I.R.S. Code Section 1031 Tax Free Exchanges
Procedure Manual
&
Information Booklet
for
Real Estate Exchanges
"1031 Deferred Exchanges Made Easy"

NOTICE
THE INFORMATION CONTAINED IN THIS BOOKLET IS DESIGNED TO GIVE THE READER GENERAL INFORMATION ON REAL ESTATE TAX DEFERRED EXCHANGES AS DEFINED IN U.S. INTERNAL REVENUE CODE SECTION 1031. EVERY EFFORT HAS BEEN MADE TO ENSURE THE ACCURACY OF THIS INFORMATION; HOWEVER, REGULATIONS CHANGE, AND INDIVIDUAL CIRCUMSTANCES VARY. THEREFORE, "MULTI REAL ESTATE SERVICES" MAKES NO WARRANTIES OR GUARANTIES AS TO ITS APPLICATION. WE DO NOT OFFER SPECIFIC TAX OR LEGAL ADVISE, AND RECOMMEND THAT YOU CONTACT YOUR TAX ADVISORS AS TO YOUR SPECIFIC APPLICATION PRIOR TO ANY EXCHANGE. UNLESS YOU ARE HIGHLY KNOWLEDGEABLE OF IN THE AREA OF REAL ESTATE TRANSACTIONS, AND HAVE GOOD ACCESS TO CURRENT MARKET DATA, WE HIGHLY RECOMMEND THAT YOU EMPLOY THE SERVICES OF MULTI REAL ESTATE SERVICES OR ANOTHER REAL ESTATE AGENT WHO IS FAMILIAR WITH 1031 EXCHANGES.

TAX DEFERRED EXCHANGES
THE LAST HAVEN FOR PRESERVING REAL ESTATE WEALTH

The elimination of preferred tax treatment for capital gains has left real estate investors only one vehicle for preserving and building real estate wealth: THE TAX DEFERRED EXCHANGE! Section 1031 of the Internal Revenue Code allows property owners to exchange their property for other like-kind property. This makes it possible to defer payment of the tax on any financial gain that is realized from the sale of the property and use it to acquire additional property.

DELAYED EXCHANGE, IS DIFFERENT FROM A SWAP
The idea of exchanging properties is not new. There has always been the specific exchange of "your property" for "my property" (i.e., a swap). The exciting information for real estate investor is that the IRS set down guidelines allowing for delayed exchanges of real estate (sometimes called the Starker Exchange). This opened the door for the "purchase and sale" type of exchange. Anyone can now sell their property and purchase any other property they want, providing it is "like-kind". An accusal concurrent closing of the sell and purchase are allowed by the IRS, but if is any glitch in the exact closing time frames, the 1031 will be negated by the Feds. By using a qualified intermediary (accommodator\facilitator) to handle the transaction, the IRS allows for a delay in closing the replacement (up leg) property transaction after closing the sold (down leg) property transaction. Even if there is a concurrent closing scheduled, it is recommended that an intermediary is utilized, as any little glitch in the closings with make the entire transaction taxable. The money saved by not paying an accommodator for their services, may be peanuts, compared to the taxes owed to the government.

MULTI REAL ESTATE SERVICES are professionals in structuring tax deferred exchanges in real estate transactions. We are specifically structured to assist buyers and sellers in effecting successful IRC Section 1031 Deferred Exchanges. We understand the needs of the investor as well as the technical requirements of the IRS. MULTI REAL ESTATE SERVICES will consult with the principles, tax consultant, and legal advisors involved in the property exchange. We are determined to provide the fastest and most accurate service available.

A 1031 Tax Deferred Exchange is not difficult, but there are very strict rules and timetables that must be followed. If they are not followed exactly, Uncle Sam may have a problem with the exchange, and make the entire gain, on all prior properties taxable.On the following pages is a overview of the rules, but all you really need to do is call us. We will help you all the way.

INTRODUCTION
TO
1031 TAX DEFERRED EXCHANGES
I.INTRODUCTION

This is an overview of like-kind tax deferred exchanges. The exchange is an alternative to a sale and purchase. If you wish to sell one piece of real estate to buy another, you should compare the tax results of the sale and purchase with exchanging.

A. Non Recognition of Gain

There are three conditions of non-recognition of gain:

1. Property must be held for Investment or Productive use in a trade or business.

2. The properties exchanged must be of like-kind.

3. There must be an actual exchange, not a transfer of property for money only.

B. Substance Over Form

1. The substance of the transfer will rule over the form in which it is done. Intent is secondary.

C. Delayed Exchanges

In July of 1991, the IRS finalized its long awaited rules governing delayed exchanges. This gives us the opportunity to use purchase and sale techniques to structure tax deferred exchanges.

II. QUALIFIED PROPERTIES

The classification of properties exchanged determines if the property qualifies for Section 1031 treatment.

A. The IRS Classifies Real Estate Into Four Classifications:

1. Property held for personal use. (Personal Property)

2. Property held primarily for sale. (Dealer Property)

3. Property held for productive use in a trade or business. (Business Property)

4. Property held for investment. (Investment Property)

The last two qualify for Section 1031 tax deferral, the first two do not. Both the property received and the property sold must be either "Business" or "Investment" property.

What the other party does with the property does not affect your tax-free status.

---

B. Property Must Be Like-Kind

1. Like-kind refers to the nature or character of the property and not to its grade or quality.

2. Section 1031 property may be mixed as to type and still be like-kind. You may exchange land for a duplex

or a commercial building for a retail store, etc. (detailed later)

3. Property held outside the USA and its territories does not qualify for exchange with US property.

C. Partnership Interests

1. Your interest in a partnership cannot be traded for an interest in another partnership.

2. Exception: Within the partnership, you can exchange your holding for another partner's holding, or the partnership as an entity can exchange real estate it owns for other like-kind real estate.

D. Transfer Between Spouses

There is no recognition by Section 1031 of exchanges between spouses, or in exchanges during a divorce with a former spouse.

E. Sale/Lease Back As An Exchange

A lease of 30 years or longer will qualify for an exchange. However, the exchanger of leased property will be treated differently than the lessor. For the lessor, it is a prepayment of rent and is treated as ordinary income, based on the fair market value of the exchanged property.

F. Business Assets

The assets of one business can be exchanged for identical assets of another business and will be held as a like-kind exchange under Section 1031.

G. Vacation Homes

1. This type of property does not qualify if it is used solely for personal use.

2. They may qualify if rented and must pass a use test each year. It is rental property if the owner's personal use is not more than 14 days during the tax year.

---

III. TIME RESTRICTIONS

A. Introduction

In 1984, Congress amended the IRS code adding an identification and exchange period for like-kind exchanges. This signaled their approval for delayed multi-party exchanges. It was not until the spring of 1990 that the IRS issued their regulations defining delayed exchanges.

B. Identification and Exchange Periods

The Tax Reform Act of 1984 Imposed Two Time Limitations:

1. The period of time to "Identify" the replacement property begins on the date of closing of the exchange property and ends 45 days later.

2. The period of time in which the replacement property must be received by the exchanger begins on the date of closing of the exchange property and ends 180 days later.

The replacement property must be identified in writing and delivered to the facilitator or another party to the exchange. In identifying the replacement property, it is necessary to give either the legal description or the street address. It must be unambiguously identified, and we recommend that you use either a legal description or a specific street address.

IV. REPLACEMENT (UPLEG) PROPERTY

The term "REPLACEMENT" or "UPLEG PROPERTY" simply means the property or properties intended to be purchased with the funds that are received from the original property sale.

A. Number of Replacement Properties

You may identify multiple properties in the exchange by following one of two rules: 1) The three property rule; or 2) The 200 % rule. You must satisfy only one of these rules, not both.

1. The three property rule states that the maximum number of replacement properties you may identify is three properties without regard to their market value.

2. The 200% rule states that you may identify any number of properties, as long as the total market value of all those properties does not exceed 200% of the market value of the exchange property.

B. Trade Even or Up in Value

This means that the property you wish to acquire, the "REPLACEMENT PROPERTY," should be equal to, or more expensive than, the property being sold. All of the cash proceeds from the first sale should be invested in the new "REPLACEMENT" property that is being purchased. The capital gain will be taxable only to the extent that these goals are partially achieved. Any funds received is considered boot, and is taxable at full rate. If all the goals are accomplished, the entire gain will be deferred.

C. Incidental Property

Property incidental to a larger item of property such as furniture, laundry machines, appliances, pumps, wells, etc. is not treated as separate property from the larger item of property if:

1. In standard commercial transactions the property is typically transferred together with the larger item of property, and;

2. The aggregate market value does not exceed 15% of the market value of the larger item of property.

For description purposes, the legal description or street address of the larger property can be used to describe the entire property. There is no need to list the particular incidental property attached to it. For example, your Exchange or Replacement property is an apartment house complex worth one million dollars. The furniture, laundry machines, and other items that go with the apartment complex should not exceed $150,000 in value, which is 15% of one million dollars. For purposes of the three property or 200% rules, the entire apartment complex, including furniture, laundry machines, etc., will be treated as one property.

D. Revocation of Replacement Properties

Replacement properties can be revoked as long as it is done within the 45-day identification period. This revocation must be done in writing and could include a recession of a purchase and sale agreement, if one was written.

E. Receipt of Replacement Property

Replacement property is treated as received before the end of the exchange period if:

1. You actually received the replacement property. That is, closed the transaction prior to the end of the exchange period (the 180 days), and;

2. The Replacement property received is substantially the same as identified during the 45- day identification period.

F. New Construction Replacement Property

One of the more interesting stipulations is the regulation that permits you to exchange for real property that has not yet been built. A transfer will still qualify for Section 1031 treatment if the new construction is identified within the 45-day period, and received within the 180-day exchange period. This property must be carefully identified. This identification should include the legal description of the underlying ground and as much other description as possible for the property to be constructed. Also, the new construction must be completed and received in substantially the same form as described in the identification documents. Be careful not to receive new construction property that is not substantially completed before the end of the 180 day period. You can not exchange for services. You can not exchange a partially completed building, and then complete the rest of it yourself to establish the replacement value.

---

V. EXCHANGE OR SALE

A. Introduction

The intent of the delayed property exchange is that you have an actual continuation of your old property investment into your new replacement property. To qualify, you must follow the rules and requirements of Section 1031 of the Internal Revenue Code. Intent does not count. What you actually do is what determines if you qualify. However, if the transaction is ambiguous, the courts will look to the intent of the parties.

B. Exchange Requirements

Section 1031 requires an actual exchange of properties. If you sell your property and reinvest the money in a replacement property, you do not qualify for 1031 treatment, even though it is a simultaneous close. You must also be careful to overcome the doctrine of constructive receipt. Constructive receipt is achieved if you have the funds in a position in which you may draw on them, direct their usage, or give notice of intention to withdraw. In other words, you must not have control of the funds. If you have any type of control of the funds or control over the person holding the funds, you will be considered to have constructive receipt. One of the primary ways that you avoid constructive receipt is with the use of a Qualified Intermediary. This is done with a written contractual agreement.

You are considered to be in actual receipt of money if you receive the economic benefits of the money. You are not in constructive receipt if your control over this money is subject to a substantial limitation or restriction. You would be considered in constructive receipt at the time such limitations or restrictions lapse, expire, or are waived. Additionally, you are in constructive receipt of the money if the money is accepted by your agent.

C. Safe Harbors

Although there is more than one type of safe harbor, the only practical safe harbor for most exchangers is a Qualified Intermediary. The other two safe harbor arrangements call for establishing special trusts or special security and guarantee arrangements, which are quite complicated and usually are beyond the range of the average exchanger. Qualified Intermediaries act on your behalf, but only in accordance with a specific written contract. The Qualified Intermediary, for a fee, acts to facilitate the deferred exchange by entering into an agreement to exchange the properties. Under this agreement, the Qualified Intermediary acquires the relinquished property, acquires the replacement property, and transfers the replacement property to the exchanger. The exchanger, or a related party, can not qualify as Intermediary of their own exchange.

IRC Section 1031 delayed exchange rules state that a related party is anyone with a direct relationship to the exchanger. Examples include a brother, sister, husband, spouse, child, or anyone acting as an agent, including an employee, attorney, real estate broker, or CPA. Also included as related parties is a corporation of which 10% or more of the outstanding stock is owned directly or indirectly by the exchanger.

---

VI. PROPERTY BASIS

A. Introduction

The basis of the property which you acquire in the exchange (the replacement property) is the same as the adjusted basis of the exchange property, plus any increase paid. That is, the down leg property basis is increased by any additional consideration you give for the replacement property. For the purposes of a 1031 exchange, basis is the term we give to the price which was originally paid for a property less any depreciation on that property, plus any costs to acquire that property. An example would be a property you bought ten years ago for $30,000 that you've been depreciating at $1,000 a year for the last ten years. Your basis on that property is now $20,000. Basis is used as the base point for the calculation of capital gain on a transaction. Capital gain is described as the difference between the basis and the adjusted sales price of a property. The adjusted sales is the price the property sold for, less the selling cost, and less any other cost to make the property ready to sell.

Do not confuse capital gain with equity. There is no comparison between the two. Equity is the amount of money you have in your pocket after you have sold the property and paid off all of the mortgages. An example would be your property that you bought for $30,000 ten years ago, which now has a basis of $20,000. You have just sold that property for $115,000. You have paid out $15,000 in sales and other costs to prepare the property for market. You have an adjusted sales price of $100,000. Your capital gain on this property is the difference between your basis of $20,000 and your adjusted sales price of $100,000, or a capital gain of $80,000. If you do not do a 1031 Exchange, you're obligated to pay a capital gains tax of 28% or $22,400.

However, if on this same property you have borrowed some money, particularly if you have borrowed this money after you purchased the property, using a second mortgage, a refinance, or through some other instrument (let's say you have now borrowed $85,000 on the property so your equity position in the property is now $15,000), when you sell the property, you will get relief of the debt, which is the same as receipt of cash according to IRS rules. Although you only have equity of $15,000, you still have an obligation for capital gains tax of $22,400. It is in this area that we must be extremely careful not to trap ourselves with a regular sale. We are almost bound to exchange in a case like this unless we have the additional funds to cover the taxes. In larger transactions, with larger dollars and leveraging, the situation can be even more extreme.

Now, let's talk a little further about basis and how it's transferred to the replacement property. If you pay an additional amount of cash towards the replacement property, the amount paid is added to the transferred basis of the exchange property. As an example, the basis of your original property was $20,000, and you bought a new property for $150,000. You paid an additional $50,000 in cash, the new basis on your new replacement property is now $70,000. You should also note that any selling expenses paid by the exchanger is added as cash paid and increase the basis of the replacement property. These costs would include the real estate commission, selling costs, and the facilitators fee in a 1031 exchange.

---

B. Figuring Basis Where the Property is Subject to A Mortgage

The primary rule to consider, if the property has a mortgage, is that relief of debt is considered the same as receipt of cash by the IRS. The second primary rule is that mortgages are netted against each other. If the exchanger's property is mortgaged, the mortgage is counted as money received and reduces the substituted basis of the replacement property. This rule applies whether or not the mortgage is assumed by the other party or whether it's paid off, and it is recognized in the year in which the exchange takes place. Where both properties are mortgaged, the differences in the mortgages are netted and must be taken into account. If the mortgage you assume is larger than the mortgage transferred, the difference is added to the basis of the new replacement property. If the mortgage assumed is smaller than the mortgage transferred, the difference is deducted from the basis of the new replacement property.

C. Boot and Taxable Gain

Money and unlike property in an exchange is called boot. Receiving boot does not defeat the non-taxable provisions of Section 1031. If you receive money or unlike property, you may have taxable gain. However, you are only taxed on the gain that comes from the money and unlike property you receive. If the other party assumes any of your liability as part of the exchange, it will be treated as if you received cash.

In order to figure your taxable gain, you first determine the fair market value of the boot you received. Then you figure what your gain would have been had you sold the property outright for cash. Your taxable gain is the smaller of these two amounts.

---

The IRS rules require the exchanger to use a safe harbor in structuring a qualified exchange. The only practical safe harbor for the majority of investors is the use of a facilitator . A qualified facilitator will operate under a specially drawn contract between the facilitator and the exchanger. This contract agreement enables the facilitator to purchase and sell properties on behalf of the exchanger. The facilitator will charge a fee for their services. The IRS requires both the contract and the fee. Proper documentation of the exchange is very crucial. Multi Real Estate Services in conjunction with a facilitator can structure your delayed exchange to ensure a smooth and accurate transaction. We will:

1. Coordinate and help plan a successful property exchange with the client (Exchanger) and their advisors.

2. Prepare the necessary documentation for the EXCHANGE and REPLACEMENT properties.

3. Furnish escrow with the proper instructions to effect the exchange.

4. Secure the funds in an insured bank account until the exchange is completed.

5. Disburse exchange proceeds to escrow and provide the proper documents to transfer the replacement property to the exchanger.

---

The steps an exchanger takes in the sale of their property and the purchase of a replacement property. The transactions occur at separate times and involve separate escrow's. The exchanger transfers their property to the facilitator who sells it to a buyer. The exchanger then identifies the replacement property they wish to acquire. This identification of replacement property must be done within 45 days. Now the facilitator purchases the replacement property for the exchanger. The facilitator then transfers the replacement property to the exchanger to complete the exchange. The entire transaction must be completed within 180 days.

WHY EXCHANGE?
Sale
        Sale Price                               $150,000.00
        Less Selling Costs                       -$12,000.00
       
        Adjusted Sale Price                      $138,000.00
        Less Original Price (Basis)              -$50,000.00
        Plus Depreciation Taken                  +$20,000.00

        Taxable Gain                             $108,000.00
        Tax Rate                                  x 28%

        Capital Tax Due                           $30,240.00

Instead of paying the $30,240 in Capital Gains tax, the "Exchanger" can use these funds to purchase replacement property. Leaving this money in real estate holdings through a delayed exchange, and leveraging a conservative four times, there would be an additional $120,960 of purchasing power.

---

EXCHANGE - VS - BUY/SELL

Example
PROPERTY BASIS:

        Original Purchase Price                  $129,300.00
        Less Depreciation                        -$24,136.00

        Adjusted Basis                           $105,164.00

        TAX COMPUTATION:
       
        Current Sales Price                      $328,500.00
        Less Adjusted Basis (From Above)        -$105,164.00

        Taxable Gain                             $223,336.00
        Tax Rate                                 x 28%

        Capital Gains Tax Due                     $62,534.00

        CASH AVAILABLE:

        Exchange

        Buy/Sell

        Sales Price                              $328,500.00
        Less Mortgages                            $88,600.00

        Less Sales & Exch. Cst.                   $33,425.00

        Net Available                            $206,475.00

        Investment Power                         $825,900.00
        (Leveraged Four Times)

        Sales Price                              $328,500.00
        Less Mortgages                            $88,600.00
        Less Taxes                                $62,534.00
        Less Sales Cost                           $32,850.00

        Net Available                            $144,516.00

        Investment Power                         $578,064.00
        (Leveraged Four Times)

---

TYPICAL 1031 PROPERTY

DUPLEXES
APARTMENTS
RENTAL HOUSES
RETAIL BUILDINGS
INDUSTRIAL BUILDINGS
COMMERCIAL BUILDINGS
UNIMPROVED LAND
DEVELOPMENT LAND TIMBER LAND
FARMS AND RANCHES
30 YEAR+ LEASES

All of the properties listed above are considered to be of "like-kind". They may be exchanged for each other in any combination.

SUGGESTED EARNEST MONEY CLAUSE

We suggest that you insert language similar to the following clause following clause into your Purchase & Sale agreement so that all parties are aware that the transaction will be a delayed exchange, and there will be no lack of disclosure which may obstruct the transaction. (This merely a suggestion, and is not required by the "1031" regulations )

A MATERIAL PART OF THIS TRANSACTION IS THE SUCCESSFUL COMPLETION OF AN IRC SECTION 1031 DEFERRED EXCHANGE. "BUYER/SELLER" AGREES TO COOPERATE WITH THE "EXCHANGER" IN SIGNING THOSE DOCUMENTS NECESSARY TO COMPLETE THE EXCHANGE, PROVIDED THAT "BUYER/SELLER" SHALL INCUR NO ADDITIONAL COSTS OR LIABILITIES IN EXCESS OF THOSE WHICH WOULD HAVE OCCURRED HAD THIS BEEN AN OUTRIGHT "PURCHASE/SALE," AND NOT AN EXCHANGE.

Licensed Real Estate Broker with the Calif. Dept. of Real Estate