Unit 4: Property Transactions (Advanced)

• Topic 01

  Advanced Like-Kind Exchanges

  33 questions
• Topic 02

  Instalment Sales Planning

  39 questions
• Topic 03

  Section 1031 and Opportunity Zones

  45 questions
• Topic 04

  Real Estate Taxation

  39 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. A QOF purchases an existing commercial building (built in 1990) in a designated QOZ for $2,000,000 ($400,000 attributable to land). To qualify as qualified opportunity zone business property, must the QOF substantially improve the building, and what does 'substantial improvement' require?

   • A
     No, 'substantial improvement' is required only for residential rental property; commercial buildings automatically meet the original use requirement
   • B
     Yes, 'substantial improvement' requires doubling the property's fair market value within 24 months of the QOF's acquisition
   • C
     Yes, because the QOF is not the original user of the building; the QOF must substantially improve it by making additions to basis that exceed the building's adjusted basis at acquisition, within 30 months of purchase
     Correct answer
   • D
     No, any existing building purchased in a QOZ automatically qualifies as QOZB property without improvement requirements
   Explanation

   Under §1400Z-2(d)(2)(D)(ii), qualified opportunity zone business property must either commence original use with the QOF or be substantially improved by the QOF. An existing building (1990 vintage) clearly was not originally used in the QOZ by the QOF. Therefore, the QOF must substantially improve it. Under Treas. Reg. §1.1400Z2(d)-1(c)(4)(i)(B), substantial improvement requires that the additions to the adjusted basis of the property during any 30-month period beginning after acquisition exceed the building's adjusted basis at the beginning of that period. For the $2,000,000 building (land $400,000 excluded), the building basis is approximately $1,600,000; the QOF must add more than $1,600,000 of improvement basis within 30 months.

2. Under §1400Z-2(d)(2)(A), how is the 90% asset test measured — on what dates during the year, and what is the consequence of failure?

   • A
     The test is measured on the last day of the first 6-month period and the last day of the tax year; failure triggers a monthly penalty equal to the shortfall multiplied by the underpayment rate plus 3%, divided by 12
     Correct answer
   • B
     The test is measured semi-annually, and failure automatically disqualifies the QOF for the entire year without penalty calculation
   • C
     The test is measured annually at year-end only; failure results in a 10% excise tax on total assets held in non-QOZ property
   • D
     The test is measured only at the time of investor entry and exit; ongoing compliance is not monitored by the IRS
   Explanation

   Under §1400Z-2(d)(1) and (f)(1), the 90% asset test is measured on two testing dates: (1) the last day of the first 6-month period of the QOF's taxable year (e.g., June 30 for a calendar-year QOF), and (2) the last day of the taxable year (December 31). The average of the two must be at least 90%. If the average falls below 90%, the monthly penalty is: (aggregate shortfall) × (applicable percentage / 12). The applicable percentage is the federal short-term underpayment rate plus 3%. The penalty does not disqualify the QOF but imposes a monetary charge for each month of non-compliance. A reasonable cause exception exists under §1400Z-2(f)(2).

3. Under §1031, what is 'boot,' and how does receiving boot affect gain recognition in a like-kind exchange?

   • A
     Boot is the profit element of the exchange equal to the difference between the selling price and original purchase price
   • B
     Boot is property received that is not like-kind real property, including cash and net mortgage relief; receiving boot triggers gain recognition equal to the lesser of the realised gain or the fair market value of the boot received
     Correct answer
   • C
     Boot is any personal property included in the exchange; it triggers recapture income but not capital gain recognition
   • D
     Boot is excess value received over the relinquished property's fair market value; it is fully taxable as ordinary income in all cases
   Explanation

   Under §1031(b), boot is property received in an exchange that is not like-kind real property. Boot includes cash, net mortgage relief (when liabilities assumed by the buyer exceed liabilities assumed by the taxpayer on replacement property), and non-like-kind property. Receiving boot does not disqualify the entire exchange; instead, the taxpayer recognises gain only to the extent of the boot received, limited to the total realised gain. If realised gain is $200,000 and boot received is $50,000, only $50,000 of gain is recognised — the remaining $150,000 is deferred in the replacement property's basis.