Toolkit · Tax

The Exchange Agreement, Identification Notice, and Qualified Opportunity Fund Toolkit

26 U.S.C. § 1001

Type
Toolkit
Jurisdiction
National
Date
2024-09-30
Topic
Tax

This toolkit supplies the working documents a gain deferral matter requires, each keyed to the authority it implements. Exchange materials include contract cooperation language, escrow instructions that prevent constructive receipt, an intermediary diligence questionnaire, a written identification notice, a boot model, and a basis and depreciation split worksheet. Governance materials include a business purpose memorandum outline and a client deadline letter. Opportunity zone materials include a fund diligence questionnaire, an asset test tracker, a substantial improvement computation, and the written working capital plan that is the most commonly missed requirement in the regime. Installment and involuntary conversion materials include a year-one recapture model and a replacement period tracker. Each template states the failure it prevents.

The Exchange Agreement, Identification Notice, and Qualified Opportunity Fund Toolkit

Tax > Like-Kind Exchanges, Opportunity Zones, and Gain Deferral | Published 30 September 2024 - Updated 2 July 2026 | UpLaw - uplaw.us

Authority reference card

Question Authority
Is gain recognized by default? 26 U.S.C. § 1001
What is adjusted basis? 26 U.S.C. § 1011
What is cost basis? 26 U.S.C. § 1012
What is basis at death? 26 U.S.C. § 1014
What is basis of gifted property? 26 U.S.C. § 1015
How does holding period tack? 26 U.S.C. § 1223
What is a like-kind exchange? 26 U.S.C. § 1031
What is an involuntary conversion? 26 U.S.C. § 1033
What is installment reporting? 26 U.S.C. § 453
What interest charge applies? 26 U.S.C. § 453A
What recaptures personal property depreciation? 26 U.S.C. § 1245
What recaptures real property depreciation? 26 U.S.C. § 1250
What governs business property character? 26 U.S.C. § 1231
What governs partnership contributions and allocations? 26 U.S.C. § 721, 26 U.S.C. § 704, 26 U.S.C. § 706
What governs spousal transfers? 26 U.S.C. § 1041
What excludes residence gain? 26 U.S.C. § 121
What is gross income? 26 U.S.C. § 61
What is broker reporting? 26 U.S.C. § 6045
Where are the income tax regulations? 26 C.F.R. Part 1

Case anchors. Realization and income: Cottage Savings Assn. v. Commissioner, Commissioner v. Glenshaw Glass Co.. Debt and basis: Crane v. Commissioner, Commissioner v. Tufts. Assignment of income: Helvering v. Horst. Substance: Gregory v. Helvering, Commissioner v. Court Holding Co., United States v. Cumberland Public Service Co., Frank Lyon Co. v. United States, Knetsch v. United States, Higgins v. Smith, Moline Properties, Inc. v. Commissioner, Commissioner v. Brown. Character: Corn Products Refining Co. v. Commissioner, Arkansas Best Corp. v. Commissioner. Open transactions: Burnet v. Logan. Deference: Mayo Foundation for Medical Education & Research v. United States, Loper Bright Enterprises v. Raimondo.

Tool 1: Contract cooperation clause

Exchange cooperation. Seller may consummate the sale of the Property as part of a like-kind exchange under 26 U.S.C. § 1031. Buyer agrees to cooperate with Seller in effecting such an exchange, including consenting to the assignment of Seller's rights under this Agreement to a qualified intermediary, provided that Buyer shall incur no additional cost, expense, liability, or delay, shall not be required to take title to any property other than the Property, and shall not be required to make any representation or warranty concerning the exchange. Seller shall indemnify Buyer for any cost or liability arising from the exchange. This provision shall survive closing.

Reverse form, for the replacement contract:

Exchange cooperation. Buyer may acquire the Property as part of a like-kind exchange or a qualified exchange accommodation arrangement. Seller agrees to cooperate, including consenting to assignment of Buyer's rights to a qualified intermediary or exchange accommodation titleholder and to conveying title as directed, provided Seller incurs no additional cost, expense, liability, or delay.

Why it matters. A seller who asks for cooperation after the contract is signed sometimes gets it and sometimes does not. Put it in the first draft.

Tool 2: Escrow and closing instructions

To: [Closing Agent] Re: [Property] — Exchange closing instructions

Seller is effecting a like-kind exchange under 26 U.S.C. § 1031. Seller's rights under the purchase and sale agreement have been assigned to [Qualified Intermediary], and written notice of the assignment has been given to Buyer (copy attached).

1. All net proceeds shall be wired directly to [Qualified Intermediary] at the account identified below. 2. No portion of the proceeds shall be disbursed to Seller, to Seller's counsel, or to any account Seller controls or may direct, for any purpose, including the payment of Seller's expenses, except as expressly authorized in writing by [Qualified Intermediary]. 3. Seller shall have no right to receive, pledge, borrow, or otherwise obtain the benefits of the proceeds. 4. The settlement statement shall reflect [Qualified Intermediary] as the recipient of net proceeds. 5. Please confirm wire receipt to the undersigned on the day of closing.

The failure this prevents. Constructive receipt is the most common fatal defect in exchange practice, and it usually happens because a closing agent followed habit and wired funds to the seller or the seller's lawyer. This instruction, delivered in writing before closing, is the whole protection.

Tool 3: Intermediary diligence questionnaire

Disqualification screen — answer for each of the taxpayer's advisers and affiliates:

Person or firm Role Acted for the taxpayer as employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the last two years? Related party?
Y / N Y / N

Any "yes" disqualifies that person from serving. There is no cure after the fact.

Financial and operational diligence:

  1. Are exchange funds held in a segregated account, and in whose name?
  2. Is the account a qualified escrow or qualified trust?
  3. What fidelity bond or errors and omissions coverage is maintained, and in what amount?
  4. Are funds commingled with the intermediary's operating funds?
  5. What is the intermediary's financial condition? Provide statements.
  6. Who are the authorized signatories, and what dual-control procedures apply?
  7. How is interest on exchange funds handled?
  8. What is the process if the exchange fails — timing and mechanism for return of funds?
  9. Has the intermediary or any affiliate been subject to regulatory action, receivership, or bankruptcy?
  10. Provide the form of exchange agreement in advance for review.

Why this matters. Intermediaries hold client money and are lightly regulated. Failures have produced total losses of exchange proceeds, and the tax consequence is a fully taxable sale on top of the loss.

Tool 4: Written identification notice

[Date — must be on or before day 45] To: [Qualified Intermediary] Re: Exchange of [Relinquished Property], closed [date] — Identification of Replacement Property

Pursuant to 26 U.S.C. § 1031, the undersigned taxpayer hereby identifies the following replacement property or properties:

1. [Street address and full legal description; if a portion, describe the portion precisely.] 2. [] 3. []

This identification is made under the [three-property rule / two-hundred-percent rule / ninety-five-percent rule]. [If the two-hundred-percent rule: aggregate fair market value of identified properties is $[], which does not exceed 200% of the $[] value of the relinquished property.]

This identification supersedes and revokes any prior identification made in this exchange.

[Taxpayer], by [name and title]

Delivery: [method], received by [name] on [date] at [time].

Rules this enforces. Written, signed, delivered by day 45, to a non-disqualified person involved in the exchange, describing the property unambiguously. Retain proof of delivery. Identify more than one property; a single identification with a failed closing is a fully taxable sale.

Tool 5: Client deadline letter

[Date — send the day the relinquished property closes] Re: Your exchange — two deadlines that cannot be extended

Your property at [address] closed on [date]. Two deadlines now run, and neither can be extended for any reason short of a declared disaster:

Day 45 — [date]. By the end of this day you must deliver to [Intermediary] a written, signed identification of the replacement property or properties. A phone call is not enough. An email to us is not enough. If nothing is validly identified by this date, the exchange fails and the sale is fully taxable this year.

Day 180 — [date]. By the end of this day you must receive the replacement property. (If your return is due earlier, the earlier date controls: [date].)

Between now and then: you may not receive, borrow against, pledge, or direct any of the sale proceeds. Not for a day and not for any purpose. If you do, the exchange ends.

Please identify at least two properties, and preferably three. Deals fall apart, and a single identification leaves you with no alternative.

We have calendared both dates. Please calendar them as well.

Tool 6: Boot model

Line Relinquished Replacement
Contract price
Less selling costs —
Mortgage payoff / new mortgage
Equity
Cash contributed by taxpayer at replacement closing —
Cash received by taxpayer —
Debt relief (old mortgage − new mortgage, if positive) —
Debt assumed (new mortgage − old mortgage, if positive) —
Exchange expenses paid from proceeds
Net boot received

Then:
Amount realized
Adjusted basis
Realized gain
Recognized gain = lesser of realized gain or net boot
Of which recapture (26 U.S.C. § 1245 / 26 U.S.C. § 1250)

Netting rules to apply. Cash paid offsets liability relief. Cash received does not offset liability assumed. Exchange expenses generally reduce boot.

Delivery. In writing, to the client, before the replacement closing.

Tool 7: Basis and depreciation split worksheet

Line Amount
Adjusted basis of relinquished property
Plus cash contributed
Plus gain recognized
Plus debt assumed on replacement
Less cash received
Less debt relieved on relinquished
Basis in replacement property

Depreciation split

Component Amount Method and life
Carryover basis (continues relinquished property's schedule) remaining life, original method
Excess basis (newly placed in service) new life, current method
Land allocation (nondepreciable) —

Embedded position to record for the file:

Item Amount
Cumulative depreciation carried forward
Potential 26 U.S.C. § 1250 unrecaptured gain
Potential 26 U.S.C. § 1245 ordinary recapture
Deferred gain embedded in basis

Why record it. Ten years and two exchanges later, nobody will remember why the basis is what it is, and the recapture position will be the largest number in the eventual sale computation. Holding period tacking under 26 U.S.C. § 1223 should be noted here as well.

Tool 8: Business purpose memorandum

Transaction: ___ Date: ___ Prepared by: ___

  1. The client's objective, stated in business terms: what is being sold, what is being acquired, and why.
  2. Non-tax reasons for the disposition: management burden, market timing, tenant concentration, deferred maintenance, geographic consolidation, financing terms.
  3. Non-tax reasons for the acquisition: yield, growth market, asset class, operational fit.
  4. Investment intent for both properties: how each was and will be held, rental history, and any personal use.
  5. Roles of the intermediary and any accommodation titleholder: functions performed and risks borne.
  6. Alternatives considered and why they were rejected.
  7. Confirmation that the taxpayer had no access to proceeds at any point.

Why it exists. Gregory v. Helvering, Commissioner v. Court Holding Co., Knetsch v. United States, Higgins v. Smith, and Moline Properties, Inc. v. Commissioner are all available to the government against a formally correct but economically empty structure. Frank Lyon Co. v. United States and United States v. Cumberland Public Service Co. show what a respected structure looks like: real parties, real functions, real reasons. One hour, written contemporaneously.

Tool 9: Opportunity fund diligence questionnaire

The gain

  1. Source, date, character, and amount of the capital gain being deferred.
  2. Date of the 180-day deadline for investment.
  3. Amount being invested (gain only) and amount retained.

The fund 4. Entity type, formation date, and self-certification status. 5. Asset test results for each testing date since formation. 6. Penalty history for failed asset tests. 7. Composition of qualified zone property held.

The property or business 8. Was the property acquired after the zone designation date? 9. Is it original use in the zone, or is substantial improvement required? 10. If substantial improvement: provide the adjusted basis of the building at acquisition, the improvement budget, and the thirty-month schedule. 11. For an operating business: provide the written working capital plan and schedule. 12. Percentage of tangible property that is qualified zone business property.

The investment terms 13. What events under the fund agreement would be inclusion events accelerating the deferred gain — distributions exceeding basis, transfers, redemptions? 14. What is the expected hold period, and does the structure permit a ten-year hold? 15. What happens if the fund fails an asset test? 16. Fees, promote, and reporting obligations.

The underlying deal 17. Provide the underwriting: rent roll, comparable sales, construction budget, and sensitivity analysis. 18. Would you make this investment without the tax benefit? If the honest answer is no, the tax benefit is not large enough to fix it.

Tool 10: Substantial improvement computation

Line Amount
Purchase price allocated to building
Purchase price allocated to land (excluded from the test)
Adjusted basis of the building at acquisition
Required additions to basis (must exceed the above)
Improvement budget
Improvements completed to date
Remaining budget
Thirty-month deadline
Months remaining

Notes. Land is excluded from the substantial improvement computation. Only capitalized additions to the basis of the building count. Track completion against the deadline monthly; this test and the semiannual asset tests are where funds fail.

Tool 11: Written working capital plan

Required for the safe harbor. This is the most commonly missed document in the regime.

  1. Designation. The amount of working capital designated in writing for the acquisition, construction, or substantial improvement of tangible property in the zone, or for the development of a trade or business in the zone.
  2. Written schedule. A schedule consistent with the ordinary start-up of a trade or business showing that the working capital will be expended within the permitted period.
  3. Use. A statement that the property is being used in a manner substantially consistent with the designation and the schedule.
  4. Milestones and dates, with the person responsible for each.
  5. Quarterly tracking of actual expenditures against the schedule, with variance explanations.
  6. Amendment protocol for changes in the plan, documented at the time.

Rule. Adopt this before the working capital is received, not afterward. A plan reconstructed later is not a plan.

Tool 12: Installment sale model

Line Amount
Contract price
Less selling expenses
Contract price for gross profit ratio
Adjusted basis
Gross profit
Gross profit ratio (gross profit ÷ contract price)
Down payment in year one
Gain recognized on the down payment
Plus: 26 U.S.C. § 1245 ordinary recapture — recognized in full in year one
Plus: 26 U.S.C. § 1250 recapture — recognized in full in year one
Total year-one taxable income
Tax on year-one income
Down payment less year-one tax

The line that matters is the last one. If it is negative, the client owes more tax than the cash received. Restructure the down payment before signing.

Also assess: the 26 U.S.C. § 453A interest charge on larger obligations; whether any pledge of the note is contemplated (treated as a payment); related party resale acceleration; character under 26 U.S.C. § 1231; and security for the note.

Tool 13: Involuntary conversion tracker

Item Entry
Event type (destruction, theft, seizure, requisition, condemnation)
Date of event
Proceeds received (insurance or award)
Date proceeds received
Adjusted basis of converted property
Realized gain
First taxable year in which gain is realized
Replacement period — 2 years from close of that year, or 3 years for condemned business or investment real property
Replacement deadline
Applicable standard — "similar or related in service or use," or like-kind for condemnations of business or investment realty
Replacement property identified
Replacement acquired (date, cost)
Basis in replacement (cost less unrecognized gain)

Standing instruction. Ask about fires, floods, thefts, and condemnations in every real estate engagement. Clients experience these as losses and do not report them as tax events, and the 26 U.S.C. § 1033 clock runs from a date nobody has noticed.

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