Lynne Bagby, Asset
Preservation, Inc.

Recently, legal counsel for several different New England investors have contacted me with Purchase & Sales Agreement contingencies for future sales—and in some cases purchases, which created questions about when the actual “burdens & benefits of ownership” would actually transfer from one party to another.

This is a particularly significant issue when an investor wants IRC Section 1031 tax deferred exchange treatment, since the 180 day exchange timeline for completion of the exchange starts on the date that the those “burdens & benefits of ownership” transfer from one party to the other.

Therefore, it is important in a1031 exchange to understand when the transfer of ownership has actually passed from one party to another and to grasp the distinction between receiving legal title as compared to an equitable ownership interest in property. Legal title represents a bundle of rights in a property and documents the transfer of ownership by a deed and evidence of legal title is established through a title report prepared by a title insurance company. Equitable ownership represents possession and is an ownership right in a property that may be protected by an equitable remedy. In some cases, legal title and equitable ownership may be transferred independently of each other.

Investors should be aware that equitable ownership of a property is complete generally upon the earlier of (A) the passage of legal title; or, (B) the buyer’s assumption of the benefits and burdens of ownership. The IRS can look at a number of factors to determine if the burdens and benefits of ownership have transferred from one party to another and look to the following seven criteria: (1) A right to possession; (2) An obligation to pay taxes, assessments, and charges against the property; (3) A responsibility for insuring the property; (4) A duty to maintain the property; (5) A right to improve the property without the seller’s consent; (6) A bearing of the risk of loss; and, (7) A right to obtain legal title at any time by paying the balance of the full purchase price.

Although T.C. Summary Opinion 2014-77 is not about a 1031 exchange related issue, the Jeffers case includes an analysis of the seven criteria involved in determining when the burdens and benefits of ownership are transferred from a seller to a buyer. In this case, the taxpayers (the Jeffers) acquired a home in 1993 from a seller through an installment sale contract pursuant to IRC Section 453. The taxpayers made the final payment on the installment sale contract in December 2008 and legal title was transferred from the seller to the Jeffers in February 2009. The taxpayers claimed the first-time homebuyer credit on their 2009 federal tax return, the year they received legal title. However, the IRS determined that equitable ownership actually transferred in 1993 when the taxpayers first entered into the installment sale contract and they were not entitled to the first-time homebuyer credit in 2009. The tax court looked at the seven benefits and burdens associated with equitable ownership arriving at this decision:

(1) A right to possession: The taxpayers had the right to possess the property during the life of

the contract.

(2) An obligation to pay taxes, assessments, and charges against the property: The contract

required the taxpayers to pay a portion of the annual property taxes every month.

(3) A responsibility for insuring the property: The contract required the taxpayers to pay a

portion of the annual property insurance premium each month.

(4) A duty to maintain the property: Although the contract did not assign the duty to maintain

the property, the seller did not make any repairs including even those that were necessary to keep

the home in a habitable condition.

(5) A right to improve the property without the seller’s consent: This was one aspect in favor of the taxpayers as they had no right to improve the property without the seller’s consent.

(6) A bearing of the risk of loss: The taxpayers were responsible for the risk of loss and they

would have had to continue making monthly payments even if the house had been destroyed.

(7) A right to obtain legal title at any time by paying the balance of the full purchase price: The taxpayers had the right to demand title from the seller upon payment of the full purchase price.

New England real estate investors seeking tax deferral in a 1031 exchange should be aware there is a difference between transferring legal title of a property and having equitable ownership of a property. Every investor should review their specific transaction and unique facts and circumstances with their tax and/or legal advisors.

Lynne Bagby, CES, is the Northeast division manager for Asset Preservation, Inc., Boston, Mass.