1031 TAX DEFERRED EXCHANGE: A deferred Exchange is defined as an exchange in which, pursuant to “An Agreement”, the taxpayer transfers property held either for productive use in a trade or business or for investment and subsequently receives another property to be held either for productive use in a trade or business or for investment.
1031 BUYER REPRESENTATION: A real estate brokerage company with expertise in 1031 Exchanges whose sole function is to represent the interests of the 1031 buyer as opposed to the property broker who has a fiduciary responsibility to the seller.
1033 TAX EXCHANGE: An exchange based on evidence other than the actual property. For instance, in the event of destruction by fire the insurance settlement would suffice as the property exchange.
ADJUSTED BASIS: The basis of the property adjusted for any capital improvements or depreciation. To calculate the adjusted basis, take the basis (the cost of the property) and add the cost of any capital improvements made to the property during the taxpayer’s ownership, and subtract any depreciation taken on the property during the same time period. Once the adjusted basis is known, gain or loss can be computed on a transaction.
BASIS: Method of measuring investment in property for tax purposes. Example: Original cost, plus improvements, minus depreciation taken. This is the starting point for determining gain or loss in any transaction. In general, basis is the cost of the taxpayer’s property.
BASIS IN THE REPLACEMENT PROPERTY: In an exchange, the deferral of the tax on the gain is accomplished by requiring the taxpayer to carryover (substitute) the basis of the relinquished property to the replacement property with appropriate adjustments in the event additional consideration is paid. See Deferral.
BOOT: In an exchange of real property, any consideration received other than real property is “boot.” The amount of gain recognized is always limited to the gain realized or boot, whichever is the smaller amount. Therefore, for a transaction to result in no recognized gain, the taxpayer must receive property with an equal or greater market value and debt than the property relinquished, and receive no boot. In exchanges, there are two types of boot: cash boot and mortgage boot. Cash boot is cash or anything else of value received. Mortgage boot is any liabilities assumed or taken subject to in the exchange. Taxable situation, whether Cash or Mortgage (Debt Relief).
BUYER: The person who wants to acquire the exchanger’s property. In a three- or four-party exchange, the buyer usually has cash.
CONSTRUCTIVE RECEIPT: Control of the cash proceeds without actual physical possession by Exchanger or their agent.
DEFERRAL: The tax on an exchange transaction is not paid at the time of the transaction. Rather, it is paid at the time the replacement property is ultimately sold. Substituting, or carrying over the basis of the taxpayer’s relinquished property to the replacement property making any necessary adjustments for additional consideration, either in the form of cash or debt accomplishes deferral.
DEFERRED EXCHANGE: This term is now used in place of “Non-Simultaneous Exchange” or “Starker Exchange”. This is the type of an exchange where the Exchanger utilizes the exchange period described above.
DEPRECIATION RECAPTURE: Exchanges of like-kind property ordinarily do not trigger any depreciation recapture (that is, deductions taken in excess of straight-line depreciation under Section 1250 I.R.C.). Where there is an exchange into a property of lower value, or where the exchange consists partly of cash and property not of a like -kind, consideration must be given to the depreciation recapture provisions of Section 1250 and the higher capital gain tax rates for depreciation recapture.
DIRECT DEEDING: Vested owner deeds directly to the Ultimate Owner. Does not eliminate the duties of the Qualified Intermediary to acquire and transfer the relinquished property and acquire and transfer the Replacement Property.
EXCHANGE AGREEMENT: A deferred Exchange is defined as an exchange in which, PURSUANT TO AN AGREEMENT, the Exchanger transfers the relinquished property and subsequently receives the replacement property. THEREFORE, AN EXCHANGE AGREEMENT IS VITAL.
EXCHANGE PERIOD: The replacement property must be received by the taxpayer within the “Exchange Period”, which ends on the earlier of 180 days after the date on which the taxpayer transferred the property relinquished, or the due date for the taxpayer’s tax return for the taxable year in which the transfer of the relinquished property occurs (such as April 15th). Due to the Taxpayer’s ability to extend the date of payment, the exchange period is usually 180 days.
EXCHANGER: Taxpayer, Client
GAIN: The amount obtained for a property minus the property’s adjusted basis, and transaction costs. No matter what the adjusted basis of a property is, there is no gain until the property is transferred. There are two types of gain: “realized gain” and recognized gain.” Realized gain is the difference between the total consideration (cash and anything else of value) received for a piece of property and the adjusted basis. Realized gain is not taxable until it is recognized. Gain is usually, but not always, recognized in the year, which it is realized. If gain is not recognized in the year it is realized, it is said to be deferred. In an exchange under Section 1031, realized gain is recognized in part or in full to the extent that boot is received. Where only like-kind property is received, no gain is recognized at the time of the exchange.
GROWTH FACTOR: Interest earned during the exchange, payable at the end.
IDENTIFICATION PERIOD: The replacement property must be identified within 45 days of the close of escrow/closing the relinquished property. This 45-day rule is very strict and is not extended if the 45th day should happen to fall on a weekend or a legal holiday.
INTERMEDIARY: The party who facilitates a tax deferred exchange by acquiring and selling property in an exchange. The intermediary plays a role in almost all exchanges today. He or she neither begins nor ends the transaction with any property. He or she buys and then resells the properties in return for a fee.
LIKE-KIND PROPERTY: Any real property for any other real property is said properties are held for productive use in trade or business or for investment purposes.
QUALIFIED INTERMEDIARY: Intermediary is the company who acts as the accommodator in the exchange. A qualified intermediary is identified as follows:
1.) Not a related party to the Exchanger, (e.g. agent, attorney, broker, etc.);
2.) Receives a fee;
3.) Acquires the relinquished property from the Exchanger; and
4.) Acquires the replacement property and transfers it to the Exchanger.
RELINQUISHED PROPERTY: Old property, property being sold by the Exchanger. (Use to be called the DownLeg Property, now commonly called Phase 1 Property.) The property that the taxpayer begins the exchange with. This is the property that he or she wishes to dispose of in the exchange.
REPLACEMENT PROPERTY: New property, property being acquired of the target property being bought by Exchanger. (Use to be called UpLeg Property, now commonly called Phase 2 Property.) The property that the taxpayer ends the exchange with. This property, usually owned by the seller, is the property that the taxpayer acquires in the exchange.
SAFE HARBOR: Term used to identify the requirements to protect the Exchanger’s money as well as the “Qualified Intermediary.”
SELLER: In a three – or four-party exchange, the person who owns the property that the taxpayer wants to acquire in the exchange.
SEQUENTIAL DEEDING: Property is actually deeded to the Intermediary and the Intermediary deeds to the Ultimate Owner.
SIMULTANEOUS/CONCURRENT: An exchange without any time spans between the sale and buy.
STARKER: Name of the taxpayer in U.S. Court of Appeal’s case which authorized Delayed Exchanges. The term “Starker Exchange” is no longer used to describe a Delayed Exchange.
TAXPAYER: Also called the Exchanger. The taxpayer has property and would like to exchange it for new property. While all parties in an exchange are theoretically taxpayers, this term applies to the party who expects to receive tax-deferred treatment under Section 1031.
TAX REFORM ACT OF 1984: In the Tax Reform Act of 1984, Congress addressed the IRS’s continued displeasure with the Starker decision by amending Section 1031 to allow Delayed Exchanges; but only if all of the exchange property is identified and acquired within specific deadlines (see Exchange Period). And most important in the Conference Report accompanying the 1984 Act, Congress specifically reaffirmed that a “sale” followed by reinvestment in like-kind property does NOT qualify for tax deferral under Section 1031. So to qualify for tax deferral, it is still quite essential to carefully structure an exchange to avoid actual or constructive “receipt” of proceeds of sale and to prevent characterization of the transaction as a taxable sale and reinvestment.
TRANSACTION COSTS: Any cash paid by way of commission or other expense in an exchange. Transaction costs are deducted in computing the consideration received.
1991 REVISIONS: Basically the IRS held a hearing to try and “clean up” the Tax Reform Act of 1984 and to provide uniform terminologies, which are included herein. One of the main results for this revision is that IRS finally had a change of attitude toward Delayed Exchanges by accepting