You realize the client does not understand his $500,000 private equity commitment locks capital for ten years, capital calls will demand hundreds of thousands on unpredictable schedules, and early statements will show negative returns for years. The fund promises 18% IRR, but you see the liquidity trap underneath.
Direct ownership offers rental income, depreciation deductions, leverage, and appreciation. Depreciation: 27.5 years residential, 39 years commercial (building only, not land).
HIGH-FREQUENCY: The 1031 exchange deadlines and qualified intermediary requirement appear on virtually every exam.
Section 1031 like-kind exchanges defer capital gains on real property:
- Real property only (TCJA eliminated personal property exchanges)
- Identify replacement within 45 days
- Close within 180 days
- Qualified intermediary must hold proceeds, touch the cash and the exchange fails
- "Like kind" is broad: apartment for raw land, retail for office
The gain is deferred by carrying forward the original basis. Eliminated at death through step-up.
Because TCJA cut C-corp rates to 21%, Congress created §199A so pass-through owners (including REIT investors) would get comparable relief.
Common mistakes
- Reversing the 1031 deadlines. 45 days to identify. 180 days to close. Both run from the sale date. No extensions. Trap: reversing them.
- Applying 20% LTCG to collectibles. Collectibles max rate is 28%. Trap: using 20% or 23.8%.
- Expecting positive PE returns early. The J-curve means years 1-2 are typically negative. Comparing early PE performance to public market benchmarks is wrong.
Bottom line
- 1031 exchange: 45 days to identify, 180 days to close (both from sale date), qualified intermediary must hold proceeds. Real property only.
- Hedge fund fees (2-and-20) consume roughly one-third of gross returns. The high-water mark delays performance fees until the prior peak is recovered.
- Private equity follows the J-curve: negative early, positive later. Use IRR, not time-weighted return, because the GP controls cash-flow timing.
- Collectibles are taxed at 28% max LTCG, 8 points above the standard 20%.
Exam shortcut
For multi-year hedge fund fee calculations, track the high-water mark explicitly each year. After a loss year, the mark stays at its prior level. In recovery years, check if post-management-fee value exceeds the mark before applying any performance fee. The trap is always charging the performance fee in a partial recovery year.
The full lesson (about 3,338 words, 22 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- D.35
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