The Legal Play Hap May

1031 like-kind exchanges are a tax provision dictated by section 1031 of the Internal Revenue Code. They are used to defer taxes on capital gains resulting from a sale of real property, and therefore are an option for taxpayers who want to reinvest their funds into a different property.



Although 1031 exchanges are mostly straightforward, there are rules and deadlines to observe during the process. Failing to observe these rules may result in an expensive tax bill (and penalties). So, before engaging in a 1031 exchange, it is recommended that investors consult with a knowledgeable tax attorney first.





How a 1031 Like-Kind Exchange Works - a Small Business Example

1031 exchanges are generally reserved for investment purposes - a rule cemented by the 2017 Tax Cuts and Jobs Act (TCJA). Prior to the TCJA, tax paying entities could swap out some types of personal property (such as equipment), but 1031 exchanges are now confined to real estate property exchanges only.



For example, a small business owner - let’s say an auto dealership owner - decides that his current location is no longer suitable for his current needs, or perhaps the value of his current property has skyrocketed. Being a savvy investor, he starts looking for another location that might serve his auto dealership better and prepares to sell his current property. After a brief search, he finds an excellent location in a nearby suburb.



Economically, it’s better for everyone - the business owner, the real estate companies, the local community and the IRS - for this transaction to go ahead. It drives additional economic activity and produces additional tax revenue. However, by selling his current property, the auto dealership owner must pay capital gains taxes from the  proceeds of the sale.



To prevent taxes from blocking important economic activity, the IRS allows investors to switch out one like-kind property for another and defer capital gains taxes in the process. This is the tax-led philosophy behind allowing 1031 like-kind exchanges.



In this example, the auto dealership owner opts for a 1031 exchange to essentially move his business to a better location, using the funds generated from the initial property’s sale to acquire the new property. Any capital gains taxes generated from the sale are deferred, perhaps indefinitely.



This is a general overview of 1031 exchanges. In practice, there are several moving parts during the 1031 exchange process that taxpayers must manage to successfully see the process through.

The 1031 Like-Kind Exchange Process

If you and your tax attorney agree that a 1031 exchange makes sense for your current tax needs, here is what the process typically looks like:



* Determine which properties to exchange - First, you’ll need a pair of real properties to exchange. They must be “like-kind,” though the IRS’s definition in this area is broad. As long as both properties are investment properties, a 1031 is acceptable in most cases. Taxpayers can exchange an apartment complex for an industrial center, for example.

* Identify an intermediary (middleman) to facilitate the transaction - 1031 exchanges are automatically invalidated if the taxpayer accesses the proceeds from the sale at any point. Once the initial property is sold, the proceeds must be given to an intermediary that holds the funds in escrow. Those funds are used to facilitate the purchase of a new property. There are dedicated exchange facilitators who can serve in this role for investors.

* Make the exchange - From the date that the initial property is sold, you have 45 days to identify up to three potential exchange properties. These must be identified in writing and given to the intermediary. There’s a second deadline. From the date of sale,

For those who have never experienced an IRS audit, your only exposure to the process may be the brief portrayal in TV shows and movies where someone, or a team of people, wearing bland neutral suits shows up at your workplace and declares, “You’re being audited. Show us your books.” The reality of real-life audits is a bit different. If you’re being audited by the IRS, your first notification will likely come through the mail. The dreaded tax letter will be sent to the address on file with the agency, which means if you’ve moved without informing the government, it could be sent to a previous address. Whether it’s sent to the right address or not, the IRS will proceed with the audit, assessment, and collection process.



If you have received a tax letter from the IRS, a tax attorney can provide representation to the agency and guidance to their client on how to proceed.





You’ve Received Notice, but is it an Assessment or a Full-scale Audit?

 Increasingly, the IRS is sending out letters notifying taxpayers of an assessment rather than a full-scale audit. These assessments tend to be income adjustments that the IRS makes on their end due to information they’ve received from reporting agencies. In the letter, the IRS will explain the amount of taxes they believe is correct, with a possible explanation as to why, and then there will be an explanation of your rights to protest this change and the procedure to follow. When a taxpayer receives an assessment letter, they may respond and take steps to protest or appeal the decision. Otherwise, if the taxpayer does not respond, the IRS will move forward with collection. If the taxpayer has underpaid, notices that follow will inform the taxpayer how much is owed.



If the IRS has determined a full audit is necessary, the agency will notify the taxpayer that an audit is underway and that an assessment may be forthcoming. In the past, the IRS would often show up at the taxpayer’s place of residence or business to acquire documentation. Since the COVID pandemic, this part of the process is now largely done online and via telephone.

 Audit, Assessment, Collections: The Three-stage Notification Process

 It generally takes several months to complete an audit, and the taxpayer will be notified by mail throughout the process. Typically, the IRS will communicate with the taxpayer through the audit, assessment, and collection process, and typically looks like the following:



* Audit - The first piece of mail from the IRS will either be notification of an audit or of an assessment. If it’s an audit, the letter will notify the taxpayer that their tax situation is being reviewed. Requests for financial documentation will likely be forthcoming.

* Assessment - Once the audit is underway, or after it’s complete, the IRS will send a letter with an assessment in it. This assessment is the IRS’s official stance on the taxpayer’s position, specifying whether income or deductions are to be adjusted, and whether this will require the taxpayer to remit additional taxes. Following an assessment, the taxpayer will have a brief window where they may contest the IRS’s conclusions.

* Collections - If an assessment is made and moved forward, the taxpayer will receive a collections letter requesting payment.



A tax attorney can provide assistance at any point during this communication. For example, an attorney can help with acquiring or interpreting financial documentation. They can also push back against the IRS’s assessment, arguing on behalf of their taxpayer client and attempting to have the assessment thrown out.

 How Does the IRS Determine Who to Audit? 

The IRS audits one out of every 500-1,000 tax returns a year, and it uses a handful of strategies to determine who to audit, including:



* Random selection - A large part of the IRS’s selection cri...

When a business owner suddenly passes away, it raises the following questions about the company's future:



* Will the business continue to exist, and in what form?

* Who will oversee the business's affairs and decision making?

* How will clients and employees be retained?

* How can the business be guided through management and ownership uncertainty?



If a business owner dies with a will and succession plan, preserving the business may be as simple as pivoting to the next in line, whether that's a vice president, a partner, or a family member who has an interest in the organization.



This guide is for those instances when a business owner dies without a clear transition plan in place. If this is the case, you'll need to act fast to ensure the business can be preserved.





When a Business Owner Dies It Is Important to Act Quickly

Whether the business will be captained by someone else or liquidated, it's important for everyone involved to move quickly. Why? There are a few reasons, including:



* Client and customer retention - When a business owner dies, the resulting uncertainty may compel clients to terminate their relationship with the company and seek services through a competitor. By sorting through the company's affairs quickly, you will maintain confidence among existing clients.

* Employee retention - A business owner's death can create a great deal of uncertainty among employees. If the company's operations are sidetracked, it will also sidetrack payroll and benefits. The longer this goes on, the harder it will be to retain essential people. By implementing employee retention measures right away, you can prevent extended downtime due to labor shortfalls.

* Equipment and facility upkeep - Retaining customers and employees are the pressing matters, but some businesses also rely on equipment, which may deteriorate without constant upkeep. When a business owner dies, these assets will decline in value and condition if new ownership doesn't act promptly.



If the business and its assets are to be sold off, any heirs and partners will want to maximize the company's value. If the business is to be preserved and operated by a new person, retaining as much of its value as possible is also the priority. In both cases, you'll need to move quickly to keep the company intact.

First, Determine the Nature of the Business and Who Has an Interest in It

Whether the plan is to liquidate the business or continue operating it, the first thing to do is to determine what kind of entity the business is, and who has an interest in it.



Regarding the first point, business entities may be classified as a sole proprietorship, a partnership, or a corporation. If the business was a sole proprietorship, there may be no succession plan, or anyone empowered to step into the decedent's role.



If the business was a partnership or a corporation, you have some options. For instance, if the business was a general partnership, then another partner may be able to assume management duties and ensure there is no interruption in production or operation. If the entity was a corporation, shareholders may be able to quickly appoint a new head if the bylaws allow for it.



Once the entity's classification is clear, you'll need to speak to family members and employees to determine who has an interest in the business. It's important to establish early on who is interested in running the business and who wants to liquidate its assets. If there are disagreements, it's highly recommended that any heirs or beneficiaries bring in an attorney to mediate the process.

If No One Is In Charge of the Business,

When an individual passes away, it falls to those left behind to determine what happens with any property and assets that individual possessed during their lifetime. The process of finding all the property and assets can be extremely complex, depending on what the property is and where it is kept. It’s relatively simple to find things like a house and a car, as those are large, tangible items. But in many cases, a person’s wealth that may be passed to beneficiaries and heirs can be difficult to locate, especially if the assets are intangible items such as investment accounts and partnership interest. Often, the breadth and nature of an individual’s property and assets hasn't been communicated to any loved ones. This makes it far more difficult to locate some of the following assets:



* Bank accounts

* Brokerage accounts

* Property titles

* Insurance policies

* Interest holdings in partnerships or corporations



Records of these assets, and the ability to access them, are necessary to complete probate and ensure all heirs and beneficiaries receive their share.





Who is Authorized to Access a Decedent’s Assets?

Although family members may perform a basic database search following the estate owner’s death, they will find it difficult to get information about, let alone access to certain things like retirement or bank accounts. If the decedent planned ahead, they may have named a third-party to be able to ask questions or access the account in the event of an emergency or their death. But if no other party has been given the authority to access that information, most financial institutions will require letters testamentary or court orders to release information. Often it falls to the estate's executor to access those assets. Also termed an administrator, executors are empowered either by the decedent or by the courts to manage the decedent's affairs following death.



A probate case concerning the estate will need to be opened before an administrator - independent or dependent - can start accessing assets.



An independent administrator is named in the decedent's will and has broad powers in discovering and managing a decedent's assets. A dependent administrator is designated by the court if no one is specified in the will. Dependent administrators are limited in comparison to independent executors and must receive court authorization before they can access or make any decisions regarding the estate's assets.

 Leaving Assets Behind? Create and Leave a Will 

If you know you'll be leaving behind considerable wealth, invest a small amount of time into creating a will. Though it is fairly simple to create one, it is recommended to have an estate planning attorney help with this. (We are currently working with a client where the decedent used a software program to create her will, and there are lots of problems with it that have caused the client to hire our firm to resolve.) Once you have created your will, put it in a place where loved ones can easily find it. Make sure an executor has been named. Your will should also include a general summary of the estate's assets and where they can be found. This information will be valuable when it's time for your executor to gather property for probate.

Where Can an Executor Search for a Decedent’s Assets?

If no estate planning documents are available to provide an inventory and location of assets, the only option is to begin a thorough search that may include the following:



* Searching the decedent's home for documentation - The first step in every asset search is surveying the decedent's home for any helpful documentation.

Talk of condemnation and eminent domain are standard for most attorneys, but they are not as well understood by the general public. This is due in part to the multiple definitions of condemnation. The most widely accepted explanation of this term is generally the declaration of something as reprehensible or wrong, or the declaration of something as unfit for use.



However, when it comes to condemnation and eminent domain and their relation to each other in the legal sphere, the definition rings a little different.





The Basics of Condemnation and Eminent Domain

The power of eminent domain is the government’s right to take private property that is intended for public use. In this scenario, condemnation describes the process by where a government agency can utilize the power of eminent domain.



Condemnation and eminent domain have long been an issue in American history as the country has grown and required modifications of land for the people who live on and around it. For example, as a form of condemnation, the government may need a particular piece of property to:



* build or expand a public road

* enact measures for flood control

* perform infrastructure work such as building a school



Under the lens of eminent domain, the government does have the power to take property used for public use, but both the federal constitution and state laws require fair compensation be paid to the landowner. Specifically, the United States Constitution features the Takings Clause, which stipulates that the government cannot take property without providing just compensation to the owner.



As you might imagine, there is not always an agreement as to what constitutes as fair. For this reason, it is not uncommon to have hearings and disputes with the government over the property’s land value and the amount being paid for it. Contrary to what you may think, there does not have to be a final determination of just compensation before the government may take possession of the property.



Many times, the property is already in the process of public use while the parties are still debating the land value. As explained below, the parties can agree to government use of the property while the fair value is later determined in hearings and appeals.

The Main Steps in Condemnation and Eminent Domain

There are two main steps that must happen in a condemnation and eminent domain case:



* Determining if the land in question is required for public use

* Determining how much the property is really worth



When it comes to confirming land is indeed intended for public use, the government must indicate what they plan to use it for. Often in Texas, the government is serious about the process because it is needed to promote community safety via widening a road, expanding a landfill, or managing flood control.



However, there are instances in which someone could question the legitimacy of that public use. For example, if certain members of the government have become corrupt and abuse the process by taking land they do not need in the name of some political issue, it can be challenged. Proving corruption and an abuse of power can be an uphill battle. Another example might be if the government says they need six inches of a person’s land to widen a road. Six inches is not much; therefore, it may be questioned if there really is a proper “public use” argument. Yet, the landowner can be at a disadvantage in winning these cases if a safety issue is involved.



Once it has been established that the piece of property is indeed for public use, the next step is determining how much the land or property is effectively worth. This also includes consideration of how much the taking of that land might reduce the value of any remaining land on the property.

A receivership is a legal process through which a “receiver” (or trustee) is given limited control over an individual’s or entity’s assets in order to protect those assets and ensure they can be used in transactions with creditors.



Receiverships are typically requested by creditors and ordered by the court, though they may be established by a regulatory body, such as the FDIC, or requested by a private party. The court may also appoint a person as the receiver when ordering the receivership, but not always. In some instances, the court may request the parties involved to agree on a receiver, who then steps into the role.





When Is a Receivership Needed?

Receiverships are usually requested by a creditor seeking payment from a borrower in default. Once requested, they are authorized through a court order or an order through a regulatory body. Creditors ask for a receivership in order to protect the assets owed to them.



Other instances when a receivership may be required include:



* During a bankruptcy case - During bankruptcy proceedings, the court may appoint a receiver to manage the bankrupt entity’s assets and oversee their liquidation. By entrusting the assets to a receiver, creditors know their interests are protected by an independent third party.

* When an entity’s principals cannot negotiate a decision - If partners or shareholders dispute the ownership of assets within the entity or cannot otherwise come to an important business-related decision, they may request a receivership. In this instance, the receiver acts as an impartial manager for the entity’s assets while its principals work through their disagreement. This is common for businesses heading toward bankruptcy and in the process of liquidating assets.





* When mismanagement of a trust or estate is suspected – Receiverships may necessary in the case of family disputes over the management of trusts or the assets in a decedent’s estate. Parties who suspect trust or estate assets are being misused or not allocated according to the grantor’s or decedent’s wishes may motion the court to appoint a receiver to manage the assets according to estate documents or private agreements.





* When a company has acted fraudulently - If a company is suspected of fraud, a government regulator may order a receivership to prevent assets from being lost or hidden from creditors. When a receiver is appointed during a fraud case, they may be given expanded powers to discover litigation and attain financial documentation.



What Can a Receiver Do with the Assets They Are Trusted With?

The court (or regulator) dictates the terms of the receivership upon its creation. Among these terms are the powers granted to the receiver, which may include:



* Making any decisions allowed under an entity’s charter, articles or bylaws or allowed by any previous agreements or estate documents

* Taking any actions deemed necessary to manage the company’s business affairs

* Purchasing or leasing vehicles, equipment or other materials necessary to run the business

* Making payments to creditors

* Making any payments necessary to preserve the receivership’s assets

* Borrowing funds to maintain the company’s operations

* Engaging in legal action, or responding to legal action against the business

* Paying out - or cease paying out - dividends to shareholders

* Redistributing disbursements to beneficiaries per agreement and court order



In the case of a receivership of business assets, the company’s original owners remain the material owners of the entity,