What is the Bundle of Rights Theory?
If you were to scrape off the outer covering of an electrical cord to your TV set, you would find a number of intertwined electrical wires. You, the owner of the TV set and its attached electrical cord, would own all of the intertwined electrical wires in that electrical cord. When one owns real estate, they own a number of rights.
The owners of the real estate have the right to build on the property; the right to sell the property; the right to borrow money (mortgage) on the property; the right to lease the property; the right to occupy the property; the right to have quiet enjoyment on the property, the right to farm the property, etc. This is called “The Bundle of Rights”.
So when a purchaser has a contract to purchase a piece of real estate, they in fact already own a piece of the property (the right to sell and now purchase the property), even though the purchaser has not even closed on the final purchase of the property. They own one little wire—not all of the wires, but one of them (the right to purchase that real estate), as the seller cannot sell the property to another, because the seller has given away that right when the seller and purchaser executed the contract for sale.
How can the Bundle of Rights theory apply to Section 1031 Exchanges?
The Bundle of Rights theory has been used by exchangers exercising their rights on a Section 1031 exchange.
The Federation of Exchange Accommodators (FEA) and yours truly met with the IRS about 10 years ago and asked them whether this theory held up on Section 1031 exchanges. The IRS answered in the affirmative. Last month, I and other members of the FEA met again with IRS and asked the same question: “Under the Bundle of Rights Theory, can an Exchanger sign a contract for the purchase of real estate and then resell that contract to another and qualify for a Section 1031 exchange?” I am pleased to report that IRTS replied again in the affirmative.
The Buyer on the executory contract ( a contract made by two or more parties in which the terms are set, but are to be fulfilled at a later date) for the purchase of real estate, exchanges the right to purchase (its existing contract to purchase) with another and then purchases another contract to purchase or an existing piece of real estate as its Replacement Property.
Imagine how many 1031 exchanges can now be transacted with the help of industrious Realtors, Real Estate Attorneys, and Title Companies. For example, those parties that represent condominium developers or purchasers of condominium units that are not completed at the time of the execution of the sale/purchase contract can on these investments, resell their contracts and do Section 1031 exchanges. What a wonderful tool. Our office has recently completed three (3) of these types of transactions.
I am not aware of any audits and as of today, there are NO reported legal cases involving this use of “Like Kind” exchanges. Please remember that 1031 Tax-Deferred Exchanges apply to investment property and investors—not to parties that do this for a living (Dealers), sometimes referred to as “Flippers”, as they are not classified as investors.
At Liberty 1031, we always recommend that the taxpayer consult with their tax and/or legal counsel on all matters dealing with the Internal Revenue Serice.