1031 Exchange Glossary

Plain-language definitions of the terms used in a 1031 exchange and a Delaware Statutory Trust (DST) offering.

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1031 Exchange

A transaction under Section 1031 of the Internal Revenue Code in which an investor exchanges business or investment property for like-kind property and defers recognition of capital gain. The tax is deferred, not forgiven.

1033 Exchange

A deferral under Section 1033 available when property is lost involuntarily — condemnation, casualty, theft — and converted into cash or other property. Unlike a 1031, no qualified intermediary is required and the replacement period is longer.

45-Day Identification Period

The period beginning the day the relinquished property closes and ending at midnight on the 45th calendar day, during which the exchanger must identify replacement property in writing to the qualified intermediary. It is not extended if the 45th day falls on a weekend or holiday.

95% Rule

One of the three identification rules. An exchanger may identify any number of replacement properties of any value, provided they acquire at least 95% of the total value identified.

180-Day Exchange Period

The period in which the exchange must be completed, ending on the earlier of midnight on the 180th calendar day after the relinquished property closes, or the due date of that year’s federal tax return including extensions.

200% Rule

One of the three identification rules. An exchanger may identify any number of replacement properties provided their combined fair market value does not exceed 200% of the value of the relinquished property.

721 Exchange (UPREIT)

A contribution of property to a REIT’s operating partnership under Section 721 in exchange for operating partnership units, on a tax-deferred basis. Sometimes used as an exit route for DST investors once a property goes full cycle. It ends the ability to do further 1031 exchanges with that interest.

A

Accredited Investor

Defined in Rule 501 of Regulation D. Individuals generally qualify with a net worth over $1,000,000 excluding their primary residence, or income over $200,000 in each of the two most recent years — $300,000 jointly with a spouse — with a reasonable expectation of the same in the current year. Some states apply additional requirements.

Adjusted Basis

The original purchase price plus capital improvements, less depreciation taken. Gain on a sale is measured against adjusted basis, not against the original price.

B

Beneficial Interest

The ownership interest an investor holds in a Delaware Statutory Trust. Under Revenue Ruling 2004-86 it is treated as direct ownership of real estate for federal tax purposes rather than as a security interest, which is what allows it to serve as 1031 replacement property.

Boot

Any consideration received that is not like-kind property. Boot is taxable to the extent there is capital gain. It can accumulate across successive exchanges and traces back to the original relinquished property. It takes the form of cash boot, mortgage boot or personal property.

C

Capital Gains Tax

Tax on the gain from selling an asset. For real property held over a year, federal long-term rates are generally 15% or 20% depending on taxable income, and state tax may also apply.

Cash Boot

Funds received by the exchanger from the sale that are not reinvested in replacement property. Taxable to the extent of gain.

Constructive Receipt

Control over exchange proceeds without physically holding them. If the exchanger could have obtained the funds — if they sat somewhere the exchanger had the right to direct — the IRS may treat that as receipt and disqualify the exchange. Avoiding constructive receipt is the reason a qualified intermediary is required.

Cost Segregation

An engineering-based study that reclassifies parts of a building from the 39-year depreciation schedule to 5, 7 or 15-year schedules, accelerating depreciation deductions.

D

Delaware Statutory Trust (DST)

A legal entity formed under Delaware law that holds title to real estate and allows multiple investors to own fractional beneficial interests. When structured to comply with Revenue Ruling 2004-86, those interests can serve as 1031 replacement property.

Depreciation

An annual deduction reflecting the theoretical wearing out of a building. Commercial property is generally depreciated over 39 years, residential rental over 27.5.

Depreciation Recapture

On sale, the portion of gain attributable to depreciation previously taken is taxed at a different rate than the rest of the gain. A 1031 exchange defers recapture along with the capital gain.

Direct Deeding

Transferring title directly from the seller to the buyer rather than routing it through the qualified intermediary, while the intermediary still handles the exchange contractually.

Due Diligence

The investigation of an offering — sponsor track record, property condition, financing, projections and disclosures — carried out before an investment is recommended or made.

E

Exchange Accommodation Titleholder (EAT)

An entity that temporarily holds title to either the replacement or relinquished property in a reverse or improvement exchange, for no more than 180 days.

Exchange Agreement

The written contract between the exchanger and the qualified intermediary setting out how the exchange will be carried out and how funds will be held.

Exchange Period

The full period in which the exchange must be completed — see 180-Day Exchange Period.

Exchanger

The taxpayer carrying out the 1031 exchange. Also called the taxpayer or the investor.

F

Full Cycle

A DST offering that has run its course — the property has been sold and proceeds distributed to investors. Investors may then exchange again into another property, or in some cases into a REIT under Section 721.

I

Identification Period

See 45-Day Identification Period.

Improvement Exchange

Also called a build-to-suit or construction exchange. Exchange proceeds are used to make improvements to replacement property before the exchanger takes title, typically through an exchange accommodation titleholder.

L

Like-Kind Property

Real property held for business or investment use, exchanged for other real property held for business or investment use. The term is broad — an apartment building and raw land can be like-kind. It excludes property held for personal use, such as a primary residence.

Loan-to-Value (LTV)

The ratio of debt on a property to its value, expressed as a percentage. A commonly quoted figure in DST offerings.

M

Master Lease

A structure in which the DST leases the entire property to a master tenant, who then handles day-to-day leasing. Used because Revenue Ruling 2004-86 prevents the trust itself from renegotiating leases or entering new ones.

Mortgage Boot

Debt relief. If the debt on the replacement property is less than the debt paid off on the relinquished property, the difference is treated as boot and may be taxable.

N

Net Lease / Triple Net (NNN)

A lease under which the tenant pays property taxes, insurance and maintenance in addition to rent. Common in DST offerings involving single-tenant commercial property.

Non-Recourse Debt

A loan secured only by the property. If the borrower defaults, the lender can take the collateral but cannot pursue the borrower’s other assets. DST debt is typically non-recourse to investors.

O

Opportunity Zone

An economically distressed census tract designated under the Tax Cuts and Jobs Act of 2017, offering certain capital gains tax benefits to long-term investors. A different deferral route from a 1031 exchange, with different rules and timelines.

P

Private Placement Memorandum (PPM)

The disclosure document for a private offering, setting out the property, structure, fees, risks, projections and terms. It should be read in full before investing.

Q

Qualified Escrow Account

An account holding exchange proceeds under terms that restrict the exchanger’s access, helping avoid constructive receipt.

Qualified Intermediary (QI)

An independent third party, defined in Treasury Regulation §1.1031(k)-1(g)(4), who facilitates the exchange and holds the proceeds so the exchanger never takes actual or constructive receipt. Also called an exchange accommodator. A QI is required for a delayed exchange.

R

Recourse Debt

A loan under which the lender can pursue the borrower personally for any shortfall after taking the collateral. Common in tenants-in-common structures, generally not in DSTs.

Regulation D Offering

A private securities offering exempt from SEC registration under Regulation D. Rule 506(b) prohibits general solicitation; Rule 506(c) permits it but requires the issuer to take reasonable steps to verify that every purchaser is accredited.

Related Party

A person or entity connected to the exchanger by family or ownership. Exchanges with related parties are subject to additional restrictions, including a two-year holding requirement in many cases.

Relinquished Property

The property the exchanger is selling. Sometimes called the downleg.

Replacement Property

The property the exchanger is acquiring. Sometimes called the upleg.

Revenue Ruling 2004-86

The 2004 IRS ruling establishing that a beneficial interest in a properly structured Delaware Statutory Trust is treated as direct ownership of real estate for federal tax purposes, and therefore qualifies as 1031 replacement property. It imposes the seven restrictions known as the Seven Deadly Sins.

Reverse Exchange

An exchange in which the replacement property is acquired before the relinquished property is sold, using an exchange accommodation titleholder to hold title in the interim.

S

Safe Harbor

A set of procedures which, if followed, the IRS will accept — for example the qualified intermediary safe harbor that avoids constructive receipt.

Seven Deadly Sins

The seven restrictions imposed on a DST by Revenue Ruling 2004-86. In summary: no further capital contributions once the offering closes; no renegotiating existing loans or borrowing more; no reinvesting sale proceeds; capital improvements limited to minor non-structural work and anything required by law; reserves held only in short-term debt obligations; all cash beyond necessary reserves distributed to investors; and no renegotiating leases or entering new ones. Limited exceptions apply where a tenant becomes bankrupt or insolvent.

Simultaneous Exchange

An exchange in which the relinquished and replacement properties close on the same day. Rare in practice.

Sponsor

The firm that acquires the property, structures the offering, arranges financing and manages the investment on behalf of investors.

Springing LLC

A provision allowing a DST to convert into a limited liability company if circumstances require action the trust is prohibited from taking — refinancing, for instance. Conversion may carry tax consequences for investors and is used only where necessary.

Suitability

The requirement that a recommended investment be appropriate for a particular investor given their financial situation, objectives, risk tolerance and other holdings.

T

Three-Property Rule

The most commonly used identification rule. An exchanger may identify up to three replacement properties regardless of their combined value, and may acquire one, two or all three.

Trustee

The party responsible for decisions affecting DST property. Because the trustee holds this authority, DST ownership is passive — investors do not control the asset.

This is general information, not tax or legal advice. NexTrend Securities is not an accounting firm and does not provide tax advice — consult your own tax and legal advisors. DST investments involve risk, including possible loss of principal. See our Risk Disclosures for accredited investor criteria.