1031 Exchange Glossary

Exchange: The act of giving one thing as equivalent for another. To trade. The process of conveying and acquiring “Like kind” investment properties in a manner to avoid or defer payment of taxes on the capital gain.

Deferred Exchange: This term is now used in place of "Non-Simultaneous Exchange" or "Starker Exchange". This is the type of an exchange where the Exchanger utilizes the exchange period described above.

STARKER: Name of the taxpayer in U.S. Court of Appeal's case which authorized Delayed Exchanges. The term "Starker Exchange" is no longer used to describe a Delayed Exchange.

SEQUENTIAL DEEDING: Property is actually deeded to the Intermediary and the Intermediary deeds to the ultimate owner.

Direct Deeding: Vested owner deeds directly to the ultimate owner. Does not eliminate the duties of the Qualified Intermediary to acquire and transfer the relinquished property and acquire and transfer the Replacement Property.

Exchange Agreement: A deferred Exchange is defined as an exchange in which, PURSUANT TO AN AGREEMENT, the Exchanger transfers the relinquished property and subsequently receives the replacement property. THEREFORE, AN EXCHANGE AGREEMENT IS VITAL.

Relinquished Property: (Also called “Downleg” or Sale Property)This is the property you now own and are planning to sell or exchange. This is also sometimes referred to as the "exchange" property or the "downleg" property.

Replacement Property: (Also called “Upleg” or Purchase Property). Replacement Property is the property or properties intended to be purchased with the funds that are received from the sale of the Relinquished Property. There are limitations on how many replacement properties you may identify in the same deferred exchange, no matter how many relinquished properties you transfer. This is sometimes referred to as the "acquisition" property or the "upleg" property.

Qualified Intermediary: A Qualified Intermediary, or QI, is an independent party who facilitates tax-deferred exchanges pursuant to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person. Acting under a written agreement with the taxpayer, the QI acquires the relinquished property and transfers it to the buyer. The QI will hold the sales proceeds to prevent the taxpayer from having actual or constructive receipt of the funds. Finally, the QI acquires the replacement property and transfers it to the taxpayer to complete the exchange before the end of the exchange period.

Constructive Receipt: A taxpayer is said to be in constructive receipt of money or property at the time the money or property is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available so that the taxpayer may draw upon it.

Like Kind Property: Like kind does not refer to the grade, type or quality of property, but only to the way the taxpayer uses the property. So, all real property in the U.S. is like kind to all other real property in the U.S. so long as each is either held for productive use in trade or business or held for investment by the taxpayer doing the exchange.

Equity: The fair market value (FMV) in excess of mortgages and other liens.

Basis: The value of property for purposes of depreciation. For a purchased real property asset the basis is the initial amount paid for the property, plus capital improvements, less depreciation.

New Basis: Basis of the new property in the hands of the new owner after acquisition of the property through purchase or exchange.

Old Basis: Adjusted cost basis of the property being exchanged.

Continuity of investment rationale: One of the rationales believed to be behind the original enactment of IRC §1031 which provides that if the taxpayer’s money is still tied up in the same kind of property as that which is was originally invested, he is not allowed to compute and deduct his theoretical loss, nor is he charged with the tax on his theoretical profit.

Capital Gains: Gains realized from the sale or exchange of capital assets. Generally, the difference between cost (i.e. basis) and selling price, less certain deductible expenses. Used mainly for income tax purposes.

Realized Gain: The excess of the amount realized over the adjusted basis of the property transferred.

Recognized Gain: In a qualifying 1031 exchange, the taxpayer’s realized gain is recognized only to the extent of the sum of money and the fair market value of other “Non-Like kind” properties received by the taxpayer in the exchange.

Boot: Something given in addition to. Cash or personal property over and above equity. Generally used in exchange transactions to refer to something given, other than the major properties to be exchanged, in order to equalize value.

Cash Boot: Cash and non-qualifying property (i.e. not like kind) received in an exchange.

Mortgage Boot: Liabilities assumed or taken subject to in an exchange.

Debt Relief: Another term for mortgage boot received, which means that the taxpayer’s liabilities have been assumed or taken subject to, in the exchange.

Net Loan Relief: Net mortgage boot received after applying boot-offset rules. The amount of the taxpayer’s liabilities which have been assumed or taken subject to by another, less the amount of liabilities which the taxpayer has assumed or taken subject to.

Boot-Offset: When a taxpayer both pays and receives boot certain boot-offset rules apply.

Dealer: A person who holds property primarily for sale to customers in the ordinary course of his trade or business. The importance of the term is for tax purposes. If IRS determines that a taxpayer is a dealer, the taxpayer will not be allowed the capital gains benefits of an investor, but will be taxed at ordinary rates.

Depreciation: Decrease in value to real property improvements brought about by age, physical deterioration, functional or economic obsolescence. Also a loss in value as an accounting procedure to use as a deduction for income tax purposes.

Disqualified Person: Treasury Regulation §1.1031(k)-1(k) has chosen to restrict the use of related parties as qualified escrow agents, trustees and intermediaries. Generally a person who has acted as the taxpayer’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within a two year period, direct linear relations (i.e. taxpayer’s parent, child, sibling, etc.), and certain other parties are not allowed to act as the intermediary. Furthermore, none of these persons can own as much as 10% of any Qualified Intermediary used by their clients without also becoming disqualified. For example, if even so much as 10% ownership of a Qualified Intermediary is held by a CPA or Real Estate Agent, then that QI is considered to be a “Disqualified Person” for every client who has used that CPA or Real Estate Agent in the last 2 years.

Disregarded Entity: An entity that the IRS has determined need not file its own tax return. The two most common and most applicable to 1031’s are the “Living Trust” and the “Single Member LLC”. Any income or expense from the assets owned by the “Living Trust” must be reported on the tax return of the entity controlling the trust. Likewise with LLC’s and the tax return of the LLC’s sole member.

Exchange Period: The period of time within which the taxpayer must receive the replacement property. It begins on the date the taxpayer transfers the relinquished property and ends at midnight on the earlier of the 180th day thereafter or the due date (including extensions) for the taxpayer’s tax return for the tax year in which the transfer of the relinquished property occurs.

Holding Period: In an exchange, it begins on the date of acquisition of the original property.

Identification period: The period set by IRC §1031 during which the taxpayer must identify replacement property. The identification period begins on the date the taxpayer transfers the relinquished property and ends at midnight on the 45th day thereafter.

Incidental Property: Property which will not be treated as property separate from a larger item of property if in standard commercial transactions the property is typically transferred together with the larger item of property, and the aggregate fair market value of the incidental property does not exceed 15 percent of the aggregate fair market value of the larger item of property. (Treasury Regulation §1.1031(k)-1( c)(5), i.e. Laundry room facilities in an apartment complex.)

Ninety Five Percent Rule: One of the rules for identifying alternative and multiple replacement properties specified by Treasury Regulation §1.1031(k)-1(c)(4)(ii)(B) which provides that the taxpayer may identify any number of replacement properties, no matter their aggregate fair market value, so long as the taxpayer receives no less than 95% of the aggregate fair market value of all identified properties, before the end of the exchange period.