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§ 1031 Exchange
Internal Revenue Code, Section ß1031 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. There are several kinds of ß1031 exchange methods used today, including delayed exchanges, simultaneous exchanges, and reverse exchanges.
180 Days
The number of days an exchange investor has to close the replacement property.
1991 Revisions
The year when the IRS held a hearing to "clean up" the Tax Reform Act of 1984 and provide uniform terminologies. A main result of this revision was that the IRS eventually had a change of attitude toward Delayed Exchanges by accepting them instead of fighting them.
45 Days
The number of days an exchange investor has to identify in writing replacement properties for a 1031 exchange. The period starts the day the relinquished property closes, including weekends and holidays, until midnight of the 45th day.
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Accredited Investor
An investor who is both experienced and financially qualified to invest in a private placement offering. It is the duty of the registered securities broker/representative and the broker dealer to determine the accredited status of a client before offering TIC investments. By SEC definition, an individual is accredited if their joint net worth is equal to or greater than $1 million dollars including personal possessions or their annual income is greater than $200,000 (single), $300,000 (joint).
Accommodator
A qualified intermediary (QI) is a person or firm who holds monies for an exchanger during a 1031 tax-deferred exchange. Also described as a facilitator or an intermediary, a qualified intermediary cannot be the taxpayer, a related party, or an agent of the taxpayer.
Adjusted Basis
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 specific time period. Once the adjusted basis is known, the gain or loss can be computed.
Agency
An agency is considered a fiduciary relationship, where the agent represents the principal and acts only with the principalís consent and are subject to his or her direction and control.
Anchor Tenant
Any major tenant, such as a large department or discount store or supermarket, which forms the nucleus of a modern shopping center. The anchor tenant is the mainstay that draws the public and stabilizes the center by assuring a profitable operation for all the tenants. Anchor tents are usually sought out first by developers, and they are usually given favorable leases.
Appraisal
A fair market value of real property determined by a third party when considering implications from market, incomes and replacement costs of the property.
Appreciation
An increase in value over time.
Asset allocation
Dividing investments among different kinds of assets, such as stocks, bonds, real estate and cash, to balance the risks of investing. Asset allocation models vary based on an individualís specific financial goals and situation.
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Basis
Method of measuring investment in property for tax purposes. Calculation: Original cost plus improvements minus depreciation taken.
Basis in the Replacement Property
In a 1031 exchange, the deferral of the tax on the gain is accomplished by requiring the taxpayer to carryover (substitute) the basis of the relinquished property to the replacement property with suitable adjustments in the event additional consideration is paid.
Bear market
A prolonged period of generally declining prices.
Boot
The amount of gain not recognized under section 1031 and is subsequently subject to tax.
Broker Dealer
A firm that recommends, offers or sells investments to the public which is required to be registered with the SEC, NASD, and the state securities divisions in every state in which the firm operates or the customer resides.
Broker Dealer Supervision
A broker dealer firm that employs registered securities brokers/representatives and has an obligation to supervise those representatives.
Building Classifications
Class "A": Buildings of the highest quality and best locations.
Class "B": Building of good quality and location.
Class "C": Building with below average quality and location.
Bull market
A prolonged period of generally rising prices.
Buyer
An individual who wants to acquire replacement property in a 1031 exchange.
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Capital appreciation
Increased market value of an asset as measured by sales price.
Capital Gain
The difference between the sales price and the adjusted cost basis of the property.
Capitalization Rate (Cap Rate)
A measure of value calculated by dividing property value by the net operating income of a property (NOI).
Cash-On-Cash Return
The annual rate of return an investor receives divided by their original cash investment.
Class "A" property
Please see ‘Building Classifications' definition.
Compensation
The compensation a broker dealer receives for a client making an investment. Anyone who receives compensation of any kind associated with offers and sales of TIC interests by a broker dealer must be a licensed registered securities broker/representative.
Concurrent Exchange
Also referred to as a simultaneous exchange when the Exchanger transfers out of the Relinquished Property and receives the Replacement Property at the same time.
Conflicts of Interest
A person recommending, offering or selling a security to an investor must disclose all material facts affecting the recommended investment. If circumstances affect the objectivity of the recommendation, a conflict of interest may exist. The failure to disclose the financial interest of all parties to the transaction deprives the customer of the knowledge necessary to make a decision based upon investment value. Misrepresenting or omitting to disclose material facts with respect to the investment is a violation of federal and state securities laws.
Constructive Receipt
Control of proceeds (money) from the sale of a property even though funds may not be directly in your possession.
Closing
The transfer of title between buyer and seller.
Credit Tenant
Tenants with the highest credit quality, generally associated with companies high net worth or market share.
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Deferral
Deferral is accomplished by substituting or ‘carrying over' the basis of the taxpayer's relinquished property to the replacement property making any necessary adjustments for additional consideration paid.
Deferred Exchange
The term currently used in place of "Non-Simultaneous Exchange" or "Starker Exchange." A type of exchange where the Exchanger utilizes the exchange period of 45/180 days to identify and close on replacement property.
Delayed Exchange
Also known as non-simultaneous, deferred, and/or Starker Exchange. A delayed exchange is accomplished when the Replacement Property is received following the transfer of the Relinquished Property. All potential Replacement Properties must be identified within 45 days from the transfer of the Relinquished Property and the Exchanger must close on all Replacement Properties within 180 days or the due date of the Exchanger's tax return, whichever comes first.
Depreciation
Decline in value of an asset. Property depreciation occurs due to general wear and tear.
Depreciation Recapture
Exchanges of like-kind property ordinarily do not trigger any depreciation recapture (that is, deductions taken in excess of straight-line depreciation under Section 1250 IRC). When there is an exchange into a property of lesser value, or when the exchange consists partly of cash and property not of a like kind, consideration must be given to the depreciation recapture provisions of Section 1250 and the higher capital gain tax rates for depreciation recapture.
Direct Deeding
Vested owner deeds directly to the final owner. Doesn't eliminate the duties of the Qualified Intermediary to acquire and transfer the Relinquished Property and acquire and transfer the Replacement Property.
Disclosure
A person recommending, offering or selling an investment contract to an investor must disclose all material facts affecting the recommended investment. Such information includes the risks of the investment, the compensation paid to any person involved in recommending the investment, the potential conflict of interest between the firm and itís professionals, and any other fact that may affect the objectivity of the recommendation should be known.
Diversification
Similar to asset allocation, diversification is the method of allocating investment dollars into different asset classes or sub-types of a particular asset class. This is generally considered a conservative investment strategy designed to reduce overall portfolio risk.
Due diligence
The practice of investigating a potential investment.
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Equity Investment
Also known as the cash investment. That portion of the total purchase price of a property that is not covered by financing.
Exchange Equity
The cash available at the time of closing from the sale of the relinquished property.
Exchanger
The property owner(s) seeking to defer capital gains taxes by utilizing a Section 1031 exchange. (The Internal Revenue Code uses the term "Taxpayer.")
Exchange Period
The replacement property should be received by the taxpayer within the "Exchange Period," which ends on the earlier of 180 days after the date which the taxpayer transferred the property relinquished, or the due date for the taxpayer's tax return for the taxable year when the transfer of the relinquished property occurs (such as April 15th). The exchange period is effectively 180 days due to the Taxpayer's ability to extend the date of payment.
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Finder's Fees
Referral or finder's fees are generally considered transaction-based compensation. Any transaction based commission or compensation paid to an individual or firm involved in recommending, offering or selling TIC investments is compensation that can be paid only to a licensed registered securities broker/representative.
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Gain
The amount obtained from the sale of a property minus the property's adjusted cost basis, and transaction costs. No matter what the adjusted basis of a property is, there's no gain until the property is transferred. There are two types of gain "realized gain" and ìrecognized gain." Realized gain is the difference between the total consideration (cash and anything else of value) received for a piece of property and the adjusted basis. Realized gain is not taxable until it is recognized. Gain is usually, but not always, recognized in the year which it is realized. If gain is not recognized in the year it is realized, it is said to be deferred. In an exchange under Section ß1031, realized gain is recognized in part or in full to the extent that boot is received. (See definition of Boot) Where only like-kind property is received, no gain is recognized at the time of the exchange.
Growth Factor
Interest earned for the duration of the exchange that is payable at the end.
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Identification Period
Replacement property must be identified within 45 days of the close (escrow/closing) of the relinquished property. If the 45th day happens to fall on a weekend or legal holiday, it is not to be extended.
Income property
Real estate that generates cash flow.
Intermediary
The party who facilitates a tax deferred exchange by holding funds during an exchange. The intermediary plays a role in almost all exchanges these days. He or she neither begins nor ends the transaction with any property. He or she facilitates the sale and purchase of replacement properties in return for a fee.
Investor Suitability
Registered securities brokers/representatives who recommend an investment to a customer have a suitability obligation with respect to that recommendation. This duty requires a registered securities broker/representative to have a clear understanding of the investment goals and the current financial status of the investor, and to ensure that the recommended investment is suitable for that particular customer in light of his or her financial situation and objectives.
IRR (Internal Rate of Return)
The return on investment adjusted for the time value of money.
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Leverage
The degree to which an investor or business is using borrowed money.
Like-Kind
To qualify as like-kind property for a 1031 exchange, the property must, by its nature, be real estate and not personal property. All real estate can be exchanged for real estate and qualifies as like-kind. Raw land for improved property is like-kind and vice versa.
Like-Kind Property
Any valid property for any other valid property if the property(s) are held for productive use in trade, business or for investment purposes.
Liquidate
To convert assets into cash.
Liquidity
The ability of an asset to be converted into cash quickly. A TIC private placement should be considered an illiquid investment. There is currently no active market to resale a TIC interest. A TIC investment in real estate is similar to a sole ownership interest in real estate, the owner of the TIC interest has the right to sell their interest at any time subject to the terms outlined in the TIC ownership agreement of the private placement memorandum.
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Market Indicators
Statistical measures of construction and real estate activity, including issued permits, indices of building costs, deeds recorded and homes for sale.
Master Lease
A primary lease that controls subsequent leases and which may cover more property than subsequent leases.
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NASD
National Association of Security Dealers. The NASD is self-regulatory agency that supervises the activities of broker dealers and registered securities brokers/representatives ensuring compliance with all SEC rules. Broker dealers and registered securities brokers/representatives are required to be members of the NASD.
Negative Leverage
The use of debt financing which reduces the percentage return to equity because the rate of interest on the debt is higher than the free and clear rate or return on equity.
Net lease
A property lease in which the tenant pays all expenses normally associated with ownership, such as utilities, maintenance, repairs, insurance, and taxes.
Net Operating Income
The income remaining after vacancy and operating expenses are deducted from gross income.
Net worth
Total assets minus total liabilities of an individual or company.
Non-Recourse Loan
A loan whose terms include the lender agreeing that its sole remedy in the event of failure to repay will be to foreclose against the property securing the loan.
NNN Triple lease
A lease that requires the tenant to pay for property taxes, insurance and maintenance expenses in addition to the rent (also referred to as Net Net Net Lease or Triple Net Lease).
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Operating costs
The ordinary day-to-day expenses incurred by the owners of a property. Generally operating expenses include any expense outside of debt expense, capital expense, and/or reserve expense.
Ordinary income
Income derived from the operation of the property, income other than capital gains.
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Passive income
Income derived from business investments in which the individual is not actively involved, such as a real estate limited partnership.
Portfolio
An individual's (or organization's) collective investments.
Positive Leverage
The use of debt financing that increases the percentage return to equity because the rate of interest on the debt is lower than the free and clear rate of return on equity.
Pre-Marketing
The wrongful process of reserving indications of interest from investors for a private placement (TIC) investment offering before the final Private Placement Memorandum has been prepared by the Sponsor and a selling agreement is in place with the broker dealer.
PPM
A document referred to as a "Private Placement Memorandum" is prepared by the Sponsor that is offering the investment to qualified individuals. A PPM discloses the facts of the property, terms of the investment offering, and potential risks associated with an investor's participation in the investment.
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Qualified Intermediary (QI)
The entity that facilitates the 1031 exchange for the Exchanger. A qualified intermediary is identified as follows:
• Not a related party to the Exchanger, (e.g. agent, attorney, broker, etc.);
• Receives a fee;
• Acquires the relinquished property from the Exchanger; and
• Acquires the replacement property and transfers it to the Exchanger.
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Real Estate vs. Securities
The majority of Tenant-in-Common (TIC) offerings today are packaged as Reg. D Private Placements and are regulated by the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers (NASD). Properly packaged TIC offerings qualify as real estate for 1031 Exchange purposes, but must be sold through licensed securities representatives.
Real Property
In general, land and everything growing on it, attached to it, or erected on it. Examples of real property are single-family rent houses, apartments, shopping centers and office buildings.
Realized Gain
The return an investor recognizes at the point of sale, which may or may not be taxable. In a successful exchange the gain is realized but not recognized and thus not taxed.
Recapture
The amount of tax an investor will pay on the spread between book value after depreciation deductions and sales price. The tax rate on recapture is 25%.
Recognized Gain
Amount of gain that is subject to tax when a property is sold at a profit in a taxable transfer.
Recourse
The right of a lender or holder of a note secured by a mortgage to look to the personal asset of the borrower or endorser for payment should they default, may not be limited to just the property assets.
Reg. D Offering
A safe harbor exemption for TIC investment offerings where participating investors must be qualified as Accredited Investors. This is the most frequent type of TIC investment offering used by TIC Sponsors.
Registered Securities Broker/Representative
An individual, who recommends, offers or sells investments in return for a commission. A registered securities broker/representative must be associated with a broker dealer and licensed as a securities professional with the SEC, the NASD and all states in which he conducts business. Any unlicensed individual or firm involved in recommending, offering or selling TIC investments is in violation of federal and state securities laws.
Relinquished Property
The original property that is being sold by the Exchanger. Formally referred to as the Down leg property, currently referred to as the Phase 1 property.
Replacement Property
The property acquired by the Exchanger. This is sometimes referred to as the ìacquisitionî property or the ìuplegî property.
Return
The profit made on an investment, expressed annually as a percentage of the total amount invested.
Registered Representative
An individual who is licensed to sell securities and has the legal power of an agent, having passed the Series 7and Series 63 examinations. Usually works for a brokerage licensed by the SEC, NYSE, and NASD.
Revenue Procedure 2002-22
On March 19,2002, Revenue Procedure 2002-22 was issued to provide guidance regarding the conditions under which the IRS will entertain a private letter ruling that a TIC interest will not be treated as a partnership interest for tax purpose. The guidance clarifies the criteria which the IRS views as distinguishing a real estate TIC arrangement from a partnership, and enables sponsors to create rental real estate structures that have ownership units capable of being used in a like-kind exchange.
Risk
The possibility of losing capital on an investment, the inverse of the return possibility.
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Safe Harbor
Term identifying the requirements to protect the Exchanger's money and the "Qualified Intermediary."
Securities and Exchange Commission (SEC)
The law making government agency that defines the rules by which broker dealers and registered securities brokers/representatives must operate when offering investment to the public.
Securities Investor Protection Corporation (SIPC)
A non-profit membership corporation established by Congress that insures securities and cash in customer accounts up to $500,000 (up to $100,000 in cash) in the event of brokerage bankruptcy.
Seller
The person who owns the property that the taxpayer wants to acquire in the exchange in a three or four party exchange.
Sequential Deeding
Property that's deeded to the Intermediary whereby the Intermediary deeds to the final owner.
Simultaneous/Concurrent
Exchange without any time between the sale and purchase.
Simultaneous Exchange
Also referred to as a concurrent exchange when the Exchanger transfers out of the Relinquished Property and receives the Replacement Property at the same time.
Sponsor
A real estate provider that sources the investment property, garners the financing, and manages the assets for the owner. Sponsors provide the service of packaging the investment property into a TIC format, allowing fractional undivided interests in one property to be sold to multiple co-owners as TIC interests.
Starker Exchange
A term used to describe delayed exchanges. "Starker vs. Commissioner" established the delayed exchange concept. The term "starker exchange" is used as another way of referring to delayed, deferred or any other non-simultaneous exchange.
Syndication
1) A combining of persons or firms to accomplish a joint venture of mutual interest. 2) The process of acquiring and combining equity investment from multiple sources.
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Tax-advantaged
Having other tax benefits that typically result in tax savings.
Taxpayer
Also known as the exchanger. A taxpayer has property and would like to exchange it for new property. While all parties in an exchange are theoretically taxpayers, this term applies to the party who expects to receive tax-deferred treatment under Section §1031.
Tax Reform Act of 1984
In the Tax Reform Act of 1984, Congress addressed the IRS's continued displeasure with the Starker decision by amending Section ß1031 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 ß1031. 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.
Tax shelter
A technique that allows an investment to be legally exempt from federal, state, and local taxes to varying degrees.
Tenant-In-Common (TIC)
As a TIC owner, you have an undivided fractional interest in an entire property and share in your portion of the net income, tax shelters, and appreciation. Each TIC owner receives a separate property deed and title insurance for their portion in the property investment. This gives you the same rights of ownership that a single owner would enjoy.
TIC Distribution Process
A real estate provider sources an investment property and prepares an investment offering through a PPM. Broker dealers conduct due diligence on the investment offering and execute an agreement to sell the TIC investment to qualified investors through its registered securities brokers/representatives. A cooling off period is then recommended allowing registered securities brokers/representatives and investors sufficient time to review the PPM and make a determination of the merits of the investment offering. Interested Investors then submit applications to participate in the TIC investment through their registered securities broker/representatives and broker dealers to the Sponsors.
Transaction Costs
Any cash paid by way of commission or other expense in an exchange. Transaction costs are deducted in computing the consideration received.
Transfer Tax
A tax assessed by a city, county or state on the transfer of property that may be based on equity or value. The use of direct deeding in an exchange avoids additional transfer tax.
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Undervalued
Generally referring to the perception that a property is below fair market value.
