1031 exchanges can be straightforward; however, the capital gain tax deferred strategy can also be quite complex, requiring the insight and direction of an experienced tax attorney. As a Qualified Intermediary (QI), providing legal advice is the unlicensed practice of law. A smart QI will know when to say no and refer the question to a tax attorney, along with seeking financial advice from the client’s CPA. Nearly everyone wants free advice, but there is a time and place when securing a tax attorney and CPAs’ input is incredibly valuable.
Limited Liability Companies
One of the popular ways to own real property is in a single and multi-member limited liability company. Should the members get along, all is fine, but what happens when it comes time to sell and the members want to go their separate ways? There are a variety of ways to accomplish the desired outcome given proper planning and input from a tax attorney. The challenge can be to secure planning prior to selling the property rather than just before closing.
Exchange Accommodator Titleholder
In a reverse 1031 exchange, an Exchange Accommodator Titleholder, or EAT, is created to park or take title to either the new or the old property. The Internal Revenue Service (IRS) does not allow the taxpayer initiating the 1031 exchange to own both the new and the old property at the same time. The EAT is a term and role created by the IRS. The EAT takes title to one of the properties for the duration of the 1031 exchange. If improvements are to be constructed with exchange proceeds from a sale, the EAT takes title to the replacement property to pay taxpayer approved contractor invoices. Understanding the EATs role in a variety of circumstances, such as a husband and wife in a community property state, can require a tax attorney’s input.
Real and Personal Property
1031 exchanges are used by companies and owners of personal property held in the productive use of a business and or for investment. Personal property can be either tangible– aircraft, livestock or equipment–or intangible, such as franchise rights and intellectual property. Numismatic coins sold trigger a 28 percent federal capital gain tax rate, but what if the numismatic coin is held primarily for the bullion content rather than the age, number minted, history and aesthetics? Is the numismatic coin eligible for a 1031 exchange based on bullion content? The IRS rules are not current. Numismatic coins are only exchangeable for other numismatic coins and not bullion.
Air rights, transferable development and residential density development rights are considered real property and eligible for tax deferral in a 1031 exchange. Depending upon whether the rights are perpetual has an impact of their eligibility for a 1031 exchange.
Are precious metals Exchange Traded Funds or EFTs backed by the physical bullion eligible for 1031 consideration? “If a physically backed metal ETF is treated as a trust under Regulation § 301.7701-4(c), investors are considered to own undivided beneficial interests in the underlying physical metal” per Revenue Ruling 90-7, 1990-1 C.B. 153. “If the investor sells his interest in the ETF or the trust sells a portion of the collectible, the investor is treated as having sold all or a portion of his share of the collectible held by the trust,” per PTMA 2008-01809. The IRS has issued a memorandum on a physically backed metal ETF as an undivided interest in the underlying metal for purposes of capital gains; however, the IRS has not issued guidance on whether it may be exchanged under a 1031 exchange. Input should be secured from an experienced tax attorney when considering the sale and possible 1031 exchange of physically backed metal ETFs.
In general where the IRS has not provided guidance regarding 1031 exchanges, the input and or opinion from a tax attorney is and should be a required step. QIs may accommodate 1031 exchanges; however, are indemnified from the tax consequences.
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