Why It’s Important to Avoid Boot in a 1031 Exchange

In a 1031 exchange, you want to do your best to avoid receiving any boot so your exchange is completely tax-deferred. But many people aren’t sure what exactly “boot” is. In this article, we are going to talk about boot in a 1031 exchange – what it is and how to avoid it.

What Exactly is Boot?

In a 1031 exchange of real estate, “boot” means any non like-kind property that the taxpayer receives during the course of the exchange. Ideally, you want to avoid receiving any boot in your exchange. The goal with a like-kind exchange is to defer 100% of your capital gains. If you receive boot, you will recognize at least a partial amount of that gain and the exchange will not be completely tax deferred.

Tips for Avoiding Boot

Because boot can trigger taxable gain, it’s important to do everything you can to avoid receiving it during your exchange.

You want to pay special attention to any taxes, rent prorations, and security deposits during closing. The best course of action is to keep these off the closing statement and pay for them with cash out of pocket to avoid boot. Certain closing costs can also potentially trigger boot. It’s important to consult with a qualified intermediary about these items before your closing.

1031 Exchange Companies in Minnesota

At CPEC1031, LLC, our qualified intermediaries have been working with clients in Minnesota and across the country for the past three decades. Our team can advise you on the details of your exchange, prepare your 1031 documents, and answer any of your questions throughout the process. If you want to learn more about the tax-saving benefits of the 1031 exchange, don’t hesitate to reach out to us today and set up an appointment via phone or at our office in downtown Minneapolis.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges - Does Minnesota Comport with the Federal Standard?

In the state of Minnesota, we're very fortunate in that the state pretty much conforms exactly with the federal standard. So if you defer your gain for federal tax purposes you also defer your gain at the state level.

Other States

Other states differ from the federal standard. For example, Pennsylvania does not recognize non-simultaneous 1031 exchanges. And if you do a sale of property in Pennsylvania, though you may defer the gain at the federal level you do not get the same deferral at the state level.

The thing about states is that they can differ from the federal standard and they can be more aggressive than the feds in searching out to make sure that they get paid the amount of tax that they're due.

California 1031 Exchanges

In California for example if you sell a relinquished property there, each year after you have to file a tax return with the state of California to let them know if you’ve subsequently sold your replacement property, because when and if you ever do recognize the gain on the sale of your replacement property they want to collect their state tax at that time when you finally do recognize the gain. If you have questions about state taxation give us a call so that we can talk through the specifics of your situation.

1031 Qualified Intermediaries

For any other questions regarding the 1031 exchange process, contact the qualified intermediaries at CPEC1031, LLC. With twenty years of experience, we can confidently walk you through the 1031 exchange process and answer all of your questions. Contact us today to learn more about our services. Our main office is located in downtown Minneapolis, but we provide services to clients throughout the country.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

A Brief Explanation of Construction / Improvement 1031 Exchanges

When you're doing a 1031 exchange you’ve got to find a replacement property. Wouldn’t it be awesome if you could build your replacement property exactly to your own specifications so you get exactly the property that you need and want?

Build-to-Suit Exchanges

A build-to-suit exchange may be the trick that you need to use to complete your exchange and get exactly the property you want. This is the way it works - you sell the relinquished property and the proceeds come to the intermediary. Then you find your piece of raw land or ugly duckling - some property that needs a lot of rehab work (could be an existing building or rental home with extensive deferred maintenance) and you sign a purchase agreement on it at the best and lowest price that you can get it.

But rather than having you close on that replacement property (because your exchange would be over once you received it), you instead have the qualified intermediary form an LLC and the intermediary buys the replacement property by and through this LLC. The qualified intermediary then holds title to the replacement property during the 180 day exchange period – exhausting the exchange funds that are held by the intermediary to fund the improvements.

Further, the improvements can be funded by either third party financing or additional cash advanced by the taxpayer. The idea is that you use all this time during the 180 day period to construct and remodel and fabricate real property improvements that count towards the 1031 exchange so that when the taxpayer receives this newly constructed replacement property, ideally they’re receiving a property of at least equal or greater value and equity as the property they gave up.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

3 Quick Tips for Identifying Property in a 1031 Exchange

One of the most stressful parts of doing a 1031 exchange is knowing that you have this looming deadline that you have to designate in writing your replacement property within 45 days after the sale of your old relinquished property.

Be Mindful of Time

Knowing that, many smart and prudent investors will use all of their time leading up to the sale of the relinquished property to hone in and target the replacement properties. Sometimes they’ll even sign purchase agreements or option agreements locking up that replacement property before they’ve sold their old relinquished property. The idea is that they don’t want to be sweating that 45 day identification period.

Other investors are a little bit more cavalier and freewheeling. They may go right up until the eleventh hour on day 44 to figure out what they're going to identify. Sometimes taxpayers will list the three best candidates under the three property rule and pray that they can close on one of those three properties during the remainder of their hundred and thirty-five days in the exchange period.

3 Rules for Identifying Replacement Property

The trick with identifying is knowing that there are three different alternate rules for identifying replacement property.

1. The first rule is the three property rule that we talked about. It’s very simple. You identify three or fewer properties, doesn't matter how expensive they are.

2. An alternative rule is called the 200% rule. Under that rule you can identify any number of properties so long as the total aggregate value of all of those identified properties does not exceed 200% of the gross sales price of your relinquished property.

3. Finally, the last identification rule is called the 95% rule. It is very rarely used because it says you can identify a number of properties - more than three, more than 200% of your old property - but you actually end up receiving 95% of the value of those properties that you identified. So if I list 100 oil and gas wells, I have to purchase that entire portfolio. But if one of those oil wells runs dry and I decide not to purchase it, I still receive 95% of those properties that I identified.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Title Closers – Don’t Forget These Tips for Closing a 1031 Exchange

Title closers deal with settlement statements day in and day out, but there are additional precautions required when the closing involves a 1031 exchange. There are three essential items that title closers need to be cognizant of so the 1031 exchange goes off without a hitch – taxes, security deposits, and rent prorations. In this article, we’ll discuss how title closers should handle each of these items on the settlement statement to avoid any issues with a 1031 exchange. Our primary goal when the seller of a property is doing a 1031 exchange, is to roll all of the net-sales proceeds over into the 1031 escrow account so that they can be re-invested into like-kind replacement property. Not all transactional costs and fees should be paid for from the sale proceeds on the closing statement.

Taxes

The seller of the relinquished property needs to pay the real estate taxes owed for the time period that they owned the property during the year. When there’s no 1031 exchange involved, the seller typically pays these taxes out of their sale proceeds on the closing statement. But when the seller is conducting a 1031 exchange, we need to keep these payments separate from the sales proceeds. In an ideal world, the seller would pay their prorated real estate taxes in out-of-pocket cash at the closing. This can avoid a big headache later on in the exchange.

Security Deposits

If the closing involves a property that has been or is currently being rented out to tenants, we also have to be careful about security deposits. The seller of the property should be holding all security deposits for their tenants in a bank account separate from their operating account. If that’s the case, then the seller can simply take the money out of that separate account and pay the security deposits over to the buyer at the time of closing. However, if the seller has been keeping these deposits in their general operating account and the seller is feeling cash-poor, things get more complicated. If this is the case, it’s time to talk to a 1031 professional to determine the best way to proceed so you don’t jeopardize the exchange.  Ideally, the seller will come up with the money to transfer the security deposits over to the buyer out-of-pocket rather than dipping into the sales proceeds (which could diminish the value of the 1031 exchange).

Rent Prorations

At closing, the seller should also pay the buyer the portion of the rents they have collected for the month. Since the seller has likely already collected the rents for the month and deposited them into their operating account, it’s best to have the seller wire this money out of their operating account and pay it out of pocket at closing to the buyer.  This is the preferred way to handle rents, as opposed to dipping into the sales proceeds (which could diminish the value of the 1031 exchange).

The Big Picture

The big picture when closing a 1031 property is that you want to move all of the equity (the net proceeds) over to the qualified intermediary. If you’re ever in doubt, it’s always best practice to have the seller pay closing expenses out of pocket at closing.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved