1031 Exchange FAQ

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Common 1031 Exchange Questions

Can I 1031 Exchange an easement and avoid capital gain on the sale?

Are the selling expenses I paid for my 1031 exchange considered boot?

I want to buy a bed and breakfast on a piece of property that hasn't been built. How does that work for a 1031?

How do I find a 1031 Exchange qualified intermediary in New Jersey?

I heard I can take back cash from my 1031 Exchange proceeds. Is that true?

I have a note secured with real estate, can I 1031 Exchange this for another property?

Real Estate notes  are always excluded from 1031 Exchange treatment and will not qualify.

Sometimes you have property you want to sell yet some of the items do not qualify for 1031 treatment.

A transfer of that property in an exchange transaction will be treated as a sale of that property.

Section 1031 excludes these assets from nontaxable treatment:

Property you hold for personal use such as your primary residence.
Stock in trade and property held primarily for sale such as inventories and real estate held by dealers.
Stocks, bonds, notes, or other securities or evidences of indebtedness such as accounts receivable.
Partnership interests.
Notes
Choses in action.
Certificates of trust or beneficial interest


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What are the legal fees associated with a 1031 Exchange?

As with any sale of real estate, often tax payers will consult an attorney to facilitate the creation of a Purchase and Sale Agreement for their 1031 Exchange. The fees associated with paying at attorney varies, though most have standard rates. A simple phone call to your attorney can help with this question. There should be no other legal fees associated with your exchange unless you are having an attorney facilitate the closing of sale on the property. Again, this is a question for your attorney and a simple phone call should suffice.

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1031 Exchange Information Network

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In a 1031 Exchange, why isn't Book Value considered over Fair Market Value?

1031 Exchange is always based on Fair Market Value as this is how the rule was written by the IRS. There is not mention of Book Value in the statute. Also, who's book are we talking about? There could be several books published with their own value.  Book value has either little or no meaning to some people, OR is lots of meaning to some people. Problem is, Book Value is determined by factors other that what is commonly accepted as Fair Market Value.

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How do I do a 1031 Exchange?

We've been reading countless daily internet articles explaining the benefits and the whys of an IRS 1031 Exchange. The reasons why someone should do a 1031 Exchange are quite simple, the taxpayer wants to defer their capital gains tax. But what about how? How do you do a 1031 Exchange?

1. Own Qualified Real Estate.

Make sure you have real estate that qualifies for 1031 Exchange. Make sure you or your business owns either investment real estate, such as land. Or, real estate held for business use, such as a rental property or an office complex. Careful consideration of your property must be taken into account. Do not be fooled by individuals telling you you can 1031 Exchange your primary residence or property you purchased yesterday with the intent to flip tomorrow. This is a horrible trap. Consult your CPA for more information.

2. Find a buyer

Realty Exchangers has two very popular venues for finding buyers of your property and finding 1031 Exchange pros who know how to make all happen. Visit our 1031 Exchange Property Search Engine to find looking at http://www.exchangersclearinghouse.com. You can also look up a local professional with our 1031 Exchange Pro Directory located at http://www.realtyexchangers.com/1031_Exchange/index.html. Both of these services are free!

3. Accept the and write up a purchase and sale agreement.

Work with your buyer and attorney to make sure all parties are happy with the offer and that all contingencies are considered. Be sure to inform the buyer that this is a 1031 Exchange.

4. Contact a closing company.

Finding the right closing/title company can be a chore. Your attorney or real estate agent may have some ideas of which closing company to use, better to find one that knows how to handle 1031 Exchanges.

5. Setup a 1031 Exchange with a Qualified Intermediary. (QI)

Choosing your 1031 Exchange QI is important. You need one with experience and integrity. Realty Exchangers has been providing 1031 Exchange QI services since 1989. In over 20 years, we helped thousands of tax payers defer their capital gains tax. We are the experts at making the transaction simple and easy.

6. Close sale on your property and transfer your proceeds into your QI's trust.

When you sale closes, you closing company is directed to transfer the proceeds from your 1031 exchange into your QI's trust account. Here the funds will sit while you search for your 1031 Exchange Replacement Property.

7. Know your 45 day and 180 day deadlines.

Soon as the sale closes on your Relinquished Property the clock starts ticking on securing qualified Replacement Properties.

45 day Identification Period. The IRS stipulates that you have 45 days to officially "Identify" your replacement properties. This must be done in writing and Realty Exchangers provides you with the forms necessary.
180 Closing Deadline. The IRS also stipulates that you have 180 to close sale on ALL of your identified replacement properties.

8. Identify your Replacement Properties.

Use the same web site tools mentioned in number 2 above. These must be of like-kind, meaning they must follow the same qualifications test as mention in step 1. The number of Replacement Properties you can chose, depends on which rules you want to follow. The 3 property rule, the 200% rule or the 95% rule. The most popular is the 3 property rule because it is the easiest for most people to understand.

9. Close on your Replacement Properties.

Essentially, this step is the same as steps 3 and 4, mentioned above.

That is all there is to it.

Realty Exchangers takes pride in keeping this process as clean and simple as possible. Only when you attempt to circumvent the above steps do you invite trouble with your 1031 Exchange. You have two options with the IRS. Pass or Fail. If you follow the rules, your Exchange will pass and you will defer your capital gains. Failure to follow the rules or attempts to circumvent the process creates issues that can force your Exchange to collapse.

And always, if  you have questions, the best option is to call Realty Exchangers at 800-570-1031.

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Some 1031 companies say “defer”, some say “don’t pay” capital gains tax with a 1031 Exchange. Which is correct?

Answer:  When you sell your property and purchase another property with a like-kind property you are conducting an IRS 1031 Exchange. "Defer" or "Don't Pay" is simply marketing language intended to get your to consider a 1031 Exchange if you have property to sell. With a 1031 Exchange the reality is that "some day" you will be paying the capital gains on your property but with a 1031 Exchange you are really "deferring" it to some other time. We have had customers defer their capital gains several times by buying and selling the same piece of land. Since land almost always qualifies, under the 1031 Exchange rules you can do this. The question is with a 1031 Exchange are you saying that you will "never" pay your capital gains tax. In our 20 plus year experience with the US Internal Revenue Service we learned to "never say never".

Related Info: correct, gains, capital, defer, companies, land, buying, selling


I sold a property last month, is it too late to 1031 Exchange it now?

 Hi, I am interested in determining if I can qualify for a 1031. I sold a property on Sept 22, 2011. I did deposit the cash into my bank account. I am now bidding on another property and could close before the end of the month. The properties are both investment properties. Can I still qualify? Can you assist me in the transaction? Thank you.

1031 Exchange must happen at the time of closing. Because your property has already closed, you now have access to the funds, this means you cannot 1031 Exchange. However, there are times when you have closed sale on a property but the money is still in escrow and out of your control. If that is the case, there may still be time to setup a 1031 Exchange. Check out http://www.realtyexchangers.com for more information.

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In a 1031 Exchange can you pay in full instead of using a mortgage?

Mortgages are not a function of the 1031 Exchange Rules. In its 20-year history, countless tax payers have used the benefits of the 1031 Exchange to defer their Capital Gains tax whether they owned their property outright or it was mortgaged. If your property is mortgaged, you can trade for a property that isn't mortgaged. You can also trade a mortgaged property for another mortgaged property. Their are rules for this and you can read more about it, if you like in our 1031 Exchange Knowledge Base, or by clicking here.

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Can my 1031 exchange proceeds held at the bank earn interest?

The 1031 Exchange proceeds held in Safe Harbor by your Qualified Intermediary may earn interest that you can keep without penalty to your 1031 Exchange. This is an arrangement that you need to make a head of time with your Qualified Intermediary. Some QI's keep the interest as part of their fee to transact your 1031 Exchange. Sometimes you can work out deals where you can share the interest with your Qualified Intermediary or you can keep the interest outright, thought this make affect the fees your QI charges for your Exchange.

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When does the 45 day identification period begin?

Great question and one that often gets confused. Some professionals think that the 45 day identification 1031 Exchange period begins when the QI gets the money. Others think it begins on the date that the documents are signed during the closing. Well, what if it takes a week for the QI to get the money? Or, what if one party signs for a property and the other party signs 4 days later? The correct date for when the 45 day identification period is the date that the sale is recorded with the county, sometimes this is the same day as the closing. Sometimes it is when the QI gets the money. But date you begin your calculation of the 45 days is the date the sale is recorded. This date is also the beginning of the 180 day closing period as well.

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The seller of my 1031 Exchange Replacement Property wants an Earnest Money Deposit. What do I do?

Treat the purchase of your 1031 Exchange Replacement Property as a regular sale and if the seller requires an Earnest Money Deposit, use funds from your own bank account. DO NOT use any of your protected 1031 Exchange Proceeds for an Earnest Money Deposit.  The reason for this is because what if the deal falls through? You would be in constructive receipt of your funds, which would negate your 1031 Exchange. Better to use your own money, then have the Closing company refund you your deposit after the sale closes.

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How can I 1031 Exchange a vineyard in Oregon for an apartment complex in Hawaii?

So long as the property you own in Oregon qualifies a like-kind, you may 1031 Exchange it with any other like-kind property in any state, including Hawaii. So the answer to your questions, is YES, you may 1031 Exchange a vineyard in Oregon for an apartment complex in Hawaii, so long as you follow the rules set down by the IRS and use a Qualified Intermediary to act as facilitator of the transaction.

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What if I can't find a replacement property during the 1031 exchange 45 day identification period?

Yes. This is a risk. The IRS gives you 45 days after you close sale on your Relinquished Property to officially Identify the properties that you intend to purchase or replace your relinquished property with. Some people already have a replacement property in mind before they close BUT this is not a necessity. You DO NOT have to have a replacement property in mind before you close on your relinquished property. Many clients use the entire 45 days to identify their replacements and as your IRS 1031 Exchange Qualified Intermediary, Realty Exchangers will provide you with the necessary Identification Form that you use to show the IRS that you property Identified your Replacement Properties.

We also have a number of resources on our web site that can help you find your Replacement Property, be sure to check out the Exchanger's Clearinghouse and our 1031 Exchange Professionals Directory that will help you find a local 1031 pro.

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How much of 1031 exchange recognized gain is recapture?

In a 1031 Exchange your Realized Taxable Gain is always the Adjusted Basis of your property subtracted from the Adjusted Basis of your property. We determine adjusted basis by adding Capital Improvements and closing costs to your Original Sales Price, then subtracting the Depreciation you took from your property over time. The amount of Depreciation Recapture is always 25% of the total amount of Depreciation.

So if you took $10k in Depreciation, your Depreciation Recapture would be $2,500.

When add your Depreciation Recapture Amount to your Net Realized Gain you get your Total Capital Gains Tax due.

You can check your Capital Gains Tax due yourself! Just visit our Capital Gains Tax Estimator at http://www.realtyexchangers.com/estimatecapitalgains.php

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Can I 1031 Exchange vacant land that I intend to sell later on?

Vacant land can qualify as real estate held for investment at the time of the 1031 exchange even though you might sell it two years later. Of course, you might not. That's why land held for investment but with the possibility of developing it or selling it years later is treated as land held for investment until when and if something happens to change its classification. However, one taxpayer acquired real estate and immediately sold a two-year option to sell it to a prospective buyer. IRS said no exchange because the land was held for sale right at the start. You need to be very careful with any property that you intend to sell right away. Intent to sell a property quickly can get that property classified as Dealer property which does not qualify for IRS 1031 exchange.

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I want to 1031 Exchange a building that I intend to demolish. Can I write off the demolition costs?

Sometimes in a 1031 exchange, the exchanger acquires land and buildings with the intent of tearing down the buildings to make way for new construction. This type of exchange qualifies for exchange treatment if the Replacement Property is held for use in a trade or business (such as rental property) or is held for investment. But taxpayer, be wary, there is a sinister double tax trap when the demolition tax rules apply.

The Internal Revenue Code bars deduction of the cost of demolition or any loss sustained on account of the demolition. And you are denied a write-off for the adjusted basis of the depreciable assets being demolished. Both the cost of demolition and the adjusted basis of the depreciable assets must be capitalized and added to the basis of the land where the demolition structures are located.

Here’s an example of how this works: You exchange a commercial property you have owned and operated as a rental for several years. You exchange for a large older residential rental complex located on ten acres of land. You intend to tear down the existing structures and build a new rental residential apartment complex.

Under the substituted basis rules of Section 1031, you figure the basis of your Replacement Property to be $2,300,000 with $1,100,000 allocated to the basis of the existing buildings. Your cost of demolition is $200,000. Under the demolition rules, you are required to add $1,100,000 – adjusted basis of the buildings – and the demolition costs of $200,000 to the basis of the land. You are not permitted to write-off as an expense the adjusted basis of the depreciable buildings or the cost of demolition.

Comment: The tax-writing mystics who conjured up this provision have magically reincarnated your demolished depreciable buildings as nondepreciable land, proving once again there is life and taxes in the great hereafter.


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If I sell a property in Maryland, can I buy a property in Texas?

Answer: Believe it or not, this is a very common question. Many people don't realize that the IRS 1031 Exchange is a federal action that can be executed in all 50 states, including the U.S. Virgin Islands. In short, the answer is "yes". For example, if you own land in Maryland and want to purchase land in Texas, a 1031 Exchange is certainly an option if you goal is to defer the capital gains tax on the sale of your property.

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What is a 1031 Exchange Disqualified person?

The exchanger or a disqualified person cannot qualify as qualified intermediaries for their own 1031 exchange. A person is a disqualified person if:

The person is an agent of the exchanger at the time of the transaction.
The person and the exchanger bear a relationship described in Section 267(b) or Section 707(b). However, you must substitute “10 percent” for “50 percent” each time it appears in those Sections.
The person and a person who is an agent of the Exchanger at the time of the transaction bear a relationship described in (2) above.

These people are treated as agents of the exchanger: A person who has acted as the exchanger’s employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the 2-year period ending on the date of the transfer of the first of the relinquished properties. However, the regulation disregards certain services for purposes of determining if an agency relationship exists. Performance of services with respect to exchanges of real estate intended to qualify under §1031 is not taken into account.

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Can I take Earnest Money from my sales proceeds?

No.  Your sales proceeds may ONLY be used to purchase 1031 Exchange replacement properties. The best option is to use your own funds for Earnest Money deposits and then get these back at the time of closing.

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Can I 1031 Exchange my portion of a property that my business partners are selling?

If you are part of a partnership that owns 1031 Exchange property such as business real estate (like an apartment building) or real estate held for investment (like a parcel of land) and the partners have decided to sell, you can 1031 Exchange your ownership into another qualifying property, even if the other partners have decided to do something else with proceeds.

Be sure to enter into 1031 exchange agreement with a Qualified Intermediary prior to the sale and have your proceeds proceeds paid into the QI's trust account.

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Does 1031 Exchange apply to selling my primary house?

There are 4 classifications  of Real Estate according to the IRS. The two that qualify for 1031 Exchange are real estate held for investment, usually land AND real estate held for use as a business, usually some sort of rental property. Your personal residence or primary residence or your second home are NOT qualified for the benefits of IRS 1031 Exchange. If you are selling the land around your home, there are opportunities under the mixed classification rules concerning 1031 Exchange. We recommend a discussion with your tax advisor to see if you qualify for this inclusion.

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How do I find 1031 Exchange Replacement Properties?

Answer: Often Exchangers already have their 1031 Exchange Replacement property lined up before they close on their Relinquished Property. For those who don't, there are many resources on-line for finding a replacement property. Our 1031 Exchange web site at realtyexchangers.com has a couple of really good resources available to you.

First. Check out our list of 1031 professionals from every major US city in every state! Shopping for Realtors? This is where to look. There are probably many 1031 pros available in your area, RIGHT NOW. Visit our 1031 Exchange Professionals Directory today!

Second. When we first launched our web site over 15 years ago, we were the first to offer a comprehensive search engine for finding 1031 Exchange replacement properties. It was called the Exchanger's Clearinghouse and it was extremely popular among 1031 Exchangers. When we relaunched our web site last Summer, the Exchanger's Clearing house was relaunched as well. Though still new, it is fast becoming a resource of for 1031 Exchange properties. Listing your properties is always FREE and we have "Haves" and "Wants" lists. Visit the new Exchanger's Clearinghouse today!

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You mean I can 1031 Exchange a house for a duplex, triplex, etc?

It depends. You have to remember that a qualified 1031 Exchange must be of like-kind real estate. The only 2 kinds of real estate that qualify for IRS 1031 Exchange is Real Estate held for investment purposes, such as land AND Real Estate being used as a Business, including duplexes, triplexes, etc.

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Are 1031 Exchange Qualified Intermediary Escrow Accounts safe?

The Safe Harbors required to conduct a 1031 Exchange insist that your 1031 Exchange proceeds are stored in an escrow account held by your Qualified Intermediary. It should be understood that not all QI accounts are created equal. Insist that your Qualified Intermediary pay to have every penny of your 1031 Exchange proceeds FDIC insured. Many banks only offer FDIC insurance for funds up to $250,000. Few banks over this coverage on amounts higher than $250k. Another safety measure is to request that your QI establish a Qualified Escrow Account with your money, which mean that no funds are accessed without your knowledge and consent signature. As your Qualified Intermediary Realty Exchangers takes the safety of your money seriously. Review our safety protocols by clicking here.

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Why can't a 1031 Exchange Qualified Intermediary pay the Exchanger directly?

A very good question. Thank you. One of the most important aspects of the IRS 1031 Exchange is avoiding Constructive Receipt.  The IRS signifies that in order to reap the benefits of a 1031 Exchange you must not be in direct control of the 1031 Exchange proceeds at any time during the 1031 Exchange period. This period begins at the closing of sale of your Relinquished Property and the closing of sale of the final Identified Replacement Property. You cannot prove that your funds were in a Safe Harbor if you have direct access to the money during this time. If the IRS sees that the QI paid you directly, you 1031 Exchange will collapse and your exchange instantly convert into a sale. At the point, your sale is subject to the Capital Gains Tax. If you goal is to enjoy the Capital Gains Deferment of a 1031 Exchange, DO NOT TOUCH THE MONEY! Leave the Safe Harbor in place and let your 1031 Exchange proceed!

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1031 exchange, can money in escrow be transferred to another escrow account for property deposit?

We've had this question before where a customer is wondering if the 1031 Exchange Proceeds can be held in an escrow account with their title company rather than be transferred to Qualified Intermediary. This is an issue of Constructive Receipt. Constructive Receipt is where you have direct control over your 1031 Exchange funds. This is something you want to avoid at all costs because if the IRS discovers that you had Constructive Receipt of your 1031 Exchange proceeds, they will rule that your Exchange was actually a sale and you could be subject to capital gains tax. So, in order to defer your capital gains tax, should use the Safe Habor rule recommended by the IRS. Safe Harbor is a dis-interested 3rd party, while acting on your behalf and under your direction, has complete control over the proceeds. Safe Harbor is your Qualified Intermediary.

Having your 1031 Exchange proceeds held in an escrow account under the direction of your closing company is not using the Safe Harbor rule, which puts you in direct control over the money and puts you in Constructive Receipt of the funds. If you ever have Constructive Receipt, you have no 1031 Exchange.

If your funds are held in a Safe Harbor, then you cannot transfer them to another escrow account as an earnest money deposit. They can only be used for the direct purchase. Better to use your own funds for this purpose and get them back from the closing company after the sale closes.

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What are the 1031 Exchange laws regarding turning a 1031 exchange property into a personal residence?

What you are asking can be tricky. The 1031 Exchange Replacement Property must be acquired and held as a rental or a property held for investment. You need to show that this is your intent. The code and regulations are silent regarding a specific holding period before your property can be reclassified as a personal residence. But we've seen that rulings and opinions point to a minimum of two tax periods before you can convert it to a personal residence.

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Can my Title Company force me to use their 1031 Exchange Qualified Intermediary?

Absolutely not! Your 1031 exchange Qualified Intermediary is completely YOUR CHOICE!

In fact, the safe harbors of IRS Section 1031 Exchange specifically permit the Qualified Intermediary to be your agent, answerable only to you—absolutely no one else. Real or perceived. We also suggest that you you be careful of “steering.” Steering is the act by real estate agents and others referring business to friends or related parties. In our opinion, your QI should have no relationship or business connections to other parties you are dealing with in your deferred exchange transaction.

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Who regulates 1031 Exchange Qualified Intermediaries?

There is no federal body that regulates 1031 Exchange Qualified Intermediaries. Many of the states are requiring licensing in their state. Washington State requires that 1031 Exchange Qualified Intermediaries are managed by either a CPA or an Attorney. The Federation of Exchange Accommodators is a national organization of Exchange Professionals who have tried to put into place federal guidelines for regulation and education of Exchange professionals. Realty Exchangers, is licensed, bonded and insured in Washington State and a CPA and attorney are officers of the company.

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Can a partnership interest sell a property at a loss and still get 1031 Exchange treatment?

Partnership interests are specifically excluded as qualified property under 1031 Exchange rules. However, it is possible in many situations to design a transaction to accomplish the goal of an investor to get out of the partnership and still qualify for 1031 treatment Exchange Treatment.

The first thing to examine is the legal status of the investor. For example, tenants in common can split up without dealing with outsiders and get §1031 treatment in the split-up. Under Rev Rul 73-476, the IRS approved this transaction. Three investors owned an undivided interest as a tenant in common. There were no mortgages on the property and the property was held for investment. Each of the three investors exchanged his undivided interest in the three separate parcels for 100% ownership of one parcel.

Sometimes, however, the investors are partners rather than tenants in common. If this is the case, the investors should seek expert legal and tax counsel regarding a tax-free liquidation in kind of the partnership properties to the investors. Then, as tenants in common, they could seek to execute a §1031 exchange.

Caution: This procedure can be risky but if the savings are substantial, it’s worth checking out with counsel.

A very common situation is the single property held by two “partners.” Many joint owners of a rental income property consider themselves as partners when in fact they are tenants in common. In general, a partnership is formed when two or more persons (includes corporations) join together to conduct a business activity with the intent of sharing profits and losses. However, mere co-ownership of real estate maintained and leased or rented is not a partnership unless the co-owners provide services to the tenants other than the normal landlord activities.

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