often will you see? Most Likely LKEM #2 #1 Cash Relinquished Property See Rev. Rul TITLE $ for Direct Deeding BUYER Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What is the identification period? 45 Days (8-8-18) LKEM

96 Starker Exchange 1. Title to Relinquished Property is transferred on June 24, a. What is the identification period? b. What is the exchange or replacement period? c. How many properties may be identified? d. What happens if the end of the identification period falls on a Saturday, Sunday, or holiday? e. How must the properties be identified? f. May other replacement properties be substituted for the previously identified properties? g. What additional type of property may be received within the replacement period, e.g., laundry machines with an apartment building? As long as the incidental property is not in excess of 15% of the value of the replacement property, the incidental property is unambiguously described with the replacement property. h. What result if the exchangor has the ability to touch the money? 1) What about using the funds with the qualified intermediary for upgrades or improvements? 2) When is the exchangor entitled to the interest earned on the funds with the qualified intermediary? i. What are the four exceptions to constructive receipt? 1) Who is not eligible to act as a qualified intermediary on behalf of the exchangor? j. What result if the taxpayer does not file an extension for 2018 and the return is due before the end of the replacement period? VOGEL.SEM/LKEM.18

97 1. Identification Requirements Requirements for Starker Exchange Worth Keeping! Section 1031 treatment will not apply if the replacement property is not identified before the end of the identification period or the identified replacement property is not received before the end of the exchange period. 2. Identification & Exchange Periods The identification period starts the day the exchangor transfers the relinquished property and ends 45 days later. The exchange period begins on transfer of the relinquished property and ends on the earlier of: a. 180 days later or b. The due date, including extensions, for the exchangor s tax return for the year in which the transfer of the relinquished property occurs. Time periods are calculated in the traditional manner do not count the first day, do count the last. 1) These time periods must be strictly observed. In Christensen v. Comm r, 98- th 1 USTC 50,352 (9 Cir. 1994), the Ninth Circuit ruled that for the due date to include extensions in measuring the exchange period, the taxpayer must actually apply for and receive an extension. The language of 1031 is unambiguous and the use of the substantial compliance doctrine is inappropriate because it would defeat the policy underlying the time period requirements which is to provide strict time and reporting requirements on the completion of like-kind exchanges. (See also, Smith, T.C. Memo ; Dobrich, T.C. Memo ; and PLR ) 3. Application of 7503 The regulations provided that in determining the dates on which the identification and exchange periods end, 7503 does not apply. Section 7503 provides that where the last day for performance falls on Saturday, Sunday, or legal holiday, performance on the next succeeding day that is not a Saturday, Sunday, or legal holiday will be considered timely. In T.D. 8346, the Service held that the timing requirements relating to the identification and exchange periods are statutory, and no requests for extension will be granted. Citing Rev. Rul , the Service holds that 7503 is limited to procedural acts VOGEL.SEM/LKEM.18

98 required to be performed in connection with the determination, collection, or refund of taxes and does not apply to Method of Identification A replacement property is identified, under the regulations, only if it is: a. Received by the exchangor before the end of the identification period, or b. Identified in a written agreement for the exchange of properties, or c. Designated as replacement property: i. In a written document ( or Fax) ii. iii. iv. Signed by the exchangor Hand delivered, mailed, telecopied, or otherwise sent before the end of the identification period To a person involved in the exchange other than the exchangor or a disqualified person (Reg (a)-3(c)). Note: The taxpayer still needs to provide that the identification was made within the identification period. 5. Property Description The replacement property must be unambiguously described in the document or agreement by a legal description or street address. When the target property is under construction, it will be unambiguously identified if the underlying land is properly described and as much detail as is practicable at the time and identification is made is provided for construction of the improvements. In determining whether the property received is substantially the same as that identified, variations due to usual or typical (construction) changes are not taken into account. Only that portion of the property to be constructed which constitutes real property at the time of receipt by the exchangor will be included in the exchange and only if, when finished, it would have been considered substantially the same as the property identified. The balance of the construction completed after the exchangor receives the target is considered the receipt of services and not like-kind property i.e., boot VOGEL.SEM/LKEM.18

99 6. Incidental Property 15% Rule Incidental property is considered to have been unambiguously described if normally transferred with the larger property (e.g., laundry machines in an apartment), even if not mentioned, provided the larger property is unambiguously described. However, property incidental to another larger property will be treated as separate from the larger property and require separate identification when the FMV of the incidental property is over 15% of the FMV of the larger property. 7. Revocation Note: Do not ignore personal property in the exchange documents due to this 15% rule. The identification of a property may be revoked provided the following requirements are met: a. Made prior to the end of the identification period, b. In a written document, c. Signed by exchangor, d. Hand delivered, mailed, telecopied, or otherwise sent before the end of the identification period, e. To the person to whom the identification was originally sent. 8. Substantial Receipt The property received must be substantially the same as property identified. The regulations imply a 75% rule of thumb in an example where 2 acres of raw land (worth $250,000) is identified, but only 1.5 acres (worth $187,500) are actually received. The 1.5 acres are held to comply with the original identification. 9. Multiple Replacement Properties More than one property can be identified as replacement property. Regardless of the number of relinquished properties, the maximum number of replacement properties the exchangor may identify is: VOGEL.SEM/LKEM.18

100 a. Three properties of any fair market value (Reg (a)-1(c)(4)(i)(A)), or Note: The fair market value of property for purposes of the deferred exchange rules is the property s fair market value without regard to liabilities secured by the property. b. Any number of properties as long as the aggregate FMV of all properties identified as of the end of the identification period does not exceed 200% of the aggregate fair market value of all relinquished properties as of the date of transfer by the exchangor (Reg (a)-1(c)(4)(i)(B)), or Note: For purposes of the 200% rule and incidental property, the F.M.V. of the target is its estimated value of the on date it is expected to be received by the exchangor. In addition, properties received within the identification period are counted for purposes of the 3-property rule and the 200% rule. c. Any number of properties of any value provided that 95% of FMV of all properties identified are received by the end of the exchange period (Reg (a)- 1(c)(4)(ii)(B)). If the number of properties identified exceeds these requirements, no properties will be considered identified; however, any property received prior to the end of the identification period will be deemed properly identified VOGEL.SEM/LKEM.18

101 Example Debbie and Ralph enter into a delayed exchange. Debbie transfers Beach-Lot to Ralph on May 17, Beach-Lot, which Debbie has held for investment is unencumbered and has a value of $100,000. By July 1, 2018 (end of the 45-day period) Debbie must identify the replacement property. By November 13, 2018 (end of the 180-day period) Ralph must buy the replacement property and transfer it to Debbie. No replacement property is described in the delayed exchange agreement. On June 3, 2018, Debbie identifies the replacement property as a lot located in Denver County with a value not to exceed $100,000. The designation is made in a written document signed by Debbie and personally delivered to Ralph. On July 8, 2018, Debbie and Ralph agree that Whiteacre is the property described in the June 3 document. The June 3 designation is not an unambiguous description. The replacement property was not unambiguously described until July 8. Since this was after the end of the identification period (July 1, 2018), the exchange of Beach-Lot for Whiteacre does not qualify (Reg (a)-3(c)(7), Example 2). Example Facts are the same as the Example above, except that instead of the June 3 document, Debbie, on June 28, 2018, identifies by legal description three other specific properties in a written document she signs and personally delivers to Ralph. The written document also provides that by August 1, 2018, Debbie will orally inform Ralph as to which of the three properties he must buy and transfer. As of July 1, 2018, the respective values of the three properties are $75,000, $100,000 and $125,000. The 3-property rule is satisfied and the properties have thus been properly identified before the end of the 45-day period (Reg (a)-3(c)(7), Example 3) VOGEL.SEM/LKEM.18

102 10. Actual and Constructive Receipt Rule Because taxpayers typically are unwilling to rely on a transferee s unsecured promise to transfer the like-kind replacement property, the use of various guarantee or security arrangements is common in deferred exchanges. In addition, because persons who want to purchase the relinquished property may be unwilling or unable to acquire the replacement property, taxpayers often retain an intermediary to facilitate the exchange. Use of these arrangements, however, raises issues concerning actual receipt, constructive receipt, and agency. If an exchangor actually or constructively receives money or other property in the full amount of the consideration for the relinquished property before receiving like-kind replacement property, the transaction represents a sale and not a deferred exchange, even though the exchangor may ultimately receive like-kind replacement property. 11. Safe Harbors Avoiding Actual and Constructive Receipt The extent to which a taxpayer is in actual or constructive receipt of money (boot for an exchangor)is determined by the rules of 61 and 451: a. Actual receipt occurs when the taxpayer actually receives money or the economic benefit of it. b. Constructive receipt occurs when cash is credited to the taxpayer or otherwise made available so that the taxpayer may draw upon it. c. Taxpayer control cash does not constitute constructive receipt if such control is subject to substantial limitations or restrictions ( 83). However, when such limitations or restrictions lapse or expire, constructive receipt will occur. d. Actual or constructive receipt of cash by an agent of the taxpayer is attributed to the taxpayer. For many years, the rules of actual and constructive receipt ( 451) have been unclear as applied to 1031 exchanges. Can exchangor receive interest (or a growth factor) on funds held in the delayed exchange? Will the use of a hired intermediary create a damaging agency relationship? Can the accommodator s or intermediary s performance be secured? To clarify such questions, the regulations give four safe harbors which can be used without risk of actual or constructive receipt. (The use of these safe harbors will result in a determination that the taxpayer is not, either directly or through an intermediary that may be an agent, in actual or constructive receipt of money or other property for purposes of the regulations.) VOGEL.SEM/LKEM.18

103 Safe Harbor #1 Security The obligation of the exchangor s transferee to complete the delayed exchange can be secured or guaranteed by: a. A mortgage, deed of trust, or other security interest in property (other than cash or a cash equivalent), b. A standby letter of credit which satisfies all of the requirements of Reg. 15A.453-1(b)(3)(iii) and which does not allow the taxpayer to draw on the letter of credit except on default of the transferee s obligation to transfer like-kind replacement property, or c. A guarantee of a third party (Reg (a)-3(g)(2)). Safe Harbor #2 Escrow Accounts & Trusts The obligation of the exchangor s transferee to complete the delayed exchange may be secured by cash or a cash equivalent if held in a qualified escrow account or a qualified trust. In a qualified escrow account or trust, the escrow holder or trustee must not be the exchangor or a disqualified person, and the exchangor s rights to receive, pledge, borrow, or otherwise obtain the benefits of the cash or cash equivalent held in escrow or trust must be limited (Reg (k)-1(g)(3). Disqualified Person A person is a disqualified person if: i) The person is an agent of the taxpayer at the time of the transaction, or ii) The person and the taxpayer (or the taxpayer s agent) bear a relationship defined under 267(b) or 707(b) substituting 10% ownership for 50% ownership (Reg (k)-1(k)). Who Is An Agent? A person who has acted as the taxpayer s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the 2-year period ending on the date of the transfer of the first of the relinquished properties is treated as an agent of the taxpayer at the time of the transaction. However, under this provision, the mere performance of services with respect to exchanges intended to qualify under 1031 will not make one an agent of the exchangor. Furthermore, for these purposes, the performance of routine financial, title insurance, escrow, or trust service by a financial institution, title insurance company, or escrow company is not taken into account VOGEL.SEM/LKEM.18

104 Safe Harbor #3 Qualified Intermediary The exchangor s use of a qualified intermediary who is the exchangor s agent does not destroy an exchange, provided the exchangor s rights to receive money or other property are limited. The benefit of using the qualified intermediary is that the potential agency attack on the exchange is eliminated. Who is A Qualified Intermediary? A qualified intermediary is a person who is not the exchangor or a disqualified person (see definition above) and who, for a fee, acts to facilitate a delayed exchange by agreeing with the exchangor to an exchange of properties in which the intermediary: i) Acquires the relinquished property from the exchangor (either on its own behalf or as the agent of any party to the transaction), ii) iii) iv) Transfers the relinquished property, Acquires the replacement property (either on its own behalf or as the agent of any party to the transaction), and Transfers the replacement property to the exchangor (Reg (k)- 1(g)(4)). Note that the definition of a qualified intermediary is a transactional definition. The regulations require that the qualified intermediary acquire the relinquished property from the taxpayer, acquire the replacement property, and transfer the replacement property to the taxpayer. The final regulations describe the circumstances under which an intermediary is treated as acquiring and transferring property regardless of whether, under general tax principles, the intermediary actually acquires and transfers the property. Under the regulations, an intermediary is treated as acquiring and transferring property if the intermediary: a) Acquires and transfers legal title to that property; b) Enters into an agreement (either on its own behalf or as the agent of any party to the transaction) with a person other than the taxpayer for the transfer of the relinquished property to that person and, pursuant to that agreement, the relinquished property is transferred to that person; c) Enters into an agreement (either on its own behalf or as the agent of any party to the transaction) with the owner of the replacement property and, pursuant to that agreement, the replacement property is transferred to the taxpayer VOGEL.SEM/LKEM.18

105 Direct Deeding Consistent with item (c) above and Rev. Rul , C.B. 154, the transfer of property in a delayed exchange facilitated by the use of a qualified intermediary may occur via a direct deed of legal title by the current owner of the property to its ultimate owner. Note: Unfortunately, the regulations do not clarify the Service s position on direct deeding when a qualified intermediary is not used. Assignment An intermediary is treated as entering into an agreement if the rights of a party to the agreement are assigned to the intermediary and all parties to that agreement are notified in writing of the assignment on or before the date of the relevant transfer of property. Simultaneous Exchanges While several commentators requested that all safe harbors be made available to simultaneous exchanges, the Service, in final regulations, determined it necessary to make only the qualified intermediary safe harbor available for simultaneous exchanges. Thus, effective for transfers of property made by taxpayers on or after June 10, 1991, Reg (b)-2 provides that in the case of simultaneous transfers of like-kind properties involving a qualified intermediary, the qualified intermediary will not be considered the agent of the taxpayer under 1031(a). In such a case, the transfer and receipt of property by the taxpayer will be treated as an exchange. Safe Harbor #4 Interest The exchangor can receive interest (or a growth factor) in a delayed exchange provided his rights to receive interest and other economic benefits are limited. The interest (or growth factor) is treated as interest regardless of whether it is paid in cash or in property (Reg (k)-1(g)(5)). The exchangor will be treated as being entitled to receive interest or a growth factor if the amount of money or property the exchangor is entitled to receive in the exchange depends upon the length of the delay period. The interest or growth factor is interest income for tax purposes, includable in income according to the exchangor s method of accounting, whether paid in cash or property (like kind or otherwise). Note: Even if a transaction is within the safe harbors, to the extent the exchangor has the ability or unrestricted right to receive money or other property before he receives like-kind replacement property, the transfer of the relinquished property won t qualify for nonrecognition of gain or loss. This means that a taxpayer generally does not have the right to the interest until the end of the exchange period VOGEL.SEM/LKEM.18

106 Interest Reporting Section 468B(g) Section 468B(g) provides that nothing in any provision of law will be construed as providing that an escrow account, settlement fund, or similar fund is not subject to current income tax. It also directs the Secretary to prescribe regulations relating to the taxation of these accounts or funds whether as a grantor trust or otherwise. While the regulations permit taxpayers to receive interest or a growth factor in a deferred exchange (provided the taxpayer s right to such interest is limited) Reg B-6(c) addresses the proper manner for reporting interest income earned on money held in an escrow account or trust. 1) Reg B-6(c) governs the taxation of income earned on a qualified escrow account or qualified trust. Under the regulations, exchange funds are treated, as a general rule, as loaned by a taxpayer to an exchange facilitator, and the exchange facilitator takes into account all items of income, deduction, and credit (including capital gains and losses). (But only applies to deposits of more than $2 million). If, however, the escrow agreement, trust agreement, or exchange agreement specifies that all the earnings attributable to exchange funds are payable to the taxpayer, the exchange funds are not treated as loaned from the taxpayer to the exchange facilitator, and the taxpayer takes into account all items of income, deduction, and credit (including capital gains and losses). 2) If an exchange facilitator commingles exchange funds with other funds (for example, for investment purposes), all the earnings attributable to the exchange funds are treated as paid to the taxpayer if the exchange facilitator pays the taxpayer all the earnings of the commingled account that are allocable on a pro rata basis (using a reasonable method that takes into account the time that the exchange funds are in the commingled account, actual rate or rates of return, and the respective principal balances) to the taxpayer s exchange funds. 3) Reg B-6(b)(4) provides that payments from the exchange funds, or from the earnings attributable to the exchange funds, for the taxpayer s transactional expenses are treated as first paid to the taxpayer and then paid by the taxpayer to the recipient. Transactional expenses include the costs of land surveys, appraisals, title examinations, termite inspections, transfer taxes, and recording fees. An exchange facilitator s fee is a transactional expense only if the escrow agreement, trust agreement, or exchange agreement, as applicable, provides that (a) the amount of the fee payable to the exchange facilitator is fixed on or before the date of the transfer of the relinquished property by the taxpayer (either by stating the fee as a fixed dollar amount in the agreement or determining the fee by a formula, the result of which is known on or before the transfer of the relinquished property by the taxpayer), and (b) the amount of the fee is payable by the taxpayer regardless of whether the earnings attributable to the exchange funds are sufficient to pay the fee VOGEL.SEM/LKEM.18

107 4) Reg B-6(d) requires the escrow holder of a qualified escrow account or trustee of a qualified trust to report the income of the escrow account or trust on Form 1099 to the extent the information reporting provisions of the Code otherwise require the filing of Form ) Reg provides that 7872 applies to loans from taxpayers to exchange facilitators, unless all the earnings attributable to exchange funds are payable to the taxpayer. Below-market exchange facilitator loans are treated as compensationrelated loans under 7872(c)(1)(B) and are treated as demand loans for purposes of ) Prop. Reg B-6(f) applies to qualified escrow accounts and qualified trusts established after the date the regulations are published as final. With respect to a qualified escrow account or qualified trust established after August 16, 1986, but on or before the date of publication of final regulations, the Service will not challenge a reasonable, consistently applied method of taxation for income earned by the account or trust. Restrictions On Rights to Money & Other Property g(6) Limitations Under the regulations, the safe harbors generally apply only if the taxpayer has no right to receive, pledge, borrow, or otherwise obtain the benefits of the funds or interest in escrow or trust or held by the intermediary before the occurrence of certain enumerated circumstances. Specifically, in safe harbors, #2, #3, and #4, the exchangor s right to receive money or other property must be limited. These limits exist if the exchangor has no right to receive money or other property until: 1) The end of the identification period (if the taxpayer does not identify replacement property before identification period ends), or 2) The exchangor receives all the identified replacement property to which he is entitled, or 3) If the exchangor identifies replacement property, the later of: a) The end of the identification period b) The occurrence of a material and substantial written contingency beyond the exchangor s (or a related person s) control, or 4) The end of the exchange period (Reg (k)-1(g)(6)) VOGEL.SEM/LKEM.18

108 Constructive Receipt of Funds Example Debbie and Ralph enter into delayed exchange agreement on May 17, Debbie is to transfer Whiteacre to Ralph. Whiteacre, which Debbie has been holding for investment, is unencumbered and has a value of $100,000. Debbie is to identify replacement property by July 1, By November 13, 2018, Ralph must purchase the identified replacement property and transfer it to Debbie. At any time after May 17, 2018, and before Ralph buys the replacement property, Debbie can demand that Ralph pay her $100,000 in lieu of the replacement property. Since Debbie has the unrestricted right to demand the $100,000 before she receives the replacement property, she is treated as having sold Whiteacre for $100,000 (Reg (k)-1(g)(8)). Constructive Receipt of Funds Example Same facts as in Example above except that Debbie and Ralph use a qualified escrow account and also agree that if the value of the replacement property is more or less than Whiteacre s, the difference will be made up with a cash payment. The escrow agreement provides that the $100,000 deposited by Ralph on his receipt of Whiteacre be used to buy the replacement property. If Debbie fails to identify the replacement property by July 1, 2018, she may demand payment of the escrowed funds at any time after that date. If Debbie identifies and receives replacement property, she may demand any remaining funds in escrow after she receives the replacement property. Otherwise, Debbie is entitled to the escrowed $100,000 after November 13, 2018 (the end of the exchange period). Debbie does in fact identify replacement property which Ralph purchases, using the escrowed funds, and transfers to Debbie. There is no constructive receipt of the $100,000 and the transaction qualifies as a like-kind exchange (Reg (k)-1(g)(8), Example 1). Outside Transfers of Money or Other Property Under the proposed regulations, in a delayed exchange, the exchangor s receipt (actual or constructive) of any boot prior to receipt of all of the replacement properties invalidated at least three of the safe harbors. This posed problems for delayed exchanges generated by the exercise of an option where the exchangor has received prior option consideration. The final regulations clarify that the limitations on a taxpayer s rights to receive, pledge, borrow, or otherwise obtain the benefits of the funds apply only to the money or other property in a qualified escrow account or qualified trust, or held by the qualified intermediary. Under the final regulations, a taxpayer may receive money or other property directly from another party to the transaction, but not from a qualified escrow account, a qualified trust, or a qualified intermediary, without affecting the application of a safe harbor VOGEL.SEM/LKEM.18

109 State Law Conflict Federal tax treatment of deferred exchanges is not intended to be dependent upon state law. The final regulations clarify that the terms of the applicable agreement, rather than state law, determine whether the limitations imposed by a safe harbor with respect to a taxpayer s rights to receive, pledge, borrow, or otherwise obtain the benefit of money or other property are satisfied. Thus, the safe harbors require that the applicable agreement expressly limit the taxpayer s rights to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property before the end of the exchange period. Note: The applicable agreement may, but need not, give a taxpayer rights to receive, pledge, borrow, or otherwise obtain the benefits of the money or other property before the end of the exchange period if the exchange is completed or the requirements of 1031(a)(3) can no longer be met. The final regulations also provide that rights conferred upon a taxpayer under state agency law to dismiss an escrow holder, trustee, or intermediary are disregarded in determining whether the taxpayer has the ability to receive or otherwise obtain the benefits of money or other property held by the escrow holder, trustee, or intermediary. However, actual or constructive receipt will occur at the time the taxpayer exercises these rights. Acquisition & Closing Costs Funds in a qualified escrow account or qualified trust, or held by a qualified intermediary, may be needed to pay closing costs for which the taxpayer is responsible. The taxpayer is in receipt of the funds to the extent the funds are used to pay the taxpayer s closing costs. The final regulations provide that the use of money or other property in a qualified escrow account or qualified trust, or held by a qualified intermediary, to pay certain specified items does not result in actual or constructive receipt of the remaining funds, and furthermore, are disregarded in determining whether the applicable agreement properly limits the taxpayer s rights to receive, borrow, pledge, or otherwise obtain the benefits of money or other property. The specified items are transactional items that: a) Relate to the disposition of the relinquished property or to the acquisition of the replacement property, and b) Are listed as the responsibility of a buyer or seller in the typical closing statement under local standards VOGEL.SEM/LKEM.18

110 Note: Examples of these transactional items include commissions, prorated taxes, recording or transfer taxes, and title company fees. In addition, under the final regulations, a taxpayer s rights to receive items (such as prorated rents) that a seller may receive as a consequence of the disposition of property and that are not included in the amount realized from the disposition of property are disregarded. Bankruptcy of Qualified Intermediary In Rev. Proc , the IRS has provided a safe harbor method of reporting gain or loss for certain taxpayers who undertake deferred like-kind exchanges using a qualified intermediary (QI) that defaults on its obligation to acquire or transfer replacement property to the taxpayer. This predominantly involves situations where the QI enters bankruptcy or receivership, with the result that the taxpayer does not have immediate actual or constructive access to the proceeds from the sale of the relinquished property VOGEL.SEM/LKEM.18

111 Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What is the exchange or replacement period? 180 Days Ends on December 21, 2018 LKEM Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, How many properties may be identified? Must use the three properties of any value See QI Agreement LKEM

112 Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What happens if the end of the identification period falls on a Saturday, Sunday, or holiday? It is a day and the 45 days is not extended. LKEM Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, How must the properties be identified? Legal description Physical address notification to QI is allowed LKEM

113 Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, May other replacement properties be substituted for the previously identified properties? Only within 45 days LKEM Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What additional type of property may be received within the replacement period, e.g., laundry machines with an apartment building? As long as the incidental property is not in excess of 15% of the value of the replacement property, the incidental property is unambiguously described with the replacement property. But is boot received? LKEM

114 Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What result if the exchangor has the ability to touch the money? What about using the funds with the qualified intermediary for upgrades or improvements? See QI Agreement. When is the exchangor entitled to the interest earned on the funds with the qualified intermediary? What result if sold property on and client did not identify any replacement properties by ? Qualifies for installment sale treatment. LKEM Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What are the four exceptions to constructive receipt? Who is not eligible to act as a qualified intermediary on behalf of the exchangor? Not an EE, relative, attorney, accountant, banker Use a professional LKEM

115 Nice Try Award Do Not Use Your Son in a Deferred Exchange (No) In Blangiardo v. Comm r, T.C. Memo : 1. T bought Property A for $488,000 in In 2000 T and his first wife divorced and T paid her $500,000 to relinquish her rights in Property A. In 2006, T divorced his second wife and T paid her $80,000 to relinquish all claims she may have against him. 2. T sold Property A on August 15, 2008, for $2,250,000. T s attorney-son handled the sale and kept the proceeds in a trust account. On August 29, 2008, T bought vacant land for $1,430, T: Property A was held for business (contrary to IRS claim) and I did a like-kind deferred exchange with my attorney acting as a QI. IRS: No like-kind exchange and Property A was T s principal residence. T gets gain with a $250, exclusion. LKEM Nice Try Award Do Not Use Your Son in a Deferred Exchange (No) In Blangiardo v. Comm r, T.C. Memo : 1. Court on IRS motion for summary judgment: Under the deferred exchange regulations, a QI cannot be a disqualified person. Family members including lineal descendants are disqualified persons. 2. The fact that the son was an attorney does not change the fact that the son was disqualified to be a qualified intermediary. There is no exception to the rule based on the family member s profession. It is irrelevant the son held the sales proceeds in an attorney trust account. 3. T: I get to increase my basis by the $580,000 I paid to my ex-wives to release their rights in Property A. Court: Read Transfers incident to divorce are treated as gifts with a carryover basis. LKEM

116 Starker Exchange (Yes) Title to Relinquished Property is transferred on June 24, What result if the taxpayer does not file an extension for 2018 and the return is due before the end of the replacement period? Starker exchange on and file Form 1040 on LKEM Starker Exchange (Yes) (Skip to Slide 126.) Title to Relinquished Property is transferred on June 24, What will a professional QI charge? $450 to $1,200 For Bankruptcy of QI See Rev. Proc LKEM

117 Interest Reporting Section 468B(g) (No) Section 468B(g) provides that nothing in any provision of law will be construed as providing that an escrow account, settlement fund, or similar fund is not subject to current income tax. It also directs the Secretary to prescribe regulations relating to the taxation of these accounts or funds whether as a grantor trust or otherwise. While the regulations permit taxpayers to receive interest or a growth factor in a deferred exchange (provided the taxpayer s right to such interest is limited) Reg B-6(c) addresses the proper manner for reporting interest income earned on money held in an escrow account or trust. LKEM Interest Reporting Section 468B(g) (No) Reg B-6(c) governs the taxation of income earned on a qualified escrow account or qualified trust. Under the regulations, exchange funds are treated, as a general rule, as loaned by a taxpayer to an exchange facilitator, and the exchange facilitator takes into account all items of income, deduction, and credit (including capital gains and losses). If, however, the escrow agreement, trust agreement, or exchange agreement specifies that all the earnings attributable to exchange funds are payable to the taxpayer, the exchange funds are not treated as loaned from the taxpayer to the exchange facilitator, and the taxpayer takes into account all items of income, deduction, and credit (including capital gains and losses). LKEM

118 Interest Reporting Section 468B(g) (No) If a loan between the taxpayer and the exchange facilitator does not provide for sufficient interest and the loan is not otherwise exempt from 7872, income is deemed transferred to the exchange facilitator as compensation and retransferred to the taxpayer as interest. The exchange facilitator has income from the imputed compensation and an offsetting deduction for the interest deemed paid to the taxpayer. (See Reg (c).) LKEM Final Regulations Income Earned on Exchange Funds (No) Exchange funds are generally treated as loan by T to the exchange facilitator such as the QI. Exchange funds include relinquished property, cash, and proceeds held in escrow. Loan treatment does not apply if the agreement specifies the earnings on the exchange funds are payable to T. If loan treatment, 7872 imputed interest rules apply, but exception applies if amount treated as a loan does not exceed $2 million and duration of loan is 6 months or less. Effective 10/8/08. LKEM

119 Interest Reporting Section 468B(g) (No) However, the final regulations provide a generous exemption from 7872 for exchange transactions in which the amount of exchange funds treated as loaned does not exceed $2 million and the funds are held for six months or less. This exemption amount may be increased in future published guidance. (See Reg (f).) IRS says that based on comments it received, the $2 million amount is expected to exempt from the application of 7872, most deferred exchange transactions handled by small business exchange facilitators. (There are less than 325 large QI.) LKEM Like-Kind Exchange Safe Harbor When the QI Defaults (No) Rev. Proc : Provides a safe harbor for taxpayers who initiate a deferred like-kind exchange but fail to complete it because a qualified intermediary (QI) defaults on its obligations to acquire replacement property and transfer it to the taxpayer. 1. Problem: T commences a deferred like-kind exchange and the relinquished property is sold through a QI who holds the proceeds to use in acquiring the replacement property. The QI, through misconduct or business failure, does not acquire the replacement property, and is in bankruptcy or receivership. The taxpayer is unable to complete the exchange within the 180-day required time period. LKEM

120 Like-Kind Exchange Safe Harbor When the QI Defaults (No) General rule: A T who in good faith sought to complete the exchange but was unable to do so due to a QI default will not be required to recognize gain from the sale of the relinquished property until the year in which the T receives a payment attributable to the relinquished property. Applies if T transferred relinquished property to a QI in accordance with regulations, identified the replacement property in the 45-day required period (unless the QI defaults in that period), T did not complete the exchange due to a QI default involving a QI that is in bankruptcy or receivership, and T did not have constructive receipt of proceeds from the sale of the relinquished property. T must report gain under the safe harbor gross profit ratio method, which is similar to the installment method. LKEM Like-Kind Exchange Safe Harbor When the QI Defaults (No) The procedure defines terms such as payment, gross profit, selling price, contract price, and satisfied indebtedness in a manner similar to definitions of such terms or similar terms as used under the installment sale rules. As the taxpayer receives any payment attributable to the relinquished property, the taxpayer must recognize gain in accordance with installmentsale-type rules. Adjustment are made in the final year the taxpayer receives a payment. Debt relief (satisfied indebtedness) with respect to the relinquished property is also taken into account under rules like the installment sale rules. A loss may be claimed if the taxpayer receives total payments and debt relief less than his basis. LKEM

121 Like-Kind Exchange Safe Harbor When the QI Defaults (No) Example: T owns property, RLQ, with a FMV of $150 and a basis of $50. In Year 1,T intends to do a like-kind exchange and sells the RLQ through a QI for $150 and the QI holds the proceeds. The QI enters bankruptcy and does not acquire replacement property. At the end of Year 1, T has received nothing from the QI or the bankruptcy court. 1. In Year 2 the bankruptcy is concluded and T receives $130 in full satisfaction of his claim, and receives no other payment. 2. T need not recognize any gain in Year 1, as he received no payment. In Year 2, T has a selling price and contract price of $130, gross profit of $80 ($130 basis of $50), and gross profit ratio of $80 gross profit/ $130 contract price. T recognizes gain in Year 2 of $80 ($130 payment X $80/$130 gross profit ratio). LKEM Like-Kind Exchange Safe Harbor When the QI Defaults (No) Example: Same general scenario, but the relinquished property RLQ has a FMV of $160, basis of $90, and mortgage of $60. In Year 1 the QI sells it for $160 cash and pays off the mortgage. The QI enters bankruptcy, and T receives nothing by the end of Year In Year 2 the bankruptcy court awards T $70, $35 of which is paid in Year 2 and $35 in Year T s selling price is $130 ($70 recovery plus $60 satisfied debt). His contract price is $70 ($130 selling price - $60 satisfied debt). T s gross profit is $40 ($130 selling price - $90 basis). T s gross profit ratio is $40 gross profit/$70 contract price. 3. In Years 2 and 3 T recognizes gain of $20 ($35 payment X $40/$70). LKEM

122 Reverse Starker Exchange (Yes) (Skip to Slide 152.) Purchase Replacement Property before the sale of Relinquished Property. Purchased Replacement Property on June 20, 2018 Sell Relinquished Property on September 1, 2018 Use the same steps to determine L.15 and L.18 LKEM

123 Reverse Starker Exchange 1. Purchase Replacement Property before the sale of Relinquished Property. 2. What is an EAT? 3. Who may be an EAT? 4. May the EAT be a tax-exempt organization? 5. Who must hold the qualified indicia of ownership (QIO)? 6. What is a QEAA? 7. What are the time limits for identifying the relinquished property and the sale of the relinquished property? 8. How many relinquished properties may be identified? 9. During the time that the replacement property is parked with the EAT, who may: a. Lease the property? b. Manage the property? c. Who is required to report the income? d. Who may depreciate the property? VOGEL.SEM/LKEM.18

124 Reverse Starker Exchange Rev. Proc Examples a. A and C agree to exchange properties. On June 1, 2018, C transfers property Y to A. On July 1, 2018, A transfers property X to C. The exchange is a deferred exchange for C and a reverse exchange for A. b. A owns property X, wants property Y. Owner C of property Y requires transfer date before X can be transferred. Later, A transfers X to B, who pays off the note given by A to C as purchase price. Neither B nor C have an exchange, but A may have a reverse exchange. 2. Neither the statute nor the regulations address the issue of whether taxpayers may structure like-kind exchanges under 1031 as Reverse Starker Exchanges, i.e., an exchange in which the taxpayer receives the replacement property before it disposes of the relinquished property. For example, a situation may arise in a multi-party exchange in which the taxpayer needs to take immediate possession of the replacement property, but the exchangor is unwilling to acquire the taxpayer s relinquished property until he is able to locate a potential buyer. While there is nothing in the statute or the legislative history of the 1984 Act Amendments that would necessarily preclude such an exchange from qualifying under 1031(a)(3), it is unlikely that such an exchange was intended to so qualify. Since the only property that needs to be identified and received within the applicable time limits is the replacement property to be received by the taxpayer, allowing a reverse exchange to qualify under 1031(a)(3) would not place any time restriction on when the taxpayer had to transfer his relinquished property. 3. In the initial set of proposed regulations issued by the Treasury on the amendments made to 1031 by DRA 1984, the Treasury solicited comments on whether a Reverse Starker Transaction should qualify for tax-free exchange treatment under 1031 (see Preamble to Proposed Regulations, C.B. 633). When it finalized the regulations in 1991, the Treasury settled on the determination that both the deferred exchange rules of 1031(a)(3) and the final deferred exchange regulations do not apply to Reverse Starker Transactions. The Treasury indicated, however, that it will continue to study the applicability of the general rule of 1031(a)(1) to these transactions (see the Preamble to Final Regulations, 56 Fed. Reg (5/1/91)) VOGEL.SEM/LKEM.18

125 4. Notwithstanding the unwillingness of the Treasury to conceded the issue, practitioners have sometimes cited cases such as Rutherford v. Comm r, T.C. Memo , Bezdijian v. th Comm r, 845 F.2d 217 (9 Cir. 1988), Lee v. Comm r (T.C. Memo ), and In re Exchanged Titles, 159 Bank. Rptr. 303 (Bkrpt C.D.Cal. 1993) as authorities supporting reverse exchanges. While it is true that language in the opinions issued in these cases in helpful, the cases themselves are of limited value because either they do not squarely address the issue or, in the case of In re Exchanged Titles, it was not a tax case. 5. Rev. Proc provides a safe harbor for certain reverse exchanges which utilize parking arrangements, thereby allowing taxpayers to compile an exchange to acquire replacement property prior to the disposition of the relinquished property. a. EAT (exchange accommodation titleholder) - May hold either the replacement property or the relinquished property. Generally, the EAT acquires and holds the replacement property from its purchase until the exchangor sells the relinquished property to a third-party buyer. A simultaneous or deferred exchange, with the property held by the EAT completes the transaction. However, Rev. Proc also allows the completion of the exchange concurrent with the EAT s purchase of replacement property, resulting in the receipt of the replacement property by the exchangor in return for transfer of the relinquished property to the EAT (referred to as an exchange first transaction). The EAT then holds the relinquished property until it is sold to a third-party buyer. b. Who May be an EAT. 1) Rev. Proc applies the same limitations to EATs that are applied to qualified intermediaries, qualified escrow holders, and qualified trust trustees under Reg (k)-l(k). Under this rule, disqualified persons include parents, siblings and children of exchangors, and corporations or partnerships that are more than 10% owned by exchangors. Disqualified persons also include the exchangor s employees, attorneys, accountants, brokers, and others who act as agents, plus financial institutions where the exchangor has more than routine deposit or borrowing relationships. 2) Rev. Proc further stipulates that the EAT must be subject to federal income tax. If the EAT is a pass-through entity, more than 90% of the EAT s owners must be subject to federal income tax. 3) An EAT may also act as the exchangor s qualified intermediary if it satisfies the requirements of the qualified intermediary safe harbor VOGEL.SEM/LKEM.18

126 c. Qualified Indicia of Ownership. 1) A property is considered to be held in a qualified exchange accommodation agreement only if the qualified indicia of ownership ( QIO ) is demonstrated by the EAT at all times from the date of acquisition by the EAT until the property is transferred to the exchangor or a third-party buyer. 2) To satisfy the QIO test, the EAT must acquire legal title to the parked property, or other indicia of ownership of the property that are treated as beneficial ownership of the property under applicable principles of commercial law. Rev. Proc cites a contract for deed (i.e., an installment sales contract where the seller retains title as a security device) as an example of an arrangement, short of legal title, that satisfies the QIO test. Other commercial transactions in which a creditor holds legal title as a security device (e.g., an owner trust structure) will satisfy the QIO test. A long-term ground lease (lease term in excess of 30 years including options to renew) should also constitute other indicia of ownership. Rev. Proc permits the EAT to hold the parked property through a single member limited liability company or other types of entities that are disregarded for tax purposes if the disregarded entity satisfies the QIO test. 3) Both the exchangor and the EAT must report the federal income tax attributes of the parked property on their respective federal income tax returns consistent with the EAT s status as owner during the QEAA. d. Requirements of QEAA Agreement. 1) No later than five business days after an EAT acquires the QIO with respect to a parked property, the EAT and the exchangor must enter into a qualified exchange accommodation agreement ( QEAA ). The QEAA must be in writing and must specify that (a) the EAT is holding the parked property for the benefit of the exchangor in order to facilitate a 1031 exchange pursuant to Rev. Proc , and (b) the EAT will be treated as the beneficial owner of the parked property for all federal income tax purposes. e. Bona Fide Intent to Exchange. 1) At the time the EAT acquires QIO of property which will serve as either replacement or relinquished property in an exchange, the exchangor must have a bona fide intent to qualify the transaction as a 1031 exchange VOGEL.SEM/LKEM.18

127 f. Identification Requirement and Time Limits. 1) If a parked property represents replacement property, Rev. Proc requires the exchangor to identify the proposed relinquished property in the exchange within 45 days after the EAT acquires QIO with respect to the parked property. If the parked property is the relinquished property, there will be no identification issue since the exchange with the replacement property has already occurred. 2) Rev. Proc adopts the deferred like-kind exchange identification requirements of Reg (k)-1(c). Therefore, the exchangor may identify up to three relinquished properties without regard to the fair market value of the replacement property ( 3-property rule ), or any number of properties provided that aggregate value of all properties identified does not exceed 200% of the fair market value of the replacement property ( 200-percent rule ). The exchangor may also identify more relinquished properties than allowable under the 3-property rule, or the 200-percent rule, by using the 95- percent rule. The 95-percent rule for deferred exchanges permits exchangors to identify any number of properties as replacement property as long as the replacement property ultimately acquired represents 95% of the value of all properties identified. 3) The identification must be in writing, signed by the exchangor, and delivered in the manner prescribed in the deferred like-kind exchange regulations before the end of the identification period. These methods include hand delivery, mail, facsimile, or otherwise sent to a party involved in the transaction. g. Duration of QEAA. 1) The most significant limitation incorporated into Rev. Proc is an absolute 180-day limit on the duration of QEAAs, whether they involve exchange last or exchange first transactions. Unless property held by an EAT is transferred to the exchangor (in an exchange last), or to a party who is not the taxpayer or a disqualified person (in an exchange first) within 180 days of the EAT s acquisition of QIO, the safe harbor is lost. In order to avoid attempts to double-dip, Rev. Proc further explicitly limits the combined time period that an exchangor s replacement property and relinquished property can be held in a QEAA to 180 days. 2) Rev. Proc severely limits build to suit transactions VOGEL.SEM/LKEM.18

128 h. Permissible Arrangements. 1) The EAT may enter into an exchange agreement with the exchangor to serve as the QI in a simultaneous or deferred exchange of the parked property. 2) The exchangor or a disqualified person may guarantee some or all of the obligations of the EAT, including secured or unsecured debt incurred to acquire the parked property. The exchangor or a disqualified person may also indemnify the EAT against any costs and expenses incurred on the parked property during the QEAA. 3) The exchangor or a disqualified person may advance to the EAT the funds necessary to acquire the parked property. 4) The exchangor or a disqualified person may lease the parked property during the QEAA. 5) The exchangor or a disqualified person may manage the property, may supervise improvement of the property, may act as a contractor, or may provide other services to the EAT with respect to the parked property. 6) The exchangor and the EAT may enter into various agreements related to the purchase or sale of the property, including fixed or formula puts and calls as long as the option period does not exceed 185 days from the date the property is acquired by the EAT. 7) In an exchange first transaction, the exchangor will agree to make the EAT whole if the proceeds from the sale of the relinquished property are less than the estimated value on the date the EAT took QIO to the parked property VOGEL.SEM/LKEM.18

129 i. Problems. 1) Rev. Proc points out that certain amounts paid to the EAT pursuant to the QEAA may be recharacterized as a fee paid to the EAT in its capacity as such in order to reflect the true economic substance of the arrangements. It also points out that other federal income tax implications that arise as a result of the arrangement are not addressed as part of the revenue procedure, such as whether the EAT may claim depreciation deductions during the parking period. Whether the EAT may claim depreciation deductions depends on whether the EAT is treated as holding property for investment purposes (i.e., an intent to make a profit) or as property held for sale (such as inventory). Reg (a)-2 specifically excludes depreciation deductions on tangible property held as inventory or stock in trade. The property held by the EAT may very well be an operating property during the parking arrangement; therefore, the EAT is holding parked property for investment purposes. 2) In order to satisfy the benefits and burdens of ownership test, will the accommodator be required to provide equity, or be liable for recourse debt? If so, how much equity or recourse debt liability will be required? 3) How close to arm s length terms must the parties construct the financing, leasing and purchase/sale options which are likely to be part of all parking arrangements? 4) Who is entitled to the tax benefits of 1033 if the parked property is condemned or destroyed during the parking period? 5) What happens to the exchangor, and its ability to complete a like-kind exchange, if the EAT fails to satisfy its obligation to transfer the property to the exchangor at the end of the QEAA period? 6) Will the EAT be required to report taxable income if a payment is required by the exchangor for any variation in the relinquished property proceeds and the original value assigned to it at the time the EAT took title to the parked property? VOGEL.SEM/LKEM.18

130 Reverse Starker Exchange (Yes) What is an EAT? LKEM Reverse Starker Exchange (Yes) Who may be an EAT? LKEM

131 Reverse Starker Exchange (Yes) May the EAT be a tax-exempt organization? LKEM Reverse Starker Exchange (Yes) Who must hold the qualified indicia of ownership (QIO)? LKEM

132 Reverse Starker Exchange (Yes) What is a QEAA? LKEM Reverse Starker Exchange (Yes) What are the time limits for identifying the relinquished property and thesaleof the relinquished property? Purchase replacement property today and sell relinquished property in February LKEM

133 Reverse Starker Exchange (Yes) How many relinquished properties may be identified? LKEM Reverse Starker Exchange (Yes) During the time that the replacement property is parked with the EAT, who may: Lease the property? Manage the property? Who is required to report the income? Who may depreciate the property? LKEM

134 Reverse Starker Exchange (Yes) (Skip to Slide 152.) What will a professional EAT charge? $4,000 to $5,000 LKEM Problems w/ Reverse Starker (No) Rev. Proc points out that certain amounts paid to the EAT pursuant to the QEAA may be recharacterized as a fee paid to the EAT in its capacity as such in order to reflect the true economic substance of the arrangements. It also points out that other federal income tax implications that arise as a result of the arrangement are not addressed as part of the revenue procedure, such as whether the EAT may claim depreciation deductions during the parking period. Whether the EAT may claim depreciation deductions depends on whether the EAT is treated as holding property for investment purposes (i.e., anintentto make a profit) or as property held for sale (such as inventory). Reg (a)-2 specifically excludes depreciation deductions on tangible property held as inventory or stock in trade. The property held by the EAT may very well be an operating property during the parking arrangement; therefore, the EAT is holding parked property for investment purposes. LKEM

135 Problems w/ Reverse Starker (No) In order to satisfy the benefits and burdens of ownership test, will the accommodator be required to provide equity, or be liable for recourse debt? If so, how much equity or recourse debt liability will be required? LKEM Problems w/ Reverse Starker (No) How close to arm s length terms must the parties construct the financing, leasing and purchase/sale options which are likely to be part of all parking arrangements? LKEM

136 Problems w/ Reverse Starker (No) Who is entitled to the tax benefits of 1033 if the parked property is condemned or destroyed during the parking period? LKEM Problems w/ Reverse Starker (No) What happens to the exchangor, and its ability to complete a like-kind exchange, if the EAT fails to satisfy its obligation to transfer the property to the exchangor at the end of the QEAA period? LKEM

137 Problems w/ Reverse Starker (No) Will the EAT be required to report taxable income if a payment is required by the exchangor for any variation in the relinquished property proceeds and the original value assigned to it at the time the EAT took title to the parked property? LKEM Reverse Like-Kind Exchange Meets Requirements Even If No Safe Harbor (No) In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The Tax Court held that a reverse like-kind exchange qualified under 1031, even though the IRS claimed that: a. The accommodation party only held bare legal title to the replacement property until the relinquished property was sold; and b. The transactions was not completed within i thesafe harborperiod of 180 days. (See Rev. Proc ) LKEM

138 Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The taxpayer is an S corporation ( BD ) that owns and operates drug stores. In May 1999 BD entered into an agreement to purchase property L from a third party, with both parties agreeing to cooperate to permit BD to accomplish a reverse like-kind exchange. a. In July 2000, BD assigned its rights under the purchase agreement to an exchange facilitator ( EPC ) (EPC)and those parties entered into an Exchange Cooperation Agreement. b. Under a related agreement, EPC agreed to purchase property L, and BD had the right to acquire property L from EPC for 24 months at a specified price. LKEM Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. EPC purchased property L on August 1, 2000, for about $1.9 million, with bank financing guaranteed by BD. EPC held title to property L. a. BD then managed the construction of a drugstore on property L, using proceeds from the bank financing. Upon substantial completion of the construction, BD leased the property from EPS starting June 1, b. In September 2001, BD contracted to sell its existing property E to a buyer. On December 17, 2001, BD entered into an exchange agreement with an intermediary (SS), identifying property E as the relinquished property and property L as the replacement property in a like-kind exchange. LKEM

139 Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. BD assigned its sales contract for property E to SS, which sold property E, applied the proceeds to the acquisition of property L from EPC, and caused the title to property L to be transferred to BD as in exchange for property E. 2. BD reported the transactions as a like-kind exchange with deferred gain of about $2.8 million. The IRS challenged that treatment. It claimed that BD already owned property L long before the supposed exchange in December 2001 because it possessed the benefits and burdens of ownership. It also claimed that there was a 180-day deadline from completing the transaction, and BD had taken about 17 months. LKEM Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. History: 1031 itself did not provide for deferred exchanges. A forward deferred exchange (relinquished property sold first) with multi-parties was approved in Starker v. U.S., 602 F.2d 1341 (9th Cir. 1979). a. Congress then amended 1031(a) to expressly sanction specified deferred exchanges, and added requirements for forward exchanges. Those included a requirement that replacement property be identified within 45 days after the relinquished property was transferred, and that the deferred exchange be completed by the earlier of 180 days after the taxpayer transferred the relinquished property or the due date of the taxpayer s return for that year. LKEM

140 Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. Subsequent regulations under 1031 provided guidance on forward exchanges, but not on reverse exchanges. 2. The IRS then issued Rev Proc to provide a safe harbor for reverse exchanges where a taxpayer parks replacement property with an exchange accommodation titleholder who acts as the beneficial owner of the property under a qualified exchange accommodation arrangement. 3. That procedure was effective for arrangements entered into on or after 9/15/2000. LKEM Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The safe harbor in Rev. Proc imposed time limits paralleling these for deferred forward exchanges under the regulations, including a 45-day rule for identification of properties and a 180-day rule for closing the like-kind transaction. 2. The safe harbor, however, was inapplicable in Estate of Bartell because EPC acquired title to property L on August 1, 2000, before the effective date of Rev. Proc The parties, therefore, argued the case under general tax principles and case law. LKEM

141 Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The fundamental question in the case was whether an exchange occurred at all. 2. The IRS claimed that BD already held the benefits and burdens of ownership of property L long before the alleged exchange in December 2001, and therefore there was no exchange because a taxpayer cannot exchange property with itself. 3. BD responded that under cases such as Alderson v. Comm r, 317 F.2d 790 (9th Cir. 1963), a third-party exchange facilitator or equivalent need not assume the benefits and burdens of ownership of property to effect a 1031 transaction. LKEM Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The Tax Court agreed with the taxpayer. Alderson and other cases upheld a 1031 exchange even if a title holder serving as an intermediary or the equivalent did not have the burdens and benefits of ownership of the property. 2. Tax Court: The touchstone of these cases is the requirement that there be an exchange of like-kind properties, as distinguished from a cash sale of relinquished property and reinvestment of the proceeds in a replacement property. This distinction was largely one of form. Prior cases have permitted a taxpayer to exercise any number of indicia of ownership and control over replacement property without jeopardizing 1031 treatment. LKEM

142 Reverse Like-Kind Exchange (No) Meets Requirements Even If No Safe Harbor In Estate of Bartell v. Comm r, 147 T.C. No. 5 (2016): 1. The Tax Court found it irrelevant that BD had leased the replacement property for about six months before the completion of the final exchange at the end of Case law has countenanced a taxpayer s pre-exchange control and financing of the construction of improvements on the replacement property while an exchange facilitator held title. 2. Finally, the Court rejected the IRS argument that the exchange took too long, about 17 months after the replacement property was first acquired by EPC. The safe harbor did not apply, and case law set no specific time limit on the period for completion of a reverse exchange. BD wins. LKEM FORM 8824 Review Problems (Yes) Your client participated in a Starker Exchange, selling the relinquished property on May 1, 2018 and purchasing the replacement property p on August 1, Your client s adjusted basis in the relinquished property was $159,348 (of which $20,000 was allocated to the land). The relinquished property was placed in service as commercial property in The replacement property cost $542,000 (of which $54,200 is allocated to the land and will also be used as commercial property). The following information is also available: (Sold) Relinquished (Purchased) Acquired Sales Price ($575,000) $542,000 Costs of Sale/Acquisition (Transaction Costs $33,569) 27,269 6,300 Schedule E Expense 2,293 (2,019) Loan Fees 717 Reserves 1,752 Cash Out 6,690 Loan 189,998 (200,000) Equity 355,440 (355,440) $ 0 $ 0 Compute the amount of taxable gain (L.15 of Form 8824), if any, on the exchange, the basis in the replacement property (L.18 of Form 8824), and discuss how you would calculate depreciation on the replacement property. (ANS: L.15 is $9,433and L.18 is $169,350.) LKEM

143 FORM 8824 Review Problem Your client participated in a Starker Exchange, selling the relinquished property on May 1, 2018 and purchasing the replacement property on August 1, Your client s adjusted basis in the relinquished property was $159,348 (of which $20,000 was allocated to the land). The relinquished property was placed in service as commercial property in The replacement property cost $542,000 (of which $54,200 is allocated to the land and will also be used as commercial property). The following information is also available: Relinquished Acquired Sales Price ($575,000) $542,000 Costs of Sale/Acquisition 27,269 6,300 Schedule E Expense 2,293 (2,019) Loan Fees 717 Reserves 1,752 Cash Out 6,690 Loan 189,998 (200,000) Equity 355,440 (355,440) $ 0 $ 0 1. Compute the amount of taxable gain (L.15 of Form 8824), if any, on the exchange, the basis in the replacement property (L.18 of Form 8824), and discuss how you would calculate depreciation on the replacement property. 2. What would you advise if title to the relinquished property was in Abby s name alone and Abby would like to take title to the replacement property in her name and her spouse s, Ben s, name as either joint tenants or tenants in common VOGEL.SEM/LKEM.18

144 FORM 8824 Review Problems (Yes) Relinquished Property Replacement Property Selling Price $575,000 Contract Price $542,000 Less Debt (189,998) Less Debt (200,000) Cash Rec d $385,002 (-) Cash Paid $342,000 Line 15: Net Cash Rec d $ 43,002 + Dbt Debt on Rli Relinquished ihd > + 0 Debt on Replacement - Exchange Expenses (33,569) L.15 $ 9,433 = LKEM FORM 8824 Review Problems (Yes) Relinquished Property Replacement Property Selling Price $575,000 Contract Price $542,000 Less Debt (189,998) Less Debt (200,000) Cash Rec d $385,002 (-) Cash Paid $342,000 Line 18: 10% Land A/B of Relinquished $159, % Bldg 29yrs Cash Paid > CashReceived Debt on Replacement > 10% Land Debt on Relinquished + 10, % Bldg 39yrs Exchange Expenses + 0 L.18 $169,350 LKEM

145 FORM 8824 Review Problems (Yes) What would you advise if title to the relinquished property was in Abby s name alone and Abby would like to take title to the replacement property in her name and her spouse s, Ben s, name as either joint tenants or tenants in common. LKEM FORM 8824 Review Problem Multi-Asset Exchange Facts for Relinquished Property Summary of Form 8824 Multi-Asset Exchange: Sold: 220 North Street Received: 5019 East Street, 1601 Western Street, 64 Berry Drive Details for 220 North Street, property given up: Original purchase 8/27/2006 Sold 5/4/2017 Depreciation Basis $158,719 Land Basis 6,781 Less accumulated depreciation (91,121) Basis (property sold) $ 74,379 Relinquished Property 220 North Street (sold 5/4/2017) Selling Price $400,503 Mortgage (85,207) Cash Received $315,296 LKEM

146 FORM 8824 Review Problem Multi-Asset Exchange Replacement Properties Property # East Street Purchased 5/15/2017, Identified 5/8/2017 Purchase price $132,500 Cash paid $132,500 Transaction costs $605 Property # Western Street Purchased 6/18/2017, Identified 5/18/2017 Purchase price $190,000 Mortgage gg $128,000 Transaction costs $1,444 Property #3 64 Berry Drive Purchased 6/30/2017, Identified 6/5/2017 Purchase price $225,000 Mortgage $126,000 Transaction costs $2,585 LKEM FORM 8824 Review Problem Multi-Asset Exchange How much gain recognized and what is the basis of each property? The sum of the exchange expenses is $17,636 ($13,002 + $605 + $1,444 + $2,585). The total purchase price of the replacement properties is $547,500 ($132,500 + $190,000 + $225,000) and the sum of the debt on the purchased properties is $254,000 ($126,000 + $128,000). LKEM

147 FORM 8824 Review Problem Multi-Asset Exchange (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $400,503 Contract Price $547,500 Less Debt (85,207) Less Debt (254,000) Cash Rec d $315,296 (-) Cash Paid $293,500 Line 15: Net Cash Rec d $21,796 + Debt on Relinquished > + 0 Debt on Replacement Transaction Expenses (17,636) Gain L.15 $ 4,160 LKEM = FORM 8824 Review Problem Multi-Asset Exchange Line 18: Old Basis $74,379 + Cash Paid > Cash Received Debt Replacement > Debt Relinquished $254,000 > $85, ,793 + Transaction Costs 0 L.18 $243,172 LKEM

148 FORM 8824 Review Problem Multi-Asset Exchange Basis $243,172 Allocated in Proportion to Gross FMV FMV Basis Debt Property #1 $132,500 $58,850 $ 0 Property #2 190,000 84, ,000 Property #3 225,000 99, ,000 $547,500 $243,172 $254,000 What looks strange on Property 2 & 3? Old Basis Basis Boost $74,379 $168,793 LKEM

149 Summary of Form 8824 Multi-Asset Exchange Facts for Relinquished Property Summary of Form 8824 Multi-Asset Exchange: Sold: 220 North Street Received: 5019 East Street, 1601 Western Street, 64 Berry Drive Details for 220 North Street, property given up: Original purchase 8/27/2006 Sold 5/4/2017 Depreciation basis $158,719 Land 6,781 Less accumulated depreciation (91,121) Basis (property sold) $ 74,379 Relinquished Property 220 North Street (sold 5/4/2017) Selling Price $400,503 Mortgage (85,207) Cash received $315, VOGEL.SEM/LKEM.18

150 Summary of Form 8824 Multi-Asset Exchange Facts Details for Property Given Up: Sold: 220 North Street Received: 5019 East Street, 1601 Western Street, 64 Berry Drive Details for 220 North Street, property given up: Original purchase 8/27/2006 Sold 5/4/2017 Depreciation Basis $158,719 Land Basis 6,781 Less accumulated depreciation (91,121) Basis (property sold) $ 74,379 Relinquished Property 220 North Street (sold 5/4/2017) Selling Price $400,503 Mortgage $85,207 Transaction costs incurred $13, VOGEL.SEM/LKEM.18

151 Summary of Form 8824 Multi-Asset Exchange Facts Replacement Properties: Property # East Street Purchased 5/15/2017, Identified 5/8/2017 Purchase price $132,500 Cash paid $132,500 Property # Western Street Purchased 6/18/2017, Identified 5/18/2017 Purchase price $190,000 Mortgage (128,000) Cash Paid $ 62,500 Property #3 64 Berry Drive Purchased 6/30/2017, Identified 6/5/2017 Purchase price $225,000 Mortgage (126,000) Cash Paid $ 99,000 FMV of Like-Kind Property Received ($132,500 + $190,000 + $225,000) $547,500 Form 8824, Line VOGEL.SEM/LKEM.18

152 Summary of Form 8824 Multi-Asset Exchange Facts Summary Net Cash Received: Cash received relinquished property: 220 North Street $315,296 Cash paid replacement property: 5019 East Street (132,500) Cash paid replacement property: 1601 Western Street (62,000) Cash paid replacement property: 64 Berry Drive (99,000) Net Cash Received $ 21,796 Amount Realized Relinquished Property Sold: Cash received $315,296 Plus: Debt relief (relinquished property) 85,207 Total amount received $400,503 Less: Adjusted basis (relinquished property) (74,379) Realized gain $326,124 Less: Exchange expenses (17,636) Realized Gain (w/ Rev. Rul ) Form 8824, Line 19 $308, VOGEL.SEM/LKEM.18

153 Summary of Form 8824 Multi-Asset Exchange Facts Replacement property FMV $547, Debt relief 85, Net cash received 315,296 Total A/R $948,003 Less: A/B $ 74, Debt on new property 254, Net cash paid 293, Transaction costs 17,636 (639,515) Realized Gain - Line 19 $308, VOGEL.SEM/LKEM.18

154 Summary of Form 8824 Multi-Asset Exchange Facts Recognized Gain: Lesser of Real Gain or Net Boot Received: Net boot received $21,796 Less: Total transaction costs incurred: Relinquished property 13,002 Replacement property 4,634 (17,636) Gain Recognized - Form 8824, Line 15 & Line 23 $ 4,160 Basis of Like-Kind Property (w/ Rev. Rul ): Old Basis $ 74,379 Plus: Gain recognized 4,160 Less: Boot received (4,160) Plus: Liability assumed 254,000 Less: Debt relief (85,207) Basis of Like-Kind Property (w/ Rev. Rul ) Form 8824, Line 18 and Line 25 $243, VOGEL.SEM/LKEM.18

155 Form 8824 (2017) Page 2 Name(s) shown on tax return. Do not enter name and social security number if shown on other side. Part III Realized Gain or (Loss), Recognized Gain, and Basis of Like-Kind Property Received Your social security number Caution: If you transferred and received (a) more than one group of like-kind properties or (b) cash or other (not like-kind) property, see Reporting of multi-asset exchanges in the instructions. Note: Complete lines 12 through 14 only if you gave up property that was not like-kind. Otherwise, go to line Fair market value (FMV) of other property given up Adjusted basis of other property given up Gain or (loss) recognized on other property given up. Subtract line 13 from line 12. Report the gain or (loss) in the same manner as if the exchange had been a sale Caution: If the property given up was used previously or partly as a home, see Property used as home in the instructions. 15 Cash received, FMV of other property received, plus net liabilities assumed by other party, reduced (but not below zero) by any exchange expenses you incurred. See instructions FMV of like-kind property you received Add lines 15 and Adjusted basis of like-kind property you gave up, net amounts paid to other party, plus any exchange expenses not used on line 15. See instructions Realized gain or (loss). Subtract line 18 from line Enter the smaller of line 15 or line 19, but not less than zero Ordinary income under recapture rules. Enter here and on Form 4797, line 16. See instructions Subtract line 21 from line 20. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form 4797, unless the installment method applies. See instructions Recognized gain. Add lines 21 and Deferred gain or (loss). Subtract line 23 from line 19. If a related party exchange, see instructions Basis of like-kind property received. Subtract line 15 from the sum of lines 18 and Part IV Deferral of Gain From Section 1043 Conflict-of-Interest Sales Note: This part is to be used only by officers or employees of the executive branch of the Federal Government or judicial officers of the Federal Government (including certain spouses, minor or dependent children, and trustees as described in section 1043) for reporting nonrecognition of gain under section 1043 on the sale of property to comply with the conflict-of-interest requirements. This part can be used only if the cost of the replacement property is more than the basis of the divested property. 26 Enter the number from the upper right corner of your certificate of divestiture. (Do not attach a copy of your certificate. Keep the certificate with your records.) Description of divested property 28 Description of replacement property 29 Date divested property was sold (month, day, year) MM/DD/YYYY 30 Sales price of divested property. See instructions Basis of divested property Realized gain. Subtract line 31 from line Cost of replacement property purchased within 60 days after date of sale Subtract line 33 from line 30. If zero or less, enter Ordinary income under recapture rules. Enter here and on Form 4797, line 10. See instructions Subtract line 35 from line 34. If zero or less, enter -0-. If more than zero, enter here and on Schedule D or Form See instructions Deferred gain. Subtract the sum of lines 35 and 36 from line Basis of replacement property. Subtract line 37 from line Form 8824 (2017)

156 Installment Sale (Yes) On June 1, 2018, Susan agreed to sell 100 acres of orange groves worth $500,000, 000 with a $400, adjusted basis, in return for Steve Smith's $150,000 promissory note, and Smith's avocado farm worth $350,000. How much gain is Susan required to recognize. Assume that there are no transaction costs. Sold Total LKE Install. Sale A/R: Note $150,000 $ 0 $150,000 FMV of Avocado 350,000 $350,000 0 Total A/R $500,000 $350,000 $150,000 A/B 400, ,000 50,000 Real Gain $100,000 $ 0 $100,000 LKEM Installment Sale (Yes) (Sold) (Purchased) Relinquished Property Replacement Property Selling Price $500,000 Contract Price $350,000 Debt 0 Debt 0 Cash Rec d $500,000 Cash Paid $350,000 Net Cash Received $150,000 But, gain recognized limited to realized gain of $100,000 See next slide. LKEM

157 Installment Sale (Yes) LKEM Installment Sale (Yes) Installment Sale: S.P. $150,000 A/B 50,000 Why? Gross profit $100,000 Contract price 150,000 G.P. % 66-2/3% (A/B sold $400,000 and basis in LKE property is $350,000.) If note paid in a balloon payment in three years: Gain $100,000 ($150,000 x 66-2/3%) LKEM