1031 Case Study: Paying Down Personal Debt with Sales Proceeds

Recently, we had a client who was looking to do a 1031 exchange on a duplex that they owned. The property was worth roughly $300k, the taxpayer owned $190k and had lived in the upstairs portion of the duplex for 2 of last 5 years. The first question the client had was how to determine the amount of net proceeds he needed to put into the new replacement property?

Half of the Net Proceeds

Assuming that the property is treated as a 50/50 duplex on your prior tax return, half of the net proceeds will go into the 1031 exchange to buy new real estate worth about $150K (maybe a little less due to ½ of transaction costs).

Paying Down Personal Debt

The client also wanted to use the half of the net proceeds that had no capital gains to pay down some personal debt. Here’s the second big question: how much does he need to spend on replacement property to avoid paying taxes on the part that is susceptible to capital gains? Or since the client lived in the property, is the entire thing exempt from capital gains taxes?

Section 121 Exclusion

If you qualify for the Section 121 Exclusion of gain from sale of a principal residence for the portion that you lived in, then you can take half the net proceeds and do whatever you want with that portion.

It’s also important to double-check all of this with your own CPA or accountant.

• Start Your 1031 Exchange: If you have questions about principal residence exclusions and 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Acquiring 1031 Property as an Individual vs. Corporation

If I sell my property that was held in my individual name can I acquire my like-kind replacement property in my corporation? That’s our topic for conversation in this article.

Same Taxpayer Requirement

The short answer is no. Remember that the same taxpayer that sold the relinquished property needs to be the same tax payer that acquires the replacement property.

Oftentimes corporations are viewed as a separate or different taxpayer. They have their own EIN number, the stockholders may be the same as the owner of the relinquished property but they're probably not viewed as a disregarded entity or pass through for the purposes of 1031s.

Individual or Disregarded Entity

A more appropriate purchaser of the replacement property would either be the individual that owned the relinquished property or a disregarded entity such as an LLC that is wholly owned by the individual that sold to relinquished property.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Can I do a 1031 if my Property is Being Purchased Under Eminent Domain?

Sometimes we have clients call and say that their property is being purchased as part of an eminent domain or involuntary taking and they wonder if a 1031 exchange is an option in this scenario.

Section 1033

There is another code section that maybe applicable in these situations - code section 1033 of the Internal Revenue Code. Under that provision you can have a longer period of time (sometimes two to three years) to redeploy the cash. Furthermore you can actually hold your own proceeds, without needed a qualified intermediary.

When to Use a 1031 Exchange

But 1033 isn't always that simple. Sometimes there are some areas of gray. Perhaps you're voluntarily selling the property to the government agency and it's not really an involuntary taking, it's more of a negotiated voluntary sale that maybe would have resulted in the involuntary taking if the parties hadn’t come to a meeting of the minds.

In those situations where the potential taking never really amounted to an actual legal proceeding and it's more of a voluntary sale on your part - in those situations it's probably better to do a 1031 exchange.

However, if you actually have been served with a condemnation notice, this is a real legal proceeding, and it's not just the threat of condemnation it's an actual taking, in those situations you know you're clearly in the 1033 category.

1031 & 1033 Exchange Professionals

In either instance you can give us a call and we can help you understand the process and give you some pointers on what to do. For example, under 1033 it’s critical that you file an election on the tax return for the first year in which you receive any payments under that eminent domain taking.

• Start Your 1031 Exchange: If you have questions about section 1033, 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 Real Estate Closing Agents

If you work as a closer for real estate transactions and you're notified that one of the parties to the transaction wants to do a 1031 exchange, it’s important for you to make note of that right away in the file and find out who are the people that are helping facilitate this exchange. Here are a few tips for closing agents who encounter 1031 exchanges.

Eleventh Hour Fire Drills

We often get calls from closers at the eleventh hour saying that nobody made arrangements for the 1031 exchange. Everybody involved thought it was someone else's job to do, and now we need to hurry up and get 1031 documents prepared for a closing that's imminent. We can do that, but it's a real fire drill.

Questions to Ask

The better arrangement is to contact the party that intends to do a 1031. Ask them the following questions:

• Is this your relinquished property that you're selling?

• Have you started your process with a qualified intermediary?

How a Qualified Intermediary can Help

If they haven't started with a qualified intermediary, have them contact CPEC 1031 right away. We can get a copy of the purchase agreement and title work from you; we can gather the specific details in particular that we need from the seller; and we can put together the 1031 and the closing instructions that you'll need to know how to prepare the settlement statement and what notices need to be given to the other parties. This allows all of the documentation to be dealt with up front well before the closing occurs so that we have a smooth signing ceremony.

• Start Your Exchange: If you have questions about closing documents related to 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

What is a Related Party When it Comes to a 1031 Exchange?

The IRS is paranoid of related party transactions and they're more so concerned about your buying your 1031 replacement property from a related party. So what is a related party in a 1031 exchange?

Blood Relatives

A related party can be related to you by their business affiliation or blood relationship. So your mother, your father, your sister, your brother - these are all people that are related to you by blood. Under the statutes, if you are acquiring the property from them you need to disclose that on form 8824 and there are complications that stem from your acquisition of the property from a related person.

First you have to hold the property for 2 years and there cannot be an intent to avoid the imposition of the tax which really means it can't be part of a scheme to avoid taxes.

Business Affiliates

Now the other way a person could be related to you is by business affiliation. So you could be buying your replacement property from a partnership that you are the majority partner in or a corporation that you're the majority shareholder in.

There are other situations in which the seller would be considered to be a related party. Here is a listing of what the IRS considers “related parties”:

• Members of a family, including only brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.);

• An individual and a corporation when the individual owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• Two corporations that are members of the same controlled group as defined in §1563(a), except that "more than 50%" is substituted for "at least 80%" in that definition;

• A trust fiduciary and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• A grantor and fiduciary, and the fiduciary and beneficiary, of any trust;

• Fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts;

• A tax-exempt educational or charitable organization and a person who, directly or indirectly, controls such an organization, or a member of that person's family;

• A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest, or profits interest, in the partnership;

• Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation;

• Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation; or

• An executor of an estate and a beneficiary of such estate, except in the case of a sale or exchange in satisfaction of a pecuniary bequest.

• Two partnerships if the same persons own directly, or indirectly, more than 50% of the capital interests or profits in both partnerships, or

• A person and a partnership when the person owns, directly or indirectly, more than 50% of the capital interest or profits interest in the partnership.

Start Your 1031 Exchange: If you have questions about related parties in 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