2004 - A Very Busy Year For I.R.S. 1031
Regulations!

                                                   By Mary Lou Schwab CPA

The I.R.S. released a number of regulations and rulings that affect exchange 1031 transactions during 2004. From new guidelines for depreciation of replacement property, to a 5-year ownership requirement for converted rental property to a primary residence - the IRS was very busy! Listed below are the significant rule changes that will affect all individuals who participated in a 1031 exchange during 2004.

Sale of Personal Residence Acquired in a Like-kind Exchange - Taxpayers who convert rental property to a principal residence should know that a tax law change may limit their ability to exclude gain on the sale of that residence if they obtained the property through a like-kind exchange. Generally, a taxpayer can exclude up to $250,000 of gain on the sale of a home, provided the individual has owned and used it as a principal residence for two out of the five years before the sale. The exclusion is $500,000 for a married couple if both meet the use test. The American Jobs Creation Act of 2004 does not allow any exclusion if the taxpayer sells the home within five years of acquiring the property through a like-kind exchange. The new law applies to sales after October 22, 2004.

No Reverse Exchange Safe Harbor if Replacement Property has been Owned by the Exchanger within the past 180 days - Effective July 20, 2004 the I.R.S. is no longer allowing the safe harbor provisions for Reverse Exchanges if an exchanger has previously owned the intended replacement property within the 180 day exchange period.

New Guidance on Depreciation of Replacement Property Acquired in a 1031 Exchange - Since 2000, taxpayers were required to set up two assets for their replacement property for depreciation calculations. The "Old Basis" asset continues to be depreciated in the same manner as the relinquished property. The "New Basis" asset was depreciated under current MACRS depreciation rules. Effective February 27, 2004 these depreciation rules were modified. Replacement property cannot be depreciated during the time-gap between the time the relinquished property is sold and the new replacement property is purchased and put into service. The depreciation start date for the "Old Basis" property is now consistent with the start date of the depreciation of the "New Basis" asset. The "Old Basis" property will continue to depreciate in the same manner as the relinquished property was being depreciated only if the replacement property has the same or shorter recovery life or depreciation method as the relinquished property. Otherwise there are very specific modifications of depreciation recovery periods that are defined in Notice 2000-4.

I.R.S. adds Delaware Statutory Trusts to their "Disregarded Entities" definition - One of the requirements of a 1031 exchange is that you must take title to the replacement property in the same way that you held title to the relinquished property. If an exchanger takes advantage of the "Disregarded Entity" definition from the I.R.S. they could change the form in which they acquire replacement property. The I.R.S. now has 4 types of disregarded entities defined. An individual taxpayer can be considered the same as a Delaware Statutory Trust, a revocable living trust, a single member Limited Liability Company and an Illinois Type Land Trust. If you have more than one exchange party, a Delaware Statutory Trust may offer both flexibility of a trust and the asset protection of a Limited Liability Company.

Mary Lou Schwab CPA, CES (Certified Exchange Specialist) is Vice President of Bankers Escrow Corp. and oversees the 1031 Exchange Division. She has over 23 years experience in real estate taxation. For questions on 1031 exchanges call 303-986-4848 or 800-571-6595. ©2005 Bankers Escrow Corp.