Tips for Doing a 1031 Exchange with a Significant Other

1031 Exchange Funds

When a taxpayer is doing a 1031 exchange, they may want to buy their new replacement property together with another person. Maybe they want to buy the replacement property with their significant other or partner, for example.

The Problem with Proceeds

The problem with this generous idea is that in order for the exchange to be respected, all of the proceeds from the relinquished property need to be earmarked and used exclusively for that taxpayer’s exchange.

If the proceeds from the relinquished property are utilized to buy someone else's interest in the replacement property, the IRS will say:

"These funds were earmarked to buy the taxpayer’s interest in the replacement property but instead were used by someone else who is not the exchangor’s interest in the property. We don't see that as being a continuation of investment by the taxpayer.”

So you may inadvertently cause the recognition of gain as to any proceeds that were sidetracked and used to basically ante up someone else's interest in the replacement property.

The Best Course of Action

The better course of action is to have the taxpayer that relinquished the property use their proceeds solely for their purchase of the replacement property. If someone else is coming in as a cold purchasor they should bring in their proportionate share of the down payment and contribute their cash out of their pocket so that they have a place at the table that they pay for out of their own funds.

  • 1031 Hotline: If you have questions about 1031 exchange funds, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Keeping Operational Expenses Off of the 1031 Exchange Closing Statement

1031 Exchange Title Closers

Title closers often wonder what they can put on a settlement statement when a client is selling their old relinquished property in a 1031 exchange. Here are a couple tips.

Don't Gum Up the Closing Statement

In any 1031 exchange, you want to take all of the proceeds or equity that the seller has in the relinquished property and move that to the new replacement property. So we don't want to gum up the closing statement on the relinquished property with a bunch of sale expenses that are peculiar and weird. For example, we wouldn't want to put items on the closing statement that debit the sales proceeds for unusual, non-customary expenses, nor do we want to include expenses that are really operational.

Taxes, Rent & Insurance Costs

So if you have a debit for tax prorations, rent prorations, insurance costs, or anything that is really an operational expense related to the property, it's prudent to have the taxpayer and the taxpayer’s CPA or tax advisor talk about those expenses before the settlement statement is finalized.

It may actually be prudent for the seller to bring money into the closing to pay the prorated taxes, to pay the prorated rents, to pay any security deposits that need to be transferred to the buyer, and also to pay any other operational expenses like insurance. By having this preliminary settlement statement prepared and circulated to the appropriate advisors you can assure yourself that the seller will get the best result at the closing with the least amount of drama and disruption.

  • 1031 Hotline: If you have questions about 1031 exchanges and title closers, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Converting Rental Property into Personal Use Property

1031 Exchange Rental Property

When you do a 1031 exchange you need to acquire a replacement property that's like-kind. The definition of like kind in the realm of real estate is very broad. A lot of people that have been holding single-family rental property (a small duplex or fourplex) may be inclined to buy a property as a replacement that eventually could be converted into a personal use property such as a second home. Here are some things to keep in mind when converting rental property into personal use property.

Qualifying Purpose

You need to be very careful that when you receive the replacement property you have the requisite intent to hold it for a qualifying purpose of investment or business use.

Sometimes people will buy a property that is a vacation type property and put it into a rental pool and predominantly they're using the property as a rental property with incremental tenants. Now the taxpayers that have acquired this vacation property may be inclined to use it for personal use. Under a safe harbor that the IRS has you can use it up to 14 days a year or up to 10% of the time the property is actually rented.

IRS Guidelines

The IRS can test each of the two years after you acquire that replacement property to see if your personal use was within those guidelines. By the way if you go and use the property but you're there predominantly to maintain the property (to repair it, paint it, or fix it) then those periods that you're there for business would not count against your 14 days or 10% that you use it for personal use.

  • 1031 Hotline: If you have questions about 1031 exchanges rental pool properties, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Steps to Take After a Reverse 1031 Exchange

Information in a 1031 Exchange

After a reverse exchange is completed and a replacement property that was parked by the intermediary has been conveyed to the taxpayer, the business may not be done. There may still be some administrative tidying up that needs to be done.

Change of Address

For example, the LLC that parked and held title to the replacement property may have been assigned to the taxpayer, but the records with the Secretary of State may still reflect the intermediary’s address as the business address of the LLC and as the registered agent. One administrative step after the reverse exchange is done is to file a new annual report with the Secretary of State reflecting the correct address and who is the new registered agent of the LLC.

If the address where the county tax statements are being sent to is showing as the intermediary’s address, the local county may continue to send the tax bills to the intermediary’s address rather than to the taxpayer. So another item to tidy up is to file or notify the local tax assessor where you want your tax statements and tax bills to be sent to in the future.

Notify the IRS

It may also be prudent to contact the IRS and notify them that the ownership of the LLC has substantially changed and request a new EIN number for the LLC.

These are little administrative items that are prudent to take immediately after the reverse exchange has been wrapped up. It's important not to delay too long because otherwise correspondence and important communication may be routed to the wrong address and the taxpayer may not receive that information for some time.

  • 1031 Hotline: If you have questions about administrative items after a reverse 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Tips for Tenancy in Common Property

Tenancy in Common Property

A lot of times people own real estate in a partnership or LLC that's taxed as a partnership. If the property goes up in value some of the partners may be inclined to sell the underlying real estate while other partners are not so inclined because they don't want to pay the taxes.

This divergent opinion between the partners can be exasperated if there's been a death of one of the partners and the heirs of the now-deceased step into the partnership with a stepped-up basis and perhaps a more cavalier attitude about selling the underlying real estate. Because they may not have much of a tax burden if the property is sold, they may be less concerned about the tax consequences of a sale.

Setting up a Tenancy in Common

Furthermore, they may not want to be in a partnership with all the other folks. So when this sort of divergent opinion exists it may be a prudent step to bifurcate the ownership of the asset so that rather than having a partnership we would have a tenancy in common. If a sale were to ever occur, the exchange minded folks could be in one entity, and the cavalier folks that have a high basis and are less concerned about taxes would be in a separate distinct tax-paying entity.

When the sale occurs, hopefully we have two sellers on the purchase agreement, and two sellers that are separately 1099’d by the title company. The exchange minded group can set up their proceeds to go with a qualified intermediary and defer their gain, while the cavalier high basis folks that are less concerned with the tax can simply take their share of the proceeds and go.

Give Yourself Time

When do you want to set up this bifurcation? Do you want to set up the split up on the eve of the closing right before you sell the relinquished property? Do you think the IRS will respect a last minute switch? Probably not. The better course of action is to have this conversation amongst the partners early, before there's even a tacit agreement to sell the property and to break up the property well in advance of any proposed sale. Let some time pass after the break up before you actually sell the property. The IRS is much more likely to respect a reconfigured ownership arrangement if it is done well in advance of any sale and some time has passed.

1031 Holding Requirement

Furthermore, remember there's a holding period requirement in section 1031 that the relinquished property must have been held for investment or business purposes. If you do a drop and then a swap immediately you may not have held your property for a sufficient period to satisfy the requirements of 1031.

  • 1031 Hotline: If you have questions about 1031 exchanges of TIC property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved