Property Type: Land
City: Oak Bluffs
State: Massachusetts
Description: Oak Bluffs, MA-Land-wooded 0.73 corner lot abuts conservation land with protective covenants in the private setting of Vineyard Hills. Town center, bike paths, beaches, Sailing Camp Park and Lagoon Pond are all just minutes away.
Price: $350,000
Contact: (860) 623-6581
Archive for the ‘1031 Exchange Basics’ Category
Property Listing: Land
Tuesday, August 2nd, 2011 by phillip
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Thank you Veterans
Thursday, November 11th, 2010 by Alexandra Hart
Especially on Veterans day, we remember and thank all those brave men and women who have served this wonderful country. We are grateful for their selfless bravery and the sacrifices those service members and their families have made to afford us the freedom we enjoy everyday. Thank you Veterans!
No depreciation deductions or like-exchange treatment for equipment held for rent or sale
Thursday, July 1st, 2010 by Moore McLaughlin
In Chief Counsel Advice (CCA) 201025049 dealing with equipment for rent or sale, the IRS has concluded that a taxpayer could not demonstrate that the equipment was devoted to use in its trade or business and that it looked to such use of the equipment to recover the cost of the equipment. Instead, the taxpayer held the equipment primarily for sale and, as a result, it could not claim depreciation deductions for the equipment and could not treat exchanges of the equipment as like-kind swaps under Code Sec. 1031.
Background. Under Code Sec. 167(a), taxpayers may claim a depreciation deduction for the exhaustion, wear and tear of property used in a trade or business or held for the production of income. However, under Reg. §1.167(a)-2, depreciation deductions can not be claimed for inventories or stock in trade.
Under Code Sec. 1031(a)(1), gain or loss is not recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind which is held either for productive use in a trade or business or for investment. Nonrecognition treatment is not allowed under Code Sec. 1031(a)(2)(A) for an exchange of property that is stock in trade or other property held primarily for sale.
Facts. Corp X distributes, sells, rents, services, and finances an unspecified type of equipment. It orders the equipment directly from the manufacturer and identifies certain equipment as rental property before receiving it from the manufacturer. When it receives the equipment, Corp X capitalizes the cost of the equipment that has been designated as rental property and claims depreciation deductions on this equipment from the time it is available for rent. Apparently, Corp X capitalizes the cost of equipment other than designated rental property as “inventory” (as defined in Code Sec. 471) upon the receipt of the equipment from the manufacturer. Corp X’s rental equipment is available for rent by the hour, week, or month, and it reserves the right to withdraw the rented equipment during the rental period and substitute similar equipment. The rental agreements permit a renter to buy the rented equipment, but the information provided IRS does not indicate the amount of rent, if any, that would be applied against the purchase price in the event a renter buys the equipment. However, Corp X has indicated that the sales price would be the subject of further negotiation between it and the renter/purchaser.
Corp X structures its sales of property designated as rental equipment as like-kind exchanges under Code Sec. 1031. It negotiates sales with customers and assigns the sales contracts to a qualified intermediary (QI). Corp X then orders replacement property from a manufacturer and assigns its rights to acquire the equipment to the QI. The trustee under the exchange agreement collects the proceeds from the sale of the relinquished property and makes disbursements for purchase of the replacement property on Corp X’s behalf. The replacement property is assigned an order number and is entered into Corp X’s fixed asset depreciation system. Corp X sends a monthly statement to the QI and the manufacturer informing them of the replacement property and includes a statement to the effect that under Code Sec. 1031, Corp X has assigned its rights to acquire the equipment to QI.
An analysis of Corp X’s Year 1 fiscal year results shows that 91% of its income was generated from sales while 9% was generated from its rental operation. Also, a substantial amount of the equipment designated as rental equipment was sold by Corp X before the equipment generated any rental income.
Neither depreciation nor tax-free swap treatment is available. The CCA says that where an asset can function as both merchandise held for sale and as an asset used in a trade or business, the taxpayer’s primary purpose for holding that asset determines whether that asset is inventoriable. On the facts, the CCA concludes that Corp X’s equipment should be treated as inventory held primarily for sale to customers in the ordinary course of business. While Corp X does rent or hold some equipment for rent, it did not show that the equipment is actually devoted to use in its business and that it looks to consumption through this use to recover the cost of the equipment. A significant fact leading to the CCA’s conclusion is that a substantial amount of the equipment designated as rental equipment was sold by Corp X relatively soon after acquisition and before the equipment generated any rental income. Based on the available facts, the best that could be said is that for a relatively short period, Corp X rents or holds for rent some of its equipment pending the sale of that equipment.
As a result, the CCA concludes that Corp X cannot depreciate its equipment under Code Sec. 167. What’s more, because it holds the equipment primarily for sale, Corp X’s exchanges are not eligible for tax-free swap treatment because of Code Sec. 1031(a)(2)(A).
For more informaiton regarding this ruling or other 1031 exchanges issues, contact Alexandra L. Hart at AHart@AllStates1031.com or by phone toll-free at 877-395-1031.
IRS rules swap of emissions credits is tax-deferred Sec. 1031 exchange
Tuesday, June 29th, 2010 by Moore McLaughlinPrivate letter ruling 201024036 issued recently by the IRS concludes that the swap of two different types of emissions credits will be a tax-deferred exchange under Code Sec. 1031.
Background. In general, under Code Sec. 1031, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind which is held either for productive use in a trade or business or for investment, if statutory identification and receipt time limits are met. “Like kind” refers to the nature or character of the property and not to its grade or quality, and one kind or class of property can’t be exchanged for property of a different kind or class. (Reg. § 1.1031(a)-1(b))
Intangible personal property is of like kind to other intangible personal property only if (1) the nature or character of the rights involved are of like kind (e.g., a patent is of like kind to a patent and a copyright is of like kind to a copyright) and (2) the nature or character of the underlying property to which the intangible personal property relates is of like kind. For example, an exchange of a copyright on a novel for a copyright on a different novel is a like-kind exchange, but an exchange of a copyright on a novel for a copyright on a song is not. (Reg. § 1.1031(a)-2(c)) Under Rev Proc 92-91, 1992-2 CB 503, Q&A 5, emission allowances are like-kind property for Code Sec. 1031 purposes.
Ground Level Ozone (Smog)
Facts. The concentration of ground level ozone (i.e., smog) in Region often exceeds permissible air quality standards established by the Environmental Protection Agency (EPA). Ground-level ozone is principally created by two types of pollutants: nitrogen oxide (”NOx”) and volatile organic compounds (”VOCs”). NOx is produced during combustion of natural gas. VOCs are organic chemical compounds that evaporate under specific conditions. A program set up by a Region government agency we’ll call Authority develops and implement air pollution control measures in Region. To improve Region’s air quality and bring the area into compliance with state and federal law, Authority has established a program to review and control emissions in Region. Under this program, businesses that take measures to reduce their emissions of pollutants, for example by installing emission reduction equipment, may apply for and receive emission reduction credits. These credits are used by the holder to “offset” emissions that would otherwise exceed permitted levels. Each credit is a grant to the holder of the right to emit a specified amount of the pollutant per year for an indefinite period of time. Credits may be transferred temporarily or permanently. Credits for reducing ozone are designated by Authority as either NOx or VOCs credits.
Apart from the underlying pollutant, the terms and conditions of the two types of credits are identical. NOx credits may be used to offset VOCs emissions and VOCs credits may be used to offset NOx emissions, as long as the holder of the credits demonstrates that using the credits in this way will not cause or contribute to a violation of state or federal air quality standards.
Sub is a wholly owned subsidiary of Parent and a member of Parent’s consolidated group. Sub holds NOx credits for productive use in a trade or business or for investment. Parent anticipates the future need for VOCs credits in order to meet emission standards related to an undisclosed project. Authority has historically granted permission to use NOx credits to offset VOCs emissions, but this interpollutant use of credits is not economically optimal for Parent because the NOx credits are more valuable due to their relative scarcity. From a business perspective Parent would prefer to exchange NOx credits for VOCs credits held by unrelated third parties. This would generally allow Parent to emit a greater amount of VOCs than if it obtains authorization to use its NOx credits to offset its VOCs emissions.
Sub’s NOx credits exceed its needs. Parent proposes to cause Sub to distribute its NOx credits to Parent. Thereafter, Parent will swap the NOx credits it acquires from Sub for VOCs credits held by unrelated third parties. Parent would then use the VOCs credits to offset emissions from its trade or business.
Favorable ruling. Parent asked for a ruling that the exchange of emission credits was tax-deferred under Code Sec. 1031 and IRS responded positively. It ruled that the NOx and VOCs credits are like-kind property for Code Sec. 1031 purposes. It also ruled that Parent is considered to have, prior to the exchange, held the NOx credits for productive use in its trade or business. IRS concluded that gain or loss won’t be recognized on Parent’s exchange of NOx credits for VOCs credits immediately following the distribution of the NOx credits from Sub, provided all other Code Sec. 1031 requirements are met.
For more information regarding this PLR or any other 1031 questions, contact Alexandra L. Hart by e-mail at AHart@AllStates1031.com or by phone toll-free at 877-395-1031.
Like-kind exchange relief for those snared by QIs in bankruptcy or receivership
Wednesday, March 10th, 2010 by Moore McLaughlinThe IRS has at long last granted relief for taxpayers who were unable to timely complete a like-kind exchange because their qualified intermediary (QI) entered into bankruptcy or receivership. IRS will not treat taxpayers as being in actual or constructive receipt of exchange proceeds if they cannot complete an exchange because of a default of a QI in bankruptcy or receivership. Affected taxpayers may use a special safe harbor method to report gain or loss.
The IRS received many comments on this issue and has been promising action on it for a long time. As far back as 2007, when the real estate market started heading south in many areas, the IRS wrote Rep. Barney Frank (D-MA) to say that IRS was considering whether it was appropriate for it to extend relief where QIs went bankrupt. In substantially similar letters written to a number of Washington legislators in mid-2009, the IRS again said it was considering relief measures.
Background. In general, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind which is held either for productive use in a trade or business or for investment. (Code Sec. 1031) Under Code Sec. 1031(a)(3), for a deferred exchange to be treated as tax-free, a taxpayer must identify the replacement property within 45 days of the transfer of the relinquished property and must acquire the replacement property by the earlier of 180 days after the date on which the taxpayer transfers the property relinquished in the exchange, or the due date (determined with regard to extensions) of the taxpayer’s federal income tax return for the year in which the transfer of the relinquished property occurs. Absent relief, if the statutory timing requirements are met, a taxpayer would have to treat the relinquished property as having been disposed of in a taxable sale or exchange.
The regulations allow a taxpayer to use a QI to facilitate a like-kind exchange. (Reg. §1.1031(k)-1(g)(4)) When a taxpayer uses a QI, generally he will transfer the relinquished property to the QI, who sells the property to a buyer. The QI then takes the proceeds of the sale of the relinquished property, buys the replacement property, and transfers the replacement property to the taxpayer. If the taxpayer receives the replacement property within the period in Code Sec. 1031(a)(3) and meets the other Code Sec. 1031 requirements, he is treated as having engaged in a like-kind exchange of property with the QI and he will not recognize gain on the exchange.
Victims of the recession and the troubled real estate markets. In Rev Proc 2010-14, IRS says it is aware of situations in which taxpayers initiated like-kind exchanges by transferring relinquished property to a QI but were unable to complete the exchanges within the statutory time period solely due to the failure of the QI to acquire and transfer replacement property to the taxpayer (a “QI default”). In many of these cases, the QI enters bankruptcy or receivership, thus preventing the taxpayer from obtaining immediate access to the relinquished property’s sale proceeds.
The IRS says it’s generally of the view that in such situations, a taxpayer should not have to recognize gain from the failed exchange until the tax year in which he receives a payment attributable to the relinquished property.
Who is entitled to relief. A taxpayer is entitled to relief under Rev Proc 2010-14 if he:
(1) Transferred relinquished property to a QI in accordance with Reg. §1.1031(k)-1(g)(4).
(2) Properly identified replacement property within the identification period (unless the QI default occurs during that period).
(3) Did not complete the like-kind exchange solely because of a QI default involving a QI that becomes subject to a bankruptcy proceeding or a receivership proceeding under federal or state law.
(4) Did not, without regard to any actual or constructive receipt by the QI, have actual or constructive receipt of the proceeds from the disposition of the relinquished property or any property of the QI before the QI entered bankruptcy or receivership. For purposes of this condition, relief of a liability under the exchange agreement before the QI default, either through the assumption or satisfaction of the liability in connection with the transfer of the relinquished property or through the transfer of the relinquished property subject to the liability, is disregarded.
Relief provisions. Rev Proc 2010-14, Sec. 4, provides that a taxpayer meeting the above conditions recognizes gain on the disposition of the relinquished property only as required under the safe harbor gross profit ratio method, and only as he receives payments attributable to that property.
Under the safe harbor gross profit ratio method, the portion of any payment attributable to the relinquished property that is recognized as gain is found by multiplying the payment by a fraction, having the taxpayer’s gross profit as the numerator, and having the taxpayer’s contract price as the denominator. For this purpose:
- A payment attributable to the relinquished property means a payment of proceeds, damages, or other amounts attributable to the disposition of the relinquished property (other than selling expenses), whether paid by the QI, the bankruptcy or receivership estate of the QI, the QI’s insurer or bonding company, or any other person. Unless it exceeds adjusted basis, satisfied indebtedness is not a payment attributable to the relinquished property.
- Gross profit means the selling price of the relinquished property, minus the taxpayer’s adjusted basis in it (increased by any selling expenses not paid by the QI using proceeds from the sale of the relinquished property).
- The selling price of the relinquished property is generally the amount realized on its sale, without reduction for selling expenses. But if a court order, confirmed bankruptcy plan, or written notice from the trustee or receiver specifies, by the end of the first tax year in which the taxpayer receives a payment attributable to the relinquished property, an amount to be received by the taxpayer in full satisfaction of his claim, the selling price of the relinquished property is the sum of the payments attributable to the relinquished property (including satisfied indebtedness in excess of basis) received or to be received and the amount of any satisfied indebtedness not in excess of the adjusted basis of the relinquished property.
- The contract price is the selling price of the relinquished property minus the amount of any satisfied indebtedness not in excess of the property’s adjusted basis. Satisfied indebtedness means any mortgage or encumbrance on the relinquished property that was assumed or taken subject to by the buyer or satisfied in connection with the transfer of the relinquished property.
Rev Proc 2010-14, Sec. 4, has detailed rules covering situations involving satisfied indebtedness exceeding adjusted basis, recapture income, and imputed interest.
A Code Sec. 165 loss deduction may be claimed for the amount, if any, by which the adjusted basis of the relinquished property exceeds the sum of (1) the payments attributable to that property (including satisfied indebtedness in excess of basis), plus (2) the amount of any satisfied indebtedness not in excess of basis. Those claiming a loss deduction may also claim a Code Sec. 165 loss deduction for the amount of any gain recognized in accordance with Rev Proc 2010-14, Sec. 4, in a prior tax year.
Illustration: Mr. Able, a calendar year taxpayer owned investment property (Property 1) with a fair market value of $1.5 million and an adjusted basis of $500,000. He entered into an agreement with QI to facilitate a deferred like-kind exchange. On May 6, Year 1, Able transferred Property 1 to QI and QI transferred the property to a third party in exchange for $1.5 million. Able intended that the QI use the money held by it to acquire Able’s replacement property. On June 1, Year 1, Able identified Property 2 as replacement property. On June 15, Year 1, QI notified Able that it filed for bankruptcy protection and could not acquire replacement property. As a result, Able failed to acquire Property 2 or any other replacement property within the exchange period. As of December Year 1, QI’s bankruptcy proceedings are on-going and Able has received none of the $1.5 million proceeds from QI or any other source.
On July 1, Year 2, QI exits from bankruptcy and the bankruptcy court approves the trustee’s final report, which shows that Able will be paid $1.3 million in full satisfaction of QI’s obligation under the exchange agreement. Able receives the $1.3 million on August 4, Year 2 and does not receive any other payment attributable to the relinquished property.
Under Rev Proc 2010-14, Able is not required to recognize gain in Year 1 because he did not receive any payments attributable to the relinquished property in that year. He recognizes gain in Year 2, as follows:
… His selling price is $1.3 million, i.e., the payments attributable to the relinquished property (the amount specified by the trustee before the end of the first tax year in which he receives a payment attributable to the relinquished property).
… His contract price also is $1.3 million because there is no satisfied or assumed indebtedness.
… His gross profit is $800,000 (the selling price of $1.3 million less his $500,000 adjusted basis).
… His gross profit ratio is 80/130 (gross profit over the contract price).
… Able’s recognized gain in Year 2 is $800,000 (the $1.3 million payment attributable to the relinquished property multiplied by the gross profit ratio (80/130)).
Even though the payment attributable to the relinquished property ($1.3 million) is less than the $1.5 million that the QI received, Able is not entitled to a Code Sec. 165 loss deduction because the payment attributable to the relinquished property exceeds his adjusted basis in the relinquished property ($500,000). (Rev Proc 2010-14, Sec. 4.10, Ex. 1)
Rev Proc 2010-14 carries four other detailed examples illustrating nuances of the new safe-harbor relief.
Effective date of relief. Rev Proc 2020-14 is effective for taxpayers whose like-kind exchanges fail due to a QI default occurring on or after January 1, 2009. A taxpayer who is within the scope of Rev Proc 2020-14 may, subject to the Code Sec. 6511 limitations on credit or refund, file an original or amended return to report a deferred like-kind exchange that failed due to a QI default in a tax year ending before January 1, 2009, in accordance with Rev Proc 2010-14.
What do I do if my TIC is in trouble?
Saturday, February 20th, 2010 by Moore McLaughlinAlexandra L. Hart, CES® and I have been asked this question almost every other day for the past several months. With the national commercial real estate and financial markets in turmoil, many investments that seemed solid only a year or two or three ago are now floundering. Lenders are beginning foreclosure proceedings or are negotiating with the owners to take back a deed in lieu of foreclosure. Buildings are being sold in so-called short sales. And, lenders are selling off the promissory notes at deep discounts. In other instances, the banks are not taking any immediate action, but the sponsors are offering to buy out investors for the amount of their investment. Sometimes, individual investors are concerned and want to sell their interests, thus giving the other co-tenants an opportunity to buy a larger percentage for a small amount.
The question that we are continually asked is “What is my tax exposure?” As a tax lawyer, I have been trained to answer “Well, it depends.”
In every TIC I know of, the property is encumbered by non-recourse debt. Non-recourse debt is a loan made by a lender (could be a bank, an insurance company, a pension plan or some other type of lender) which debt is secured only by the property. The key feature of non-recourse debt is that no one is personally liable for the debt and the lender can look only to the property for repayment. As long as the rents are able to cover the expenses of the property and make the mortgage payments, then the lender typically feels comfortable. However, if the cash flow only covers the expenses and the investors do not receive any distributions, then the investors are not comfortable. Once the cash flow fails to cover the expenses, then the trouble really begins.
Sometimes the sponsor or property manager will make a cash call. If one or more of the owners is not willing or able to contribute enough cash, then the tenant-in-common agreement generally provides that the non-contributing owner either has to sell his or her interest, or the property has to be sold. In any event, if there is insufficient cash to cover the expenses, the lender will eventually take action.
In most of these cases, the TIC investors do not contribute additional cash. Thus, the lender starts the process of taking back or selling the property. Because the debt is non-recourse, the lender cannot go after the TIC owners, and cannot force the TIC owners to pay any money. So, the TIC owners generally lose the property, and their investment, but that is the extent of their losses.
These investors are convinced that they have sustained a loss for tax purposes. In almost every instance, that is not the case. For tax purposes, if a property that is encumbered by non-recourse debt is foreclosed upon or transferred back to the lender by a deed in lieu of foreclosure, the investor is treated for tax purposes as if he or she sold their interest in the property for their share of the non-recourse debt. For tax purposes, this is known as the amount realized. Taxable gain is calculated as the amount realized minus the adjusted tax basis of the property.
So, the next issue is to determine the investors’ adjusted tax basis in the property. Most of the TIC owners acquired the TIC interest as a replacement property in a 1031 exchange. If so, then their adjusted tax basis in the TIC interest is determined, in whole or in part, based on their adjusted tax basis in the property or properties that they sold in the 1031 exchange(s). If the investor traded up in value on the 1031 exchange, then the investor may have added to his or her adjusted tax basis. Any investor facing this dilemma should consult a qualified CPA or tax attorney who can make these complicated calculations.
Non-recourse debt that is forgiven does not result in cancellation of indebtedness income (”COD income”). COD income can be generated only from recourse debt. COD income is subject to a completely different set of tax rules. So, investors should not become confused with how the COD income rules operate.
The character of the gain on the foreclosure or deed in lieu of foreclosure of a TIC interest is likely to be capital. The holding period of the TIC interest is determined, to some extent, based upon the holding period the investor had in his or her relinquished property or properties from the 1031 exchange. However, if the investor traded up in value, he or she could have a split holding period. In order to enjoy the lower long-term capital gains tax rates, the property has to have been held for more than twelve months. In calculating the 12-month holding period, the investor may be able to tack on the holding period from his or her relinquished property. Again, any investor in this situation needs to consult a qualified CPA or tax attorney.
Remember also that there is no bright-line test for how long a property has to be held to qualify as “held for investment” for purposes of section 1031. There is no 2-year rule, 1-year rule or any other hard and fast rule.
In summary, the investor is treated as having sold the TIC interest in an amount equal to his or her share of the non-recourse debt. The investor will recognize gain or loss on this deemed sale based on his or her adjusted tax basis. In addition, the investor must determine his or her holding period.
The good news is that for investors facing a large tax bill, they may be able to defer the tax by effectuating another 1031 exchange. Click here for more information about “coffin or “no equity” exchanges.
For more information about these issues, or to ask questions about a specific scenario, please contact Alexandra L. Hart, CES® by e-mail at AHart@AllStates1031.com or by phone toll-free at 877-395-1031 ext. 217.
How To Purchase 1031 Replacement Property at an Auction
Monday, February 15th, 2010 by Moore McLaughlinAlexandra L. Hart, CES® at All States 1031 Exchange Facilitator, LLC has been asked several times recently about how to buy replacement property at an auction. While there is certainly nothing in section 1031 that specifically prohibits or disqualifies such replacement property, the real problem lies in the process and logistics of the auction process. Most of the auctions are being held in connection with a mortgage foreclosure.
At most auctions, the bidders must show a certified check in a certain minimum amount, such check being evidence of the ability to make a deposit payment. Other than proof of ability to pay, and proof of identification, very little is required. Standard purchase and sale agreement are not typically used. The issues affecting the 1031 exchange include meeting the identification rules, assignment to the qualified intermediary of the right to buy the replacement property, and potential constructive receipt and boot issues.
In many auctions outside the 1031 arena, the bidders will bring a certified check payable to themselves. If they are the successful bidder, they will endorse the check to the seller or the auctioneer. In the 1031 world, if the QI issues a certified check payable to the exchanger, and then the exchanger endorses the check to the auctioneer, the IRS will likely assert that such amount was received by the exchanger and taxable as boot. Furthermore, the payment could possibly disqualify the entire exchange as a distribution in violation of the specific restrictions (known as the g(6) limitations (see Treasury Regulation Section 1.1031(k)-1(g)(6)) on payments from the exchange account. In other words, issuing a check payable to the exchanger is not a good idea.
One alternative is, prior to the auction, ask the auctioneer for the name of a title company they trust and have the QI place the exchange funds with them subject to the acceptance of the bid. The exchanger can take blank assignment of contract documents with them to the auction to be executed in the event that they are the successful bidder.
Another alternative is to have a certified check issued by the QI to the auctioneer to be used in the event of a successful bid. Otherwise, the check is returned to the QI.
Or, if the exchanger is trading up in value, the exchanger can use his or her own funds.
Other solutions could be found in particular situations. If you are contemplating purchasing a replacement property through the auction process, be sure to contact Alexandra L. Hart, CES® or F. Moore McLaughlin, Esq., CPA, CES® to determine the best alternative. You can reach Alexandra at AHart@AllStates1031.com or toll-free at 1-877-395-1031 extension 217.
1031 Exchanges Become More Valuable in Rhode Island
Sunday, December 13th, 2009 by Moore McLaughlin1031 exchanges gained significant value recently in Rhode Island thanks to the state legislature and the Governor. The leaders of Rhode Island determined that raising the Rhode Island tax rate on capital gains from 1.67% to 9.9% was good for the economic viability of the state. These leaders did not really explain the basis for such a determination, they just passed the bill. This enormous rate increase will take effect for sales after December 31, 2009.
So, in order to avoid this additional tax, a 1031 exchange should be considered. See our website for the basics of 1031 exchanges and the types of properties that are eligible. But, for the right types of properties and for the right investor, the 1031 exchange will allow the Rhode Island tax to be deferred.
For more information on the Rhode Island tax, contact All States 1031 Exchange Facilitator, LLC owner F. Moore McLaughlin, IV, Esq., CPA, CES at 877-395-1031 or by e-mail at fmm@AllStates1031.com.
Non-Resident Tax Withholding and 1031 Exchanges
Monday, November 23rd, 2009 by Moore McLaughlinBecause we handle 1031 exchanges in every state, we are frequently asked about the tax laws of individual states. Alexandra L. Hart, CES® and I always encourage exchangers to seek tax and legal advice from their own professionals, who are generally more knowledgeable about local laws and the exchangers’ particular circumstances. One of the most frequently asked questions involves non-resident tax withholding.
In many states, when an individual or entity that is not a resident of the state is selling real property, the state may impose a capital gains tax or other income tax. Because the seller is not a resident of the state, the state assumes that the seller will not file a tax return for that state. Once the property has been sold, the seller may have no further contacts within the state. If the seller does not voluntarily file a tax return and pay the tax, the state may never collect the tax.
As a measure to make sure all taxes are collected, most states have implemented a mechanism whereby the closing attorney or escrow company is required to withhold a portion of the sales proceeds and remit them to the state. In most cases, the amount required to be withheld is based on the gross selling price, not the actual amount of the gain. The reason for this technique is to make sure the taxes are collected, but without requiring an inquiry into the tax basis and other tax attributes of the seller. If too much is withheld, the seller can file a non-resident income tax return and claim a refund, if one is due.
Many states recognize 1031 exchanges and adopt the federal tax rules. As a result, exchangers who complete a valid 1031 exchange, with no boot, will owe no taxes to the state. If taxes are withheld and then later returned to the exchanger, then such amounts could be treated as boot, and subject the exchanger to tax; which is quite a bad outcome.
To ameliorate this Catch-22 scenario, states typically allow an exchanger to provide a statement or certificate at the closing which relieves the closing agent from the requirement to withhold any amounts for taxes. In Rhode Island, the form is known as Form 71.3. Other states have similar forms or processes. Some states require the seller to request the certificate days or weeks in advance of the closing.
So, if you are selling real estate located in a state in which you or the selling entity is not a resident, call us or check with your tax professional to determine whether non-resident withholding is required and, if it is, whether an exception exists for 1031 exchanges. Please click here to find some of the state non-resident withholding forms. Or click here for links to the various state websites.
Please contact us with any questions you may have. You can reach Alexandra L. Hart CES® at 877-395-1031 or by e-mail at AHart@AllStates1031.com.
Exchanging Real Estate Intangibles
Tuesday, October 27th, 2009 by Moore McLaughlinWhen exchanging real estate, the exchanger must acquire property that is like-kind to the property that was sold. Like-kind in connection with real estate is defined as “all other real estate.” The types of property that qualify are very broad. For example, raw land will be like-kind with improved real estate. An office building is like-kind with an apartment building. Real estate in Massachusetts or Rhode Island is like-kind with real estate in Florida, Texas or Arizona.
Further, a partial or fractional interest in real estate is like-kind to a full or fee simple interest in real estate. So, an exchanger could sell a fee simple interest in real estate and purchase a tenant-in-common interest in real estate.
Recently, a series of rulings have been issued by the IRS which confirms that certain intangible interests in real estate are like-kind to fee simple interests in real estate.
Conservation Easements
In Private Letter Ruling (PLR) 9621012, the IRS ruled that the exchange of a “perpetual scenic conservation easement” (PSCE) for a fee simple interest in land that was either timberland, a ranch, or a farm qualifies for tax-free treatment under section 1031. A PSCE means any limitation in a deed in the form of an easement, restriction, covenant, or condition, the purpose of which is to retain land predominantly in its natural, scenic, historical, agricultural, forested, or open-space condition. Under a PSCE, the subject property remains as scenic open space in perpetuity, and its owner is not able to develop the property. The ruling is based on a state’s civil code, which provides that a conservation easement is an interest in real property voluntarily created and freely transferable in whole or in part. Assuming the PSCE is, by virtue of state law, an interest in real property, the exchange of the PSCE for the proposed replacement property qualifies as an exchange of like-kind property for purposes of Section 1031.
In PLR 9232030, the IRS ruled that an agricultural conservation easement on a farm is of like kind to a fee simple interest in real estate.
In PLR 200201007, the IRS ruled that a taxpayer’s exchange of a perpetual conservation easement (PCE) on a ranch for other ranch property that would be subject to a PCE upon receipt by the taxpayer qualifies for like-kind exchange treatment under Section 1031.
In PLR 200651018, the IRS ruled that a perpetual stewardship easement as described in the ruling is of like-kind to fee interest in other real property, and use of proceeds from relinquished perpetual stewardship to purchase one or more fee interests in real property to be held by taxpayer for productive use in trade or business or for investment will not disqualify transaction from tax deferred exchange treatment.
Development Rights
The IRS ruled in PLR 200901020 that residential density development rights to be transferred by taxpayer as relinquished property were for Section 1031 purposes of a like-kind to a fee interest in real estate, leasehold interest in real estate with 30 years or more remaining at time of the exchange, and land use rights for hotel units. The land use rights that were a part of the put option addressed in this PLR and the restrictive covenant (collectively referred to as Development Rights) constituted interests in real estate under state law. Taxpayer intended to exercise the put option and use the sales proceeds from the Development Rights (the relinquished property) to acquire like kind replacement property. Taxpayer’s replacement property included a fee interest in real estate, a leasehold interest in real estate with 30 years or more remaining, and land use rights for hotel units. The IRS ruled that the Development Rights to be transferred by Taxpayer as relinquished property were of like kind, for purposes of Code Sec. 1031, to a fee interest in real estate, a leasehold interest in real estate with 30 years or more remaining at the time of the exchange and land use rights for hotel units (which Taxpayer would receive if the Development Rights it transferred were for more than a certain number of residential units). The new rights for hotel units were to be applied to property Taxpayer already owned. The Development Rights were in perpetuity and were directly related and requisite to Taxpayer’s interest, use and enjoyment of the underlying land. The Development Rights were also interests in real property under state law. In effect, Taxpayer exchanged one set of Development Rights (pertaining to residential density) for other development rights (pertaining to hotel development). Some of the Development Rights were also to be exchanged for another fee interest in land, and another long-term leasehold interest in additional real property.
IRS has also ruled recently that development rights were like kind to the fee interest in property that a taxpayer relinquished in the exchange. The swap involved a complex exchange set up through a qualified intermediary (QI). In the PLR, Taxpayer was a C corporation that owned Property 1 and Property 2 located in City, State Z. It intended to transfer its fee interest in Property 1 (”Relinquished Property”) to a QI under an exchange agreement. QI wwould sell the Relinquished Property to a third-party purchaser in an arm’s-length transaction. QI would use part of the cash proceeds from this sale to buy Development Rights (”Replacement Property”) from a third-party seller. QI would transfer Development Rights to Taxpayer, who would cause Development Rights to be recorded with respect to Property 2. They would permit Taxpayer (or its lessee) to develop Property 2 with greater floor space than would otherwise have been allowed if Property 2 did not have Development Rights. Sections of State Z Tax Statute (and the corresponding sections of State Z regulations), defined “real property” to include “every estate or right, legal or equitable, present or future, vested or contingent, in lands, tenements or hereditaments, including buildings, structures and other improvements thereon, which are located in whole or in part within [State Z].” Sections of State Z Tax Statute further defined an “interest in real property” to include “title in fee, a leasehold interest, a beneficial interest, an encumbrance, development rights, air space and air rights, or any other interest with the right to use or occupancy of real property or the right to receive rents, profits, or other income derived from real property.” Whether property constitutes real or personal property generally is determined under state or local law. In this case, Taxpayer proposed to acquire Development Rights as its replacement property and to transfer such rights to Property 2, which Taxpayer already owns. The IRS has previously noted that for purposes of Code Sec. 1031(a), it is not material that the property acquired by the taxpayer as the replacement property is on property already owned by that taxpayer so long as it is acquired in an arm’s-length transaction. For purposes of determining if Taxpayer’s proposed transaction qualifies as a like-kind exchange, IRS said it is thus immaterial that Development Rights to be acquired by Taxpayer will be used merely to enhance the real property already owned by it. More important is whether Development Rights constitute interests in real property under the state and local laws of State Z. Although it is unclear whether Development Rights were treated as interests in real property for all purposes of State Z law, it is clear that Sections of State Z Tax Statute and the regulations thereunder did treat Development Rights as an interest in real property. Moreover, the various sections of the local Ordinances provided that Development Rights are as-of-right and not discretionary, meaning that they exist permanently rather than at the discretion of a city agency or other decision-making authority. As such, these rights appear to be analogous to perpetual rights. In addition, a deed transfer is similar to the perfecting of Development Rights, which involves an actual transfer of rights from one property to another. Thus, while the Tax Statutes of State Z do not explicitly state that Development Rights are granted in perpetuity, IRS concluded that such rights do arise out of an interest in the underlying real estate. Moreover, City Ordinances did not set an expiration date for Development Rights, and thus they were effectively perpetual in nature. Thus, IRS concluded that Development Rights that Taxpayer intended to acquire as replacement property were like kind to the fee interest in Relinquished Property.
The point of this discussion is to alert all potential exchangers to the borad definition of real estate and what will qualify under Section 1031. For more information or questions about specific scenarios, please contact Moore McLaughlin, Esq., CPA, CES, owner of All States 1031 Exchange Facilitator, LLC at fmm@AllStates1031.com or Alexandra L. Hart, CES at AHart@AllStates1031.com.