Glossary

A 1031 exchange involves swapping one investment property for another to defer capital gains tax on the sale. The term comes from the Internal Revenue Service (IRS) code Section 1031.

To meet the Exchange Period Deadline, the investor must complete the acquisition transaction of the replacement property(ies) on or before the earlier of 1) midnight on the 180th calendar day after the close of the relinquished property sale transaction, or 2) the due date of their federal income tax return for the year in which the relinquished property was sold.

Whichever time frame is earlier is the one that applies to your situation. So, if the 180-day rule is earlier than the due date of your tax return, then you will need to close on your new property in those 180 days.

The 200% Fair Market Value Identification Rule, or “200% Rule,” allows for the identification of an unlimited number of like-kind replacement properties in a 1031 exchange. However, the combined fair market value of all these identified properties must not exceed 200% of the total net sales value of the relinquished property or properties.

In a delayed exchange, the 45-day rule serves as the identification period for your replacement property.

To meet the identification period deadline, an investor must identify a list of potential replacement properties and provide that list to their qualified intermediary at or before midnight on the 45th calendar day after the close of the relinquished property sale transaction.

A 721 Exchange is a tax-deferred transaction in which property owners exchange their real estate assets for operating partnership units in a Real Estate Investment Trust (REIT). This exchange enables property owners to diversify their investments while deferring capital gains taxes.

Any number of properties may be identified as long as the taxpayer purchases 95% of the fair market value of all properties. 

The 95% Identification Exception (“95% Exception”) states you can identify an unlimited number of potential like-kind replacement properties with an unlimited aggregate fair market value as long as you actually acquire and close on 95% of the value identified.

Accredited investors have the financial ability to absorb losses. They can trade unregistered securities provided they satisfy one or more requirements for specific financial or professional criteria such as net worth, assets, etc. The SEC-accredited investor definition is in Rule 501 of Regulation D of the Securities Act of 1933.

Used to calculate the capital gains taxes owed on the sale of an asset. It is calculated by taking the original purchase price and adding related expenses such as closing costs, improvements, and commissions, then subtracting any depreciation or deductions taken over time.

Appreciation is the increase in the value of a property over time. It can occur due to various factors, such as market conditions, improvements made to the property, and inflation.

In a 1031 exchange, a boot is any non-like-kind property or cash received by the investor. This can include debt relief or money left over after acquiring the replacement property.

Capital gains are the profits earned from the sale of a real estate asset.

A property’s annual net cash flow divided by net investment, expressed as a percentage. For example, if the net cash flow from a property is $10,000, and the cash invested in the property is $100,000, then the cash-on-cash return is calculated to be 10% ($10,000/$100,000). 

Cash-on-cash does not include property appreciation, which is a non-cash flow item until the year of sale.

Community property refers to assets acquired by a married couple during their marriage, which are considered jointly owned by both spouses. 

In community property states, such as California, Arizona, and Texas, marital property is divided equally between spouses in the event of divorce or death. This designation has implications for tax planning, including 1031 exchanges, as it affects the ownership and transfer of real estate assets within a married couple’s portfolio.

The original purchase price of an asset, including acquisition costs and capital improvements, minus any depreciation taken on the asset during its ownership.

Calculations, starting with the purchase price you paid when you bought the property, will inform your cost basis.

Cost segregation analysis is a strategic tax planning tool used by real estate investors to accelerate depreciation deductions. It involves identifying various components of a property, such as land improvements, building systems, and personal property, and reclassifying them for tax purposes. 

By categorizing these assets appropriately, investors can maximize their depreciation deductions, resulting in significant tax savings over the property’s useful life.

Depreciation in real estate refers to deducting the cost of an income-producing property over its useful life. It is a non-cash expense that enables real estate investors to reduce their taxable income.

The Delaware Statutory Trust, or DST, is a separate legal entity created as a trust under Delaware statutory law. The law permits a very flexible approach to the design and operation of these entities. 

The Internal Revenue Service issued a revenue procedure on July 20, 2004, regarding using DSTs to purchase fractional interests in real property that would qualify as like-kind replacement property in conjunction with a tax-deferred like-kind exchange transaction. 

Unlike a Tenant in Common, investors have no control over it, and it must be sold as a security. Lenders frequently prefer this because they deal with only one entity, not several tenants.

A thorough investigation or exercise of care is expected of a reasonable business or person before entering into an agreement or contract with another party or an act with a certain standard of care. It can be a legal obligation, but the term will more commonly apply to voluntary investigations.

Equity in real estate refers to the difference between a property’s current market value and the amount owed on any mortgages or loans against it. In simpler terms, it represents the portion of the property the owner truly “owns.”

A special-purpose entity that holds title to the replacement property for the benefit of the exchanger during a reverse exchange. This allows an exchanger to secure suitable replacement property before it sells its relinquished property.

The price at which a property would sell between a willing buyer and seller, each with full knowledge of all relevant facts and neither being compelled to buy or sell. It is used to determine the value of assets for taxation purposes.

A mortgage with an interest rate that remains the same for the entire term of the loan. This ensures consistent mortgage payments for the borrower but may result in a higher interest rate than adjustable-rate mortgages.

The delayed “forward” model requires the exchanger to transfer their relinquished property before acquiring a replacement, extending the time between those steps.

The ratio of the real estate’s market value to its annual gross rental income.

Gross Rent Multiplier = Price/Gross Annual Rental Income

The resulting GRM would tell you how many years it would take to earn back the amount invested in the property purchase.

The holding period begins the day after the asset is acquired and concludes on the day the asset is disposed of.

An owner’s financial stake in their property, representing the difference between the property’s current market value and the outstanding balance of all liens on the property, such as mortgages. It measures the amount of the property the owner has paid off versus what is still owed.

Also termed a construction exchange or build-to-suit exchange, improvement exchanges allow investors to upgrade the replacement property with exchange equity. The taxpayer can spend the deferred tax amount on improving the replacement property before closing the 1031 exchange.

This type of exchange is suitable for people who want to acquire a replacement property that doesn’t match their needs. This real estate exchange allows you to make the necessary improvements on the real estate and include the construction as part of the exchange.

Joint tenancy is a form of property ownership where two or more individuals hold equal ownership rights to a property. In joint tenancy, each owner has an undivided interest in the entire property, with the right of survivorship. This means that if one owner passes away, their ownership interest automatically transfers to the surviving joint tenant(s) without going through probate.

A business arrangement in which two or more parties agree to pool their resources and expertise to achieve a specific goal. Joint ventures can be used for real estate investments, development projects, and other business opportunities.

The use of borrowed capital to increase the potential return on an investment. It involves using debt to finance the purchase of a property rather than paying the total price upfront. 

By doing so, investors can purchase more expensive properties with a smaller initial investment, amplifying their potential profits (or losses) from the property’s appreciation in value or rental income.

Like-kind properties are real estate assets of a similar nature that can be exchanged without incurring a tax liability, as specified in Section 1031 of the Internal Revenue Code (IRC).

A lease agreement that allows the lessee to sublease portions of the property to other tenants. This is commonly used in commercial real estate to maximize rental income.

A licensed professional who acts as an intermediary between borrowers and lenders to secure mortgage loans. They help borrowers find the best mortgage rates and terms and assist in the application process.

The income generated from a property after all operating expenses, such as maintenance, taxes, insurance, and utilities, have been deducted.

A loan that is secured by collateral, often in the form of real estate. In the event of default, the lender can only seize and sell the collateral to recover their losses rather than going after the borrower’s personal assets.

The occupancy rate is a crucial metric in real estate investment, representing the percentage of rented or occupied units in a rental property at a specific time. It provides insight into the property’s performance and revenue potential. 

A higher occupancy rate typically indicates strong demand and effective property management, while a lower rate may suggest challenges in attracting tenants or retaining them.

Opportunity zones are designated geographic areas across the United States that offer tax incentives to investors aiming to spur economic development and job creation. These zones are selected based on criteria such as poverty rates and economic need. 

Investors who deploy capital gains into Qualified Opportunity Funds (QOFs) for eligible projects within these zones can benefit from tax advantages, including deferred and reduced capital gains taxes.

The payment of the capital gains tax is deferred until the eventual sale of the QOF investment or the program’s expiration in 2026, whichever comes first. If the QOF investment is held for at least 10 years, the capital gains earned are tax-free. 

The regular income tax rate applied to an individual’s taxable income. This differs from capital gains tax, which applies to profits from the sale of investments such as stocks or real estate.

Tax implications arise in exchanges where cash, excluded property, non-like-kind property, or mortgage relief is involved alongside the exchange of qualified, like-kind property.

In a partial exchange, tax liability is incurred on the non-qualifying portion, while capital gains are deferred on the qualifying portion as per the Internal Revenue Code (IRC) Section 1031.

A tax-deferred exchange involves transferring personal property (relinquished property) for other personal property (replacement property) of like-kind or like-class. Personal property exchanges can include assets such as equipment, vehicles, or intellectual property.

However, it’s important to note that personal property exchanges were eliminated under the Tax Cuts and Jobs Act.

Under IRS Code Section 121, individual taxpayers can exclude up to $250,000, and couples filing jointly can exclude up to $500,000 from capital gains tax on the sale of their principal residence. To qualify, the property must have been the taxpayer’s primary residence for at least 24 months within the last 60 months.

Investing in private real estate funds that pool capital from a group of investors to acquire and manage properties. These investments typically target higher returns but come with higher risks as well.

Real estate operations, control, and oversight, including finding tenants, collecting rent, maintaining the property, and handling repairs.

A third-party account used to hold funds during a 1031 exchange until the purchase of the replacement property can be completed. This account ensures that the taxpayer cannot access the funds and, therefore, cannot use them for personal benefit, which is required for a valid 1031 exchange.

A qualified intermediary is the person a property seller chooses to oversee the 1031 exchange process.

A written agreement between the taxpayer and the Qualified Intermediary (QI) outlines their roles and responsibilities in a 1031 exchange. This agreement is an essential document for a valid exchange and should be reviewed by both parties before signing.

A qualified opportunity fund is designed for investments in “opportunity zones,” which are economically distressed or disadvantaged areas.

A REIT is a company that buys and manages real estate and holds it for the long term. REITs receive funding from investors and use the capital to purchase and operate properties. Most REITs rent out the properties to tenants and generate rental income, which they distribute to investors in the form of dividends.

The property being sold or exchanged in a 1031 exchange.

In a 1031 exchange, investors acquire a replacement property to replace the relinquished property. The replacement property must be of equal or greater value to the relinquished property.

A type of 1031 exchange where the replacement property is purchased first before selling the relinquished property. This allows investors to secure a desirable replacement property without worrying about timing issues.

Alternatively, the investor can transfer the relinquished property’s title to EAT first while simultaneously closing on the replacement one.

Specific conditions that provide an unambiguous guide for taxpayers to meet specific requirements set by the IRS. Safe harbors offer legal certainty to both taxpayers and the government.

Senior housing refers to housing communities with long-term residents, typically over the age of 65. Investors often choose senior housing-focused DSTs as the replacement property in a 1031 exchange.

The seven deadly sins of Delaware Statutory Trusts (DSTs) state that:

Future equity contributions are not allowed.
Trustees can’t renegotiate the terms of existing loans or borrow new funds.
Trustees can’t reinvest proceeds from the sale of DST investments.
Trustees’ capital expenditures are limited.
Liquid cash must be invested in short-term debt obligations.
Cash must be distributed to beneficiaries on a current basis.
Trustees can’t renegotiate the current leases or enter into new ones.

A simultaneous exchange occurs when you relinquish property and acquire the replacement property at the same time. The exchange has to happen simultaneously, and a small delay can disqualify the 1031 benefits.

Sole ownership refers to the legal status in which a single individual holds complete ownership rights and responsibilities over a property or asset. 

In the context of real estate investment, sole ownership means that one person has full control over a property without any co-owners or partners. This form of ownership provides the sole owner with autonomy in decision-making regarding the property’s management, financing, and disposition.

When an asset is inherited, the basis is increased to its fair market value at the time of inheritance. This eliminates any capital gain on appreciation that occurred during the owner’s lifetime.

Delaying the payment of taxes until a future date. A 1031 exchange allows investors to defer capital gain taxes on the sale of investment property by reinvesting the proceeds into a like-kind replacement property.

Tenant in Common (TIC) is a co-ownership agreement in which several investors combine funds to jointly own a property. Each investor owns a fractional, undivided interest in the property and is entitled to a portion of the income and expenses.

A TIC is a structure investors can use to exchange properties for partial ownership with high-value replacement properties. TICs vary in property ownership requirements in that decisions regarding the property, such as management and sale, usually require unanimous agreement among all co-owners.

Up to three properties may be identified without regard to their fair market value. The Taxpayer may choose to purchase any number of the identified properties. The 200% Rule: More than three properties may be identified as long as their total fair market value does not exceed 200 percent of the selling price of the relinquished property.

A triple net lease (or NNN lease) is a real estate agreement in which a tenant agrees to pay property expenses related to management and repairs, such as maintenance, real estate taxes, and building insurance.

The only responsibility of the owner is to pay the mortgage on the property.

TTT is an acronym for three of the biggest hassles rental property owners deal with: tenants, toilets and trash.

An umbrella partnership real estate investment trust (UpREIT) is a real estate investment trust (REIT) formed to buy income properties or mortgage loans and pay its owners in partnership units instead of cash. UPREITs are often used in 1031 exchanges as a replacement property option.

Underwriting is the process of evaluating a borrower’s financial information and approving or denying a loan. In real estate, underwriting also refers to evaluating a property’s potential profitability and risk. This process helps investors determine whether an investment opportunity is worth pursuing.

Vacancy rate refers to the percentage of unoccupied rental properties at a given time. It’s a measure of how much space in a property is not being utilized. This is an essential factor for real estate investors to consider when evaluating potential investment properties.

A waterfall distribution is a method of distributing profits or proceeds from an investment to different parties in a specific order. It is typically used in real estate partnerships. The “waterfall” refers to how the distributions flow from one party to another.