10A — December 18 - January 14, 2020 — Commercial Real Estate Law — M id A tlantic Real Estate Journal
C ommercial R eal E state L aw
By Andrew Maguire, McCausland Keen + Buckman 1031 Exchange Note Transactions: An option for real estate owners to consider
timeframes after the date of the sale. But what if some of the seller’s members prefer to
Qualified Intermediary In a typical 1031 Exchange, a qualified intermediary (“QI”)
(1) the QI takes receipt of the cash proceeds from the sale; (2) a portion of the cash proceeds is set aside and used to purchase the replacement property; (3) the remainder of the cash proceeds is retained; and (4) a promissory note is issued to and in favor of the seller in an amount equal to such remainder of the cash proceeds (“Remainder Note”). Redemption Following the sale of the property, those owners of the seller entity who wish to re- ceive their share of the sale proceeds (“Cashout Investors”) are redeemed out of the seller
entity. To effect the redemp- tion, the Remainder Note is distributed to the Cashout Investors in exchange for their interests in the seller entity. If the seller is a partnership or a limited liability company, a new partner or member may need to be admitted to the seller entity prior to the re- demption so that it remains a partnership for federal income tax purposes. Accordingly, the partnership agreement or operating agreement of the entity should be amended to reflect the exit of the Cashout Investors and, to the extent necessary, the admission of a new partner or member. Remainder Note For income tax purposes, payments made pursuant to a Remainder Note must be treated as an installment sale covering two taxable years of the seller. Accordingly, those Cashout Investors who receive the Remainder Note in re- demption of their interests will receive their cash payout un- der the Note over two tax (i.e., calendar) years. For example, if the seller entity sells a prop- erty in December of 2020, each Cashout Investor may receive a portion of the sales proceeds in December of 2020, with the balance to be collected in 2021. Conclusion A 1031 Note Transaction can be a viable method for allowing certain owners of an entity selling U.S. real estate to undertake a 1031 Exchange while allowing other owners to collect their share of the sale proceeds. However, the particulars of any 1031 Ex- change are fact dependent, and the rules governing 1031 Exchanges continue to evolve. A property owner must consult with capable tax and real es- tate counsel before undertak- ing a 1031 Note Transaction. Andrew Maguire coun- sels REITs and other pub- licly-traded companies, as well as privately held entities and family offices. He negotiates, documents and closes acquisitions, dispositions and financings across the spectrumof com- mercial real estate sectors. Please note that this ar- ticle does not constitute legal advice or tax advice, and that reading this ar- ticle does not create an attorney-client relationship with McCausland Keen + Buckman. MAREJ
or years, real estate in- vestors have enjoyed the benefits of tax de-
ferral under Section 1031 of the Inter- nal Revenue Code (“1031 Exchange”). Und e r t he 1 0 3 1 E x - change rules, sellers of U.S.
A 1031 Note Transaction can be a viable method for al- lowing certain owners of an entity selling U.S. real estate to undertake a 1031 Exchange while allowing other own- ers to collect their share of the sale proceeds.
pocket their share of the sales proceeds (and pay the result- ing capital gains tax) rather than re-investing those funds in a replacement property? One approach is to implement a like-kind exchange with a note structure (“1031 Note Transaction”). Role of the
holds the cash proceeds re- ceived from the buyer of the re- linquished property until they are re-invested in one or more replacement properties. This is done in an effort to prevent the cash proceeds from being characterized as taxable “boot” income to the seller. However, in a 1031 Note Transaction:
real estate are able to defer some or all of the capital gains tax on sales proceeds which are re-invested in replace- ment properties identified and purchased within particular
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