Can You 1031 Exchange out of Non Income Producing Property & into Income Producing Property?

In order to qualify for a 1031 exchange, the property that you're selling has to have been held for investment or business purposes. Sometimes people have been holding raw land, which may not actually generate any cash flow while holding the property.

Raw Land

If you buy raw land hoping that it will go up in value, your holding costs may be property taxes, insurance, and other expenses related to the property while you're not receiving any rental income.

Many people ask if they can exchange into cash flowing property out of property that they've held for investment purposes but which has not generated any cash flow.

Mental Intent

As long as your mental intent was to acquire and hold the old relinquished property for investment or business purposes, even if it didn't generate cash flow, you can still do a 1031 exchange into other like-kind property that will also be held for investment or business purposes.

As a bonus, it's okay if your replacement property generates cash flow. In fact it’s probably a good thing because it would substantiate that you're using the replacement property for investment or business purposes.

The reason that Congress created 1031 in the first place was to allow investors to move their capital to the most advantageous investment and to stimulate the economy by allowing investors to seize upon opportunities that both benefit them and the economy by redeploying their cash where the economy needs it.

• Start Your Exchange: If you have questions about 1031 exchanges of non-income producing property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Four Important Rules to Remember in a 1031 Exchange

1031 exchanges are excellent tools for deferring capital gains taxes on the sale of real property, but they come with a variety of rules and regulations. In this article, we are going to talk about four of the most important rules to remember when conducting a 1031 exchange of real property.

Rule 1 – Exchange Out of & Into Like-Kind Property

The like-kind property rule is perhaps the most important rule in any 1031 exchange. But what is “like-kind” property? When you’re dealing with real estate, like-kind has a very broad definition that includes basically all real estate (provided it’s held for the right purpose – more on that below).

Rule 2 – Hold Your Property for the Requisite Intent

Having the right intent or mindset is also important in a 1031 exchange. All of the property involved in the exchange needs to be held primarily for investment or business purposes, and not personal use. So your primary residence would be excluded from 1031 exchange treatment because of this rule.

Rule 3 – Finish Your Exchange within 180 Days

All 1031 exchanges (whether of personal property or real estate) need to be completed within 180 days after the sale of the relinquished property. The first 45 days of that time period are set aside for identification of the replacement properties into which you plan to exchange.

To figure out your 1031 deadlines, use our helpful calculator.

Rule 4 – Exchange Into Property of Equal or Greater Equity, Value, Debt

You also want to make sure that your replacement property is of equal or greater equity, value, and debt when compared to your relinquished property. This is also known as the “napkin test.”

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Can you do a 1031 Exchange on a Property with a Mortgage & HELOC?

Here’s a relatively common 1031 situation that many people have questions about. Imagine you have two mortgages on the property you’re selling - one is the primary mortgage for 250K and the other is a 90K HELOC. Let’s say you want to do a 1031 exchange on this property and the purchase price on the new replacement property is a lot higher than that of the relinquished property. Can you count the HELOC against the equity? In other words, can you wait and pay the HELOC at closing so you have less money than required in order to maximize the 1031 benefit?

Questions to Consider

These are all great questions and there is a lot to consider before making a decision, such as:

• Are both mortgages liens against the Relinquished Property?

• In order to give the buyer clear and marketable title, wont both mortgages liens need to be satisfied by the title company?

• Are these debts encumbering the Relinquished Property?  If they are, then they will probably have to be full paid-off and released from the Relinquished Property.

Running Up Debt Before an Exchange

In general, it is NOT advisable to run-up the debt on the Relinquished Property in anticipation of the exchange.  The IRS has challenged such transactions.

Form the IRS perspective, if you extract the equity out of the Relinquished Property just prior to disposing of it in a 1031 exchange, it is effectively the same a s taking out the boot at the time of closing.

Check out this video for additional information: 

• Start Your Exchange: If you have questions about HELOC 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

Sample Text for 1031 Exchange Sale & Purchase Agreements

In a 1031 exchange, it is a very prudent practice to ‘shout it from the mountaintops’ at every juncture that you intend to conduct a 1031 exchange. That way if there is ever a misstep, mistake or problem, everyone knows what you are trying to accomplish, and will give you the benefit of their understanding. Here is some sample text that you may use or adapt for your sale and purchase agreements:

When Selling Relinquished Property

The Buyer herein acknowledges that it is the intention of the Seller to conduct an IRC Section 1031 Tax-Deferred Exchange and that the Seller's rights under this Purchase Agreement shall be assigned to CPEC1031, to facilitate such exchange. However, any warranties that may be expressed in this contract shall remain and be enforceable between the parties executing this document. Buyer agrees to cooperate with the Seller and/or its assigns in a manner necessary to enable the Seller to initiate said exchange at no additional cost or liability. This Purchase Agreement is part of an integrated, interdependent, mutual and reciprocal plan intended to effectuate an exchange by Seller of a like-kind real properties pursuant to and in accordance with the provisions of Section 1031 of the Internal Revenue Code. The Buyer shall execute and provide to Seller prior to closing, an acknowledgement, that Buyer has received written notice of the assignment of the Seller’s rights under this Purchase Agreement to CPEC1031.

When Buying Replacement Property

The Seller herein acknowledges that it is the intention of the Buyer to complete an IRC Section 1031 Tax-Deferred Exchange and that the Buyer's rights under this Purchase Agreement shall be assigned to CPEC1031 for the purpose of completing such exchange. However, any warranties that may be expressed in this contract shall remain and be enforceable between the parties executing this document.  Seller agrees to cooperate with the Buyer and/or its assigns in a manner necessary to complete said exchange at no additional cost or liability. This Purchase Agreement is part of an integrated, interdependent, mutual and reciprocal plan intended to effectuate an exchange by Buyer of a like-kind real properties pursuant to and in accordance with the provisions of Section 1031 of the Internal Revenue Code. The Seller shall execute and provide to Buyer prior to closing, an acknowledgement, that Seller has received written notice of the assignment of the Buyer’s rights under this Purchase Agreement to CPEC1031.

• Start Your Exchange: If you have questions about 1031 sale and purchase agreements, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Is There a Difference Between Income vs. Investment Property in a 1031 Exchange?

Is there a difference between income and investment property? Do both fall within the 1031 exchange guidelines? That's our topic for today's article.

What is the Held for Requirement in a 1031 Exchange?

Section 1031 provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind that is to be held either for productive use in a trade or business or for investment. 

Whether the property exchanged is held for productive use in a trade or business or for investment is a question of fact. The manner in which the relinquished property is held at the time of the exchange controls, not the manner in which it was held when acquired - see Wagensen v. Commissioner, 74 T.C. 653 (1980).

Neither the Internal Revenue Code nor the Income Tax Regulations under § 1031 provide further guidance concerning the phrase “held for productive use in a trade or business or for investment” (the “held for” requirement).   

Rev. Proc. 2008-16

The Internal Revenue Service (the “Service”) deals with this issue in Rev. Proc. 2008-16, 2008-10 I.R.B. 547 in the context of properties in a rental pool that may be used sparingly for personal use.

Rev. Proc. 2008-16 provides circumstances under which the IRS will not challenge whether a dwelling unit qualifies as property that meets the “held for” requirement even though the property is occasionally used for personal purposes. If the safe harbor provisions of the Rev. Proc. are met, the entire property meets the “held for” requirement for purposes of § 1031. The Rev. Proc. provides the following:

The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes. In the interest of sound tax administration, this revenue procedure provides taxpayers with a safe harbor under which a dwelling unit will qualify as property held for productive use in a trade or business or for investment under § 1031 even though a taxpayer occasionally uses the dwelling unit for personal purposes. 

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved