1031 Case Study: Exchanging a Personal Residence

Recently, a client came to us with the following 1031 scenario. The client was looking to sell their personal current residence and 1031 into something different. They had only lived in the residence for 15 months and didn't plan to live in the replacement property. Is it possible to exchange this property in a 1031 transaction. If so, what are the implications?

Personal Residence Exclusion

Unfortunately, this situation does not qualify for 1031 exchange treatment. A personal residence may not qualify for section 1031 as it has not been used for investment for business purposes. However, there is another tax code section (section 121) that allows for an exclusion of up to $500,000 of gain if you're married or $250,000 if you’re single. That being said, you must have owned and use the property as your primary residence for at least two years.

Partial 121 Exclusion

Interestingly, there are certain exceptions that will permit a partial 121 exclusion in instances where the taxpayer moves for reasons that are beyond their control such as their employer transfers them to a different town.

Things can get very tricky when it comes to section 1031, 121 and the personal residence exclusion. It’s always best to speak with a tax 1031 tax professional about your situation to cover all of your bases.

• Start Your Exchange: If you have questions about section 121 and the personal residence exclusion, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

How to Offset Depreciation Recapture in a 1031 Exchange

If someone wanted to do a 1031 exchange strictly to offset depreciation recapture, is that allowed? That's our topic for this 1031 education article.

Depreciation Recapture Example

In this example - the person would be selling a property for $250,000 and basically have no excess cash once existing mortgages were paid off.

If the taxpayer did the 1031 exchange and identified/purchased properties of at least $250K or greater within the allowed time (and put $250K or more of mortgages on them) the taxpayer would just be able to carry forward his basis without any tax consequence? The qualified intermediary would sign the huds, but wouldn't really hold or transfer any cash in this scenario. Would this work?

Using 1031 to Recapture Depreciation

The short answer is yes. 1031 works for both gain from appreciation and also deprecation recapture.

The amount of debt they have is not necessarily related to the basis that they have for tax purposes, so even if they have little or no cash proceeds at closing, they may still have a big gain...and need to do a 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchange depreciation recapture, or anything regarding 1031, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Holding Periods & The Qualified Purpose Requirement

What if there's a seller that has a lot for sale that they have owned for one year - can they do a 1031 exchange on the sale of that lot?

How Was the Property Held?

The answer to the question really depends on how they have held the property.

If they purchased the lot intending to use it for investment or business purposes then they can probably do the 1031 exchange because they held it for the requisite intent.

However if they bought the lot intending to flip it, holding it primarily for resale, then the IRS could make the argument that the property doesn't qualify for 1031 because it's their inventory.

The Qualified Purpose Question

The real question is has the taxpayer held the property for a qualified purpose?

The longer that you have held it for that qualified purpose the better. The IRS has never mandated or given a bright-line ruling on how long you have to hold your property prior to a 1031 exchange. Because of that ambiguity there is a lot of uncertainty as to how long one has to hold the property.

Sometimes people want to hold it for a year. Sometimes people want to cross over into the next tax year so they have at least one tax return under their belt. Other folks are very conservative and want to hold it for several years before they dispose of it in a 1031 transaction.

• Start Your Exchange: If you have questions about qualifying purpose, the held for requirement, or anything regarding 1031, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Is a 1031 Exchange Always 100% Tax Deferred?

As we have previously noted, one of the biggest benefits of a 1031 exchange is that it allows you to defer your capital gains taxes on the sale of real property. But are all 1031 exchanges 100% tax deferred?

Full vs. Partial Tax Deferral

The short answer is no. For various reasons, some 1031 exchanges do not qualify for full tax deferral. But sometimes taxpayers are happy with a partial victory with their 1031 exchange and they may recognize some gains in any of the following scenarios:

• to the extent that they take in and receive some of the cash proceeds and put it into their pocket;

• to the extent that they buy a replacement property of lesser value than the relinquished property;

• to the extent that they pay non-standard transaction expenses that are not permitted to be paid with exchange funds.

Not a Zero-Sum Gain

A 1031 exchange is not a zero-sum gain and you can defer some of the gains while recognizing other gains. Many taxpayers looking to diversify who don't want to have all of their eggs in one basket are plenty happy with a partial victory.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Who Qualifies as an Accredited Investor & How Can it Help Your 1031 Exchange?

In the context of a 1031 exchange, taxpayers want to be able to access the best investments possible. However, not all properties are readily available to the general public because the Securities and Exchange Commission (SEC) regulates what kind of properties can be advertised and marketed to the public.

Certain types of people (accredited investors) are deemed not to need the same level of protection as the average consumer. These people are thought to be more sophisticated and appropriate to market these types of securities to.

Who Qualifies as an Accredited Investor?

In order to be deemed an accredited investor, an individual must demonstrate that they have an annual income of at least $200,000 (or $300,000 if you’re married filing a joint tax return), or show that you have a net worth exceeding $1,000,000.

If you meet the threshold then you can be given access to securitized real estate Investments that allow you to roll your money into what are typically very low management, passive Investments that generate steady streams of income without your having to engage in the day-to-day management of the business.

Delaware Statutory Trusts & Tenancy-in-Common Syndications

These offerings (often referred to as Delaware Statutory Trusts or tenancy-in-common syndications) are very popular among older investors that are getting out of management-intensive property such as farms and apartment buildings, and are looking for a place to put their replacement property proceeds into that will allow them a steady stream of income and perhaps some leisure time to travel and enjoy life.

• Start Your Exchange: If you have questions about accredited investors 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