Real estate values go up, and as you may recall from recent the Great Recession, they also go down. Some commentators are speculating that the current good times will be coming to end, bringing opportunities for investors to buy some bargains.
What is a Downward Market?
A downward market is where real estate values are declining and opportunities are rising - opportunities to buy real estate at a cheap price. Remember, “price” is set by the market which can fluctuate based on emotions, while “value” is established by the cash flow in an economic analysis. So, it is possible to buy a property at a cheap price below its value (based upon the income it produces) and in the marketplace. If you find such an opportunity you want to seize on it immediately.
Well, you say, I can’t buy it now because if I do a 1031 exchange, the typical structure is that I sell and close on my old relinquished property FIRST, and then SECONDLY, I buy my replacement property. If this great opportunity comes up, how can I take advantage of it and still avail myself of a 1031 exchange? Here's an example: a bank takes back a property, but they don’t want to have it on their books. They have to reserve for it, they have to pay for expenses related to the property; they just want to get rid of it. So they’ll sell it at a deep discount - a discount below its actual value just to get it off their books. If you want to acquire that property, you have to move fast before another investor moves in and takes it away from you. A strong cash offer will ensure you are the successful bidder.
Parking Your 1031 Exchange Property can be the Key Getting a Quick Good Deal Done
What you need to do is a reverse 1031 exchange. In a typical reverse exchange, CPEC1031 acting as your intermediary sets up an Exchange Accommodation Titleholder (“EAT”). This is typically an LLC wholly owned by the intermediary that acquires the new property for you. The EAT purchases the replacement property and holds it so nobody else can get it. The IRS has laid out a safe-harbor in revenue procedure 2000-37. This is basically a recipe on how to do a reverse exchange. The best part of this deal (procedure) is that you can have your intermediary take down this property through the EAT. The bad side is, your intermediary can only park (own) this property and hold it in the EAT for up to 180 days under the safe-harbor. That means, you basically have six months to unload or dump your old relinquished property.
The IRS 1031 Exchange Rules Favor Investors for 6 Months
If the stars come into alignment, and you can get this great deal and park it with your intermediary’s EAT, and take the next six months to market and get the highest and best price for your old property, you can really benefit. You can have your replacement property all teed up, ready and waiting for you, and then when you dispose of your old relinquished property, the steps to wrap-up are:
- Relinquished property sells.
- Parked replacement property transferred to you.
- Exchange is over.
- Tax is deferred and YOU ARE A WINNER.
If You Don’t Make It You Still Have 1031 Options
Here is a 1031 Tip. If the stars do not come into alignment (within six months), and you cannot unload your old relinquished property so that you reverse exchange fails, it’s not the end of the world. You’ll end up owning both properties. You can still do a 1031 exchange on your old relinquished property (when and if it eventually sells). But you will have to exchange into something else that you don’t already own. At the end of the 180 days, your EAT is done holding it (parking is over); they will transfer it to you, so that it is your property now. You can’t exchange into something you already own, but (when your relinquished property eventually sells) it is still possible to exchange into something else (just not the property that you already own).
PLAN B for Failing Reverse Exchanges
Another very creative option for a failing reverse exchange can be found in IRS Private Letter Ruling 200712103.
Assume that you are parking the new replacement property with the EAT. In the event that an actual third-party purchaser can’t be found to purchase your relinquished property (the old property) within the 180 days, it may be possible to “manufacture” a “White Knight” buyer that is dissimilar to the taxpayer doing the 1031 exchange. In this arrangement, you could have a “white knight” purchase the old relinquished property from you to get it off your books within the 180 day reverse exchange period. The white knight will then act as temporary owner of the relinquished property until such time that the property is later sold to a third-party purchaser.
To be treated as the owner for tax purposes, the White Knight will need to have sufficient incidents of ownership of the relinquished property, so it will be conveyed the property by deed or contract for deed. In PLR 200712103, the Internal Revenue Service ruled that a taxpayer doing a safe-harbor reverse exchange (under Rev. Proc. 2000-37) could sell its relinquished property to a "related party" (but dissimilar taxpayer) and that this related party could also subsequently market and sell the relinquished property without having to hold the property for two (2) years.
NOTE: Private letter rulings, are a written statements issued to specific taxpayers that interprets and applies tax laws to those taxpayer’s represented sets of facts. A PLR is issued in response to written requests submitted by taxpayers. A PLR may not be relied on as precedent by other taxpayers or by IRS personnel, but may give insights into how other taxpayers are dealing with similar situations.
- 1031 Hotline: If you have questions about taking advantage of downturns in the Minnesota real estate market, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
© 2017 Copyright Jeffrey R. Peterson All Rights Reserved