Can You Be Reimbursed for 1031 Expenses Paid from the Qualified Intermediary?

Can you be reimbursed for expenses paid during your 1031 exchange from the qualified intermediary? That’s a very common question that many taxpayers have when conducting 1031 exchanges of real estate.

Transactional Expenses

Let’s say that during the 1031 exchange process, you had expenses for surveys, appraisals, or other items that you paid for out of your own pocket. Is it possible to get reimbursed for these expenses from the qualified intermediary?

The gain that a person recognizes on a 1031 exchange would be equal to the gained deferral or the boot received (the lesser of the two). If an individual is putting money into their exchange and taking money out of that exchange, you can net those funds for certain transactional expenses.

Here’s how a lot of taxpayers approach this. They have a duplex they want to sell and they spend $12,000 touching up the duplex and getting it ready for sale. When the duplex sells, they want to reimburse themselves for the $12,000 that they had paid in repairs to get it ready for sale. That's where people can get a bit greedy when they want to reimburse themselves for all these expenses.

The Better Play

The better play is to only pay transactional costs that are customarily seen in that locality. If you have an attorney's bill, and accountant’s bill, a real estate agent’s bill, recording fees, etc. – those are the kind of expenses that would be permissible to pay out of the 1031 exchange proceeds.

It is a good idea to involve your attorney and accountant as early in this process as possible. As you can see there are a lot of potential landmines you can step on during a 1031 exchange. Involving your team of professionals as early as possible is the best way to ensure the success of 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Why to Consider 1031 Exchanges in Your Estate Planning

When you inherit a piece of property upon the death of a grantor, you receive that property with a step-up in basis. You can receive that inherited property and instead of having the decedent's low basis during their lifetime the basis gets stepped-up to the fair market value at the time of their death, generally speaking.

So rather than sell the property and unnecessarily trigger the recognition of gains in your latter years, many taxpayers who own property instead consider taking their gains with them to the grave. You have to stop breathing for this plan to work, but when you do, then your kids can inherit the real estate with the stepped-up basis.

When Descendants Don’t Want to Inherit Property

One thing I've noticed in my many years helping taxpayers with 1031 exchanges is that for a lot of people who have made money in real estate, their children don’t necessarily wish to inherit and deal with their property. These descendants are often in high-performing professions such as doctors, or lawyers, and they're busy with their careers and have no interest in their parent’s real estate holdings.

Consider a 1031 Exchange

In some cases they just don't have any interest in real estate because they watched their parents toil and labor and suffer with the demands of owning a piece of real estate and they don’t have any interest in repeating that story themselves. These are just some of the challenges with estate planning and thinking about the next generation because the kids may not have the aptitude or the desire to take on that responsibility of the inherited property. If this is the case, a good alternative option would be to 1031 exchange out of the management intensive property and into something less management intensive.

• 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

What Exactly is a 1031 Exchange?

Section 1031 is a provision in the tax code that allows you to defer your recognition of gain of taxes when you're selling investment or business property, typically through a qualified intermediary.

What Property Does & Does Not Qualify for 1031 Exchange

A litmus test to see if you qualify for 1031 treatment is that both the property being disposed of and the property being received has to be real estate that's held for investment or business purposes or for use in your trade.

Things that don't qualify for 1031 exchange include flipped properties or personal use properties like your home, your cabin, or a second home that's used primarily for personal use. Those types of property don’t fit into the paradigm of 1031 exchange.

Another interesting facet of a 1031 exchange is that it is an exchange. That means the same taxpayer that sold the relinquished property has to be the taxpayer that receives and completes the circuit by acquiring the replacement property. It's an exchange of asset A for asset B.

1031 Exchange Obstacles

Mechanically, there are some potential barriers or obstacles to doing a 1031 exchange that are written into the regulations. One such obstacle is that you have to identify the replacement property within 45 days after the date of the closing of your relinquished property and you have to receive the replacement property within 180 days of the disposition of the relinquished property. These two timelines run together after the date of closing of the relinquished property.

In a hot real estate market it is hard to find replacement property and that 45 days goes quick. When we talk about estate planning we need to be thinking like a chess player (two moves ahead), meaning you need to be able to identify your replacement property, designate it within 45 days, and receive it within 180 days.

• 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 Creative Alternative for Failing Reverse 1031 Exchanges

Reverse 1031 exchanges are a great option for taxpayers who wish to acquire replacement property before selling their relinquished property. But what happens if, for whatever reason, your reverse exchange is in jeopardy? In this article, we are going to offer up a creative alternative option for a failing reverse 1031 exchange.

A Creative Alternative

A creative option for a failing reverse exchange can be found in IRS Private Letter Ruling 200712103.

Assume that you are parking your new replacement property with the Exchange Accommodation Title Holder. In the event that an actual third-party purchaser can’t be found to purchase your relinquished property (the old property) within the 180 days, it may be possible to “manufacture” a “White Knight” buyer that is dissimilar to the taxpayer doing the 1031 exchange. In this arrangement, you could have a “white knight” purchase the old relinquished property from you to get it off your books within the 180 day reverse exchange period. The white knight will then act as temporary owner of the relinquished property until such time that the property is later sold to a third-party purchaser.

To be treated as the owner for tax purposes, the White Knight will need to have sufficient incidents of ownership of the relinquished property, so it will be conveyed the property by deed or contract for deed. In PLR 200712103, the Internal Revenue Service ruled that a taxpayer doing a safe-harbor reverse exchange (under Rev. Proc. 2000-37) could sell its relinquished property to a "related party" (but dissimilar taxpayer) and that this related party could also subsequently market and sell the relinquished property without having to hold the property for two (2) years. 

A Note on Private Letter Rulings

Private letter rulings are a written statements issued to specific taxpayers that interprets and applies tax laws to those taxpayer’s represented sets of facts. A PLR is issued in response to written requests submitted by taxpayers. A PLR may not be relied on as precedent by other taxpayers or by IRS personnel, but may give insights into how other taxpayers are dealing with similar situations.

• 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

Recent Trends in the Commercial Real Estate Economy

The commercial real estate economy can shift quickly and it can be difficult to stay on top of recent trends. In this article, we are going to discuss some trends that we see in the real estate economy as they relate to 1031 exchanges.

Property Management Fatigue

I have a lot of clients that have highly appreciated duplexes and single-family rental properties, and the owners are getting tired of managing these properties.

They don’t want to deal with tenants, trash, toilets, and collecting rent. As a result, they’re wanting to sell their properties and transition into other investments (whether it's triple-net-lease, single-tenant, or some other type) and try their hand at some other aspect of commercial real estate.

Regulation & Rent Control

We're also seeing some fear in the Minneapolis-St. Paul metro area that rent control and more regulation of landlords will make the business of renting even more difficult.

The landlords in Minneapolis and Saint Paul have dealt with increased property taxes and regulatory restrictions for quite a while and now many of them are done staying in that space. These investors are looking at this as a great opportunity to sell at the top of the market and reposition into other segments that are less management-intensive, such as medical office

We’ve seen an increase in marketplace velocity in 2021 and it’s mostly small investors driving this increase. It’s mom and pop stores and landlords who own small single-family rental duplexes, four-plexes, farmers, or other business owners that are taking advantage of this high-value, low interest environment to transition into other real estate Investments.

• 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