1031 EXCHANGES GLOSSARY

Allows exchange of investment property for shares of a Real Estate Trust (REIT). Also known as an UPREIT (see UPREIT). Investment property is contributed into a REIT in exchange for shares of stock pursuant to Section 721 of the Internal Revenue Code. Taxes paid on sale of stock with no further tax deferred exchange allowed. Smaller non institutional investors can exchange their properties into tenant-in-common institutional grade property that then may later be traded for REIT stock to complete and UpREIT. Advantages can be greater liquidity and diversification; disadvantages include being subject to stock-market whims, not just property performance.

A 1031 exchange is an exchange of property in which capital gains tax deferral is available to real estate owners who sell their investment, rental, or business real estate, and reinvest the proceeds in qualified replacement properties. The replacement property must be similar in nature (to be used for investment, rental, or business) and therefore considered "like-kind." Property owners may sell and replace like-kind properties and defer taxes on the profits by meeting the requirements of Internal Revenue Code (IRC) for 1031 exchange properties.

A properly structured 1031 Exchange provides real estate investors with the opportunity to defer 100% of both Federal and State (if applicable) capital gains taxes on the sale of their existing properties. The replacement property must be similar in nature to the relinquished (sold) property (to be used for investment, rental, or business) and therefore considered "like-kind."

One of the more significant benefits of investing in income-producing real estate is the ability to decrease the tax obligation on the income produced through depreciation. If an investment property is sold and no tax deferred exchange takes place there is tax owed on the amount deducted.

In a 1031 exchange boot refers to "in addition or profit" which is anything of value received by the investor which is not deemed "like kind" in the exchange. This can include personal property boot, cash boot and mortgage boot.

Section 1033 only defers gains resulting from compulsory or involuntary conversions of investment real estate. The conversion into money or other property must occur from circumstances beyond the taxpayer's control. Section 1033(a)(2)(B)(i) generally requires you invest the proceeds from such sales in qualified replacement property within the period ending 2 years after the close of the taxable year in which sale took place. Generally, replacement property does not qualify as "similar or related in service or use" unless its physical characteristics and end uses are similar to those of the converted property. When an investor owns property that is involuntarily converted, however, the focus shifts primarily to the similarity in the relationship of the services or uses which the converted and replacement properties have to the owner-investor