Advanced Sec. 1031 Terminology
We’ve devoted several posts to debt terminology (i.e. debt resolution, debt consolidation, etc.). In this post, we’d like to follow this same style and discuss a few terms which you’ll find in advanced Sec. 1031 research. These are terms which you won’t usually find in the most straightforward 1031 exchanges. As we know, 1031 exchanges can vary greatly in complexity. You have the simplest exchanges which involve a single relinquished property, a single replacement property, no boot and no other potential issues. On the other hand, you can have exchanges, such as reverse exchange or leasehold improvement exchanges, which require lots of additional documentation and are quite complex. On top of our posts on debt resolution, we will continue to contribute material on 1031 for the benefit of our clients. Let’s take a look at some advanced Sec. 1031 terminology.
A leasehold interest is a temporary interest in property, of fixed duration, negotiated for a certain price. The contract which creates this interest is a lease. Leasehold interests are “real property” as long as they have a sufficient length. Sufficient length means a length of at least 30 years, and this includes extensions or renewal options. This means that a 30 year leasehold would be eligible as a relinquished or replacement property. Leasehold interests play a central role in so-called leasehold improvement exchanges. Corporations who wish to construct a new building on raw land occasionally utilize these exchanges.
Carry Back Financing
Carry back financing (also referred to as “seller financing”) refers to deferred payments taken by a seller in certain cases. When a seller locates a buyer who does not have adequate short-term financing, the seller can choose to accept a note for deferred payments. The seller can then choose how this note should be used. The seller can sell the note on the open market, buy it from the exchange, use it as payment for property, or it can mature during the exchange. Carry back financing is fairly common, but it complicates an exchange. Typically, a facilitator will charge an additional fee to handle an exchange which involves a carry back note.
Tenancy-in-common is a form of co-ownership of real estate. Tenancies-in-common (TIC) are common in medium size commercial buildings and apartment complexes. TIC interests are considered “fractional undivided interests.” This means that they can be freely sold without the pre-approval of other co-owners. Importantly, in the context of advanced Sec. 1031, these interests are “real property” interests and so are eligible in 1031 exchanges. TICs are gradually being surpassed by Delaware statutory trusts (DSTs), which are also co-ownership arrangements involving undivided fractional interests.
Oil Rights Exchange
In a 1031 exchange, taxpayers are only eligible to transfer interests in “real property,” whether owned in fee simple or shared with other co-owners. Whether something is “real property” is a legal question and determined on a case-by-case basis. For instance, a tenancy-in-common ownership interest is an interest in real property; this is also true for DSTs, joint tenancy, and other types of interests. In some cases, rights to use real property can be considered a real property interest. This determination typically hinges on how long the right to use the property lasts. In some cases, oil rights are considered real property for 1031 exchange purposes. An oil rights exchange, therefore, is an exchange involving oil rights. Taxpayers can then use them as either the relinquished or replacement property.
In the sale of real estate, closing costs refer to costs which facilitate the sale. Common costs include real estate agent commissions, title insurance fees, escrow fees, inspection and appraisal fees, and so forth. In the context on 1031, the important thing to know is that only certain of these costs can be deducted from the exchange proceeds. This means that non-acceptable closing costs either have to be paid out-of-pocket or paid with exchange proceeds as taxable boot. If you have unusual closing costs and are unsure about deductibility, you should consult with a 1031 tax attorney.
A parking arrangement refers to the taking of title on a temporary basis by either a facilitator or a facilitator’s special purpose entity. Parking arrangements we encounter them in complex 1031 exchanges, such as reverse exchanges and improvement exchanges. In reverse exchanges, the taxpayer signs a special contract and a special purpose entity known as an “exchange accommodation titleholder” (EAT) is established. The EAT then “parks” title to the replacement property, and that property is then leased back to the taxpayer for the duration of the exchange. Parking arrangements have been approved by the IRS and so they are common practice in the 1031 industry.
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These are just a few terms you may come across in a more complex Sec. 1031 like kind exchange. In the future we may circle back and discuss more advanced terminology. At Mackay, Caswell & Callahan, P.C. we focus on helping our clients navigate through the complex tax world. We focus on IRS tax debt resolution, complex Sec. 1031 exchanges and business transactions. We offer a variety of consultation services when it comes to advanced Sec. 1031 like kind exchange transactions. If you need assistance with one of our practice areas, give one of our top New York City tax attorneys a call today.
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