Also known as a tax-deferred exchange, a transaction performed under Internal Revenue Code §1031, which states that neither gain nor loss is recognized if property held for investment or for productive use in a trade or business is exchanged for property held for investment, trade or business. §1031 exchange methods include delayed exchanges, simultaneous exchanges and reverse exchanges.
The basis of a property adjusted for any capital improvements or depreciation. To calculate the adjusted basis, add the basis (the cost of the property) to the cost of any capital improvements made to the property during the taxpayer’s ownership, and subtract the depreciation taken on the property during that period. Upon sale, a taxpayer will pay tax based on the net sale proceeds minus the adjusted basis (unless there is a §1031 exchange).
In tax accounting, a measure of an owner’s investment in a property. In simple terms, basis represents the original cost to acquire a property, which then becomes “adjusted basis” after subsequent capital improvements and depreciation.
Reflects the adjusted basis of the relinquished property, plus any additional acquisition capital or improvements and depreciation attributed to the replacement property after purchase. In a §1031 exchange, the exchanger must carry over the adjusted basis of the relinquished property.
Excess value received in an incomplete §1031 exchange. To avoid receiving boot, the exchanger must receive property with an equal or greater 1) market value and 2) debt than the property relinquished. 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 reduction in mortgage debt resulting from the exchange.
The ratio between the annual net operating income produced by a property and its current market value. Assuming a static net operating income, an increase in value will cause a decrease in the capitalization rate. When applied to a larger group of similar properties in a given area, the capitalization rate describes how much buyers are currently paying for properties as a function of their income.
Tax on an exchange transaction is not paid at the time of transaction but at the time the replacement property is sold. Deferral is accomplished by substituting, or carrying over the basis of the exchanger’s relinquished property to the replacement property, with any necessary adjustments for additional consideration paid.
Also called a “delayed”, “non-simultaneous” or “Starker exchange.” A type of exchange whereby the exchanger closes the purchase of the replacement property after, but more than 180 days beyond, the closing of the relinquished property.
Decline in value of an asset for tax accounting purposes. Property depreciation occurs due to general wear and tear over the “useful life” of an asset. The Internal Revenue Code allows depreciation of improvements and fixtures to be deducted from taxable income, subject to regulations regarding the assigned “useful life” of various assets. Land cannot be depreciated.
A special tax rate applied to the amount of taxable gains attributable to prior depreciation of a property. For example, if a taxpayer is paying capital gains tax upon sale of a property, some of that tax may be at a rate of 20%, while the gain derived from prior depreciation may be taxed at 25%. §1031 exchanges ordinarily do not trigger any depreciation recapture.
A period which ends on the earlier of 180 days after the date when the exchanger transferred the relinquished property, or the due date for the exchanger’s tax return for the taxable year when the transfer of the relinquished property occurs (such as April 15th), during which the exchanger must receive the replacement property.
The amount received from the sale of a property minus the property’s adjusted basis and transaction costs. Gain is not taxable until it is recognized, which typically is in the year the gain is realized. If gain is not recognized in the year it is realized, it is said to be deferred. In a complete §1031 exchange, realized gain is deferred (not recognized) unless boot is received. See “Boot”.
GLIDE stands for Ground Lease Interest in Development. A GLIDE is a type of DST structure in which the trust owns a ground-lease interest in vacant land, upon which an affiliate of the sponsor intends to build. DST investors may participate in a percentage of future revenues from the developed property (e.g., senior care facility or student housing community), but otherwise the primary source of income to investors is the ground-lease rent paid by the developer/tenant.
A period which ends 45 days after the date when the exchanger transferred the relinquished property, during which the exchanger must identify the replacement property. The identification must (i) appear in a written document, (ii) signed by the exchanger and (iii) be delivered to the replacement property seller or any other person that is not a disqualified person who is involved in the exchange. The custom and practice is for the identification to be delivered to the qualified intermediary, however a written statement in a contract to purchase the replacement property stating that the buyer is identifying the subject property as his replacement would meet the requirements of the identification.
Replacement property that the IRS has deemed to be similar in nature to relinquished property in a §1031 exchange. In most cases, any property held for investment, or for productive use in a trade or business, is considered “like-kind” with any other such property.
A loan in which the lender agrees that its sole remedy in the event of failure to repay will be to foreclose against the property securing the loan, thereby foregoing recourse in most instances against the individual owner(s).
Also known as an accommodator or facilitator. Similar to an escrow agent, this person or entity agrees to assist the exchanger to affect a tax-deferred exchange. A qualified intermediary is identified as follows:
Not a related party to the exchanger (agent, attorney, broker, family member, etc.)
Receives a fee
Acquires the relinquished property from the exchanger
Acquires the replacement property and transfers it to the exchanger
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 doesn’t qualify for tax deferral under Section §1031. So to qualify for tax deferral, it is still essential to cautiously 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.
Because investor situations and objectives vary this information is not intended to indicate suitability or a recommendation for any individual investor.
This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance.
There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal.
DST 1031 properties are only available to accredited investors (typically defined as having a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last two years; or have an active Series 7, Series 82, or Series 65). Individuals holding a Series 66 do not fall under this definition) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney.
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