The following list contains from terms which are commonly used in the §1031 exchange process.
A §1031 is a reference to that section of the Internal Revenue Code or “IRC” which is the source of the tax deferral. that allows a taxpayer to defer the capital gains tax, which would typically be paid at the time of sale. §1031 allows a taxpayer to defer the capital gain or loss, which would otherwise be recognized upon the sale of qualified real estate.
Accelerated depreciation allows an investor to deduct a larger portion of the depreciable property’s cost in the first years after purchase. This leads to higher tax deductions and encourages investors to increase their spending.
Accommodator refers to an “Exchange Accommodation Titleholder” or “EAT” which facilitates the exchange of properties in a reverse exchange. This party is also sometimes referred to as a Facilitator. Typically will be created as a limited liability company.
Basis is generally the amount of your capital investment in property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property. In most situations, the bases of an asset is its cost to you. In real estate, basis is allocated between the land (which is not depreciable) and the improvements (which can be depreciated). Basis is “adjusted” (meaning increased or decreased) during the period of ownership. Basis can be increased by Capital Improvements and deceased by Depreciation.
Boot can be in the form of property or money that is given or received in addition to the real estate being exchanged.
Capital gains tax is a tax imposed on the profit realized from the sale of an asset that has increased in value. When you sell an asset such as stocks, real estate, artwork, or other investments at a price higher than what you originally paid for it, the difference between the sale price and the original purchase price is called capital gain. Capital gaines are categorized into two main types:
- Short-term capital gains: These are gains from assets held for one year or less before being sold. Short-term capital gains are typically taxed at a higher rate than long-term capital gains.
- Long-term capital gains: These are gains from assets held for more than one year before being sold. Long-term capital gains often receive more favorable tax treatment, which lower tax rates compared to short-term gains.
The capital gains tax rate varies depending on factors such as your income, your filing status, and the type of asset being sold. Capital gain is taxed at the federal level and is also levied in certain states.
Capital improvements to real estate are those which are “capitalized” (and thus increase the asset’s basis and are depreciated over time) as opposed to ordinary expense items (which reduce gross income and are fully expensed in this year they occur).
Constructive receipt is where a taxpayer exercises control over the escrowed property, even though the taxpayer may not be in actual control. Example: taxpayer’s attorney is the signer on a bank account which is established to hold the taxpayer’s funds from the sale of relinquished property. Attorney represents taxpayer. Taxpayer may be in constructive receipt since Attorney acts for Taxpayer’s benefit.
A deferred exchange is one which does not occur simultaneously but instead utilizes the exchange period to complete the exchange at a later date.
§167 and §168 of the IRC are the source of most depreciation allowances. Depreciation reduces the Basis of an asset and is an expense to the taxpayer. Depreciation (and the amount allowed as an expense) is measured by the useful life of the asset. The IRS publishes tables listing the useful life of all types of assets. For real estate purposes:
- Residential Rental Properties: Residential rental properties (such as apartments, houses, and condominiums) are typically depreciated over a period of 27.5 years using the Modified Accelerated Cost Recovery System (MACRS).
- Commercial properties: Commercial properties, which include office buildings, warehouses, and retail spaces, are depreciated over a longer period of 39 years using MACRS.
- Depreciation methods: MACRS allows for different depreciation methods, with the most common one being the “straight-line” method. This method spreads the cost of the property evenly over the designated recovery period.
- Land: It’s important to note that land itself is not depreciable. Only the improvements on the land, such as buildings and other structures, can be depreciated. Land is considered to have an indefinite useful life and does not lose value over time.
- Recapture: When you sell a property for more than its depreciated value, you may be subject to “depreciation recapture” where a portion of the gain is taxed at a higher rate than the standard capital gains rate.
- Section 179 Deduction and Bonus Depreciation: In addition to regular depreciation, there are other provisions that allow for accelerated deductions in certain cases. The Section 179 deduction and bonus depreciation can provide larger upfront deductions for qualifying assets, including some improvements to real property.
It’s important to keep in mind that tax laws and regulations can change over time, so it’s recommended to consult with a tax professional or financial advisor who is up-to-date with the latest rules and regulations. They can help you determine the appropriate depreciation strategy for your specific real estate investments and ensure compliance with tax laws.
When you sell a property for more than its depreciated value, you may be subject to “depreciation recapture” where a portion of the gain is taxed at a higher rate than the standard capital gains rate.
Equity in a §1031 exchange transaction generally refers to the amount of equity which exists in the subject real estate.
The 45 day period that a taxpayer has to identify property that is intended to be part of the exchange.
“Like-kind” refers to the character of real estate as property “held for use in a trade or business or held for investment” and not to its grade or quality (i.e., whether it is a single family home, retail center or something else). Real estate in an exchange must be “Like-kind” to each other.
A qualified intermediary is a term that was created as part of the Safe Harbor regulations. In a deferred exchange a qualified intermediary is used to avoid actual or constructive receipt issues by the taxpayer. A qualified intermediary is a defined term and limits who can serve in this capacity.
In the context of a §1031 exchange, a related party is someone related to the taxpayer, such as a family member or an entity in which the taxpayer has a significant ownership interest. Special rules and restrictions apply when exchanging with related parties.
Refers to the real property that is sold or transferred by the taxpayer as part of a §1031 exchange.
Refers to the real property acquired by the taxpayer to complete a §1031 exchange. It must be of like-kind to the relinquished property and properly identified within the 45 day time frame .
A safe harbor in the context of the tax code refers to a set of specific rules, guidelines, or provisions that provide taxpayers with a predetermined level of compliance or certainty when dealing with particular tax issues. Following a safe harbor ensures that the taxpayer will not be subject to certain penalties or challenges by tax authorities, as long as they meet the conditions outlined in the safe harbor provisions
Refers to the case of Starker vs. Commissioner, 602 F. 2d 1341 (9th Cir. 1979)that set a precedent for the modern §1031 exchange process.
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