Gifted Property & 1031 Exchanges

Many people are unaware that you can conduct a 1031 exchange of property that you received as a gift. If you held the gifted property for a qualified purpose, which is for investment purposes or for use in your trade or business, then you should be able to defer the federal capital gains taxes.

In a 1031, both your old property (relinquished property) and your new like-kind property (replacement property) will qualify for 1031 exchange treatment if they are considered to be qualified use property.

Proving Your Intent to Hold for a Qualified Purpose

It is important that you intend to hold your properties for investment purposes in order to qualify for 1031 tax deferral. This means that your property involved in the exchange must be held for investment or used in your trade or business. If you used the property for personal use (such as your home) or held the property as inventory or stock in trade (i.e. they are held for sale), then they may not qualify for 1031 exchange.

A good way to prove that you have the proper intent to hold for a property for qualified purpose is to keep your properties for a substantial period of time, so that you can show you had the intent to hold for investment. During this holding period you can do things with your property that are consistent with investment or business. (i.e. renting them out for market rate lease). However, there is no mandatory minimum period of time that you must own property before conducting a 1031 exchange.

If you have a few years of tax returns showing that the property was held consistent with business or investment (i.e. showing rental income, deprecation or other business expenses) you will able to prove your case much better if you are ever audited.

• Start Your 1031 Exchange: If you have questions about gifting property after a 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 Real Estate Exchanges

One of the most popular uses for a 1031 exchange is in the sale of real estate. 1031 real estate exchanges are popular and easy because the like-kind requirements are very broad in the world of real estate.

Like-Kind Real Estate

Nearly all real property within the USA is considered to be like-kind. The types of real property that may be exchanged include property held in fee, ground leases (with remaining terms of 30 years or more), undivided interests in real property held as tenants in common (TICs) and interest in “DSTs” or Delaware Statutory Trusts. Here is a partial list of some of the kinds of properties that qualify for 1031:

• Apartment Buildings

• Farms

• Shopping Centers

• Airport Hangers

• Condos and Town Homes

• Raw Land

• Single Family-Rentals

• Industrial Property

Another reason people often structure the sale of real property as 1031 exchanges is because improvements (such as buildings) have been depreciated down over time, subjecting the sale to a maximum of 25% depreciation recapture rates (C corporations can be as high as 35%) on the portion of the gain that is attributed to the depreciation.

Depreciate your Investment Property

As a real estate investor, you can depreciate your real estate business and investment property. The maximum 20% capital gain rate is generally known as the long-term capital gains rate and is the maximum rate that applies to real estate that you have held for at least 366 days (more than one year).

There is also the Net Investment Income Tax (“NITI”) which is imposed by IRC Section 1411 and applies an extra rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts (2015 amounts: Married filing jointly = $250,000; Married filing separately = $125,000; Single = $200,000). 

The long-term capital gain tax is typically a lot less than what you pay on your regular income. If your holding period has been for less than one year, consider deferring the gain on the sale through a 1031 exchange so that you can meet the greater-than-one-year period before cashing out on a later sale.

• Start Your 1031 Exchange: If you have questions about 1031 real estate exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges Between Family Members

Generally, related party 1031 transactions should be avoided, especially as to the purchases of replacement property. We'll explain why in this article.

Would a Taxpayer be Able to 1031 into a Piece of Land Owned by His or Her Daughter?

Internal Revenue Code (“IRC”) Section 1031 (f) has special rules for exchanges between related persons that may require the related parties to hold their respective properties for two years after an exchange. However 1031 (f) also contains a killer clause that the related party exchange cannot be part of a transaction structured to “avoid” the imposition of tax. It’s hard to discern a compelling differentiation between the intention to legally and indefinitely defer one’s taxes and an impermissible intention to avoid the imposition of tax. The IRS has picked up on this and has successfully fought some heart-breaking cases. The result is that there are a string of unfriendly tax court cases and rulings that have really muddied the waters for related party purchases.  In one case a son purchased his replacement property from his mother…and the IRS disallowed the 1031 exchange.

“Related Person”

The term “related person” means any person bearing a relationship to the taxpayer described in section IRC Sections 267 (b) or 707 (b)(1) and can broadly include family members and people you are in business relationships with (such as a partnership, corporation or trust). To make matters more complicated, because of the IRS’s rules of attribution, a person may be considered to be a related person even if you wouldn’t normally consider them a related to you.

The problem for farmers who want to buy adjoining land, and families with closely located properties that they know and understand, is that these desirable replacement properties may be owned by related parties, such as an uncle, mother or brother.

• Start Your Exchange: If you have questions about 1031 exchanges between family members, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Identification Best Practices

Note: This is a continuation of our previous article: A Primer on 1031 Identification Rules.

1031 Best Practices for Sending-in an ID

The most common and safe practice is to use a qualified intermediary and to fax or otherwise send in your 1031 replacement property identification form early; then ask your qualified intermediary to send you back written confirmation that they have received it. On IRS form 8824, which is a worksheet that you attach to your federal tax return to give the IRS information about your exchange, question 5 requires you to provide the “date” the like-kind property you received was identified by written notice to another party (month, day, year).  

If you are ever audited by the IRS, is important to have a good records on When, How and to Whom you sent your identification to so that you can substantiate the information in your federal tax return and on IRS Form 8824.  For an extra level of thoroughness, in addition to faxing or e-mailing a signed PDF of the 1031 replacement property identification form, you may also send the identification to the qualified intermediary through the US Postal Service by First Class Certified Mail Return Receipt Requested. 

That way you can keep the Return Receipt as proof that you sent it, and further, your qualified intermediary can retain the postmarked envelope as proof of when it was sent. Make sure that you take your letter to the US Postal Service and have it postmarked (legibly) before the 45th day.  If you simply drop your letter into a mailbox, it may not be picked-up, processed and postmarked by the US Postal Service with the same date that you actually dropped it into the mailbox.

Is Signing a Purchase Agreement for Replacement Property Sufficient to Constitute an Identification for 1031 Purposes?

As noted before, a taxpayer can technically identify to the seller of the replacement property as long as it is done within the 45 day identification period in a written document and meets the other requirements for a valid designation.  If you want your purchase agreement to constitute an identification of replacement property (which is an uncommon but permissible practice) you may want to clearly state your intention by including text in the purchase agreement such as:

“The Seller acknowledges that the Purchaser herein designates that the subject property shall be the Purchaser’s replacement property to complete the Purchaser’s like-kind exchange of property under Section 1031 of the Internal Revenue Code regarding Purchaser’s disposition [insert address] as relinquished property.”

What if I am Doing a Build-to-Suit?

If you are going to conduct a build-to-suit exchange wherein your qualified intermediary or exchange accommodation title-holder is taking title to the new replacement property while new improvements are constructed, then you should designate in your replacement property identification not only the initial replacement property, but also the new like-kind improvements that will be completed and received by you with the 180 day exchange period.

• Start Your Exchange: If you have questions about 1031 identification best practices, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

A Primer on 1031 Identification Rules

Many taxpayers and their advisors have questions about the rules for identifying replacement property for a 1031 exchange.  For a copy of the Treasury Regulation 1.1031(k)-1(b) and (c) check-out our Library of 1031 resources.

Here is a quick primer on the identification rules of a 1031 tax exchange.

1031 Identification Period

After the closing of your old relinquished property you will have until midnight of the 45th day thereafter to designate (identify) in writing what replacement properties that you want to receive to complete your 1031 exchange.  If you do not send your written designation within that time, your exchange may fail, so it is very important to keep track of this deadline. You can run a calculation of your 45 day identification deadline and your 180 day exchange deadline by going to our 45 / 180 Day Calculator.

Eliminate Stress by Closing within the First 45 Days

Any replacement properties that you close on and receive within the first 45 days are deemed to have been identified by virtue of the fact that you bought it.  So one way to eliminate the stress of having to make an identification is to have the purchase of your new replacement property lined-up to close quickly after the closing of your old relinquished property. However, if for some reason you encounter an unexpected delay with your replacement property (that could extend the closing date beyond the 45th day), it is advisable to fill out and send in an identification just to be on the safe side.

Don’t Fail to Identify

If you do not make a written designation within the 45 day identification period (or do not actually receive your replacement property by closing on it within the 45 days), then your exchange will end, and your qualified intermediary will have to return your 1031 exchange funds back to you. 

• Start Your 1031 Exchange: If you have questions about 1031 identification rules and real estate in Minnesota, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved