Another Letter Ruling (PLR 201216007) blessed the sale of a relinquished property to a related party. Additionally, in this transaction, the related party was able to take boot that would not exceed 5% of the gain realized. There have been a number of sales to related parties allowed in recent years but buying from a related party remains trickier as IRS is concerned that related parties will exchange in an effort to shift their low basis property for high basis property. This would allow the related party to immediately sell the newly acquired property and recognize minimal gain.

Based on rulings, there are several times it may be okay to acquire from a related party:

Any transaction involving a related party should be with caution.  Who are related parties?

Recent IRS memorandum (ILM 201238027) tackles the issue of whether the federal definition of real property trumped a state's definition of real property for 1031 purposes. The memorandum was in response to a request for guidance on how state law characterizations of property as real or personal affect whether the property is of like-kind for purposes of section 1031. The following scenarios were outlined:

Case 1: A natural gas pipeline in State A (constructed along a right of way on real property) that is classified as personal property in State A is exchanged for a State B natural gas pipeline that is constructed along a right of way on real property and that is classified as real property in State B. (The right of ways associated with the exchanged pipelines in State A and State B are also exchanged.)

Case 2: A steam turbine attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity that is treated as real property in State A is exchanged for a steam turbine attached as a fixture in a State B land improvement as a component of a system for the commercial production of electricity that is treated as personal property in State B. (The land and buildings associated with the steam turbines in both State A and State B are also exchanged.)

Case 3: A steam turbine that is attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity and that is treated as real property in State A is exchanged for raw land in State B. (The land and building associated with the steam turbine were also exchanged as part of the transaction.)

Case 4: A steam turbine that is attached as a fixture in a State A land improvement (a building) as a component of a system for the commercial production of electricity and a State A natural gas pipeline (constructed along a right of way on real property), both treated as real property in State A, are exchanged for a State B natural gas pipeline (constructed along a right of way on real property and that is identical in all material physical respects to the State A natural gas pipeline) that is treated as personal property in State B. (The land, buildings and right of ways associated with the steam turbine and pipelines were also exchanged as part of this transaction.)

IRS concluded that federal income tax law rather than state law controls whether exchanged properties are of like-kind for purposes of § 1031. Under the Income Tax Regulations of § 1031, properties are generally of like-kind if they are of the same nature and character. State law property classifications, while relevant for determining if property is real or personal property, are not determinative of whether properties are of the same nature and character. Rather, all facts and circumstances should be considered in determining whether properties are of the same nature and character and thus are of like-kind.

While this ILM cannot be cited as precedent, its applicability will likely be much more far reaching that just pipelines and turbines.

 Cost segregation is a highly beneficial and widely accepted tax planning strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow.

A cost segregation study (CSS) allows taxpayers to accelerate substantial depreciation deductions by identifying costs that can be allocated to shorter recovery periods; primarily 5, 7, and/or 15-year as opposed to 27.5 (residential rental) or 39-year (commercial).

By reallocating these costs to shorter recovery periods, taxpayers can defer substantial tax payments and greatly improve cash flow. Be aware, however, that a cost segregation study does not create new tax deductions; it simply pushes deductions into the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money. And, as we all know, any amount of money is worth more the sooner it is received.

While property owners and their tax advisors routinely utilize cost segregation following the purchase or completion of a building, there are many additional applications of the practice that apply to the various stages of real estate ownership and development.

Benefits

There are a number of benefits associated with cost segregation and its various applications. The primary benefit of course is significantly improved cash flow, most often achieved through the acceleration of depreciation deductions and the resulting tax deferral. In addition to the impact of accelerated depreciation, cost segregation may also allow for the reduction of estimated quarterly tax payments, property tax savings, and transfer tax savings. When prepared correctly, a cost segregation study can also be an excellent asset management tool.

Learn More about Using Cost Segregation and the Average Results by Property Type

INTERESTED IN LEARNING MORE ABOUT COST SEGREGATION AND 1031 EXCHANGES WHILE EARNING CPE CREDITS?

Surgent McCoy, LLC is offering a live webinar on October 10th from 1:00 - 3:00 pm ET.  It will be presented by Terri Johnson and Steve Beaucaire, of Bedford Strategies and Solutions, and Margo McDonnell.  For more information and to register.