The Security and Exchange Commission defines an accredited investor as an individual with either $1 million in net worth (all assets, excluding primary residence, less all liabilities) or net income for the last two years of $200,000 or greater ($300,000 if the spouse has income) with a reasonable expectation of such earnings in the current year.
Basis (or cost basis), as used in United States tax law, is the original cost of a property plus the cost of improvements, adjusted for factors such as depreciation. When the property is sold, the taxpayer pays/saves taxes on a capital gain/loss that equals the amount realized on the sale minus the sold property’s basis. A cost basis is needed because tax is due based on the gain in the value of an asset. IRS Publication 551 contains the IRS definition of basis: “Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also, use it to figure gain or loss on the sale or other disposition of property.”
The face amount of money or debt and the fair market value of non-like-kind property received in an exchange. The fact that the boot is received does not disqualify an exchange; the boot, however, will be subject to capital gains tax to the extent of recognized gain on the sale of relinquished property.
Income not actually received or possessed is “constructively received” and reportable if it is within the Exchanger’s control.
A separate legal entity created as a trust under Delaware statutory law. Delaware law permits a very flexible approach to the design and operation of the entity. A DST may be used in in a Section 1031 tax-deferred exchange private placement program if structured in accordance with the provisions of IRS Revenue Ruling 2004-86.
Depreciation recapture refers to the portion from the sale of a property that has been previously deducted as depreciation. For example, if a property purchased for $100,000 is sold for $125,000 and during the time of ownership $50,000 was claimed as depreciation deductions, this $50,000 would be considered depreciation recapture and taxed a certain rate while the additional $25,000 would be considered a capital gain and taxed at a different rate. For more detail see Depreciation Recapture. Please note that while depreciation may not have been claimed on prior year returns, the depreciation that was allowed or allowable must still be recaptured upon sale.
A business venture designed to let investors participate directly in the cash flow and tax benefits of the underlying investment. The DPP is generally a passive investment in real estate or energy-related ventures. Also known as a “direct participation plan”, DPPs are usually organized as a limited partnership, subchapter S corporation, or general partnership, an investment that does not qualify for a 1031 exchange. While DST and TIC offerings are technically DPPs, they are structured in most cases to qualify for the 1031 exchange.
The taxpayer seeking to defer capital gains tax under the provisions of IRC Section 1031 by means of a real estate exchange.
The period of time in which the Exchanger must acquire title to replacement property to qualify under the safe harbor for the exchange. The period ends on the earlier of the day 180 days after the relinquished property is transferred or the due date (including extensions) of the Exchanger’s federal income tax return for the year in which the Exchanger relinquished the property in the exchange.
A fee interest, or fee simple, is an estate (ownership) of real property of indefinite duration that can be freely transferred. The most common and perhaps most absolute type of estate, under which the owner enjoys the greatest discretion over the disposition of the property.
The 45-day period in which the Exchanger must identify replacement property for exchange. This period begins on the day of transfer of title to the relinquished property and ends at midnight on the 45th day following the transfer.
Referring to the nature and character of the property and not to its grade or quality, so that one kind or class of property may not be exchanged, under Section 1031, for property of a different class or kind. As a general rule, as long as the purpose of the taxpayer is to hold the property as an investment for use in a trade or business, real property will be like-kind with other real property. Accordingly, real property should not be exchanged for personal property.
In a DST structure, the trust will often lease the entire property to a Master Tenant, who then subleases the property to the actual tenants. This arrangement is necessary to meet the legal requirements of the trust and allows for two seemingly contradictory situations: one, it allows the investors in a DST to have a direct interest in real estate; and two, it removes both the trust and the investors from the direct day-to-day management of the property and its subleases, which are now handled by the Master Tenant. The same results occur when the entire property of a DST is leased to one tenant on a NNN basis.
A NNN Lease is a net lease, structured as a turnkey investment property in which the tenant is responsible for paying the three major expenses associated with commercial real estate ownership: property tax, insurance, and maintenance. “NNN” stands for “Net-Net-Net”, and is pronounced, “Triple Net.”
The rent collected under a net lease is net of expenses. It, therefore, tends to be lower than, for instance, rent charged under a gross lease. Net lease types include single net, double net, triple net, and even bondable triple net leases. The term “net lease” is often used as a shorthand expression when referring to NNN leases.
The sale of securities to a relatively small number of select investors as a way of raising capital. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. Since a private placement is offered to a few select individuals, the placement does not have to be registered with the Securities and Exchange Commission. Private placement offerings can be made to institutional investors or to accredited investors.
A taxpayer who receives money or non-qualifying property is considered to have received property boot.
A third-party entity that serves to facilitate the Section 1031 exchange on behalf of the exchanger. Also known as the facilitator or accommodator, the qualified intermediary will work under an agreement with the exchanger to take possession of proceeds from the escrow of the relinquished property and utilize those same proceeds to fund the escrow of the replacement property. This safe harbor prevents the Exchanger from having constructive receipt of the funds from the sale of the relinquished property.
A mutual fund that pools capital from investors and invests primarily in equity or debt of real estate in order to produce income and capital gains for its unit holders. These investments typically involve an active management strategy ranging from moderate repositioning or releasing of properties to development or extensive redevelopment. These funds typically have a limited life span, consisting of an investment period during which properties are acquired, and a holding period during which active asset management will be carried out and the properties will be sold.
A REIT is a corporation that invests in real estate directly, either through properties or mortgages, and which is sold as a security. REITs typically raise 1-2 billion dollars in capital and purchase a portfolio of properties over a period of several years with the intention that these properties produce rental income. A REIT must abide by specific rules and restrictions so that it is not required to pay corporate income taxes. Thus, all dividend distributions made by the REIT to its investors are taxed only at the investor level, thereby avoiding any double taxation. REITs can either be offered as private placement investments to accredited investors, or publically traded.
The relinquished property, also known as the exchange property or down-leg property, is the property originally owned by the exchanger and sold by the exchanger in a like-kind exchange process.
(Acquisition property or up-leg property) The property was acquired by the Exchanger in a like-kind exchange process.
Royalties are payments made by one party to another for the use or use up of an asset. Oil and gas royalties are paid based on the amount of oil and gas produced from a lease. Oil and gas royalty interests are classified as real property similar to real estate assets that may be bought and sold privately or through public auctions, like other real estate.
The sponsor is the party who acquires the assets for and then structures and offers a securitized real estate offering such as a DST, a TIC, a REIT, an oil and gas royalty interest or a real estate fund. In the case of a DST, the sponsor will acquire the real estate, structure the trust, make the private placement offering to accredited investors through one or more brokerages, as well as contract with the master tenant and professional management company, both of whom are frequently affiliates or subsidiaries of the sponsor.
With the tenancy-in-common ownership structure, each tenant owns an undivided fractional interest in the whole property. This means that each tenant owns a fraction of the entire property (i.e. 25% or 5%), but they do not own a particular part of the property (a specific area or section). Rather, they have fractional ownership, together with the other tenants, of the entire undivided property.