1

4. Taxation and Contracts

In this module, we will discuss:

• 1031 exchanges• IRS 1033—threat of condemnation• Estate planning• Contracts in land sales

2

Tax-Deferred 1031 Exchanges

• Allow the investor to exchange investment or business real estate for like-kind real estate with little or no recognition of gain

3

Tax-Deferred 1031 Exchanges (cont.)• Real estate exchanging is a powerful

sales tool.• Can save clients valuable tax dollars• Recognizing an exchange situation

and the basic elements of structuring an exchange is necessary for all real estate professionals.

4

Tax-Deferred 1031 Exchanges (cont.)Motivating factors:

• Geographical problem• Lack of diversity in an investor’s

portfolio• Management problem

5

1031 Exchange Requirements

• Property exchanged and property received must be held for productive use in trade or business, or for investment.

• Properties exchanged must be of like-kind.

• Requires an actual exchange

6

Qualified Property

Properties that qualify for 1031 treatment include properties held:

• For business use• For investment

Properties that do NOT qualify for 1031 treatment are properties held:

• For personal use (personal residence, vacation home)

• For sale (developer’s lots, builder’s homes)

7

Types of Exchanges

1. Simultaneous exchange2. Delayed or Starker exchange3. Reverse exchange

8

Simultaneous Exchange• Rare because finding two properties with

same valuation and implementation can be difficult.

Relinquished

Exchangor

Replacement

Seller

9

Delayed or Starker Exchange

Phase One Sale

Relinquished

Facilitator

Deeded to New Buyer

Phase Two Sale

Replacement

Facilitator

Exchanger

• Used most frequently because neither seller nor buyer accepts liability for becoming a grantor on a property they do not want

10

Rules of Delayed Exchanges New property must be identified no

later than 45 days after the transfer date of the old property.

New property must be transferred before the earlier of:

180 days after the date of the transfer

Due date of the tax return for the tax year of the exchange

11

Reverse Exchange

Relinquished

Facilitator

Warehouses Title

Deeded to facilitator upon closing of replacement

Later deeded to new buyer

Replacement

Facilitator

Warehouses Title

Deeded simultaneously with closing of relinquished property

Exchangor

• Used if clients have purchased a replacement property prior to the sale of the relinquished property

12

Boot Consideration

Receiving boot in a like-kind exchange does not defeat the exchange.

Tax is only on the gain that comes from:

Amount of money received, PLUS Fair market value of unlike property

received

• Gold, silver, foreign currency

• Airplanes, motor homes

• Precious stones

• Real estate for personal residence

13

1033—Threat of Condemnation

Provides relief if property is lost through an “involuntary exchange”. The taxpayer may defer tax on any gain from this sale.

14

Examples of Involuntary Exchange• Destroyed• Stolen• Condemned• Disposed of under the threat of

condemnation

15

Involuntary Exchange Requirements• Reinvestment is made in substantially

similar property.• Reinvestment is substantial

continuation of taxpayer’s prior commitment of capital.

• Character of taxpayer’s investment has not changed.

• Entire transaction allows taxpayer to return closely to his or her original position.

16

Estate Planning

• An estate tax is imposed on the “taxable estate,” which is net value of total property transferred or considered transferred at death.

• For deaths in 2006, 2007, and 2008, net estates of less than $2 million pay no federal estate tax. State death taxes may be due for smaller estates, however.

17

Contracts in Land Sales

• Some states require final contracts to be prepared by an attorney.

• Some states have created generic contracts.

18

Provisions

• Names• Legal descriptions• Purchase price• Property tax issues• Possession• Assignment of risk for losses• Method of payment• Time limitations• Agency disclosure and confirmation

19

Additional Provisions

• Terms• Earnest money• Inspections• Remedies for failed

transactions• Survey• Tax-free exchange• Drainage

• Improvements• Ground water hazard

statement• Disposal sites• Well disclosures• Underground storage• Environmental

disclosure• Zoning information