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Issue  244  Article  390
Published:  4/1/2018

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Safe Harbors Help Taxpayers Play it Safe
STEC

Part of the 1031 XChange Index - Originally Published 10/1/2007 at STEC

1984 was a pivotal year for the 1031 Industry. It was that year that the 9th Circuit Court of Appeals issued the appellate decision (Starker, 602 F2d 1341 (9th Cir. 1979) providing the structure for non-simultaneous (delayed) exchanges. Up until that time, the IRS Code Section 1031 was predicated on simultaneous swaps of land. Several iterations were made since that time providing further clarify and guidance. These iterations included the introduction of guidelines known as the safe harbors for structuring a 1031 tax deferred exchange. These safe harbors include:

Safe Harbor time limits must be followed

There are two strict deadlines that must be met in order for the exchange to remain within the safe harbor guidelines:

  • Identification Period. The taxpayer has 45 days after the first closing (whether it was a purchase or sale) to identify property for the second closing. The identification must be made in writing and sent to the intermediary or someone else who is not closely associated with the taxpayer. The taxpayer can identify up to three replacement properties without regard to value; or can identify more than three as long as the aggregate fair market value does not exceed 200% of the fair market value of the relinquished property.

  • Exchange Period. The taxpayer has a total of 180 days for the entire exchange period. In other words, all properties must be closed within 180 days from the first closing

The property exchanged must be qualifying property

Qualifying property in a land exchange is defined as real property held for productive use in trade or business, property acquired for investment and/or income generating property. The following items do not qualify:

  • Stock in trade or other property held primarily for sale,
  • Stocks, bonds, or notes,
  • Other securities or evidence of indebtedness or interest,
  • Interests in a partnership,
  • Certificates of trust or beneficial interests

Property use must be qualified as being held for use in trade, business and/or investment.

This eliminates properties used for:

  • Personal residence
  • Second residences, vacation homes
  • Dealer Property (considered inventory)
  • Property acquire primarily for sale

Replacement property must be like kind to relinquished property

Real property is like kind to real property, regardless of character or structure. That allows taxpayers to exchange farmland for a rental unit, commercial complex for vacant land, etc.

IRS Code Section 1031 also permits exchange benefits for personal property such as airplanes, office furniture, trucks, livestock, art, collectibles and more. The definition of what is considered like kind is much more narrowly defined for personal property exchanges. The Standard Industrial Classification (SIC) Codes published by the Office of Management and Budget dictate the bands of property considered like kind.

The taxpayer cannot be in receipt of money from the sale

This rule is a key element of the tax code requirements. The purpose of this rule is fairly simple and is the underlying reason why the IRS permits favorable tax treatment in an exchange. Taxpayers swap properties and show that profits from the sale of one property went directly to the purchase of another, which effectively places the taxpayer in the same financial situation. Therefore, if a taxpayer wants to successfully defend the position that he/she is not financially better off than if he/she had not sold the property, the taxpayer cannot benefit from receiving the proceeds of the sale.

Same taxpayer must be on the both legs of the exchange

1031 Tax Deferred Exchange protection is valid only if the identical taxpayers or legal entities both buy and sell property. For example, taxpayers may not sell relinquished property vested in their individual names and take title to the replacement property in the name of a trustee for their revocable living trust. However, if taxpayers are the sole member of a Limited Liability Company (LLC), they can sell relinquished property vested in their name and take title to the replacement property in the name of the LLC. This is because a single member LLC is considered a ‘flow-through’ entity for tax purposes and does not need its own taxpayer identification if it has elected to not be taxed as a corporation. Similarly, if the relinquished property was vested in the names of both husband and wife, then both parties must take title to the replacement property to avoid potential tax consequence.


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