The section 1031 industry holds a unique place in our economy.2 Section 1031 has become an important and frequently used provision of the Internal Revenue Code. As a provision of tax law, its application requires the use of tax-law analysis, which requires specialized training. Often, the professionals (real estate attorneys and section 1031 qualified intermediaries) closest to section 1031 exchanges lack that critical training.
Section 1031 grants nonrecognition of gain on the disposition of real property if the disposition is structured as part of a qualifying exchange.3 Because section 1031 applies to real property, real estate attorneys are often connected to such transactions. Almost all real estate transactions structured as section 1031 exchanges move through section 1031 qualified intermediaries, so those service providers, as an industry, see hundreds of thousands of real estate transactions each year. The section 1031 qualified intermediary is unregulated,4 so anyone can become a section 1031 qualified intermediary. Thus, the professionals that are typically most closely connected to section 1031 exchanges are real estate attorneys and section 1031 qualified intermediaries.
This article provides a general overview of the fundamentals of tax-law analysis and shows how the application of such analysis clarifies the authorities governing the four requirements of section 1031.5 It focuses on the application of law to specific types of transactions: section 1031 exchanges that occur in proximity to business transactions (i.e., contributions to and distributions from entities, and those taxed as partnerships for federal income tax purposes in particular). The article presents the fundamentals of tax-law analysis to lay the foundation for considering the application of the law to specific tax questions that arise with respect to section 1031 exchanges that occur in proximity to business transactions: (i) the exchange requirement; (ii) the qualified-use requirement (i.e., the requirement that property be held for productive use in a trade or business or for investment); (iii) the real-property requirement; and (iv) the like-kind requirement.6 The article then examines the law that governs the exchange requirement generally and how it applies specifically to section 1031 exchanges that occur in proximity to business transactions. It shows that the law recognizes the transfer of tax ownership in transitory transactions (i.e., those in which the exchanger acquires property and immediately transfers it) and that courts elevate form over substance to find that exchanges occur. This demonstrates that the law unequivocally supports the qualified-use requirement in exchanges that occur in proximity to tax-free business transactions and confirms that courts recognize the complementary purposes of section 1031 continuity-of-investment and the entity tax rules recognizing that contributions and distributions are changes of the form of ownership but do not disrupt continued investment in property. The article also examines the real-property and like-kind requirements, which come into question if undivided interests in property are transferred as a tax-free distribution prior to an exchange or acquired as part of an exchange preceding a taxfree contribution of the interests to an entity. With such transactions, the interest that an exchanger transfers or receives must be real property and like-kind to other real property. Thus, exchangers should ensure that any co-ownership arrangement is treated as a tenancy-in-common arrangement for federal income tax purposes.
A careful examination of the law shows that there is strong support for granting section 1031 nonrecognition to exchanges that occur in proximity to tax-free business transactions. Despite that support, some advisors continue to advise property owners that they must hold exchange property for some fixed period to satisfy the exchange or qualified-use requirement. The article discusses the tax risks and non-tax risks that exchangers face when structuring exchanges in proximity to business transactions, as well as summarizes some best practices that can help ensure the arrangement is a tenancy in common for federal income tax purposes. That discussion concludes that holding property for a longer period of time does not necessarily reduce tax risk, but extending ownership of property could introduce non-tax risks. Giving advice that is not supported by law also exposes advisors to risks.
A fundamental task of tax advisors is to apply law to facts and help clients understand the tax ramifications of reporting positions.7 As part of that task, tax advisors may be asked to recommend transaction structures that help reduce or minimize taxes. As part of that process, tax advisors must determine the state of tax law. The tax law governing a specific issue might be certain and easily determinable, certain but not readily determinable, or uncertain, which uncertainty may or may not be easily determinable. Tax advisors must be able to determine the state of the law governing a specific issue and know how to give advice in any particular situation. Determining the state of the law with respect to specific issues requires understanding the basic framework of tax-reporting decision-making and tax-law analysis.
Tax-Reporting Decision-Making
In the transactional setting, taxpayers may be faced with a multitude of decisions related to the position they will report on their tax returns with respect to certain transactions and issues related to those transactions. This analysis does address the decision-making process of taxpayers who act fraudulently and considers the decisions taxpayers must make if they act in a non-fraudulent manner but are interested in minimizing their tax liability. Such taxpayers generally are concerned with three questions: (i) How much will the tax be if I do not take the favorable reporting position? (ii) What is the likelihood that I will have to pay the tax later if I take the favorable reporting position? and (iii) Could I be liable for penalties if I take the favorable reporting position?
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.
To find our more about ALI CLE’s in-person courses or webcasts, or to check out on-demand CLE, click here.
Hear the real estate insights you can’t afford to miss at Modern Real Estate Transactions 2025, taking place on April 9-11, 2025 in Chicago, Illinois, in-person or via live webcast.
Modern Real Estate Transactions 2025 is the premier CLE program that offers cutting-edge insights, practical solutions, and a collegiate atmosphere to explore the most pressing commercial real estate challenges.
This program features nationally renowned faculty from across the country and offers the chance to connect with fellow professionals, sharing ideas and building lasting connections. Designed to provide practical advice as well as advanced transactional concepts, Modern Real Estate Transactions 2025 will help practitioners transition from the turbulence of the last few years to what many expect to be a more transaction oriented 2025.
This year’s program will feature topics such as:
Real Estate Trends: Owning, Transacting, and Leasing Today
Financing a deal: What kind of loans are out there and how to secure them
Joint Ventures: Negotiation, Management, Exits, and More!
M&A Insurance Solutions: How to Protect your Real Estate Transaction
Land Use Case Study
Knowing the Players: What to Consider Before Your Lease
Retail Leases: The Avengers of Co-Tenancy and Operating Covenants
Working through a Defaulted Real Estate Project: A Case Study
Artificial Intelligence (AI): Maximizing AI in Practice and Client Portfolios
And much more!
From examining current practice hurdles to uncovering creative deal strategies, this program delivers a level of instruction unmatched by other CLE offerings. Don’t miss the essential annual conference for staying ahead in the high-stakes world of commercial real estate.
Join us for our upcoming program, Modern Real Estate Transactions 2025, in Chicago, Illinois, in-person or via live webcast, on April 9-11, 2025! To learn more about this program and to register for the live webcast, click here.
To find our more about ALI CLE’s in-person courses or webcasts, or to check out on-demand CLE, click here.
The world is full of obvious things which nobody by any chance ever observes.
Arthur Conan Doyle
In recent years, I have been amazed at how much I have missed by not paying attention to things — many, many things — right before my eyes. Most of the hidden or missed meaning was pointed out by others rather than being a product of my own initiative or observation. For example, logos. Lots of them. Seen daily yet blurred over by the mind’s eye, which favors quick, default decisions and shortcuts. Take a moment to really study the logos of FedEx, Wendy’s, Hershey’s Kisses or Baskin-Robbins. Do an internet search for hidden or subliminal messages of logos. Look closely at the height of diamonds in a deck of playing cards. I learned to play poker and other card games around age 5, but never noticed the pattern in the card until it was pointed out to me at the tender age of 70. Bloomfield is a Pittsburgh neighborhood that I have frequented thousands of times over my lifetime. Last year, I was reading a history of Western Pennsylvania that noted that at the time of the Revolutionary War, it was a massive meadow of flowers. I mentioned my only-then spark of recognition to a friend of mine who looked at me with mocking eyes while slowly mouthing the words “bloom” and “field.” So, is it only me?
Nah! Our brains are hardwired for efficiency, quick decisions, automatic responses and reactions (flight, fright, freeze, hide), honed by learning and experience. Minimal thinking leads us to Wendy’s with no more than a glance at the sign in our peripheral vision. No subtleties necessary. Fine, but what does this have to do with practicing law?
Details are the fundamental stock-in-trade of the business of lawyering. No lawyer is effective with only macro or strategic thinking. Logic and reasoning ultimately require the ability to flesh out details and to communicate minutiae to successfully solve a problem or to frame the theory of the case for resolution by a third-party or court. Lawyers navigate complex mazes, usually with at least one opposing counsel running interference to actively thwart plans A, B and whatever follows. Lawyers’ minds must always be agile — with wide-open eyes and ears. We must be diligent about paying attention.
Gloria Mark, a professor at the University of California, Irvine, is a researcher and leading expert on paying attention. She concludes that there are different types of attention, some that follow a personal rhythm. There are four common misconceptions of what it means to be engaged in concentrated thinking and tasks. The first is that people should always be focused and that they should feel guilty when their mind and actions stray. She concludes that it is not realistic to expect the mind or body to continuously run marathons of productivity. Breaks and rest are necessary to replenish resources. Each person, through trial and error, can determine how to maximize opportunities for his or her own peak performance. The second myth is that rote, mindless activities, such as phone/computer games like Candy Crush, are a waste of time. These activities, if used strategically, can help replenish overspent mental resources or enable fresh ideas to surface as we rely upon our automatic motor skills to physically respond to the game stimuli. A third myth is that electronic interruptions, such as email notifications, render us helpless to avoid distractions. Managing focus is individual and personal, with diverse ways to keep moving forward. Mark’s fourth contention is that regularly obtaining the state of flow when using technology is not easy; thus the ideal or goal should be lowered to a balance of different attentional modalities tailored to the deliverable at issue.
… [T]hat lovely poem that didn’t get written because someone knocked on the door.
Martin Luther King Jr.
Distraction
It is difficult for lawyers whose work has shifted over my four decades of practice from teamwork to being in the electronic silo of screen time. When I was younger, busy lawyers often had a paralegal and a secretary (now called an administrative assistant). They provided second opinions on the content and style of letters and legal documents. The lawyer then reviewed the document and thanked the staff for catching mistakes and making improvements. Now we wordsmith alone with spell check and Microsoft Word Editor guiding how we write and, perhaps unconsciously, even how we think. Briefs and important communications may be reviewed by a colleague or assistant, but my observation and speculation are that shorter communications such as emails and text messages are unicorns traveling from mind to fingers before romping through cyberspace at the speed of light to the end of the journey.
With the increased use of technology pushed by the pandemic, particularly remote meeting platforms, “work from anywhere” is the new norm despite, in my opinion, the encouraging trend of employers requiring or promoting more time at the office. As the venue for work changes, so does the individual management of attention span and our observational skills as we adapt to new work environments. Like most things, it is a mixture of the good, the bad and the ugly.
Regulation D Offerings and Private Placements 2025 is the premier two-day course that provides comprehensive instruction, equipping attorneys with the knowledge and strategies essential for navigating private and limited securities offerings – critical tools in today’s capital formation landscape.
Hear and interact with distinguished faculty – including current and former SEC, state, and FINRA regulators, experienced practitioners, and industry participants – as they share insights on the SEC rules and their impact, review current pertinent federal and state laws and regulations, and examine the most significant issues in today’s private placement marketplace.
This year’s program will features topics such as:
Recent SEC rule making and court cases
A deep dive into Form D
Rule 504, Rule 506(b) and Rule 506(c), and NASAA Rule 504 Coordinated Review program
Alternatives to Regulation D: Regulation S, Regulation A, and Regulation Crowdfunding
Curing a defective Regulation D offering
Mechanics of an exempt offering and drafting the offering memorandum
Professional responsibilities: Due diligence and risks
And much more!
Now more than ever, understanding the full spectrum of private financing options is essential for legal professionals advising businesses on capital strategies. Gain invaluable guidance on planning, executing, and closing private placements, along with key perspectives on the SEC’s evolving agenda under the new presidential administration.
Join us for our upcoming program, Regulation D Offerings and Private Placements 2025 in Phoenix, Arizona, in-person or via live webcast, on April 24-25, 2025! To learn more about this program and to register for the live webcast, click here.
To find our more about ALI CLE’s in-person courses or webcasts, or to check out on-demand CLE, click here.
Oregon and Washington are not alone in their desperate need for 550,0001 and 1,100,000 new housing units2 within the next 20 years, respectively. The entire nation continues to struggle with a lack of housing supply.3
Meanwhile, many states—including Washington and Oregon—have hundreds of thousands of square feet of empty office space. Perhaps the solution is to convert empty post-COVID office space to residential flats. The Washington State Legislature, and various other states, including New Jersey and New York, seem to think so.
In 2023, the Washington State Legislature passed several bills to increase housing density and streamline permitting, including a bill that allows underutilized commercial office space to be converted to residential units, regardless of zoning classifications and land use and permitting barriers.4 Even cities are getting into the action. Seattle City Council unanimously passed legislation earlier this year that exempts conversions from design development standards and the city’s Mandatory Housing Affordability requirements.5
These state and local laws and incentives pair nicely with recent federal legislation that establishes and revises grant and preferential loan programs to help fund such office-to-residential conversions. This article will discuss those federal grant and loan programs that are open to nonprofit and private entities, analyze the need for change, and consider whether the proposed changes will be sufficient to provide the housing these communities so desperately need.
In October 2023, the White House released a guidebook of available federal resources for commercial-to-residential conversions.6 The guidebook identifies 19 federal programs from the Department of Energy (DOE), the Department of the Interior, the Department of Transportation (USDOT), the Environmental Protection Agency (EPA), Housing and Urban Development (HUD), the Department of Agriculture, and the Department of the Treasury (Treasury). These programs are divided into two groups: (i) those that increase project affordability; and (ii) those that assist with the creation of zero-emissions buildings. This article focuses on the former. New federal opportunities to increase project affordability are as follows:
Grants to cover pre-development, acquisition, construction, and other costs (HUD’s Community Development Block Program);
Below-market loans for office-to-residential conversions near transportation (USDOT’s Transportation Infrastructure Finance and Innovation Act (TIFIA) and Railroad Rehabilitation and Improvement Financing (RRIF));
Land dispositions that can reduce development costs (USDOT regulations that allow transit agencies to transfer surplus property to local governments, nonprofit, and for-profit developers of affordable housing);
Tax incentives that fund conversions of historic buildings (Rehabilitation Tax Credit); and
Tax incentives that fund energy-efficiency improvements (Section 45L New Energy Efficient Home Credit).
HUD Programs
The HUD office administers the Community Development Block Grants (CDBG) program. CDBG provides funds to state and local governments who distribute money to CDBG applicants as either loans or grants. The money can be used to acquire, rehab, reconstruct, and convert commercial properties to residential and mixed-use properties. CDBG funds are not restricted to any particular locality. However, they are allocated to local or state governments who apply for the funds and distribute them using HUD’s formulas to developers, nonprofits, or smaller units of government. To be eligible for this program, states or metropolitan cities must have populations of at least 50,000. Qualified urban counties with populations of at least 200,000 may also apply. CDBG funds are expended to further the national objective of the project: to provide low-to-moderate-income benefits, to eliminate slums and blight, or to respond to a qualified urgent need. CDBG funds include an affordability requirement. If the grantees are creating rental units, they must provide affordable rates.
Similarly, if a unit is sold for purchase, the purchase price must represent a reasonable cost for low-to-moderate income households. Funding requires that the government entity that receives the funding comply with the National Environmental Policy Act (NEPA), the Davis-Bacon Act, the Build America, Buy America Act, and the Uniform Relocation Assistance and Real Property Acquisition Policy Act (Uniform Act).7 Most states have received CDGB grants. A list of CDBG grantees can be found on the HUD Exchange website.8
The USDOT administers two location-restricted programs. Both programs are designed to encourage residential development—including office-to-residential conversions if the resulting residential units are close to public transportation. Restricting or incentivizing residential development near public transportation is called Transit-Oriented Development (TOD).
As stated above, the USDOT administers funds available under TIFIA. TIFIA provides preferential loans and loan guarantees for TOD projects that: (i) improve or construct public infrastructure within walking distance (i.e., 0.5 miles) of, and accessible to, a fixed guideway transit, intercity or passenger rail, intercity bus station, or intermodal facility; (ii) projects for economic development, including residential housing, that are physically or functionally related to a passenger rail or multimodal station which includes rail service, and that improves or adds public infrastructure; and (iii) TOD projects that qualify as joint development projects between a public transit agency and a non-transit private developer in the form of residential, commercial, and mixed-use projects.9
Project Types 1 and 2 must incorporate private investment, be shovel-ready, and generate revenue that exceeds costs for the related transit station or service. Project Type 3 requires that the development: (i) create an economic benefit; (ii) create a transit benefit; (iii) provide a fair share of the revenue for transit; (iv) entail occupants who pay a fair share of the costs to operate/maintain; and (v) include collection of fees by the sponsor for use of ZEV fueling equipment, if installed.
Don’t miss your chance to register for Environmental Law 2025 in Washington, D.C. Attend in-person or live via webcast on February 20-21, 2025. To learn more about this program and to register for the in-person course or live webcast, click here.
The minimum project cost for this program is $10 million; there is no maximum loan size or project cost. A TIFIA loan can finance up to 49 percent of project costs (if eligible). Eligible project costs include development phase activities; construction, reconstruction, rehab, replacement, and acquisition of real property; and capitalized interest needed to meet market requirements, reasonably required reserve funds, capital issuance expenses, and other carrying costs during construction. The rate on the TIFIA loan is fixed and roughly equal to the yield on US Treasury securities with comparable maturity. TIFIA funds come with requirements to comply with the following federal laws: NEPA; Build America, Buy America; the Davis-Bacon Act; and the Uniform Act. TIFIA funds may be lent directly to a private entity with a public sponsor. The average time from application to financial closing is 12 months. Loans can have up to a 35-year repayment period. TIFIA currently has more than $70 billion in lending capacity.
The USDOT also administers the RRIF program, which provides below-market direct loans and loan guarantees for commercial and residential development near commuter rail or intercity rail stations.10 These funds are slightly more restricted than TIFIA money. The costs that are eligible for RRIF loan financing must: (i) incorporate more than 20 percent private investment in total project costs; and (ii) be physically connected to or inside one-half mile of a fixed guideway transit station, an intercity bus station, a passenger rail station, or multimodal station—provided the station includes service by a railroad.11
The applicant must demonstrate an ability to begin contracting within 90 days of RRIF funds becoming obligated and must demonstrate the project will generate new revenue for the relevant passenger rail station. Loans can have up to a 35-year repayment period. Unlike TIFIA, there is no maximum or minimum project cost, and up to 75 percent of eligible costs can be financed by an RRIF loan. The average time from application to financial closing is 12 to 18 months. RRIF currently has more than $30 billion it can lend.
As of April 18, 2024, both the TIFIA and RRIF programs had a 3.48 percent interest rate. These federal funds are encouraging and may allow a project to be financially feasible (or to “pencil”).
CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.
To find our more about ALI CLE’s in-person courses or webcasts, or to check out on-demand CLE, click here.