1031 Exchange Blog

Every 1031 exchange is unique. During these unprecedented times, we have already experienced the full spectrum of reactions from those involved in the buying and selling of real property. Some Exchangors have gotten much more aggressive in finding deals that suit their long-term strategy while others have determined that a conservative approach is more suited for them. 

One thing is certain, finding and vetting replacement property is different than it has ever been. In many cases, Realtors and Sellers have been forced to be creative in areas where Shelter in Place orders are still firm. Though many Exchangors are still successfully finding replacement property in the residential and commercial sectors and completing their exchanges, other Exchangors have asked for alternatives that they may be less familiar with that potentially offer a quick closing period. 

Delaware Statutory Trusts & Tenant-In-Common Properties

Taxpayers who are seeking to exit active management of their properties often consider the possibility of entering into a Section 1031 Exchange through Tenant-In-Common (TIC) or Delaware Statutory Trust (DST) opportunities. If the transaction qualifies, any capital gains taxes that would otherwise be due can be deferred until the sale of the replacement property. Among other requirements, a 1031 Exchange eligibility requires the seller to exchange the property for a property of “like-kind.” Many savvy investors are utilizing fractional ownership of TICs or DSTs to diversify, round out the remainder of unused exchange proceeds or shift to a more passive approach to their real property holdings.

Tenants-in-Common 1031 exchanges allow property owners to defer capital gains when replacing a fractional interest in cash flowing properties. It is a form of direct ownership that is not affected by the IRC §1031(a)(2)(D) exclusion as long as the co-tenants or owners are not treated as partners for income tax purposes. Tenant In Common Interests are one way that an investor can take part in the ownership of a property that they would potentially not be able to afford on their own, such as a portion of a commercial strip mall or building leased to Walgreens. It is important to note that most TIC and DST investments require an “Accredited” Investor status, meaning that your net worth exceeds $1,000,000 (excluding your personal residence) or your income exceeds $200,000 in each of the last two years or, if applying jointly with your spouse, your income must exceed $300,000. 

In 2004, the IRS released Rev. Rul. 2004-86, which allowed Delaware Statutory Trusts to acquire real estate where the beneficial interest is treated as direct interests. This allowed for the utilization of Delaware Statutory Trusts (DST) to qualify for 1031 exchange treatment. DSTs differ from TICs as they have no voting authority but also do not require forming a single-member LLC to participate. The number of investors is unlimited and determined by the structure of the DST, whereas a TIC is limited to up to 35 investors.

There are a bevy of options, including special interest DSTs, that focus on health care, government, senior living or retail properties. The key advantage to a TIC or DST interest as replacement property is their passive nature. They are terrific options if you have additional net sales proceeds to invest after identifying other property or if you are seeking a passive investment. Finally, once identified they can very often close quickly in the case that an Exchangor needs a quick replacement property solution. 

Oil, Gas, Mineral, Water and Ditch Rights 

Interest in oil, gas and mineral estates qualifies for 1031 exchange tax deferrals given the existence of a perpetual interest. Leases, royalties and production payments are often how perpetual interests are conveyed.

For federal tax purposes, mineral leases are considered a real property interest and eligible for 1031 tax-deferred treatment. Leases provide the Le[1] [TG2] Lessee with the right to remove minerals for a specific period of time or until depletion, along with incurring the costs of discovery and removal. Leases are also known as a working or an operating interest. The lessee may deduct the intangible drilling costs (IDCs) for removing the mineral. IDCs include labor, repair and maintenance, fuel, transportation, supplies and other related production expenses.

For federal tax purposes, royalties are considered a real property interest and qualify for 1031 exchange tax deferral treatment. Oil, gas or mineral royalties do not represent an operating interest and neither incur nor are responsible for production costs. Instead, the holder of the royalty receives a percentage interest in the materials removed for the life of the property.

Production payments are not eligible for 1031 exchanges given they are a right to the oil, gas or mineral at a specific value, produced and paid from a percentage of removed minerals. Unlike royalties, production payments are finite based upon a specified production versus royalties that are perpetual, or until the mineral is exhausted.

Often available in much smaller investment increments than found in traditional real estate, oil & gas minerals may allow you to utilize the dollars subject to “boot” while at the same time potentially benefiting your overall portfolio. Oil and gas royalties provide diversification into commodities-based assets and typically create passive monthly income that has historically been a very nice inflation hedge. With the drilling technology that has been developed over the last several years, there is a shale oil and gas boom—and resulting aggressive development occurring in many areas of the United States—that could provide you with appreciation.

Similar to DST and TIC interests, in many cases the Exchangor must be an accredited investor. If you’re interested in Oil, Gas, Mineral, Water and Ditch Rights you can also review our interview with Wolf Hanschen from Peregrine 1031 Energy partners here. 

Deferred Sales Trust

Should acquiring replacement real property not be of interest, a Deferred Sales Trust can defer the gain. If the exchange is structured correctly and the Exchangor is not able to locate suitable replacement property candidates by the 45^th calendar day, the Deferred Sales Trust can be initiated. To learn more about a Deferred Sales Trust, go to the following link or review the brief blog article on Five Compelling Reasons to Consider a Deferred Sales Trust. 

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. 

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

Atlas 1031 Exchange is actively monitoring the impact of Coronavirus (COVID-19) on 1031 exchanges and seeking guidance from Congress and the IRS related to time-sensitive deadlines. On April 9th, the IRS published Notice 2020-23 which appears to extend the 45-day identification or the 180-day exchange period if they fall between April 1st and July 15th to a new deadline of July 15th. 

The 1031 specific language can be found in Section III. A of the Notice as it refers to Revenue Procedure 2018-58 which includes 1031 exchange deadlines. As this Notice was just released, there are many unanswered questions that require clarification that we, as well as our colleagues in the 1031 industry, are seeking. As further clarification comes available, we will continue to provide updates.

In the interim, we encourage any existing or potential exchangors to review Notice 2020-23 with their tax advisor to determine if it will affect them. 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges both domestic and international for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. 

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page

An interview with Wolf Hanschen of Peregrine 1031 Energy Partners

Most exchangors are aware that they can both buy and sell residential and commercial property in a 1031 exchange. However, there are alternatives to these common forms of real property. Wolf Hanschen is the Co-Founder and Managing Director of Peregrine 1031 Energy Partners. Peregrine 1031 assists clients who are looking to diversify part or all of their 1031 exchange proceeds into more than traditional real estate via oil, gas, water and mineral right royalties. 

Below is a brief interview with Mr. Hanschen outlining the basics for any potential exchangor who might be looking for a less traditional form of real property to utilize as part of their exchange.

1. What type of investor are Oil, Gas and Mineral rights best suited for?

Mineral rights, or royalties, are often known as “mailbox money,” delivering monthly income directly from the operator to your mailbox. Investors who are looking for a very passive, non-managed type of property would do well with royalties since royalty owners have no part in the operations, liabilities, and expenses of the wells in which they own under.

2. What is the advantage of Oil, Gas and Mineral rights in comparison to standard residential or commercial real estate? 

Because royalty rights are harder to acquire by nature (most owners choose to never sell), it’s hard to buy at scale.  This makes the asset class less interesting for the big Wall Street money that have chased yields with traditional brick and mortar real estate, thereby compressing the cap rates to near all time lows. Royalty ownership behaves much like that of a triple net real estate property, but with annual returns often double what investors are finding in that market. Mineral rights are also a non-correlated asset class to markets such as stocks and bonds, which adds another layer of diversity to one’s overall portfolio while also providing a natural hedge against inflation. Finally, the depletion allowance in the tax code affords royalty owners a tax-shield of 15% of their gross income each year. 

3. What involvement is required of the royalty owner? –

Almost none. It’s extremely “hands off” by design. By definition, royalty owners share in none of the day to day operations of the oil and gas wells; nor do they share in the costs or liabilities involved in such operations. Once a royalty owner is set-up within the “owner deck” of an operator, the checks (or direct deposits) will be issued once a month with a 1099 being sent every January.

4. Are there any complicated steps involved in a 1031 exchange if I were to acquire Oil, Gas and Mineral rights as replacement property? 

Identifying a royalty property is a bit more complex than identifying a standard real estate address, city, and state. The IRS typically likes to see a complete listing of all wells on the property so as not to be ambiguous about what the exchangor is identifying. Peregrine handles all of the heavy lifting on the ID process. Other than that, the closing of a royalty property is very straightforward and can often be completed in a matter of weeks.

5. What are the major risks of this type of investment, in your opinion?

The two biggest unknowns with royalty ownership are production and pricing. We are able to largely mitigate production risk (how much oil or gas is left in the ground) through third-party engineering analysis that incorporates all known data about the producing wells and forecasts out a minimum reserve life of 30+ years. We’re therefore left with commodity pricing as the biggest unknown in the equation, making it the biggest risk to consider. A royalty owner’s monthly checks rises and falls each month as does the price of oil and natural gas. Because we have no control of the broader energy markets and the resulting prices, we have to assume that our income will fluctuate up and down throughout our ownership of the property. With prices for both oil and natural gas near 3 year lows, we feel that the downside risk from a pricing standpoint is fairly limited

6. Should I want to eventually sell my royalty interest, what is the process? 

Liquidating a royalty interest is similar to the process in selling a piece of commercial property. It usually takes about 90-120 days to go through the course of finding a new buyer for the cash-flowing asset which Peregrine can help with if the investor choses to use our firm (we deed the properties direct to the clients so they can control their own hold / liquidation timeframe without being tied to any other investor).

7. How can I get more information? 

Start by visiting our website at www.peregrine1031.com. There is a great 5-minute intro video that helps educate clients on the history of royalty ownership and where it might be a fit within a 1031 exchange. After that, give us a call at 214-483-1997 so we can answer any follow-up questions you have.

We have worked with Wolf and Peregrine 1031 in the past and had an excellent experience. We do not receive any compensation or benefit from Peregrine 1031 in recommending their services. We encourage each exchangor to do their own due diligence and confer with their tax and legal advisors. 

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. 

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

We often receive calls from taxpayers who are seeking information on their first 1031 exchange. In some cases, the conversation is rather short as the facts of their potential exchange do not permit them to proceed. We’ve compiled our top seven most common reasons when a 1031 exchange does not work.

1. The Property Has Already Closed

This is one of the most frustrating scenarios for a taxpayer and is by far the most common. In this scenario, a taxpayer has closed prior to discovering that a 1031 exchange could benefit them. If the taxpayer has receipt of the exchange proceeds or if the proceeds are being held in a manner that the taxpayer can pledge, direct or borrow, the taxpayer cannot move forward with a 1031 exchange. As a 1031 educator who primarily teaches courses to Realtors, I often share the cliff notes of angry calls where the taxpayer directs their angst at their agent. Whether that is fair or not, I encourage Realtors to ask their clients two simple questions at the beginning of their listing.  First, “Is the property you’re selling an investment or business property?” and if the answer is yes, then, “Is it your intent to acquire an investment or business property with the proceeds of your aforementioned sale?”. If the answer is yes, I would encourage them to speak with a Qualified Intermediary to see if their transaction qualifies for 1031 exchange treatment, as well as their CPA to determine if it is in their best interest.  

2. The Property Being Sold is a Primary Residence

As previously mentioned, the usage of the property matters in a 1031 exchange. If the property is the primary residence of the potential Exchangor, it will not qualify. Additionally, if the property that is being sold is an investment, but the intent of the taxpayer is to immediately move into the replacement property as their primary residence, this also does not qualify. One exception to this could be a multi-unit residential property like a duplex. It is possible to live in one section of the property and still utilize section 1031 towards deferring the taxable obligation of the portion that is utilized as an investment or business property. If the property is a primary residence, we often encourage the taxpayer to confer with their CPA to see if they qualify for IRC § 121, which provides an exclusion of gain if certain criteria are met.

3. The Relinquished Property is in the US and the Replacement Property is Abroad

“Like-Kind” is defined as “Domestic to Domestic” and “International to International.” In the case that a taxpayer wants to sell a residential building in Montana, they could not then buy a replacement property in Canada. They could, however, purchase a property in any of the 50 states, including the US Virgin Islands, The Marianas Island and Guam, so long as they can substantiate that they have business interests in those territories. International properties are considered like-kind with other international properties; therefore, you could sell a property in Portugal and purchase replacement property in Japan. 

4. The Taxpayer is Selling as an Individual but Wants to Acquire in Another Taxable Entity

IRC § 1031 is very clear that the “same taxpayer who sells, must be the same taxpayer who acquires”. Ultimately, this is distilled down to the tax ID of the exchangor. If an individual is selling, they have options to acquire as a disregarded entity, such as a single-member LLC, land trust or revocable trust. They could not, however, acquire in a Multi Member LLC (MMLLC) with another member. This MMLLC would have a separate tax identification number and therefore would be ineligible. It is possible to transition the property to another entity after the exchange is complete but we encourage the involvement of the taxpayer’s CPA to provide guidance regarding the potential tax consequences.

5. The Taxpayer Wants to Acquire Personal Property as Replacement Property

In some unique cases, a taxpayer has an interest in selling their real property to replace with personal property, such as a boat, RV or airplane. Real property must be exchanged for real property. Real property provides many options beyond commercial and residential real estate; however, it does not allow for the acquisition of personal property. 

6. The Real Property Does Not Satisfy Revenue Procedure 2008-16

Given the property to be sold has a dwelling unit consisting of a bedroom, kitchen, and bathroom, Rev. Proc. 2008-16 requires the property is held for at least two years. In each of the two years, no more than fourteen personal overnights are allowed, including when friends and family stay without paying fair market rent and the property has been rented at least fourteen overnights in each of the two years. Property such as single-family residential and condominiums cannot be flipped for profit and must be held for at least two years to show proper intent. Itemizing on Schedule E of the taxpayer’s return is another fact supporting a 1031 exchange. 

7. Not Reinvesting at Least 50 Percent of the Net Sale Price

Those taxpayers looking to replace a portion of the net sales price should seek the input of their CPA to understand the tax consequences. More often than not, taxpayers reinvesting less than 50 percent of the net sales price will find the tax on the difference is close to or the same as the tax on the sale if a 1031 exchange was not initiated. You can do an exchange, but why?

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. 

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

In the seemingly complex world of 1031 exchanges, sometimes it helps to hear how others have navigated their exchange. In the following example, we follow a basic transaction that represents the general sequence from start to finish. This example is purely for relatability purposes and was kept simple with the intention of showing a common scenario. Every 1031 exchange is unique; however, there are common guidelines that must be followed in order to successfully execute the transaction from start to finish. 

Zac and Stephanie Burke purchased a rental property in New Smyrna Beach, Florida in February of 2016 for $250,000. They held this property and rented it out to vacationers from the time they purchased it up until they put it on the market in March of 2019. With a confirmed sales contract for $375,000, they knew they would have a significant taxable obligation. 

As soon as they began working with their Realtor, he mentioned to them that they should consider a 1031 exchange as the Burke’s intent was to sell their New Smyrna Beach rental property to acquire a duplex near a local University that would also serve as an income generating rental property. After conferring with their CPA they decided that a 1031 would be in their best interest and that the deferral of the capital gain and depreciation recapture due would be worthwhile based on their intent to reinvest in a more appropriate investment property. 

After discussing their usage of the property with a Qualified Intermediary, they determined their property was 1031 eligible. In this conversation, they discussed the amount of time they personally used the property, which amounted to roughly 10 days in each of the previous two years and the rental amounts which they estimated were roughly 150 rental nights in each of those years. In limiting their personal usage and renting more than 14 overnights in each of the previous years, as well as the fact that they had owned the property for more than two years prior to the sale, the Burkes satisfied the IRS criteria in Rev. Proc 2008-16 and therefore their property was 1031 eligible. 

In advance of the closing date, the Burkes connected their Qualified Intermediary with the Title Agent who would be handling the closing of their New Smyrna Beach property. During this time, they continued to search for potential replacement properties with their Realtor so as to give themselves the most time to review potential replacement property options.

Once their property closed on May 1, 2019, two concurrent schedules began. First, the 45-day identification period, or the period in which the Burkes were able to identify the properties that they intended to acquire. Secondly, their 180-day exchange period began when the old property closed; this is the timeframe to close on the property identified during their 45-day period. Based on the closing statement, the Burkes, along with their Qualified Intermediary, were able to determine the amount that would need to be reinvested into their replacement property in order to maximize their deferral and ensure that their taxable obligation would not come due. 

With a sales price of $375,000 and closing costs of $10,000, the net sales price of their relinquished property equated to $365,000.00. They had a $100,000 mortgage on their relinquished property that was retired at closing; however, both the debt and equity (exchange proceeds) need to be reinvested in their replacement property. In the Burkes’ case, they need to reinvest the $100,000 in debt and the $265,000 of exchange proceeds into their replacement property. With this figure solidified, they began to focus on a group of duplexes that were equal or greater than $365,000. 

After a month of vetting possible replacement properties, the Burkes extended an offer on the duplex that they felt was their first choice. As the 45-day ID window of June 15th drew close, their QI encouraged them to add a second property as a contingency just in case there was an issue with their first choice. On June 12^th, the Burkes submitted their ID letter with both choices included and indicated that they would only be acquiring one of the properties. In doing so, they submitted their ID letter ahead of the 45-day deadline and met the IRS requirement. 

On July 20^th, they were surprised when their first-choice duplex unfortunately did not pass inspection and they were not able to move forward with it. Thankfully, they had identified a second property and immediately reached out to the listing agent. Within 48 hours, they extended a contract on the property at a listing price of $395,000. Had the Burkes not included a second property, they would not have been able to move forward with their exchange, as properties cannot be acquired that are not identified by the 45^thcalendar day. 

The Burkes connected their QI with the Closing Agent for their replacement property and all IRS required documentation was created prior to the closing. Their exchange proceeds were sent in via wire and their closing was a success. As the sales price of the Duplex was greater than the $365,000 net sales price of their relinquished property, they were able to bring a small amount of personal capital to the closing and defer all of their taxable obligation. 

After their closing on August 1^st, their QI created a PDF summary of their transaction for their records and sent a copy to both the Burkes and their CPA. 

In this 1031 example, the Burkes benefitted from identifying multiple potential replacement properties. Every 1031 exchange is unique but their situation allows for a narrative view of a common exchange scenario. 

We can help 

Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

In order to meet the requirements of an I.R.C § 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who acquires the replacement property. “Continuity of investment” must be established by a fact pattern supporting the same taxpayer as both seller and buyer. As in most real property transactions, there are nuances. In this article, we will specifically review the role of Revocable and Irrevocable Trusts, and Land Trusts as they pertain to 1031 exchange and the same taxpayer requirement. 

Disregarded Entities 

In a 1031 exchange, an individual as the Exchangor can utilize a disregarded entity, such as a single member limited liability company (SMLLC) or a revocable living trust as the entity that acquires replacement property on their behalf. SMLLC’s and revocable living trusts are considered disregarded entities and the Exchangor will file a single return using their own tax identification number and not a separate EIN for the LLC or Trust. In doing so, the “Continuity of Investment” is upheld because the Exchangor is still considered the “same taxpayer” when utilizing a disregarded entity. 

Trust Basics 

Let’s review the basics principles of a Trust. Although there are many types of trusts with varying strategic benefits, we will focus on revocable and irrevocable living trusts and land trusts. The primary function of a Trust as it pertains to real property is to protect the assets from probate upon the passing of the Grantor. Additionally, certain types of Trusts can provide added privacy to the holdings of the Taxpayer. As mentioned previously, Trusts can be utilized in 1031 exchanges, but based on their unique characteristics, they must still meet all 1031 requirements. In a typical trust there are three parties (in some trusts, they are the same individual): the Grantor or Settlor, the Trustee and the Beneficiary. The Grantor or Settlor is the creator of the trust. The Trustee is the individual who is responsible for administering the trust. The Beneficiary is the individual who would benefit from the trust by receiving the real property assets after the passing of the Grantor. 

Revocable (Living) Trusts 

Revocable (Living) Trusts (a type of “Grantor Trust”) constitute the most common type of Trust. Revocable Living Trusts do not file independent tax returns as all income, expenses, gains or losses are reported on the tax return of the Grantor of the trust. As you can determine from the name of the trust, at any time while the Grantor is living, the trust can be amended or revoked. Typically, the trustee, beneficiary(ies) and the grantor are all the same individual. This allows for the taxpayer to sell their relinquished property with the Trust on title and acquire their replacement property as an individual or a single member LLC or vice versa. A Revocable Living Trust is a helpful ownership vehicle in a 1031 exchange and can be utilized for additional privacy or to provide protection of the assets at the time of the Grantor’s death. In a 1031 Exchange where a Revocable Trust holds title, the Grantor or Trustee are considered the taxpayer. If the beneficiary is a different individual, they are not considered the taxpayer and therefore cannot benefit from a 1031 exchange directly. 

Irrevocable Trusts 

Irrevocable Trusts differ fundamentally from Revocable Trusts in that they cannot be modified or amended by the Grantor once they have been created. The Grantor has effectively removed all ownership rights to the assets once they’re held by the Trust. The primary difference for purposes of 1031 exchange treatment is that an Irrevocable Trust has its own separate tax identification number. Due to this unique attribute, an Exchangor who sells real property in an Irrevocable Trust must acquire replacement property in the same Irrevocable Trust to satisfy the same taxpayer requirement. An Irrevocable Trust is not a disregarded entity and therefore not eligible to be interchanged with a single member LLC or individual tax ID. Therefore, in a 1031 exchange, the Irrevocable Trust is considered the taxpayer. 

Land Trusts

Land trusts created in Illinois, Indiana, North Dakota, Hawaii, California and Virginia are considered interests in real property and eligible for a 1031 tax deferral. Land trusts with multiple beneficiaries must follow certain rules to not be considered a partnership; primarily that no agreement between the taxpayer and beneficiaries exists that constitutes a partnership. Partnership interests are not 1031 eligible. Revenue Ruling 92-105, 1992-2 C.B. 204 provides that real property held by a land trust is not an interest in personal property or a beneficial interest in the trust. The land trust is an agreement where the trustee agrees to hold title for the benefit of the beneficiary.

The taxpayer is typically the beneficiary or a limited liability company who holds operational control, including tax payments, liability obligations and the sale of the real property. A trust land agreement is entered into between the trustee and real property owner (taxpayer) permitting a beneficial interest in the property. Public records show only the trustee and trust as the property owner while the trust taxpayer remains anonymous.

Land trusts are either revocable or irrevocable with the difference being that once the trust conveys the property to the beneficiary, no changes to the trust are permissible without the beneficiary’s approval.

We can help 

Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 16 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange. Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.