For Your Advisor · Tax Deferred Wealth

The structure

A conventional deferred exchange under IRC §1031 and Treas. Reg. §1.1031(k)-1, using a qualified intermediary under the safe harbor in §1.1031(k)-1(g)(4). The intermediary is a safe harbor against actual and constructive receipt, not the only possible structure; it is the one used in this program.

Relinquished property: your client’s real property held for investment or for productive use in a trade or business.
Replacement property: real property held for investment, acquired by the same taxpayer who sold, with title in the client’s name or their disregarded entity. Since 2018, §1031 applies only to real property (IRC §1031(a)(1)).
Exchange funds are held by the intermediary under a written exchange agreement that restricts the client’s access to them (§1.1031(k)-1(g)(6)).

Timing

45 days from the transfer of the relinquished property to identify replacement property in writing (§1031(a)(3)(A); §1.1031(k)-1(b), (c)).
The earlier of 180 days or the due date, with extensions, of the return for the year of the transfer to receive it (§1031(a)(3)(B)).
Both periods can be postponed for taxpayers affected by a federally declared disaster when the IRS issues relief covering them (IRC §7508A; Rev. Proc. 2018-58 §17). They are not extended for a difficult deal.

Gain, boot and debt

Cash or other non-like-kind property received is taxable to the extent of realized gain (§1031(b)).
Liabilities relieved on the sale are treated as cash received unless offset, by liabilities assumed on the replacement property or by additional cash paid (§1.1031(d)-2). Net debt relief is boot.
Basis carries over, adjusted under §1031(d). Prior depreciation stays with the replacement property; unrecaptured §1250 gain remains deferred, not eliminated.

California

California generally conforms to §1031 (R&TC §18031).
When California property is exchanged for property outside California, the taxpayer files FTB Form 3840 each year the gain stays deferred, and California can tax the deferred California-source gain when the replacement property is later disposed of in a taxable transaction (R&TC §18032).
California taxes capital gains as ordinary income, at rates up to 13.3%.

Estate considerations

Under current law, property held at death may receive a basis adjustment under IRC §1014. Whether that matters for your client, and how, is for you and them to decide.

What the program does, and doesn’t, do

Tax Deferred Wealth coordinates the plan and introduces replacement options through licensed partners.
Institutional 1031 is the qualified intermediary for exchanges in this program. It holds exchange funds under written exchange agreements and does not advise on the suitability of any replacement property.
No one in the program gives your client tax or legal advice. That is your role, and we’d rather you were involved early.

Risks worth discussing with your client

Deadlines. A missed identification or closing deadline can make the whole gain taxable.
The property. Real estate values and income can fall. Tenants, including tenants under long-term leases, can default.
Distance and concentration. Property in another state, or one or two properties, concentrates risk and can be harder to oversee.
Liquidity. Real property can take time to sell.
California. The Form 3840 obligation continues for as long as the gain is deferred.

Questions worth asking

Is the relinquished property clearly held for investment, and for how long?
How much depreciation has been taken, and what is the client’s realized gain?
What debt is being paid off, and how will it be replaced or offset?
Who holds title now, and who will take title to the replacement?
Does the client need any of the proceeds? Cash taken out is taxable.
How will the replacement property be managed, and what does the lease require of the owner?

Talk to us

We’re glad to walk you through a specific transaction with your client’s permission.

The structure, the authority, and the questions worth asking.