Can you do a 1031 Exchange on a Recently Renovated Property?

If I have a property that I fixed up a year ago, am I able to do a 1031 exchange on it now? The real question is when you fixed up that property was your mental intent to hold it for investment or business purposes, or was your intention to flip it?

Selling While the Market is Hot

Many people that are buying properties or have recently purchased properties initially acquired them with the intention of holding them for long-term rental purposes. But because of the tight inventory and the limited number of properties available for sale they are having an epiphany and saying: “I need to change my mindset and put this property on the market because it has appreciated tremendously even in the short period that I've held it. Why should I hold it for years in order to get a good return when I can get a good return right now.”

While people may have initially acquired it with the intent of holding it for investment or business purposes they're dipping their toes in the market. They're testing the market to see if an exorbitant price can be had, and if they can get it, they're going to exchange it even if they have a relatively short holding.

Consult with your Tax Professional

It's important that taxpayers consult with their CPA or Tax Advisor regarding short holding periods. It’s also important that they substantiate and prove up their intent by doing any of the following:

• Showing their accountant their initial correspondence that articulates an intention to hold it for investment or business purposes.

• Showing their accountant the advertisements that they placed showing that they were advertising the property for rental purposes.

So there's a lot of different ways to prove up your intention that you initially acquired it for business or investment purposes, but because the market changed drastically and values jumped quickly, you instead decided to sell it after a relatively short holding period.

• 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 Exchange 101: What is Boot?

There are many terms of art in the 1031 exchange world, and one of the most often used words is boot. If you sell an apartment building and you receive cash, that would be considered boot or non like-kind property that you receive during the exchange. If you want to defer every cent of tax, you want to avoid receiving boot and only receive like-kind replacement property.

What are Some Common Ways that People Receive Boot?

When you sell the relinquished property if the buyer says “hey I don't have enough money to pay for this thing, can I give you an IOU or a promissory note for a portion of the purchase price?” If the taxpayer selling the property takes that IOU or note guess what they’ve just received? Boot. If you want to have a simple 1031 exchange, avoid seller-backed financing.

Another way that you can receive boot is on the purchase of the replacement property.  You need to make sure that all of your equity, all of your net proceeds gets applied for the purchase of your like kind real estate.

On the Replacement Property Side…

There's a couple different ways that you can walk off the dock on the replacement side. One way is to have too large of a mortgage or deed of trust on your replacement property such that you don't end up applying all of your exchange funds for the purchase and you end up getting back surplus or unused exchange funds at the bottom of the settlement statement.

You want zero cash due to the buyer. You want all of your funds to be applied towards the purchase price which might mean that you have to ratchet back your lender and make sure they only loan you the amount you need to make up the purchase price.

Another way that you could end up inadvertently receiving boot on the replacement property is if you receive non like kind property as part of the purchase of the replacement property.  For example, if you buy a fully furnished condominium with a brand-new granite table and that table is a movable item of personal property or chattel you want to make sure that you pay for the furnishings with non 1031 funds not the use of your exchange for me because that money that you applied towards the purchase of the furniture could result in you end up receiving boot with your exchange funds not like-kind real estate.

• 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 Qualified Intermediary Wears Many Hats in a 1031 Exchange

A qualified intermediary has many tasks and responsibilities in a 1031 exchange, but many taxpayers don’t know exactly what a QI does. This article examines the many functions of the qualified intermediary in a 1031 exchange of real estate.

Constructive Receipt Insulation

In any 1031 exchange, the exchangor needs to move all of their net proceeds from the sale of the relinquished property into the new replacement property. If they receive any of those proceeds (“constructive receipt”) the exchange will not be fully tax-deferred and they will be required to pay taxes on those funds. A qualified intermediary acts as an insulator between the exchangor and their exchange funds. The QI holds the exchangor’s net proceeds during the exchange process in a segregated account until such time as they are ready to move the proceeds into the new property. This keeps the funds safe, and also protects the taxpayer from receiving any funds before the exchange is complete.

Simplifying a Complex Process

1031 exchanges are complicated. Qualified intermediaries make the process easy for exchangors by explaining the procedure, answering questions, and facilitating all aspects of the transaction.

Document Preparation

There are many documents involved in a 1031 exchange – the necessary closing documents, written exchange agreement, and more. A qualified intermediary can help draft all these documents for you so you are fully prepared for your closing.

Minnesota Qualified Intermediary Services

At CPEC1031, we offer qualified intermediary services to taxpayers large and small. If you’re considering a 1031 exchange of real property, contact us today to discuss the details surrounding your exchange. Our qualified intermediaries have decades of experience and can answer all of your questions, prepare your 1031 documents, and advise you on the best practices regarding your exchange. 1031 exchanges offer a great method for deferring capital gains taxes. See if your property qualifies today!

• 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

How to Convert Rental Property into Personal Use Property in a 1031 Exchange

When you do a 1031 exchange you need to acquire a replacement property that's like-kind. The definition of like kind in the realm of real estate is very broad. A lot of people that have been holding single-family rental property (a small duplex or fourplex) may be inclined to buy a property as a replacement that eventually could be converted into a personal use property such as a second home. Here are some things to keep in mind when converting rental property into personal use property.

Qualifying Purpose

You need to be very careful that when you receive the replacement property you have the requisite intent to hold it for a qualifying purpose of investment or business use.

Sometimes people will buy a property that is a vacation type property and put it into a rental pool and predominantly they're using the property as a rental property with incremental tenants. Now the taxpayers that have acquired this vacation property may be inclined to use it for personal use. Under a safe harbor that the IRS has you can use it up to 14 days a year or up to 10% of the time the property is actually rented.

IRS Guidelines

The IRS can test each of the two years after you acquire that replacement property to see if your personal use was within those guidelines. By the way if you go and use the property but you're there predominantly to maintain the property (to repair it, paint it, or fix it) then those periods that you're there for business would not count against your 14 days or 10% that you use it for personal use.

• 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

How to Qualify Your Property in a 1031 Exchange

Qualifying your property is an essential first step in the 1031 exchange process. In this article, we are going to explain how to qualify real property for a 1031 real estate exchange.

Qualifying Purpose

Any property used in a 1031 exchange needs to fit the IRS definition for 1031. Specifically, property must be “held for investment or productive use in a trade or business.” That may sound black and white, but there is often a lot of gray area that makes it difficult to determine whether or not a property qualifies. Here are some of the things that the IRS considers when evaluating a property for 1031 treatment:

• The purpose for which the property was initially acquired;

• The purpose for which the property was subsequently held;

• The purpose for which the property was being held at the time of sale;

• The extent of advertising, promotion of other active efforts used in soliciting buyers for the sale of the property;

• The listing of property with brokers;

• The extent to which improvements, if any, were made to the property;

• The frequency, number and continuity of sales;

• The extent and nature of the transaction;

• The ordinary course of business of the taxpayer;

• How long the property has been owned.

Minnesota 1031 Exchange Intermediaries

1031 exchanges require the help of an experienced professional to ensure that everything goes according to plan. The qualified intermediaries at CPEC1031 have decades of experience working with clients across the country on their real estate exchanges. Give us a call today to learn more about the like-kind exchange process and whether your property qualifies. Our primary office is located in downtown Minneapolis but we serve the entire state of Minnesota, as well as the rest of 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