3 Tips for Navigating the Ins and Outs of a 1031 Exchange

There are a lot of complexities when it comes to 1031 exchanges of real estate. In this article, we are going to offer up a few tips for navigating the ins and outs of a 1031 exchange.

Tip 1 – Work with a Qualified Intermediary

The most important tip we can give you is to work with a qualified intermediary on your 1031 exchange. An intermediary is someone who knows section 1031 backwards and forwards and can help you with every aspect of your exchange. They are the most important advisor you can have by your side throughout the 1031 exchange process.

Tip 2 – Know the Rules

It’s essential to have at least a basic understanding of the rules that govern 1031 exchanges of real estate. This includes the timing rules, the qualified purpose rule, among others.

Tip 3 – Don’t Wait Until the Zero Hour

Lastly, it’s always a good idea to prepare, prepare, prepare as much as possible for your exchange. If you are thinking about doing an exchange, start looking into the details well before you intend to sell your relinquished property. This will give you and your intermediary enough time to effectively prepare everything that needs to happen to ensure a successful exchange.

1031 Exchange of Real Property

CPEC1031 prides itself on providing top-notch services to taxpayers around the country who are looking to exchange their property under section 1031. Our qualified intermediaries can help you through each and every step of your exchange. We can advise you on identifying replacement property, prepare all of your documents, and answer any questions you might have along the way. Contact us today at our Minneapolis office, or any of our satellite offices across the United States to set up a time to chat about your exchange.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

What to Know About 1031 Exchanges of Vacation Homes

For years tax controversies have stemmed from taxpayers selling their highly appreciated vacation/second homes. The problem has been that these "personal use" vacation-properties have fallen outside of the favorable tax treatments that many other real properties qualify for.

Vacation Homes

First, vacation homes normally do not qualify for the Section 121 Principal Residence Exclusion (provides an exclusion of up to $500,000 of gain for married persons filing a joint return / $250,000 of gain for single persons) because the property has not been used as the taxpayer's primary residence for two of the past five years. Second, despite the fact that many taxpayers feel that their second home or vacation condo is one of the best "investments" they ever made, and should qualify for tax deferral under Section 1031 (provides for non-recognition or deferral of capital gains tax for exchanges of properties held for "Investment" or for use in a "Trade or Business"); the IRS does not agree that these "personal use" type properties qualify for 1031 exchange treatment.

The IRS takes the position that vacation homes are held primarily for personal use rather than for investment. In May of 2007, the IRS successfully convinced the Tax Court that a taxpayer's exchange of a lake-side vacation home for another did not qualify as a 1031 exchange despite the taxpayer's expectation that the property would appreciate in value and could eventually be sold at a gain; Moore v. Commissioner, T.C. Memo. 2007-134.

SAFE-HARBOR

As a matter of administrative ease or convenience, the IRS has laid down a new safe-harbor for vacation home owners. Revenue Procedure 2008-16 gives owners who primarily rent out their vacation homes, but still occasionally use them for some personal use, a safe harbor to qualify for 1031 tax deferred treatment. Revenue Procedure 2008-16 requires that both the "relinquished property" that is sold and the "replacement property" that is purchased, must be used by the taxpayer consistent with a Qualifying Use Standard:

• TWO YEAR "OWNERSHIP" TEST: The taxpayer must have owned the vacation home for least 24 months immediately before the exchange;

• "USE" TEST FOR EACH OF THE PRIOR TWO YEARS: The taxpayer must have within each of the prior two 12-month periods immediately preceding the exchange:

  • (i) rented out the vacation home to another person or persons at a fair rental for 14 days or more, and (ii) not used the vacation home for personal use for more than 14 days; or more than 10 percent of the number of days during the 12-month period that the vacation home was actually rented at a fair rental.

A similar Qualifying Use Standard must be applied to any vacation home replacement properties. The taxpayers may take only limited personal use of their rented replacement properties for the 24 month period after completing their 1031 exchange into a vacation home.

Section 1031 has a very broad "like-kind" standard for real property. Generally, any real property within the United States that is held for "Investment" or for use in a "Trade or Business" can be exchanged for other US real property that will also be held for "Investment" or for use in a "Trade or Business".

Raw land may be exchanged for improved real property. Commercial property may be exchanged for residential rental property. Undoubtedly, many taxpayers who have grown weary of property management will consider purchasing vacation homes to be placed into a rental pool with the fringe benefit of occasional personal.

A smart taxpayer desiring more recreation might consider exchanging into multiple vacation home replacement properties. Each property would have a separate 14 day/ 10% personal use allowance. This is more advantageous than buying only one vacation home replacement property that would allow for less personal usage.

Real Estate Exchanges Under Section 1031

Under section 1031 of the Internal Revenue Code, taxpayers are able to defer their taxes when selling real property as long as they re-invest their net proceeds into replacement property. There are many rules and regulations you need to follow in a given exchange so it’s important to work with a qualified intermediary. Reach out to our 1031 exchange professionals today to talk about the details of your like-kind exchange. We work with taxpayers throughout the state of Minnesota and across the United States.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

Reverse 1031 Exchange Options - Switching It Up

In a 1031 exchange, sometimes it's not advantageous to park your new property. Perhaps the financing is be too complicated to have an exchange accommodation titleholder acquire the new property. It may not be feasible to get it through the financing committee when banks are already very jittery and uneasy. In a declining market, the financing can be the lynchpin and we don't want to upset the apple cart with very sensitive lenders. Another reason you may not want to park the ownership of your new property in a holding company is, you may want to get your hands on it right away because there might be tax incentives that go with the property. Perhaps there are low-income tax credits or other credits related to the stimulus package that may encourage you to get into the property as soon as possible. You will want to take advantage of those tax incentives you don't want to waste them on some holding company that is holding the property as inventory.

How Do We Structure the Deal So You Can Get Into the New Property as Soon as Possible?

The way we do the deal is, we structure the transaction as a front leg reverse exchange. (This is also sometimes called an exchange first reverse exchange) That means, we have the exchange accommodation titleholder, (the LLC) take title to your old relinquished property. That gets the property out of your name; you basically sell it to the exchange company. That liberates you and frees you up. Now you are no longer tied to that (old) property and this allows you to immediately acquire the new replacement property. The exchange is done except one lingering detail; you still need to find a (real) buyer for the old relinquished property. The 1031 intermediary holding title through this LLC can only hold on to the property for 180 days (per Rev. Proc. 2000-37).

Rush to Sell Your old 1031 Exchange Property within 180 Days

What are you going to do? You will need to market the relinquished property and hopefully, a third party purchaser will acquire the property from the intermediary. The Intermediary doesn't have any money of its own, so it would have borrowed that money from you or from a bank with your guarantee. So, it behooves you to get the intermediary out of title and get the new purchaser in so you or your lender can get paid off and you can be free of the guarantee.

A White Knight to Your Rescue

The EAT (exchange accommodation titleholder), needs to get out of title but, what if you can't get a 3rd party purchaser and nobody will buy your old relinquished property?

The IRS has been rather liberal. In recent private letter rulings (PLR), where a related party, (i.e. your brother in law or some entity you have an interest in) comes in and buys the relinquished property and holds it for eventual sale. These recent private letter rulings are tolerant of a related party purchase from the EAT (exchange accommodation titleholder) and thus completing the reverse exchange in a nice tidy (180 day) transaction.

Excerpt from IRS Private Letter Ruling No. 2007-12013

Under the given facts and representations, Section 1031(f) will not apply to trigger recognition of any gain realized when (1) Taxpayer purchases like-kind Replacement Property from an unrelated third party via EAT, (2) Taxpayer sells Relinquished Property to Related Party for cash consideration received by a QI, and (3) Related Party disposes Relinquished Property within two years of the acquisition.

What Do You Need to Take Away From All of This

In a downward market you can't wait around. You need to seize opportunities when they arise! A reverse exchange is another tool to get the deal done tax deferred! It allows you to purchase a property by having your exchange accommodation titleholder acquire either the new property or alternatively, take title to your old relinquished property, thus freeing you up to immediately acquire this new replacement property. Reverse exchanges are excellent and powerful tools, but they are sophisticated creatures. You need to have your CPA, your tax attorney and all your other advisors on board to get these deals done correctly.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

Allowable Closing Costs in a 1031 Exchange

One area where taxpayers can potentially slip up during the 1031 exchange process is closing costs. There are certain items that are allowable as closing costs and other items that are not. Knowing the difference is essential to the success of your like-kind exchange. In this article, we are going to discuss allowable closing costs in a 1031 exchange of real estate.

Allowable Closing Costs

In a 1031 exchange, not all closing costs can be paid with the exchange funds. The following is a list of all the allowable closing costs in a 1031 exchange:

• Broker’s commissions;

• Real estate agent commissions;

• Title transfer taxes;

• 1031 exchange facilitator fee;

• Owner’s policy title insurance fees;

• Escrow fees;

• Attorney’s fees; and

• Title recording fees

Non-Allowable Closing Costs

Here are a handful of closing costs that should NOT be paid using the 1031 exchange funds:

• Costs and fees associated with acquiring loans;

• Security deposits;

• Prorated rents;

• Insurance premiums;

• Property taxes;

• Fees associated with lender’s title insurance;

• Lender’s appraisal fees; and

• Lender’s inspection fees.

• Paying Tax with Exchange Funds or Outside Funds

It’s important to pay these costs in cash and not using the 1031 exchange funds, as doing so could threaten to derail your exchange

Tax Deferral with Like-Kind Exchanges

A like-kind exchange offers many benefits to the taxpayer – the biggest of which is capital gains tax deferral. As long as you move all of your exchange funds into a new replacement property, you can defer a hefty capital gains tax bill. This keeps your money working for you in a continued investment property. At CPEC1031, we offer like-kind exchange services to taxpayers throughout the United States. Give our like-kind exchange professionals a call today to structure your 1031 exchange.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

I’m not a Big Real Estate Investor, Can I Still do a 1031 Exchange?

A lot of clients come to us wanting to do a 1031 exchange of real estate, but think they can’t because they are not big-time investors. In this article, we are going to talk about why 1031 exchanges are not only for big time investors.

Who can Do a 1031 Exchange?

Any United States taxpayer can avail themselves of the tax-deferral benefits of a 1031 exchange of real estate. You do not need to be a big shot investor to conduct a 1031 exchange and defer your capital gains taxes. All you need is to have a like-kind property that you hold for a qualifying purpose (for investment or business purposes). When you go to sell that property, instead of cashing out, you need to reinvest your sales proceeds into a bigger, better replacement property. The end result is that your money continues to work for you in a new investment property, and you get to avoid a big tax bill.

1031 exchanges can be conducted across state lines and between different segments of the real estate market. So even if you’re not a hot shot investor, you can still use section 1031 to your advantage the next time you are considering selling real property.

A 1031 Exchange can Help You

With a 1031 exchange of real estate, you can defer your capital gains taxes that would otherwise go to the government and keep that money working for you in a continued investment. A qualified intermediary can walk you through this process step by step and make sure you are hitting all required benchmarks along the way. Give us a call today to learn more about our services and how we can help you save money on your next real estate sale. Our office is located in downtown Minneapolis but we work with taxpayers throughout the United States.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved