This is actually a fairly common question. Can a taxpayer sell rental or investment property and acquire another rental or investment property through a 1031 tax deferred exchange and still qualify for tax deferred exchange treatment if a relative lives in the newly acquired property? The answer is fairly straight forward.
Treat it as Rental or Investment Property
The key is that the acquired property must be rental or investment property or used in your trade or business in order to qualify as like kind property. So, as long as the related party is paying the taxpayer fair market rent just like any other tenant would pay, it will qualify as like kind replacement property for tax deferred exchange treatment.
Risk of Being Recharacterized as a Second Home
There will be risk that the acquired property would be recharacterized or reclassified as a second home or vacation home instead of rental or investment property if the related party does not pay fair market rent to the taxpayer.
Vacation Property or Second Home
It is possible for a property held and used as your vacation property or your second home to qualify for tax deferred exchange treatment. It depends on a number of factors. The IRS also provided certain "Safe Harbors" for situations like this. I just recently posted a blog on this subject.
Tuesday, December 30, 2008
Monday, December 29, 2008
Trading Equal or Up in Value in a 1031 Exchange
Reinvest Total Investment Amount
This seems like a relatively straight forward issue, but it can get confusing for many investors. The concept is simple. Congress wants to make sure that investors trade equal or up in value (i.e. they stay fully invested) if they are going to be able to defer the payment of their capital gain taxes.
Most Investors Trade Way Up In Value
The actual required calculation for trading equal or up in value is not generally an issue because most investors are trading significantly up in value. However, some investors are not interested in expanding their real estate holdings, but do want to make sure that they defer all of their income taxes. Other investors are simply misinformed as to what trading equal or up in value means.
It's Not Just Reinvesting Your Equity
First, trading equal or up in value does not mean just reinvesting all of your cash, equity or capital gain in the property. The investor must do that also, but it is based on the net sales price and not just the investor's equity or capital gain in the property.
The two (2) rules are as follows:
This seems like a relatively straight forward issue, but it can get confusing for many investors. The concept is simple. Congress wants to make sure that investors trade equal or up in value (i.e. they stay fully invested) if they are going to be able to defer the payment of their capital gain taxes.
Most Investors Trade Way Up In Value
The actual required calculation for trading equal or up in value is not generally an issue because most investors are trading significantly up in value. However, some investors are not interested in expanding their real estate holdings, but do want to make sure that they defer all of their income taxes. Other investors are simply misinformed as to what trading equal or up in value means.
It's Not Just Reinvesting Your Equity
First, trading equal or up in value does not mean just reinvesting all of your cash, equity or capital gain in the property. The investor must do that also, but it is based on the net sales price and not just the investor's equity or capital gain in the property.
The two (2) rules are as follows:
- Trade equal or up in value based upon the net sales price of the relinquished property; and
- Reinvest 100% of the net cash proceeds from the sale of the relinquished property.
It is technically based on your net sales price, so if you want to cut the reinvestment as close as possible, you can calculate your reinvestment by taking your gross sales price and subtracting your routine closing costs to arrive at your net sales price. The next sales price is the correct amount of value that you must reinvest in your like-kind replacement property.
Friday, December 26, 2008
Backdating the Identification Form in Your 1031 Exchange
You are probably very familiar with the 45 day identification period if you have ever completed a 1031 exchange transaction. The taxpayer must identify in writing the potential replacement properties that they are considering buying as part of their 1031 exchange transaction, and the identification must be made with in 45 calendar days of the closing of the relinquished (sale) property.
45 Day Period Moves Fast
The 45 day identification period moves very quickly. In fact, it is only six weekends, which is not a lot of time to search for suitable like-kind replacement properties for your 1031 exchange. Taxpayers should start looking for replacement property well before they have closed on their relinquished properties to help minimize the stress involved with the 45 day ID period.
It is not surprising that many taxpayers may get a little stressed out during the 45 day identification process and time period. O.K. That might be an understatement in certain cases, especially as the taxpayer gets to the end of his or her identificatio period.
Backdating or Altering the Identification Form
Actually, my favorite question is "what is your position on the 45 day period?" I can't actually say this, but I really want to respond with "Are you kidding me?" The 45 day identification requirement is contained with the Internal Revenue Services, the Treasury Regulations and in numerous IRS rulings and court decisions. I think it is just about as clear as it can be that you must identify no later than midnight of the 45th day. There is no gray area here.
"But, ABC Exchange Company will allow me to backdate my identification form." "Nobody ever gets caught." These are some of my favorate follow-up comments that we get after we inform them that there is no flexibility with the 45 day identification requirement, even though we wish there were.
It's Tax Fraud; Pure and Simple
I realize that the IRS has been very loose in its enforcement of this area, but it will happen at somepoint in time. The act of backdating, altering or amending your identification form after the end of yoru 45 day identification period is tax fraud. There is no gray area.
I don't know about you, but I certainly do not want to be the poster boy for the IRS when they decide to actually prosecute some of these cases.
It is the same as the mortgage fraud was going on for years, which is part of the reason we are n the mess that we are in now. Clients used to respond all the time that no one ever gets caught if they say it was owner occupied when in fact it was rental property. We would still warn them. Well, the FBI is investigating and prosecuting those who lied right now. Its fraud, period.
Do you really want to take the chance that you might be the one that gets caught? More importantly, do you really want to work with a 1031 exchange company that is routinely breaking the law? I would prefer that they be around for a long time so that they are there for me if I get audited. Just my two cents.
45 Day Period Moves Fast
The 45 day identification period moves very quickly. In fact, it is only six weekends, which is not a lot of time to search for suitable like-kind replacement properties for your 1031 exchange. Taxpayers should start looking for replacement property well before they have closed on their relinquished properties to help minimize the stress involved with the 45 day ID period.
It is not surprising that many taxpayers may get a little stressed out during the 45 day identification process and time period. O.K. That might be an understatement in certain cases, especially as the taxpayer gets to the end of his or her identificatio period.
Backdating or Altering the Identification Form
Actually, my favorite question is "what is your position on the 45 day period?" I can't actually say this, but I really want to respond with "Are you kidding me?" The 45 day identification requirement is contained with the Internal Revenue Services, the Treasury Regulations and in numerous IRS rulings and court decisions. I think it is just about as clear as it can be that you must identify no later than midnight of the 45th day. There is no gray area here.
"But, ABC Exchange Company will allow me to backdate my identification form." "Nobody ever gets caught." These are some of my favorate follow-up comments that we get after we inform them that there is no flexibility with the 45 day identification requirement, even though we wish there were.
It's Tax Fraud; Pure and Simple
I realize that the IRS has been very loose in its enforcement of this area, but it will happen at somepoint in time. The act of backdating, altering or amending your identification form after the end of yoru 45 day identification period is tax fraud. There is no gray area.
I don't know about you, but I certainly do not want to be the poster boy for the IRS when they decide to actually prosecute some of these cases.
It is the same as the mortgage fraud was going on for years, which is part of the reason we are n the mess that we are in now. Clients used to respond all the time that no one ever gets caught if they say it was owner occupied when in fact it was rental property. We would still warn them. Well, the FBI is investigating and prosecuting those who lied right now. Its fraud, period.
Do you really want to take the chance that you might be the one that gets caught? More importantly, do you really want to work with a 1031 exchange company that is routinely breaking the law? I would prefer that they be around for a long time so that they are there for me if I get audited. Just my two cents.
Thursday, December 25, 2008
Merry Christmas
Twas the night before Christmas and all through the house not a creature was stirring...not even your 1031 exchange Qualified Intermediary!
Have a very Merry Christmas!
Have a very Merry Christmas!
Wednesday, December 24, 2008
Two Party Swaps: Concurrent 1031 Exchanges
These type of 1031 exchanges are not that common, but they do happen on occassion. This post was triggered by a recent call that I received. The caller said that he wanted this other person's investment property and coincidentally the other person wanted an investment property that he had. He wanted to know if they merely "swapped" properties if that would qualify as a tax-deferred exchange.
Classic Two Party Swap
This is a classic two party swap or concurrent 1031 exchange. You might also hear it referred to as a simultaneous 1031 exchange. It is actually the most basic type of tax-deferred exchange or 1031 exchange and is the structure often used years ago before the current delayed exchange was allowed by the courts through the Starker cases.
You have two investors that simply want each other's investment property. This tax-deferred exchange is often over complicated by the parties involved when it should be a relatively straight forward tax-deferred exchange.
Concurrent Recording of Deeds
The procedures to complete this tax-deferred exchange are very simple. The two parties simply draw up deeds for each of their properties granting the property to the other party. The two deeds are then recorded concurrently or simultaneously, and you have accomplished the two party swap.
Property Market Values
This assumes of course that both properties are worth the same amount. One party may owe the other party a cash payment in order to "equalize" the values if the properties are not equal value. The party that receives the cash payment will recognize tax on the cash portion received or he or can set up a delayed tax-deferred exchange with a Qualified Intermediary or Accommodator.
Professional Qualified Intermediary
The use of a professional Qualified Intermediary is not generally needed when you are structuring a classic two party swap. However, you must make sure that everything is structured and recorded concurrently.
Investors often retain a professional Qualified Intermediary in order to make sure that the necessary steps are taken to protect the tax-deferred exchange transaction. This will ensure that the proper tax-deferred exchange documentation is completed accurately and there is no accidental error that could invalidate the tax-deferred exchange.
You might also want to review some of the blog posts on this subject on the Exeter Discussion Board.
Consult with Tax Advisor
Both parties should of course consult their tax advisor before proceeding with a two party swap in order to ensure that the values are correct. Any complication due to property market value or outstanding debt, etc., can be dealt with before recording the deeds.
Classic Two Party Swap
This is a classic two party swap or concurrent 1031 exchange. You might also hear it referred to as a simultaneous 1031 exchange. It is actually the most basic type of tax-deferred exchange or 1031 exchange and is the structure often used years ago before the current delayed exchange was allowed by the courts through the Starker cases.
You have two investors that simply want each other's investment property. This tax-deferred exchange is often over complicated by the parties involved when it should be a relatively straight forward tax-deferred exchange.
Concurrent Recording of Deeds
The procedures to complete this tax-deferred exchange are very simple. The two parties simply draw up deeds for each of their properties granting the property to the other party. The two deeds are then recorded concurrently or simultaneously, and you have accomplished the two party swap.
Property Market Values
This assumes of course that both properties are worth the same amount. One party may owe the other party a cash payment in order to "equalize" the values if the properties are not equal value. The party that receives the cash payment will recognize tax on the cash portion received or he or can set up a delayed tax-deferred exchange with a Qualified Intermediary or Accommodator.
Professional Qualified Intermediary
The use of a professional Qualified Intermediary is not generally needed when you are structuring a classic two party swap. However, you must make sure that everything is structured and recorded concurrently.
Investors often retain a professional Qualified Intermediary in order to make sure that the necessary steps are taken to protect the tax-deferred exchange transaction. This will ensure that the proper tax-deferred exchange documentation is completed accurately and there is no accidental error that could invalidate the tax-deferred exchange.
You might also want to review some of the blog posts on this subject on the Exeter Discussion Board.
Consult with Tax Advisor
Both parties should of course consult their tax advisor before proceeding with a two party swap in order to ensure that the values are correct. Any complication due to property market value or outstanding debt, etc., can be dealt with before recording the deeds.
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