Glossary of 1031 Exchange and Securitized Real Estate

Accredited Investor - The Security and Exchange Commission defines an accredited investor as an individual with either $1 million in net worth (all assets, excluding primary residence, less all liabilities) or net income for the last two years of $200,000 or greater ($300,000 if spouse has income) with a reasonable expectation of such earnings in the current year.

Basis (Cost Basis) - Basis (or cost basis), as used in United States tax law, is the original cost of property plus the cost of improvements, adjusted for factors such as depreciation. When property is sold, the taxpayer pays/saves taxes on a capital gain/loss that equals the amount realized on the sale minus the sold property's basis. Cost basis is needed because tax is due based on the gain in value of an asset. IRS Publication 551 contains the IRS definition of basis: "Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also use it to figure gain or loss on the sale or other disposition of property."

Boot - The face amount of money or debt and the fair market value of non-like-kind property received in an exchange. The fact that boot is received does not disqualify an exchange; the boot, however, will be subject to capital gains tax to the extent of recognized gain on the sale of relinquished property.

Constructive Receipt - Income not actually received or possessed is "constructively received" and reportable if it is within the Exchanger's control.

Delaware Statutory Trust (DST) - A separate legal entity created as a trust under Delaware statutory law. Delaware law permits a very flexible approach to the design and operation of the entity. A DST may be used in in a Section 1031 tax-deferred exchange private placement program if structured in accordance with the provisions of IRS Revenue Ruling 2004-86.

Depreciation Recapture - Depreciation recapture refers to the portion from the sale of a property that has been previously deducted as depreciation. For example, if a property purchased for $1,000,000 is sold for $1,250,000 and during the time of ownership $500,000 was claimed as depreciation deductions, this $500,000 would be considered depreciation recapture and taxed a certain rate while the additional $250,000 would be considered capital gain and taxed at a different rate. See a more detailed explanation. Please note that while depreciation may not have been claimed on tax returns prior years, the depreciation that was allowed or allowable must still be recaptured upon sale.

Direct Participation Program (DPP) - A business venture designed to let investors participate directly in the cash flow and tax benefits of the underlying investment. A DPP is generally a passive investment in real estate or energy-related ventures. Also known as a "direct participation plan," DPPs are usually organized as a limited partnership, subchapter S corporation or general partnership. Neither investment qualifies for a 1031 exchange. While DST and TIC offerings are technically DPPs, they are structured in most cases to qualify for 1031 exchange.

Exchanger - The taxpayer seeking to defer capital gains tax under the provisions of IRC Section 1031 by means of a real estate exchange.

Exchange Period - The period of time in which the Exchanger must acquire title to replacement property to qualify under the safe harbor for the exchange. The period ends on the earlier of the day 180 days after the relinquished property is transferred or the due date (including extensions) of the Exchanger's federal income tax return for the year in which the Exchanger relinquished the property in the exchange.

Fee Interest - A fee interest, or fee simple, is an estate (ownership) of real property of indefinite duration that can be freely transferred. This is the most common and perhaps most absolute type of estate under which the owner enjoys the greatest discretion over the disposition of the property.

Identification Period - The 45-day period in which the exchanger must identify replacement property for exchange. This period begins on the day of transfer of title to the relinquished property and ends at midnight on the 45th day following the transfer.

Like-Kind Property - Refers to the nature and character of the property and not to its grade or quality, so that one kind or class of property may not be exchanged, under Section 1031, for property of a different class or kind. As a general rule, as long as the purpose of the taxpayer is to hold the property as an investment for use in a trade or business, real property will be like-kind with other real property. Accordingly, real property should not be exchanged for personal property.

Master Tenant - In a DST structure, the trust will often lease the entire property to a Master Tenant, who then subleases the property to the actual tenants. This arrangement is necessary to meet the legal requirements of the trust, and allows for two seemingly contradictory situations: 1.) It allows the investors in a DST to have a direct interest in real estate. 2.) It removes both the trust and the investors from the direct day-to-day management of the property and its subleases, which are now handled by the Master Tenant.

Mortgage Boot - The liabilities assumed or taken subject to an exchange. It is not as recognizable as cash or other non-like-kind property. The taxpayer is considered to have received mortgage boot even if the buyer refinances the property as part of the exchange and used the proceeds to pay off the taxpayer's mortgage.

NNN Lease - A NNN Lease is a net lease, structured as a turnkey investment property in which the tenant is responsible for paying the three major expenses associated with commercial real estate ownership; property tax, insurance and maintenance. NNN stands for Net-Net-Net and is pronounced "Triple Net.” The rent collected under a net lease is net of expenses. It therefore tends to be lower than, for instance, rent charged under a gross lease. Net lease types include single net, double net, triple net and even bondable triple net leases. The term "net lease" is often used as a shorthand expression when referring to NNN leases.

Private Placement Offering - The sale of securities to a relatively small number of select investors as a way of raising capital. Since a private placement is offered to a few select individuals, the placement does not have to be registered with the Securities and Exchange Commission. Private placement offerings can be made to institutional investors or to accredited investors.

Property Boot - A taxpayer who receives money or non-qualifying property is considered to have received property boot.

Qualified Intermediary (QI) - A third-party entity that serves to facilitate the Section 1031 exchange on behalf of the exchanger. Also known as the facilitator or accommodator, the qualified intermediary will work under an agreement with the exchanger to take possession of proceeds from the escrow of the relinquished property and utilize those same proceeds to fund the escrow of the replacement property. This safe harbor prevents the exchanger from having constructive receipt of the funds from the sale of the relinquished property.

Real Estate Fund (Private Equity Real Estate Fund) - A mutual fund that pools capital from investors and invests primarily in equity or debt of real estate to produce income and capital gains for its unit holders. These investments typically involve an active management strategy, ranging from moderate reposition or releasing of properties to development or extensive redevelopment. These funds typically have a limited life span, covering an investment period during which properties are acquired and a holding period during which active asset management will be carried out and the properties sold.

Real Estate Investment Trust (REIT) - A REIT is a corporation that invests in real estate directly, either through properties or mortgages, and which is sold as a security. REITs typically raise $1 to $2 billion in capital and purchase a portfolio of properties over a period of several years produce rental income. A REIT must abide by specific rules and restrictions so that it is not required to pay corporate income taxes. Thus, all dividend distributions made by the REIT to investors are taxed only at the investor level, thereby avoiding any double taxation. REITs can be offered as private placement investments to accredited investors or publically traded.

Relinquished Property - The relinquished property, also known as the exchange property or down-leg property, is the property originally owned by the exchanger and sold by the exchanger in a like-kind exchange process.

Replacement Property - Acquisition property or up-leg property acquired by the exchanger in a like-kind exchange process.

Royalty - Royalties are payments made by one party to another for the use or using up of an asset. Oil and gas royalties are paid based upon the amount of oil and gas produced from a lease. Oil and gas royalty interests are classified as real property, similar to real estate assets that may be bought and sold privately or through public auctions like other real estate.

Sponsor - The sponsor is the party who acquires the assets and structures and offers a securitized real estate offering such as a DST, a TIC, a REIT, an oil and gas royalty interest or a real estate fund. In the case of a DST, the sponsor will acquire the real estate, structure the trust, make the private placement offering to accredited investors through one or more brokerages and contract with the master tenant and professional management company, both of which are frequently affiliates or subsidiaries of the sponsor.

Tenancy-in-Common (TIC) - A co-ownership structure under which an investor may own an undivided fractional interest in an entire property and participate in a proportionate share of the net income, tax shelters and growth.

Undivided Fractional Interest - With the tenancy-in-common ownership structure, each tenant owns an undivided fractional interest in the whole property but not a particular part of the property. Rather, they have fractional ownership, together with the other tenants, of the entire undivided property.