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Study Notes on Exchanges
XI. Section 1031 Exchange (Exchange Types)
- Two-party exchanges.
- An exchange of three or more properties.
- The three-party “Alderson” exchange.
- The three-party “Baird Publishing” exchange.
The person wishing to acquire the taxpayer’s property does not own like-kind property and the owner of the like-kind property does not want the taxpayer’s property.
A two-party exchange.
A reciprocal sales format.
- Audit profile.
- Exchange can be denied if the taxpayer directed the transfer of sales proceeds from one property to an escrow for the purchase of a replacement property not in a timely manner.
- The court can interpret that because neither of the transactions was conditioned on the successful completion of the other, the taxpayer had made a sale and reinvestment, rather than an exchange.
- If receipt of cash, the court can interpret that the receipt of cash by a taxpayer subject to an oral obligation to transfer it to another did not create an exchange.
A three-party-plus exchange.
The “musical chairs” ruling contained in R.R. 57-244.
The buyer, the client, and the seller.
When one of the parties cashed out in the exchange.
The three-Party “Alderson” Exchange.
Mechanics of the transaction and the conceptual intent of the parties must indicate an exchange.
Middleman or accommodator.
First step and escrow, the buyer purchases the property from a seller.
Second step and escrow, the buyer transfers the property to the client in exchange for the client’s property.
The seller.
The client.
The buyer.
It is best for the Buyer to take legal title of the property even though it will exchange with the Client.
Contingent and conditional upon one another.
- Insist that his or her purchase of the property be contingent upon the successful closing of the exchange escrow in order to protect himself or herself against acquiring unwanted properties.
- Buyer, in many instances, will also demand a hold harmless provision so that he or she will not have any additional costs or liability because of his or her momentary holding of title to the property later exchange with the Client.
It is not necessary that they close on the same day, so long as all parties are legally bound to complete the total transaction and the Client does not receive or control any cash.
The client should not enter into negotiations between the Buyer and the Seller for the purchase of the property in exchange with the Buyer.
Clients involvement should be limited to locating and ascertaining the purchase prices of parcels that are acceptable for purposes of exchange and perhaps approval of the purchase agreement, ultimately agreed to between Buyer and Seller.
- Client and Buyer would enter into an exchange agreement (This can be an addendum to a sale agreement).
- The Client would look for suitable exchange property and inform the Buyer when Client locates it.
- The Buyer would enter into a purchase-sale agreement with the Seller to acquire the exchange property.
The Buyer might grant a limited power of attorney to his or her real estate agent or attorney to sign such an agreement on his or her behalf.
Contingent upon the exchange between Client and Buyer under the exchange agreement.
Most times Buyer acts as a middleman merely as an accommodation to the Client, who desires to realize the benefits of a §1031 exchange.
Alter the substance of the transaction as being an exchange, so long as the other elements of the transaction evidence exchange and separate sale.
Sign either the purchase agreement or the purchaser’s escrow instructions on behalf of the Buyer.
Have the right, constructive, or otherwise, to unilaterally call off the exchange and receive cash.
He or she must execute the deposit receipt or otherwise lose the property.
Specify that the Buyer is the purchaser who will pay for and take legal title to the property and that the purchase agreement is contingent upon the exchange between Client and Buyer; or,
A novation should be attached to the deposit receipt permitting Client to substitute Buyer as the party contractually bound to purchase the property, and upon such substitution relieving Client of any duty to purchase the property.
It is the transfer of rights and duties. Unlike an assignment, it is usually limited to transfer rights.
Receive money from any source other than those funds, if any, deposited by the Buyer to balance the transaction in the exchange escrow, and intentionally received by Client as boot.
Acquire any rights to receive money from the transaction, except that which is paid to him or her out of the exchange escrow as intentional boot.
The Client may contract with the Buyer prior to locating suitable exchange property and may even give Buyer the right to pay cash for Client’s property should the suitable exchange property not be located before a certain date.
Clearly restrict the Client’s right to the loan proceeds (cash) used by Buyer to purchase the property.
Reflect the central theme of an integrated tax-deferred exchange, by making all distinguishable and apparently independent elements reciprocally contingent upon the completion of the exchange element of the transaction.
The Client is able to locate the Buyer for purchase of his or her property but not yet locate a Seller.
The parties could agree to a sale of Client’s property to the Buyer only if the suitable property cannot be located and purchased before the specified closing date.
It is a clause in a contract that states that the Buyer is allowed to pay the client cash for the property even if the Buyer fails to locate a suitable exchange property before a specific date. The law is well settled that such a “sale-in-lieu” agreement between the parties has no effect on an otherwise valid exchange.
When the documentation gives the intended buyer the right to purchase the property “in lieu” of the exchange, the IRS can argue that there were two separate transactions: one in which the taxpayer sold his or her property to Buyer, another in which he or she purchased the property he or she wished to exchange into.
The exchange step of the transaction occurs before the sale step and the middleman is the Seller rather than the Buyer.
The property will transfer to the Seller and the Client will receive the Seller’s property.
The Seller will sell the property received from the Client to the Buyer.
An option to purchase the property.
Because there is no precedent exists which has approved this type of exchange, and the Client has negotiated the sale in terms of the option contract.
For a period of at least 90 to 120 days so that Client will have time to locate property and Buyer will not exercise the option prior to the exchange with Seller.
An agent for one of the remaining three parties.
Actually a three-party exchange with a fourth-party agent.
It is often difficult to tell for whom the agent is acting since there is seldom a formal agency relationship.
A title Company.
The agent acts on behalf of the Buyer.
The agent acts on behalf of the Seller.