Video - 1031 Exchanges Involving Contracts for Deed & Seller-Backed Financing

If you sell your property under a contract for deed with a percentage down and the balance paid in a balloon in five years, can you do a 1031 exchange?

First of all, a disclaimer: every contract is written differently. In general, when you enter into a contract for deed you’re effectively conveying equitable title to the buyer. You’re giving them possession of the property. Typically, the vendee on a contract has to pay the property taxes, insurance, and more. They’re the owner for tax purposes. Think about who takes the depreciation deductions on the property that was purchased on a contract for deed. The vendee does (generally speaking) because they have the rights to utilize the property.

When you’re a vendor on a contract for deed you’re selling the property with an installment sale. You’re retaining the bare legal title as an enforcement mechanism to compel the vendee to make their required payments. You’re retaining the bare legal title, but you’ve effectively given the vendee equitable title for tax purposes.

So you’ve basically sold the farm when you entered into the contract for deed. Five years from now when you get paid off on the balloon payment you probably cannot do a 1031 exchange when you’re giving the legal title to the buyer.

How do you work around the fact that you’ve conveyed equitable title in this situation? The first option is to not do seller-backed financing because it complicates 1031 exchanges. That’s not a satisfying answer for many, particularly when interest rates are rising.

Here’s another option: let’s say you’re selling a duplex for $500,000, the buyer is giving you $100,000 down at closing and you’re financing $400,000 for five years. One way to fix this problem is to have the vendee bring their $100,000 in and have the vendor bring in $400,000 out of their own pocket. If you bring in your own cash to loan to the buyer, that means amount of funds in the exchange account will be the same as you’d normally get if there wasn’t seller-backed financing. Having the exchangor finance the buyer out of pocket is a great way to fix the problem, but it requires some liquidity.

In the Uptown area there’s a real estate broker that acts as a sort of problem solver for sellers. If you want a clean break from your property – you don’t want to do seller-backed financing and you don’t want to bring capital to the deal, this broker interposes himself and agrees to buy the property with cash and then sells it to the vendee on a contract for deed. This might be another option.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - Consolidating Ownership During a Trust Distribution

There are two favorable private letter rulings that deal with consolidating ownership. Let’s say a trust distributes one fifth interest in a farm to you and your other four siblings. You could tell your siblings that you’d like to retain the south quarter of the land. You could say that you’re willing to trade your interest in the remainder of the land to the siblings if the siblings give you their interest in the south quarter of the land so that you own that particular spot in its entirety.

Post-distribution from a trust, there’s an opportunity to consolidate a portion of the property in question, solely in your name by doing simultaneous related party transfers. The IRS and treasury seem to think those are OK because you’re trying to consolidate a parcel wholly in your name. In this situation there’s really no intention to trick the system because the other parties that are going to receive your fractional interest in the other parcels if they sell, they’re going to be paying the same taxes that you would’ve paid.

• 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.

© 2024 Copyright Jeffrey R. Peterson All Rights Reserved

Video - The 2 Litmus Tests of a 1031 Exchange

When it comes to 1031 exchanges, there are really two essential litmus tests. The properties involved in the exchange need to be held for investment or business purposes, and you have to exchange for like-kind property.

The two areas we often see properties not qualifying for 1031 exchange. If you own a lake cabin you may have a property that’s used for your own personal edification. That property isn’t an investment or business property. Even though you may want it to go up in value, your personal use of the property trumps the purported investment intent. There have been many cases in which people have fought with the IRS about their appreciated personal property. The IRS has been making a point of winning those cases.

In the area of VRBO and AirBnB properties, the IRS has granted a pretty broad safe harbor for properties used primarily for rental programs. In that safe harbor, the IRS will look at the first two 12-month periods after you buy the property to decide if you have used the property primarily for investment or business purposes. So they’re going to test those periods to see that a) you’ve rented it at least 14 days a year, and b) you haven’t used it more than 14 days a year or more than 10% of the time the property has been rented out. So on your use side you could use it for 14 days. Or let’s say the property was rented out for 300 days. You could use It for 29 days personally because that would be under the 10% threshold.

It’s always a good idea to be very safe with these types of properties. Keep the property rented out as much as possible for the first two years.

The other property that doesn’t qualify for 1031 is property that’s been held primarily for resale. If you buy an apartment building and you convert it to condos and you sell each of those individual units to the public, then you’re a dealer. That real estate is your product, your stock in trade. You can’t do a 1031 exchange on your dealer property – property that you intend to hold for resale. The same goes for land developers.

In order to get around this, you can change the way you do business. Rather than buy a property and do a quick flip, you could instead buy the property and rent it out for a year or more. After that time, then you can do the improvements and sell the property in a 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - The Predecessor to Section 1031

When Congress enacted the first predecessor to the 1031 exchange, they allowed for the exchange of property tax deferred. It was a law that came about after World War I, in which the United States had just spent a lot of money fighting a war in Europe and they had increased taxes during the war to fund the war effort. When the war was over, they needed to find a way to stimulate the economy to dig themselves out of the debt they had incurred. The first iteration of 1031 allowed the swapping of properties to occur. That provision didn’t just relate to real estate at the time. That provision allowed for the exchange of properties but it was anticipated to be a simultaneous swap. So in 1921 people were doing old fashioned horse swaps with actual horses as the property in question.

This provision was really intended to promote transfers. The government didn’t want people to be locked in. They wanted capital to flow to the most advantageous investment, thus stimulating the economy and creating jobs.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

Video - 1031 Exchange Deadlines & Extensions

I get a lot of calls from accountants who say: “I didn’t know my client was doing a 1031 exchange and I filed their tax return on time before the closing of the replacement property, effectively shutting down their exchange early. They want to know if they can amend the tax return to include the replacement property.”

If you’re an accountant or a CPA, make it part of your process to ask the client if they’re in the midst of an exchange. At CPEC1031, we send out a written letter to the taxpayer that gives them their estimated 45 day deadline and 180 day deadline. If those deadlines fall after their tax filing deadline, we encourage taxpayers to consult with their tax preparers.

Some people wonder whether or not there could be an extension of the 1031 exchange deadlines if the exchange ends on a weekend or a federal holiday. The practice in the 1031 exchange industry is to not anticipate that there will be any extensions. That’s the general rule. However, there is a small minority of thinkers who argue that there is an extension permitted under the code. In the initial proposed regulations for 1031, they specifically said that these extensions do not apply. They then pulled that out because they thought it was unnecessary. So there is a small minority of people who think you can extend your identification period to day 46 if it lands on a holiday or a weekend. Until we see a case litigating this matter that gives us a more definitive answer to this question, I would err on the side of caution and assume you cannot extend your 1031 exchange deadlines.

The only exception to that is if you’re in a federally declared disaster area. If you’re impacted directly by a hurricane, forest fire, earthquake, or some other federally declared disaster, then you may have some provisions that allow you to complete your exchange at a later date.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved