(1888PressRelease)
May 23, 2007 - In general if a taxpayer receives cash in a tax-free 1031 exchange, the cash received is taxable boot. Tenant-in-Common (“TIC”) transactions will often involve a lender that requires that reserves be funded at closing. If reserves are funded with cash, taxable boot is created. However, whether the funding of reserves is made with cash or debt is not always clear.
Additionally, what is the tax treatment if the reserves are funded with debt?
When a new loan is assumed on a TIC property, the lender usually requires reserves be in place to pay for tenant improvements, repairs, loan reserves, etc… Since the funded reserves are not real estate, they are not like kind to the relinquished property and thus must be taxed as boot.
The basic position of the IRS is that if you receive cash boot in a transaction, including funded reserve accounts, you cannot claim that it is not taxable because the boot should not be taxed to the extent that the taxpayer took on more debt in the exchange transaction. However, the IRS has so far been unsuccessful in taking the position that the receipt of loan proceeds following an exchange should be treated as taxable boot.
More statutory authority needs to be published regarding this issue and simply stating that reserves were funded with loan proceeds may not be enough to satisfy the IRS. At some point, the IRS may require that any loan proceeds allocated to reserves be separately funded via a special loan or be funded through a special escrow to not qualify as boot. Only time will tell on this blurred issue.
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About 1031 Interview: 1031 property exchange tenant in common. 1031 Interview is a non-profit website dedicated to increasing knowledge and promoting the value of 1031 exchange Tenant-in-Common property investments nationally. Our purpose is to provide a foundation of knowledge to investors interested in like-kind property exchanges more commonly known as a 1031 exchange property or Tenant-in-Common transactions.
