The Tax Court recently held that the sale of subdivided lots qualified for Capital Gains and Loss treatment. The case involves a husband and wife who purchased a large parcel of property to build their residence on. The property was only available for purchase as a single unit. While they initially wished to keep the entire property for themselves, they eventually decided to subdivide and sell the excess lots over a number of years.

The court decided that the excess lots were held for investment purposes and the proceeds of their sales resulted in capital gains and losses. The Court looked at several facts in determining that their primary intent was more characteristic of investors than dealers. The couple had day jobs, had never sold real estate (outside of their residence), they hired consultants for every step of the process and sold less than a lot a year. The moral of the story is that a taxpayers original intent when purchasing a property plays a critical role in whether or not a property qualifies for 1031 Exchange treatment. (See: Rice, TC Memo 2009-142)

As a Qualified Intermediary we are often asked about the holding period in a 1031 Exchange. Investors who are taking advantage of short-sales, foreclosures and REO’s need to be especially mindful of the 1031 Exchange rules.

Since 1031 is for deferring Long Term Capital Gains (LTCG) taxes, some advisors feel that holding a relinquished property for a minimum of one year is sufficient as LTCG is a holding period of more than a year. Additionally, if a property is held for over a year it will show up on two tax returns. The IRS takes a much more conservative approach in a Private Letter Ruling stating that a holding period of two years would be a sufficient. The IRS also created a Safe harbor for vacation home exchanges in a recent Revenue Procedure which includes a two year holding period for both the relinquished and replacement properties.

Given the IRS’s decisions in the above rulings most advisors prefer to see a holding period of two years. Holding period needs to be addressed on a case by case basis, taking into account investment intent as well as the facts and circumstances of an investor’s particular situation.

Yes in many cases but not all. The amount of mortgage relief in an exchange is called "mortgage boot received" and is taxable to the extent it is less than the realized gain had the property been sold. However, if the exchangor adds cash to the transaction, gives cash boot, the cash boot given will offset the mortgage boot received and may reduce the tax liability to zero.



This potential tax liability is independent of the type or nature of the debt given or received. The debt may be new mortgages or mortgages taken subject to or assumed by the other party, may be recourse or non recourse or may be purchase money mortgages financed by the seller. Also, mortgages given up and mortgages taken on may be in first position or may be subordinate to one or more other mortgages.



The amount of mortgage relief is the difference between the mortgages given up on the disposition of the relinquished property and the mortgages taken on with the acquisition of the replacement property. If mortgages taken on are less than mortgages received then there is net mortgage boot received which may be subject to a gains tax.



Conversely, if mortgages received exceed mortgages given up, the difference is mortgage boot given which adds to the substitute basis of the replacement property.



It is important to structure the payoff and discharge of the mortgages on the taxpayers' relinquished property so that they are not paid off for the benefit of the taxpayer. If the transaction is structured incorrectly, the payoff of mortgages may be interpreted as constituting constructive receipt by the taxpayer which will violate the provisions of Section 1031.



Whenever mortgages are to be paid off in an exchange the taxpayer should hire the services of a qualified exchange intermediary to properly structure the payoff and protect the taxpayer benefits of the exchange.

Did you know that under IRC §1031 you can defer capital gains taxes on the sale of personal property?  Although the majority of exchanges involve real estate, the exchange of “personal property” is also possible and presents a substantial tax deferral opportunity for business owners.  In a single asset exchange, the “like kind” requirement is usually met easily, with both the relinquished and the replacement property being the same “General Asset Class” or the same “Product Class”.  These classifications are used to determine the recognition or non-recognition of gain upon the sale.



General Asset Classes:

1.    Office furniture, fixtures and equipment

2.    Information systems, such as computers

3.    Non computer data handling equipment

4.    Airplanes, helicopters, air frames & engines

5.    Buses

6.    Automobiles

7.    Light general purpose trucks

8.    Heavy general purpose trucks

9.    Over the road truck tractor units

10.    Trailer & Trailer mounted containers

11.    Railroad cars and Locomotives

12.    Vessels, barges, tugs & marine transportation equipment

13.    Industrial steam & electric generation & distribution systems



Under the regulations, personal property may be “like kind” even if it is not “like class” or within the same product class under the safe harbor.  However, the like kind standard is less broad than for exchanges of real property and requires properties to be of the same “nature or character”, as shown here in these examples:

 

1.    Copyrights of Novels are like kind to other copyrights of novels – not like kind to copyrights of songs

2.    Major league player contracts are like kind to other major league player contracts

3.    Livestock (of the same sex) stallion for stallion, mare for mare

4.    FCC television licenses for FCC radio licenses

5.    Fishing permits for fishing permits (regardless of species or fishery location



It is important to note that the IRS’s position that “goodwill” and “going concern value” of a business does not qualify and is not considered “like kind” to “goodwill and going concern value” of another business.  In addition to the more specific requirements discussed in this article, a delayed exchange of personal property must also comply with the general requirements of the Qualified Intermediary “safe harbor” provided by the regulations, including the use of an independent third party as the Qualified Intermediary, time deadlines (45 & 180 days) for the identification and the receipt of replacement property, etc.



The regulations require that the identification of the replacement property to be received in an exchange, be specifically described and signed by the taxpayer.  For example, an exchange of two automobiles, an unambiguous description of the replacement vehicle would describe the specific make, model and year of the automobile.  Other general rules of identification also apply to personal property; they are the 3 property rule, the 200% rule and the 95% rule.  Of course it is always wise to consult with both your legal and tax advisor prior to beginning an exchange.