Commercial Real Estate Closings

Anyone who thinks closing a commercial real estate transaction is a clean, easy, stress-free undertaking has never closed a commercial real estate transaction. Expect the unexpected, and be prepared to deal with it.

I’ve been closing commercial real estate transactions for over 35 years. I grew up in the commercial real estate business.

My father was a “land guy”. He assembled land, put in infrastructure and sold it for a profit. His mantra: “Buy by the acre, sell by the square foot.”  From an early age, he drilled into my head the need to “be a deal maker; not a deal breaker.” This was always coupled with the admonition: “If the deal doesn’t close, no one is happy.” His theory was that attorneys sometimes “kill tough deals” simply because they don’t want to be blamed if something goes wrong.

A key point to understand is that commercial real estate Closings do not “just happen”; they are made to happen. There is a time-proven method for successfully Closing commercial real estate transactions. That method requires adherence to the four KEYS TO CLOSING outlined below:

This is Part 2 of a multi-part series of articles discussing the duties, rights and remedies of commercial real estate tenants in Illinois. Part 1, entitled “Getting It Right” discussed the importance of clarity in lease drafting, and the potential for unintended leasehold easements for parking, and other uses.

In March 2015, the Illinois Institute for Continuing Legal Education (“IICLE”) published its 2015 Edition practice handbook entitled: Commercial Landlord-Tenant Practice. To provide best-practice guidance to all Illinois attorneys, IICLE recruits experienced attorneys with relevant knowledge to write each handbook chapter. For the 2015 Edition, IICLE asked R. Kymn Harp and Catherine A. Cooke to write the chapter entitled Tenant’s Duties, Rights and Remedies. We were, of course, pleased to oblige. Although each of us represent commercial landlords at least as often as we represent commercial tenants, a clear understanding of the duties, rights and remedies of commercial real estate tenants is critical when representing either side of the commercial lease transaction.

The following is an excerpt (slightly edited) from our chapter in the 2015 Edition. We hope you find this excerpt, and the excerpts that will follow, informative and useful. Feel free to contact IICLE  directly to purchase the entire volume.

The COVENANT OF QUIET ENJOYMENT
What Is It? — General Principles

It has long been the law in Illinois that a covenant of quite enjoyment is implied in all lease agreements. Blue Cross Ass’n v. 666 N. Lake Shore Drive Associates, 100 Ill.App.3d 647, 427 N.E.2d 270, 273, 56 Ill.Dec. 290 (1st Dist. 1981); 64 East Walton, Inc. v. Chicago Title & Trust Co., 69 Ill.App.3d 635, 387 N.E.2d 751, 755, 25 Ill.Dec. 875 (1st Dist. 1979); Berrington v. Casey, 78 Ill. 317, 319 (1875); Wade v. Halligan, 16 Ill. 507, 511 (1855).

A covenant of quiet enjoyment “promises that the tenant shall enjoy the possession of the premises in peace and without disturbance.” [Emphasis in original.] Checkers, Simon & Rosner v. Lurie Co., No. 87 C 5405, 1987 WL 18930 at *3 (N.D.Ill. Oct. 20, 1987). This does not mean, however, that no breach of the covenant of quiet enjoyment may be found in a leasehold without a finding that the lessor intended to deprive the lessee of possession. Blue Cross Ass’n, supra, 427 N.E.2d at 27. It simply means that a tenant must actually be in possession of the premises to claim a breach of the covenant of quiet enjoyment. If the tenant has already vacated the premises before the disturbance has commenced, no breach of the covenant of quiet enjoyment occurs. Checkers, Simon & Rosner, supra, 1987 WL 18930 at *3.

An implied covenant of quiet enjoyment includes, “absent a lease clause to the contrary, the right to be free of the lessors’ intentional interference with full enjoyment and use of the leased premises.” Infinity Broadcasting Corporation of Illinois v. Prudential Insurance Company of America, No. 86 C 4207, 1987 WL 6624 at *5 (N.D.Ill. Feb. 9, 1987), aff’d, 869 F.2d 1073 (7th Cir. 1989), quoting American Dairy Queen Corp. v. Brown-Port Co., 621 F.2d 255, 258 (7th Cir. 1980).

If the landlord breaches the covenant of quiet enjoyment, the lessee may remain in possession and claim damages for breach of lease. In such case, the measure of damages is the difference between the rental value of the premises in light of the breached covenant of quiet enjoyment and the rent that the tenant agreed to pay under the lease, together with such special damages as may have been directly and necessarily incurred by the tenant in consequence of the landlord’s wrongful act. 64 East Walton, supra, 387 N.E.2d at 755.

Although Illinois cases defining the precise scope of a covenant of quiet enjoyment are rare, BLACK’S LAW DICTIONARY, pp. 1248 – 1249 (6th ed. 1993) defines “quiet enjoyment” in connection with the landlord-tenant relationship as “the tenant’s right to freedom from serious interferences with his or her tenancy. Manzaro v. McCann, 401 Mass. 880, 519 N.E.2d 1337, 1341. (Ringing for more than one day of smoke alarms in an apartment building could be sufficient interference with the tenants’ quite enjoyment of leased premises to justify relief against the landlord.).”

HOW THE COVENANT OF QUIET ENJOYMENT MAY APPLY— CASE LAW

In Blue Cross Ass’n v. 666 N. Lake Shore Drive Associates, 100 Ill.App.3d 647, 427 N.E.2d 270, 273, 56 Ill.Dec. 290 (1st Dist. 1981), the First District Appellate Court discussed the covenant of quiet enjoyment in the lease as granting the tenant a right of quiet and peaceful possession and enjoyment of the whole premises and equated a breach of quiet enjoyment under a lease to a private nuisance. “A private nuisance in a leasehold situation is ‘an individual wrong arising from an unreasonable, unwarranted or unlawful use of one’s property producing such material annoyance, inconvenience, discomfort, or hurt that the law will presume a consequent damage.’ ” Id., quoting Great Atlantic & Pacific Tea Co. v. LaSalle National Bank, 77 Ill.App.3d 478, 395 N.E.2d 1193, 1198, 32 Ill.Dec. 812 (1st Dist. 1979).

The tenant had entered into a five-year lease on August 22, 1978, with a five-year renewal option, for approximately 53,000 square feet of the

In March 2015, the Illinois Institute for Continuing Legal Education (“IICLE”) published its 2015 Edition practice handbook entitled:  Commercial Landlord-Tenant Practice. To provide best-practice guidance to all Illinois attorneys, IICLE recruits experienced attorneys with relevant knowledge to write each handbook chapter. For the current edition, IICLE asked R. Kymn Harp and Catherine Cooke of Robbins, Salomon & Patt, Ltd., Chicago, Illinois, to write the chapter entitled Tenant’s Duties, Rights and Remedies. We were, of course, pleased to oblige. Although each of us represent commercial landlords at least as often as we represent commercial tenants, a clear understanding of the duties, rights and remedies of commercial real estate tenants is critical when representing either side of the commercial lease transaction.

The following is an excerpt (slightly edited) from our chapter, Tenant’s Duties, Rights and Remedies appearing in the 2015 Edition of IICLE Commercial Landlord-Tenant Practice. We hope you find this excerpt, and the excerpts that will follow, informative and useful. Feel free to contact IICLE directly to purchase the entire volume.

How Commercial Lease Issues Commonly Arise – Getting it Right

Commercial real estate leases, like virtually all documents and agreements relating to commercial real estate transactions and interests, are, to a very large extent, consistent only in their variety. In commercial real estate practice, there are few, if any, “standard form” documents or agreements. To be sure, there are provisions in commercial real estate leases that any experienced practitioner would expect to see, and there are some generally applicable legal concepts that apply, but the variety of issues that may arise — and the language used in each commercial lease — will directly and materially impact the “duties, rights, and remedies” of a tenant under any commercial lease.

The best answer to most questions about what are the rights, duties, and remedies of a tenant under a commercial real estate lease is “It depends.” What does it depend on? It depends primarily on what the parties to the lease — the landlord and tenant — intended, as (presumably) reflected by the express terms and conditions of the lease. However, two common challenges frequently exist, and they apply equally to commercial tenants and commercial landlords. They are (a) poorly written lease provisions that do not clearly and definitively set forth the intention of the landlord and tenant in a way that cannot reasonably be misunderstood and (b) inclusion of perceived “standard boilerplate” provisions in a lease without fully understanding their legal or practical affect on the leased premises, the parties, and the greater project of which the leased premises may be a part. When the intent of the parties is not abundantly clear, a court may find the answer implied by the facts and circumstances.

GENERAL LEASE PRINCIPLES AND RULES OF CONSTRUCTION

A “lease” is generally described as a contract for exclusive possession of land and improvements for a term of years or other duration, usually for a specified rent or other compensation. Urban Investment & Development Co. v. Maurice L. Rothschild & Co., 25 Ill.App.3d 546, 323 N.E.2d 588, 592 (1st Dist. 1975); Feeley v. Michigan Avenue National Bank, 141 Ill.App.3d 187, 490 N.E.2d 15, 18, 141 Ill.Dec. 187 (1st Dist. 1986).

In determining the duties, rights, and remedies of a tenant under a commercial lease in Illinois, the general rules of contract construction will apply. Walgreen Co. v. American National Bank & Trust Company of Chicago, 4 Ill.App.3d 549, 281 N.E.2d 462, 465 (1st Dist. 1972); Feeley, supra, 490 N.E.2d at 18; Chicago Title & Trust Co. v. Southland Corp., 111 Ill.App.3d 67, 443 N.E.2d 294, 297, 66 Ill.Dec. 611 (1st Dist. 1982). Interpretation of a lease is a question of law when the terms are plain and unambiguous. Madigan Bros. v. Melrose Shopping Center Co., 123 Ill.App.3d 851, 463 N.E.2d 824, 828, 79 Ill.Dec. 270 (1st Dist. 1984).

“An ambiguous contract is one capable of being understood in more senses than one; an agreement obscure in meaning, through indefiniteness of expression, or having a double meaning.” Advertising Checking Bureau, Inc. v. Canal-Randolph Associates, 101 Ill.App.3d 140, 427 N.E.2d 1039, 1042, 56 Ill.Dec. 634 (1st Dist. 1991), quoting First National Bank of Chicago v. Victor Comptometer Corp., 123 Ill.App.2d 335, 260 N.E.2d 99, 102 (1st Dist. 1970). However, the mere fact that the parties to a lease “dispute” the meaning of a lease provision and assign conflicting interpretations does not render the provision “ambiguous.” McGann v. Murry, 75 Ill.App.3d 697, 393 N.E.2d 1339, 1342 – 1343, 31 Ill.Dec. 32 (3d Dist. 1979); St. George Chicago, Inc. v. George J. Murges & Associates, Ltd., 296 Ill.App.3d 285, 695 N.E.2d 503, 506 – 507, 230 Ill.Dec. 1013 (1st Dist. 1998); Ford v. Dovenmuehle Mortgage, Inc., 273 Ill.App.3d 240, 651 N.E.2d 751, 745 – 755, 209 Ill.Dec. 573 (1st Dist. 1995). Whether ambiguity exists is a question of law for the court. Advertising Checking Bureau, supra, 427 N.E.2d at 1042; Pioneer Trust & Savings Bank v. Lucky Stores, Inc., 91 Ill.App.3d 573, 414 N.E.2d 1152, 1154, 47 Ill.Dec. 36 (1st Dist. 1980).

It is well-settled in Illinois that, when construing a written lease, the court must give words their commonly accepted meaning and must construe every part with reference to all other portions of the lease “so that every part may stand, if possible, and no part of it, either in words or sentences, shall be regarded as superfluous or void if it can be prevented.” Kokenes v. Cities Service Oil Co., 24 Ill.App.3d 483, 321 N.E.2d 338, 340 (1st Dist. 1974), quoting Szulerecki v. Oppenheimer, 283 Ill. 525, 119 N.E. 643, 646 (1918). See also Southland, supra, 443 N.E.2d at 297.

In construing a lease, the instrument is to be considered as a whole and the primary object is to derive the intent of the parties. However, a contract must be enforced as written, and when the terms of a lease are clear and unambiguous, they will be given their natural and ordinary meaning. Gerardi v. Vaal, 169 Ill.App.3d 818, 523 N.E.2d 1327, 1331, 120 Ill.Dec. 416 (3d Dist. 1988).

The foregoing sounds pretty straightforward, but unless attorneys and their clients draft leases with a comprehensive understanding of the interplay between particularly drafted provisions and every other part of the lease — including so-called “standard boilerplate” provisions — they may find themselves surprised by what they have “agreed to.”

PRACTICE POINTER

 Drafting a commercial real estate lease is similar to drafting any other commercial document, except that the meaning and intent of contractual lease provisions are colored by an extensive body of underlying real property law that has developed over the centuries.

A commercial real estate lease should say what the parties mean and mean what it says. Words have meaning; phrases have meaning; each provision has meaning. The interplay of words, phrases, and all provisions in a lease will help determine the meaning of each other word, phrase, or provision. See Kokenes, supra, 321 N.E.2d at 340; Szulerecki, supra, 119 N.E. at 646.

PRACTICE POINTER

 Be sure the words and phrases you use mean what your client believes they mean before proceeding.

 If there are provisions of a commercial real estate lease you do not fully understand — including provisions you believe are “standard boilerplate” provisions — you need to learn what they mean and how they affect other parts of the lease, and your client’s rights, duties and remedies, before advising your client to proceed.

The following discussion highlights some areas in which the rights, duties, and remedies of the commercial real estate tenant (and, by mirror image, the landlord) appear not to have been what one or the other party thought they were.

As the commercial real estate market begins to pick up steam, beware the urge to follow a “momentum” investment strategy rather that a “value” investment strategy.

Momentum investing relies on market increases to generate a return on investment. It is the “rising tide floats all boats” investment model. It is the investment model of which all “bubbles” are made.

As momentum investing accelerates, investment fundamentals tend to get lost. Instead of evaluating cash on cash returns using discounted cash flows that underlie “value” investing, a casino mentality takes hold – whereby investors can justify acquiring assets generating even a negative cash return, with the notion that rising prices will yield a profit. As the saying goes: “Any fool can make a profit in a rising market – and many fools do”. The challenge, of course, comes when a market hits a plateau or, worse yet, the market declines.

As a general proposition, value investing is significantly more prudent. If a project is cash flowing, and generating a positive return on investment, today and for the foreseeable future – which is a fundamental precept of a value investment strategy – the potential added return of any increase in value in the underlying asset caused by the “rising tide” effect is icing on the cake. Choose your cake with care.

There are, of course, exceptions to every rule. But, employing an “exception” is wisely done only after sober reflection of the particular circumstance to determine that in that particular case the exception is warranted. When an exception is regularly employed, it is no longer an exception – but, rather, becomes the rule itself.

As in all markets, there will be winners and there will be losers. It makes sense in the coming commercial real estate revival to position yourself and your company as a winner. You may not get another chance.

Exercise all appropriate due diligence. Use readily available and appropriate asset protection strategies. Invest with intentional regard to reliably building wealth though a well conceived value investing strategy – not a roulette table strategy that, over time, is virtually certain to fail.

If this recent economic debacle has taught us anything, it has taught that bad things can happen to good people who lose sight of the fundamentals. Good deals – even great deals – can be made if reliable commercial real estate investment fundamentals are employed.

As a wise mentor once told me: “You have a good brain – use it.”

Good luck.

R. Kymn Harp
Robbins, Salomon & Patt, Ltd.
Chicago, IL
www.rsplaw.com
JOIN MY THOUGHTBOARD: www.Harp-OnThis.com

REPORTING FROM THE FIELD. . .

At long last, the real estate investment market is beginning to show signs life. Commercial and industrial property transactions are increasingly common, and multifamily properties of all sizes are being snapped up by investors. Historically low interest rates, high occupancy rates, increasing rental rates, and rising property values are contributing factors.

Early transactions have often been cash deals, where the investor paid cash for the property rather than seek financing. This can be a great opportunity to achieve high yields for investors flush with cash, but what about everyone else?   What about potential investors who have limited cash on hand?

Unlike the easy-credit days preceding the Great Recession, real estate investment financing is more difficult to obtain and requires a significantly higher equity contribution by investors.  Common loan to value ratios are 60% to 65%, which means that for each $1,000,000 the investor needs, the investor can likely borrow only $600,000 to $650,000. Consequently, the investor must come up with between $350,000 and $400,000 in equity for each $1,000,000 of purchase price. For many investors, this may not be an easy task.

Solution? Go back to the way we did things in the old days – before the days of easy, near 100% financing: pool funds with other like-minded investors.

When raising capital from investors, keep in mind that you are engaged in a securities offering governed by state, and perhaps federal, securities laws. This is true even if the money is being invested by friends and family. A private placement memorandum (“PPM”) is advisable to protect against claims by investors that the investment turned out to be other than what it was portrayed to be. This is particularly important if the investment goes bad – as investments sometimes do.

PPM’s for real estate investments need not be particularly complicated, but they need to comply with applicable securities laws and include the disclosures and information necessary to protect the promoter from liability. The promoter must be particularly cautious if funds are being obtained from investors other than “accredited investors” as that term is defined by Rule 501 of Regulation D. Helping promoters comply with the law while raising capital is a key function for lawyers.

In September 2013, as required by the Jumpstart Our Business Startups Act (JOBS Act), new rules were established by the U.S. Securities and Exchange Commission to permit general solicitation or general advertising for certain securities offerings limited to accredited investors only. While this may prove helpful to promoters’ efforts to find investors and raise funds, the importance of a carefully crafted PPM has not diminished. Thoughtful promoters and lawyers will recognize that a well-crafted PPM may now be more important than ever.

Raising capital through a private offering of securities is a viable strategy for real estate investment, but it must be done with skill and great care.  Failure to fully comply with the law can be financially catastrophic.  Take care to do it right.

“The best time to plant a tree was twenty years ago.

        The second best time is today.”

Chinese proverb

For over 35 years, I have represented commercial real estate investors, developers and business owners. Most of that time has been spent helping them acquire, finance, expand, develop, manage and grow their assets and businesses. For the past 5 to 6 years, as we have struggled through the Great Recession, a huge amount of my time has been spent helping clients keep their assets.

Growing up, I was steeped in the practical view that it is not so much what you acquire that counts, but, rather, what you keep. My parents and grandparents were not in the real estate business to make others wealthy. They were playing real life Monopoly®. They played to win. It was less about money for money’s sake than it was

Of Course We Can Sue Them . . . But Can We Hold Them Liable?

No one knows everything. It’s a simple fact of life. Often, businesses turn to other businesses and professionals to obtain needed information. The range of commercial information providers assisting business owners and real estate investors, developers and lenders gather and analyse information is vast.

The question is: Do we have a legal right to rely on the information they provide? What if the information is wrong? What if we rely on that incorrect information and suffer a loss? Is the information provider liable?

It could be anything from hiring an appraiser to appraise a property to support a commercial loan; hiring a lab to analyze nutrition and caloric content of food products; or engaging a financial consultant to evaluate a company’s assets and liabilities as part of a business acquisition or merger; or seeking out a lending institution to provide information regarding the creditworthiness of a potential borrower. We might hire a structural engineer to evaluate the structural integrity of a building or bridge or other structure; or engage a surveyor to determine the scope and size of a parcel of land, or the location of easements and improvements located on the property, or the existence of rights of way to access the property; or we might retain a person or business holding itself out as a “due diligence” expert to investigate the essential facts necessary to enable us to determine whether to proceed with a particular transaction or project. The list of commercial information providers we rely upon to conduct our affairs is nearly endless.

Another simple fact of life is that people can and do make mistakes. They misinterpret information. Misstate the facts. Fail to discover and disclose all material information necessary to make information they have provided sufficient to enable informed action and decision-making.

What happens when your information provider gives you bad information and you suffer a loss as a result? Do you have any recourse? What if

This is the second installment of a three-part series on Section 1031 like-kind exchanges. Part 1 explained WHY you should consider use of a Section 1031 like-kind exchange when selling commercial or investment real property. Part 2 covers the key rules for HOW to implement a Section 1031 like-kind exchange. Part 3 will cover special issues applicable to a Section 1031 like-kind exchange when a Tenant-In-Common [TIC] interest is being acquired.

KEY RULES FOR SECTION 1031 EXCHANGES

The following is an outline of key rules applicable to Section 1031 exchanges. Become familiar with these rules. Unless you intend to completely cash out of real estate investing, a Section 1031 exchange may work to your benefit. If you intend to keep investing in real estate or using real estate in your trade or business, a Section 1031 exchange will maximize the capital you have available to reinvest.

Key Elements of a Section 1031 Exchange*

What is Section 1031?

Section 1031 refers to Section 1031 of the Internal Revenue Code of 1986, as amended.

What does it do?

Section 1031 permits a taxpayer (the Exchangor) to dispose of certain real estate and personal property and replace it with like-kind property without being required to pay taxes on the transaction.

What property qualifies?

To qualify for a Section 1031 exchange, the property being disposed of (the Relinquished Property) must have been used in the Exchangor’s trade or business and/or must have been held for investment purposes. The property being acquired (the Replacement Property) must likewise be acquired for use in the Exchangor’s trade or business or for investment.

What property is considered like-kind?

For real estate, to be like-kind means simply that real estate must be exchanged for real estate. The rules related to personal property are significantly more complex. Personal property is any property that is not real estate.

Real estate exchanges are fairly straightforward. A warehouse may be exchanged for another warehouse or for any other qualifying real estate including, for instance, a factory building, office building, shopping center, single-tenant store, parking garage, or even a parcel of vacant ground so long as it qualifies as being acquired for use in the Exchangor’s trade or business or is to be held for investment. This is not a difficult test to pass. Similarly, a qualifying parcel of vacant ground or a shopping center or office building or factory or other parcels of investment real estate may be exchanged for any other qualifying real estate investment.

Personal property exchanges are not so straightforward. For personal property, the property must be substantially similar and of the same type or class. For example: a car can be exchanged for another car; and a bull can be exchanged for another bull; and a cow can be exchanged for another cow; but, a bull may not be exchanged for either a cow or a car.

Although personal property exchange rules are substantially more technical and complicated than real property exchange rules, generally speaking, depreciable tangible personal property held for productive use in a trade or business can be exchanged for other depreciable tangible personal property held for productive use in a trade or business so long as they fall within the same NAICS classification code.

For instance, Limited Service Restaurants such as fast food restaurants, pizza delivery, sandwich shops, etc. fall within 2012 NAICS Code 722513. Accordingly, the assets of one can be exchanged for the assets of the other under Section 1031. But, note that the NAICS Code for a bar, tavern or nightclub is 722410, and the NAICS Code for a full service restaurant is 722511, so an exchange of assets of either of these for the assets of the other, or the assets of a Limited Service Restaurant (even though otherwise physically identical), may not likely be considered “like kind”.

The point, for purposes of this post, is that exchange rules for personal property are substantially more complex than exchange rules for real property. Accordingly, if you are exchanging personal property – either in conjunction with an exchange of real property or purely as a personal property exchange – great care must be taken to comply with the personal property exchange rules to receive the benefits of a tax deferred exchange under Section 1031.

What property is excluded?

Some types of property are expressly excluded from tax deferred exchange treatment by statute, rule or regulation The following types of property do not qualify for aSection 1031 exchange: stocks, bonds, partnership interests, limited liability company interests, personal residences, stocks in trade or inventory, and certain other intangible property.

Are there timing issues?

Section 1031 exchanges can be simultaneous, but they are not required to be. In fact, most exchanges made pursuant to Section 1031 are not simultaneous. There are, however, strict timing rules that apply tonon-simultaneous exchanges and strict rules prohibiting access to funds.

What are the time limits?

The Replacement Property or properties must be identified, in writing, not later than forty-five days after the Relinquished Property is transferred (the Identification Period). The Replacement Property or properties must be acquired not later than the earlier of (i) 180 days after the Relinquished Property was transferred, or (ii) the due date for the Exchangor’s tax return, including any extensions (the Acquisition Period). The Identification Period is included within the Acquisition Period.

How many Replacement Properties may be identified?

There is no fixed limit to the number of Replacement Properties that may be identified, but there are two primary rules that apply: (1) the Three-Property Rule, and (2) the 200% Rule.

1. The Three-Property Rule allows you to identify up to three (3) properties as potential Replacement Properties, regardless of value. You need not acquire all three properties, but as of the end of the Identification Period, not more than three properties may be identified. This is the most commonly used identification rule.

2. The 200% Rule allows you to identify any number of potential Replacement Properties so long as the aggregate value of all identified properties does not exceed 200% of the value of the Relinquished Property. You need not acquire all identified properties.

Generally, if you identify more properties than permitted, you are treated as if you have not identified any properties. However, there is one more rule that might save the day. The 95% Rule allows you to identify any number of potential Replacement Properties, regardless of value, so long as you actually acquire within the Acquisition Period at least 95% of the value of all properties identified. Use of the 95% Rule is rare, and is generally considered more a safety valve rule than an intentionally used exchange rule

Must all exchange proceeds be used?

There is no requirement that all proceeds received upon sale of the Relinquished Property be used to acquire the Replacement Property. Any exchange proceeds not used, however, are taxable.

What constitutes exchange proceeds?

Exchange proceeds means the net sale price of the Relinquished Property, including all net equity and the amount of any mortgage encumbering the Relinquished Property, whether paid off at closing or assumed by the purchaser. It is not sufficient to merely reinvest the net equity received upon sale. The purchase price of the Replacement Property must equal or exceed the aggregate of the net equity received upon sale of the RelinquishedProperty plus any mortgage encumbering the Relinquished Property at the time of the sale closing.

Example: If the Relinquished Property is encumbered by a $700,000 mortgage and is sold for $1 million as part of a Section 1031 exchange transaction, to defer all taxes, the purchase price of the Replacement Property must be at least $1 million, not merely $300,000.

When can the Exchangor obtain access to unused proceeds?

Proceeds from sale of the Relinquished Property may be accessed only when the exchange is completed, fails, or expires. If no potential Replacement Properties are identified within the Identification Period, the exchange fails, and the Exchangor may receive the funds. Those funds will, however, be taxed in the year received. But note: If a mortgage was paid off at the Closing of the Relinquished Property, and the amount of the mortgage was greater than the tax basis of the Relinquished Property, the amount paid to satisfy the mortgage in excess of the tax basis of the Relinquished Property is taxable in the year of Closing of the Relinquished Property.

If all properties identified within the Identification Period are acquired within the Acquisition Period, the exchange is completed, and any remaining funds may be received by the Exchangor. Those remaining funds are taxable. If less than all identified properties are acquired, but the Acquisition Period expires, all remaining funds may be received by the Exchangor, but are taxable.

Conclusion:

These are the basics. As tax rates rise, Section 1031 exchanges become increasingly valuable.

A Section 1031 exchange is not a new and exotic tax shelter scheme. Tax deferred exchanges of like-kind property have been recognized by the Internal Revenue Service as a valid tax deferral strategy since the early 1920s. The structure and effect of a Section 1031 exchange were specifically authorized by Congress by enacting Section 1031 of the Internal Revenue Code of 1986, as amended, and the Internal Revenue Service has promulgated extensive regulations for its implementation.

Use Section 1031 to your advantage, but be sure to strictly comply with the Section 1031 rules.

* Special Thanks to my tax partner, James M. Mainzer, for consulting on this post.

_________________________________

As required by the Internal Revenue Service under Circular 230, you are advised that any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this article.

 Tips on Selling Commercial Real Estate

Sellers are funny people. Not “ha ha” funny, but funny in the sense that they sometimes have an odd way of looking at things when they are selling commercial real estate.

This is not an indictment against any unique class of people. Let’s face it, sooner or later virtually all commercial real estate Buyers become commercial real estate Sellers. It is simply a recognition of an odd twist that occurs in the mindset of many commercial real estate investors when the tables are turned and they become Sellers instead of Buyers. If you are selling commercial real estate, or are a listing broker representing a party selling commercial real estate, here’s what you should do.

Albert Einstein:           “Everything should be made as simple as possible, but not simpler.”

Commercial Real Estate Due Diligence – the Four Areas of Inquiry

I’m a big fan of Albert Einstein. He’s one of my intellectual heroes.  He could see and understand what others could barely imagine. His greatest gift, I believe, was his ability to find answers to questions others didn’t even know existed.

Real estate due diligence requires insight as well. To find the answers, you must