Can Water, Oil, Gas & Other Like Rights be Exchanged in a 1031?

Many people think of 1031 exchanges solely in the arena of fee-title where you own all of the bundle of rights. But in some instances taxpayers have more narrowly defined rights in the property such as just the water rights, mineral interests, or gravel rights. Here are some things you need to keep in mind when exchanging these types of like rights in a 1031.

Real Property Interests

These interests are typically considered real property interests in the state where the property is located. If that’s the case you can do a 1031 on that narrow property interest into other like-kind property (i.e. real estate).

The Advantage of 1031 Exchanging Like Rights

So 1031 exchanges can be a very advantageous way of disposing of oil rights, gas rights, etc. or other interests that are generally considered appurtenant to any estate in real property, but are sometimes severed or separately held estates in property.

• Start Your 1031 Exchange: If you have questions about exchanging oil, gas, or water, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

721 Contributions & 1031 Exchanges

Sometimes a property seller is interested in contributing a portion of his or her real estate into the project as equity, but also wants to take some cash out for a 1031 exchange. Here's a strategy to accomplish that.

721 Tax-Free Contributions

One way to structure the sale agreement is to have the taxpayer (seller) enter into two agreements with the buyer — typically an LLC taxed as a partnership.

• First, the taxpayer agrees to sell to the LLC an undivided X percent of the property for cash that will be assigned to a qualified intermediary for a 1031 tax-deferred exchange.

• Second, the taxpayer agrees to contribute the remainder of his or her interest in the property to the same LLC in a 721 tax-fee contribution in exchange of a partnership interest (LLC membership interest).

By splitting the transfers in two and doing the 1031 sale first, the taxpayer is able to get the most tax efficient treatment on both transfers.

Potential Complications

There are some potential complications if the LLC distributes cash to the members after the contribution, so you need to be careful when taking-out construction financing. Here are some issues to consider:

• What amount of debt — if any — encumbers the property at this time?

• What is the seller’s current adjusted basis in the property? (check for “MOB” mortgage over basis)

• What is the cash price allocated for the sale portion of the transaction?

• What is the value or amount of the LLC/partnership interest being given in exchange for the contribution or the remainder of the property?

Having a qualified intermediary on your side to tackle these issues can ensure the most tax-efficient strategy possible.

• Start Your 1031 Exchange: If you have questions about the 1031 exchanges combined with 721 contributions, feel free to call me at 612-643-1031.

Defer the tax. MAXIMIZE your gain. 

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can I Do a 1031 Exchange Between Different States or Countries?

Section 1031 is in the Internal Revenue Code so it’s applicable to all the states in the union. You can buy your replacement property in any part of the United States. So you can sell a relinquished property in Florida and buy a replacement property in Minnesota. Many people that are in high tax states (such as California and Minnesota) are intrigued by the concept of exchanging their property into low tax states like Florida and Texas.

It’s really advantageous to be able to move your equity to the most advantageous investment which may be in a completely different state. However, you can’t exchange outside the US because foreign property is not considered like kind to US property.

Can I Do a 1031 Exchange if I’m not a US Citizen?

The short answer is yes. If you own property in the United States, you are subject to the taxation in the jurisdiction where the property is located. The United States will want to collect taxes on the sale of your US property. If you’re a US taxpayer, you can do a 1031 exchange to defer that gain indefinitely.

The idea behind section 1031 is that you have to buy a like-kind investment that’s in the US – foreign property is not considered like kind to US property.

But foreign taxpayers can still avail themselves of the benefits of a 1031 exchange (for their US tax liability) just like any US citizen would.

• Start Your Exchange: If you have questions about exchanging property between different states or countries, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can Seller Financing Jeopardize my 1031 Exchange?

In a 1031 you need to move your equity to your replacement property to defer all of the gain. If you use some of the proceeds to loan back to the buyer through a seller-backed note or a contract for deed, your equity is not available to you to redeploy into the replacement property.

Cash on the Barrelhead

The first thing I tell people is if you want a simple 1031 exchange, ask for cash on the barrelhead. Tell the seller not to be the bank. Instead, let the buyer go out and get their own financing. That’s fine sometimes, but other times the seller has to give the buyer some type of incentive in order to buy the property and has to engage in seller backed financing.

An easy way to fix that problem is to come to the closing table with a sufficient amount of money to loan directly to the buyer. If you do this that means all of your net proceeds are available to be sent to your 1031 escrow account (because you are adding in the cash to loan to the buyer out-of-pocket).

Have the Note Favor the QI

Another possibility is to loan the money to the buyer but have the note (or other debt instrument) run in favor of the qualified intermediary. That way your QI gets the cash and non-cash proceeds. But what do you do about the non-cash proceeds? We need to at some point sell that note so the QI has all-cash in their exchange account and can use that to apply it to the purchase of the replacement property.

So at some point in the process you’re going to probably have to buy that note from the QI. One way to do that is take out a temporary unsecured loan from a bank, put the money into the QI account, close on the replacement property, and in a post-exchange transaction, you can go back to your banker and increase the indebtedness on the replacement property (to pay back the unsecured loan). But that has to be done after the exchange is over in a separate post-exchange transaction.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

What Commercial Real Estate Investors Need to Know About Reverse 1031 Exchanges

Note: In this article, we hear from guest contributing blogger Kip Dunkelberger (kdunk@venturemortgage.com), the President and CEO of Venture Mortgage Corporation.  Kip leads this trusted, dynamic commercial real estate mortgage banking firm, and he himself is known as an experienced and resourceful problem solver in the realm of commercial real estate financing.  

1031 Exchange Deadlines

Today’s savvy investors, particularly those looking to defer tax consequences by taking advantage of 1031 exchanges, are wisely looking for ways to secure a replacement property before selling the soon-to-be-relinquished property.  These investors need to know that once they close on the sale of their old property, they have a new property investment to exchange into. 

They are rightly concerned, because the deadlines for a normal forward exchange require you to identify your replacement properties within 45 days and close on them within 180 days. 45 days to identify in a hot (seller’s) market  presents a potentially formidable challenge. Here in the Upper Midwest, where the competition for choice replacement multi-family properties is particularly fierce, the process of identifying and trying to close on a replacement property in a normal forward exchange is not always a realistic possibility. That’s where a reverse 1031 exchange, combined with a creative, problem solving commercial real estate mortgage banking firm with access to a wide variety of lenders, can make all the difference.

How can Investors Step into a Sure Thing via 1031 Exchange?

Many investors are turning to these reverse exchanges to increase their chances of completing a 1031 exchange. In a reverse exchange, an investor can have their replacement property purchased for them by a qualified intermediary before closing on the sale of their old relinquished property.  The qualified intermediary (“QI”) then creates a new LLC to be the purchaser of the replacement property and holds title (or “parks the ownership”) for up to 180 days while the investor sells the relinquished property.  The ability to finance the purchase of the replacement property before you have the proceeds from your sale is where the need for innovative financing comes in.

In Practice: Tip # 1 – Tax Statements

At the first closing of the replacement property, on the deed from the seller to the LLC, the lower right hand portion can be filled out to tell the county to mail the property tax statement directly to the investor’s address, rather than to the QI or its LLC.  That way the investor receives the bills and statements for the property taxes directly.

In Practice: Tip # 2 - Insurance

The insurance certificate for the liability insurance should list the lender, the LLC, and the investor all as insured parties.  That way, if there is a claim, all of the parties with an insurable interest in the property are protected.

If you have questions about obtaining a mortgage or financing for a reverse exchange or any other commercial real estate investment, you are invited to call Kip Dunkelberger at (952) 843-5125, or email him at kdunk@venturemortgage.com.

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