Can you Use the 1031 Exchange Proceeds to Pay Down Your Mortgage?

A 1031 exchange is just that – an exchange. The IRS wants to see you give up a relinquished property and receive a new replacement property that you don’t already have. Paying down debt on a property that you already own is not seen by the IRS as receiving something new – it’s not an exchange. So that’s not going to work for a 1031 exchange. You need to receive something new and different. Similarly, you want to avoid doing a cash out refinancing before your exchange.

Cash Out Refinancing?

If you run over to the bank in anticipation of your sale and draw out your equity by refinancing the relinquished property, that’s going to look a little suspicious and perhaps trigger some adverse tax consequences.

I generally avoid any refinances in anticipation of an exchange because I don’t want the IRS to come in and say that the refinancing was really the same as if you’d taken the cash at closing.

So generally, I think it’s a bad idea to refinance your relinquished property especially if you have a tacit agreement to sell it or you’re refinancing in anticipation of an upcoming sale.

A Nifty Strategy

Here’s a nifty strategy – reinvest all of your net proceeds from the sale of your relinquished property into new qualifying replacement property. Then later in a subsequent transaction, refinance that replacement property to pull some equity out and use that equity to pay off mortgages on land you already own.

If you’re going to do this you want to pick a replacement property that’s easy to refinance. You don’t want to buy raw land that sits idle and costs you money each year. You probably want to buy an income producing replacement property because that’s easier to go to the bank and lever up.

1031 Exchange Company

If you have questions about this or anything else relating to 1031 exchanges, reach out to our qualified intermediaries today! We have over two decades of experience in the 1031 exchange industry and can answer any questions you might have. Contact us today to learn more!

• 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 Simple Tips for Title Closers Conducting 1031 Exchanges

Many title closers have questions about how to set up the closing statement and what transactional expenses are permitted to be shown on the closing statement.

Relinquished Property Equity

First let's talk about the relinquished property that a taxpayer is selling. Remember that all of the equity (all of the net proceeds) needs to be moved into that replacement property so we don't want to clutter up the closing statement with a bunch of transactional expenses that should really be paid out of the seller’s own pocket.

Security Deposits & Taxes

Next, security deposits, taxes, and things that the seller would normally pay out of their own operating account. To the extent that we can pay those out of closing and have the seller come in with their own funds for those transaction expenses, the better we're going to be.

Moving forward to the replacement property again there are certain expenses that should not be paid for out of the 1031 exchange. Unusual expenses for insurance for example, or even cost of the new loans such as loan origination fees, rate lock fees, and underwriting fees that the lender charges. In an ideal world those transaction expenses would be paid for out of closing by the seller or in this case the buyer.

1031 Exchanges

If you have questions about this or anything else relating to 1031 exchanges, reach out to our qualified intermediaries today! We have over two decades of experience in the 1031 exchange industry and can answer any questions you might have. Contact us today at our downtown Minneapolis office to learn more!

• 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

The Housing Hack for Tax-Efficient Real Estate Investing

Lately, many people have been engaging in the “housing hack” in which they buy a duplex with first-time home assistance (so they have a low-down payment and low interest rate) and move into one half of the duplex. They then rent out the other side of the duplex and use the rental income from their tenant to supplement the cost of the mortgage, the property taxes, and insurance.

If you do the housing hack well you can almost live for free without having to deal with the expenses of ownership because the tenancy leasehold is covering a lot of your overhead for the mortgage taxes and insurance.

Cost-Effective & Tax-Efficient

You still have a lot of ownership responsibilities of course. There are always things that break on a house, as well as routine maintenance and unexpected repairs, but in general this is a very cost-effective and tax-efficient way to get into the real estate market.

Young people are buying these smaller rental properties and driving a lot of mom and pop owners to sell and subsequently exchange into a different type of real estate that’s less management intensive.

It's a great time to be a seller right now. There is very little inventory, lots of demand, and cost of financing is incredibly cheap. These factors are driving demand higher, which makes it a very difficult time to be a buyer. That's where people are having trouble with their 1031 exchanges currently as they’re getting outbid or unable to lock down a replacement property fast enough. This is why it’s always important to remember the 1031 exchange time period that you have to abide by in order to complete a successful 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

Estate Planning Considerations with Community Property States

In the realm of estate planning, many taxpayers don't really have their estate plan in place before they've sold their relinquished property. In the course of doing the organizational work, they may ask “can John Doe sell his relinquished property and have John Doe as Trustee of his own grantor revocable trust receive the replacement property?”

Generally, a revocable grantor trust is going to be running under the same social security number as John Doe in this hypothetical and it's going to be considered a continuation of investment by John Doe.

The same goes for a single-member disregarded entity such as a pass-through LLC that is wholly owned by John Doe. That would be another suitable way to acquire the replacement property.

Community Property States

Many of our clients have amassed wealth in real estate over a long period of time and now they're in their golden years and they may have moved to a community property state such as California, Texas, or Wisconsin. Does a taxpayer’s step-up in basis change if they’ve relocated to a community property state?

The short answer is yes. How assets transfer in terms of your estate plan are impacted by the local law and also by the federal and state taxation scheme.

So stepped-up basis is something that is a local concern as well as a federal concern. If you change your residence you need to make sure that you consult with local council to confirm that your current estate plan is valid.

Minnesota Property Considerations

In some states (like Minnesota) a lot of residents attempt to modify their residence for purposes of taxes by becoming snowbirds and permanently residing in Florida (for example) but continuing to own Minnesota real estate in pass-through entities. The current Minnesota estate tax treats any real estate owned that is located in Minnesota as a Minnesota taxable asset. So even though you are a Florida resident, if you own an apartment building or other type of real estate in Minnesota either in your individual name or in a pass-through entity, you will potentially be subject to a Minnesota estate tax.

• 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 Long Can You Wait to Identify Your 1031 Exchange Property?

In a 1031 exchange, is it possible to sell your relinquished property first and then identify your new replacement property? The short answer is yes. You can fly by the seat of your pants and wait until day 44 in your identification period to really hone in on what you want to identify.

Do Your Homework Early

However, if you do your homework early, even before you sold your relinquished property and started to think about your replacement property options, you will benefit from that homework because it is a very tight market. If you want to go back into traditional brick-and-mortar property, it is a very competitive market and wouldn't it be nice to have a purchase agreement already in place on your replacement asset?

That way when you identify you have the certainty that you're going to be able to acquire it. It can't be sold out from underneath you because you have it under contract.

Many people get locked up with paralysis and they can't decide what to identify. Meanwhile all the other buyers in that Marketplace are gobbling up the available inventory. In places with very competitive real estate marketplaces people are making offers sight unseen at full price.

Think Like a Chess Player

You really need to think ahead like a chess player if you want to be able to navigate these issues. That said, you can wait until the 45th day do identify and designate your official 1031 exchange replacement property. But a pro tip is to plan ahead so that this is a less stressful process.

• 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