10A — February 12 - 25, 2016 — Financial Digest — M id A tlantic 26A — February 12 -25, 2016 — Pennsylvania — M id A tlAntic
Real Estate Journal
Real Estate Journal
F inancial D igest
By Jessica Zolotorofe, Ansell Grimm & Aaron Completing the 1031 process: DON’T GET THE BOOT!
1 031 exchanges are among the most effective tax-de- ferral tools for real estate
not extend to the next business day, and literally, a single minute after the identification or closing periods expire, in- vestors are out of luck and can only avoid boot to the extent of the replacement properties actually identified and closed prior to the prescribed dead- lines. Calculating and calen- daring reminder alerts for two or three business days before the deadlines is a helpful way to ensure investors will be prepared to timely meet these requirements. (B) Identification Rules. There are three options for identifying potential proper- ties in order to qualify them as “replacement properties” for 1031 purposes: (1) The Three Property Rule : Up to three properties may be identified to replace the relinquished property or properties, without regard to the aggregate purchase prices or market values. (2) The 200% Rule: Any number of replacement prop- erties may be identified, pro- vided the aggregate fair mar- ket value thereof does not exceed 200% of the value of the relinquished property or properties. For example, if the relinquished property was sold for $1,000,000, then the investors can identify any number of like-kind properties so long as their values don’t collectively exceed $2,000,000. (3) The 95% Rule: Any number of properties (even if the total combined value ex- ceeds 200%) can be identified so long as the investors actu- ally consummate the purchase of at least 95% of the value of the properties identified prior to the expiration of the
costs. While the IRS has not pro- vided a comprehensive list of qualifying costs, the following have been deemed acceptable: (i) real estate commissions; (ii) title searches and owner’s title policy premiums; (iii) deed recording fees, realty trans- fer fees and transfer taxes; (iv) costs of due diligence performed in connection with the purchase of a replacement property; and (v) legal fees. Costs incurred in connec- tion with financing are not qualified to reduce 1031 cash requirements, including (i) lender’s title policies; (ii) mort- gage insurance; and (ii) points or fees paid to a lender. The other category of costs which
Closing Period. For example, if the relinquished property was sold for $1,000,000, and five properties are identified with a total market value of $3,500,000, the investor would have to close properties with at least a combined value of $3,325,000 in order to avoid boot. Investors must submit de- tailed descriptions of each po- tential replacement property, in writing and signed, prior to the identification deadline. It is always wise to request that the qualified intermediary countersign, or acknowledge receipt of the identification form in writing, and to keep copies of fax confirmations or other delivery receipts.
The objective of undertaking a 1031 exchange is defeated if an investor ends up with substantial boot. In addition to having to pay taxes on the rec- ognized gain, the investor will also be left with less money to reinvest in replacement properties. To maximize the benefits of a 1031 exchange, investors should structure the transactions to result in as little boot as possible. This article is intended for infor- mational purposes only, should not be considered legal advice, and is not intended to create an attorney-client relationship. Please consult with your attorney and accountant prior to relying on any information contained herein.
investors if c omp l e t e d s t r i c t l y i n accordance with the gov- erning rules and regula- tions. It is important for investors to
consult with their legal coun- sel and accountants to devise a plan in order to properly complete the 1031 process and to avoid “boot”. While not defined in the Internal Revenue Code, the term “boot” has become the common term in the industry to describe any portion of in- vestors’ (i) sale proceeds, or (ii) mortgage debt satisfied in connection with the sale of the relinquished property, which is not reinvested in the replacement properties. Any boot received is taxable to the investor-taxpayers. The most common ways that investors end up with signifi- cant boot are (A) missed dead- lines, (B) improper replace- ment property identification, or (C) miscalculation. (A) Deadlines. 1031 ex- changes are subject to two hard deadlines. The period during which investors must identify all replacement prop- erties (the “ID Period”) expires on the 45th day following the closing of the relinquished property. Thereafter, all re- placement properties must be closed on or prior to the 180th day after the relinquished property was closed. Even if those deadlines fall on a week- end or holiday, the period does PHilADElPHiA, PA — Colliers international Capital Markets (CiCM) , a provider of commercial real estate finance and capi- tal markets expertise, ar- ranged $24 million of debt for the acquisition and re- development of the former West Philadelphia High School located at 4700 Wal- nut St. The 442,200 s/f, four story building will be converted to a 298 unit multifamily prop- erty. Kristopher Wood and John Banas , both senior vice presidents/directors in
do not qualify are adjustments between a buyer and seller such as (i) real property taxes; (ii) insurance; (iii) utilities; and (iv) rent adjustments. In fact, because payment of non-qualified expenses by the qualified intermediary out of exchange proceeds will result in taxable boot, investors should be prepared to bring cash to the closing table to cover those costs. “The borrower wanted to purchase and reposition the former school located in West Philadelphia near University City,” said Wood. “Getting a construction loan was challenging because this was the first development the New York developer had done in Philadelphia, and many thought the location was not ready for 298 new apartments. CICM sourced a loan from a national Real Estate lender who took the time to under-
(C) Calculations. Main- taining and updating a de- tailed “roadmap” or spread- sheet throughout the 1031 exchange process can prove invaluable in effectively navi- gating the transactions. The following is some of the impor- tant information to include: As reflected in the roadmap above, some of the cash re- placement requirement can be satisfied with qualified closing
Jessica Zolotorofe is an attorney with the law firm of Ansell Grimm & Aaron. Her practice is focused on commercial real estate trans- actions, including financing, acquisitions, development, sales, leasing, and structur- ing tax-deferred exchanges. Jessica can be reached at 973- 247-9000 or by email at JTZ@ AnsellGrimm.com. n stand what was happening in University City and what a great opportunity such a large building afforded the developer to build.” Wood added. “Many apartment oper- ators are capitalizing on quality assets that present opportunities for adaptive reuse of older assets into great apartment buildings,” adds Banas. The three year adjustable loan is interest only at Libor plus 3.75% and was done as a Section 47 Historic Tax Credit deal. n
Colliers International’s Capital Markets Team srranges $24million in financing CICM’s Philadelphia office, arranged the loan.
4700 Walnut St.
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