Death & Taxes (Part 2)

Note: This is part 2 of our Death & Taxes blog series. Read part 1 here.

Tax-free Transfers

Section 102 of the internal revenue code says that an heir (beneficiary who inherits property) that receives property as a gift, bequest, devise, or inheritance takes that property tax-free. Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.

Basis of an Heir

The question then becomes, what if your heir sells the property that they received as an inheritance from you? What is the heir’s basis for calculating his or her gain? Will the heir have any tax liability?

At present, Section 1014 of the internal revenue code allows your heirs to take your property through inheritance with a stepped up basis (roughly Fair Market Value (FMV) of the property at the time of your death) so they would not take over your low basis in the property. However, the tax code in this area could change, so you need to talk about this with your CPA or accountant.

Under current Section 1014(a) the general rule applied to property an heir receives from a decedent is that the heir’s basis equals the fair market value of the property at the time the decedent dies. Because of Section 1014, any appreciation of the affected property that occurred (as well as deprecation recapture) during the decedent’s lifetime may never be taxed. The current operation of this code section provides an incentive for taxpayers to defer taxes throughout one’s lifetime until death. One strategy that people refer to with 1031 exchanges is called Defer, Defer, Defer, Die. The idea is that one never recognizes any gains during one’s lifetime, but instead continually defers the recognition of gain (compounding and building wealth tax-free) again and again until they die.

Compounding Returns Tax Deferred Offers One of the Most Powerful Ways to Build Wealth

The importance of compounding and re-investing your gains tax-deferred cannot be stressed enough.  Over time, the more you are able to reinvest without the drag of having to pull-out capital for taxes, means you will have much more capital to put down on bigger and better like-kind investments. Compounding tax-deferred has a tremendous impact on wealth creation, and this is why people like to invest in tax efficient vehicles like 401K plans, Roth IRAs, and whole life insurance products.

If Congress ever acts to change the Step-up Basis under Section 1014, they will probably still allow for a modified form of carry-over basis, so your heirs would likely take over your low basis, and would then need to continue to defer the taxes by utilizing 1031 tax exchanges. The good news (if that ever happens) is that they could also continue the strategy of Deferring, Deferring, Deferring, Dying generation after generation.

• Start Your Exchange: If you have questions about tax-free transfers and 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Sale-Lease Backs & 1031 Exchanges

Many taxpayers own a business and they also own the real estate and building in which they run their business.  Over time, this real estate may appreciate significantly, while the debt on the property is reduced from years of paying down the mortgage.  This can represent a large, concentrated piece of a taxpayer’s net worth. These taxpayers may come to realize that they have too many eggs in one basket, and have too much risk exposure if that one property falls in value.

Diversify & Position Yourself for Retirement

As the taxpayer gets up in years and is looking to retire, they may want to diversify their wealth (and lessen their risk exposure) by selling the real estate, but still have their business continue to stay in the property as a tenant on a long-term fixed lease.  The advantage for the taxpayer is that they can 1031 exchange their hard-earned equity into a more safe and diverse portfolio of like-kind properties in different geographic localities and in different business segments such as:

• Retail

• Multi-family

• Industrial

The advantage for their buyer is that the buyer gets a good property with a steady reliable tenant already in place on a long-term fixed lease that both parties can rely on.

1031 the Real Estate…Then Sell the Business

If the taxpayer is also considering selling their business, the buyer of the business would not have to purchase the real estate, and could get into the business with a lower down payment, because they would not have to qualify for a loan on the real estate. The buyer of the business would also have the certainty of being able to assume the long-term fixed lease and continue to run the business where it has been located.

Cash is King for 1031 Exchanges of Real Estate

Generally if you are selling real estate, you want to receive cash on the barrelhead so you can reinvest ALL of your equity through a 1031 exchange into your new replacement properties. So selling to a strong unrelated cash buyer is often more desirable than trying to sell both the real estate and the business to one buyer, who may already be stretching their finances just to purchase the business.

Getting Top Dollar By Splitting the Sales

In order to get the top price on the sale of a business, it is not uncommon to have seller-back financing with the seller getting their proceeds over a long period of time.  That’s fine of the sale of the business; however, because of the requirements for 1031 exchanges (see Napkin Test), seller-back financing of the real estate is a much less attractive option for a taxpayer looking to defer all of the gains from the real estate. It’s often better to split the sale of the business from the sale of the underlying real estate in order to maximize both the financial returns and tax efficiency for the seller.

• Start Your 1031 Exchange: If you have questions about sale-lease backs and 1031 exchanges in Minneapolis, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Death & Taxes (Part 1)

Many people ask me questions along the lines of: "over the years I have invested a large amount of money into an investment property. How does this affect my taxes if I sell the property or if I die?"

First, I would like to talk about the sale vs. 1031 exchange part of the question, and then I would like to go into the ramifications of dying while owning the property.

Selling ~ The 1031 Question

Section 1031 is a very taxpayer-friendly provision of the internal revenue code. It gives you a way to sell your investment property without having to recognize the gains. This defers your taxes indefinitely…perhaps forever.

There are some rules and regulations that you must follow in order to get this tax deferral. One of the key rules is that your property must have been held for investment or for use in your trade or business. Watch the video below for more information on this: 

Like-Kind Property

The other major requirement is that you have to re-invest your proceeds into like-kind property. If you have watched the video above then you have probably picked up that certain property held for investment can be exchanged for certain other like-kind properties that will be held for investment.

In a delayed exchange using a qualified intermediary, your proceeds from the sale must be invested in a like kind property within 180 days of the sale. Also, your replacement property must be identified within the first 45 days.

Remember, both your relinquished property and your new replacement property must be held either for investment or for productive use in a trade or business.

Start Your 1031 Exchange

Start your 1031 exchange today to defer your capital gains taxes on the sale of real estate. Contact CPEC1031, LLC to start the exchange process. Our intermediaries can walk you through every stage on your way to the closing table and answer any questions you may have along the way.

• Start Your Exchange: If you have questions about the time value of money and Minnesota 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Can I Call My Replacement Property My Personal Residence & Investment?

Sometimes people want to do a 1031 Exchange into a property that they plan on immediately occupying as their home. As we've discussed before, they would have to treat the replacement property as either:

• Business property,

• Property used in my trade,

• Or as investment property.

In this example, the exchangor hopes that the personal residence goes up in value. But is this considered an investment?

1031 Tax Court Case on 1031 Property Exchange of Lake Cabin

In a case called Moore vs. The Commissioner of Internal Revenue, a similar question was put before the tax court. A person was trying to do a 1031 Exchange from a second home lake cabin into a bigger, better second home lake cabin. The taxpayer in the case said, you know that this is a scarce commodity, and I anticipate that it will go up in value. I hope it goes up. The taxpayer was trying to make the argument that, even though it was his second home, his lake cabin that he never rented out, never advertised as a business property that it was still held for investment, so that it should qualify for 1031.

Hoping For an Increase In Value on Your Personal Use Property is not an Investment for 1031 Purposes

The tax court did not buy this argument. They said yes, everybody hopes that their primary residences and second homes go up in value. But, we really need to look at how you use the property to decipher what your intention was:

1. Was your intention primarily to use the property for recreational and personal use or,

2. Was your intention to hold it for investment?

These two intentions seem to be diametrically opposite to the IRS’s way of thinking (and their litigation position in the Moore case).

1031 Lesson Learned - Do Not Hold Primarily for Personal Use

Under the facts of the Moore case, the taxpayer was found to primarily hold the property for personal use…and the exchange failed. So, getting back to our question, Can I call my replacement property home/personal residence an investment, especially if I move into it immediately after I have completed my exchange? The answer is probably, no. That would probably not qualify because your use as your home is antithetical, completely opposite to use in one's business, use in one's trade, or holding for investment.

A Better Plan

If you are looking for help with your 1031 exchange of real estate, look no further! CPEC1031, LLC has over two decades of experience facilitating like-kind exchanges under section 1031 of the IRC. Contact us today to learn more about the process and how we can help!

• Start Your Exchange: If you have questions about eventually converting your replacement property into a personal use type property in Minnesota, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Taking Advantage of Downturns in the Real Estate Market

Real estate values go up, and as you may recall from recent the Great Recession, they also go down.  Some commentators are speculating that the current good times will be coming to end, bringing opportunities for investors to buy some bargains.

What is a Downward Market?

A downward market is where real estate values are declining and opportunities are rising - opportunities to buy real estate at a cheap price. Remember, “price” is set by the market which can fluctuate based on emotions, while “value” is established by the cash flow in an economic analysis. So, it is possible to buy a property at a cheap price below its value (based upon the income it produces) and in the marketplace. If you find such an opportunity you want to seize on it immediately. 

Well, you say, I can’t buy it now because if I do a 1031 exchange, the typical structure is that I sell and close on my old relinquished property FIRST, and then SECONDLY, I buy my replacement property. If this great opportunity comes up, how can I take advantage of it and still avail myself of a 1031 exchange? Here's an example: a bank takes back a property, but they don’t want to have it on their books. They have to reserve for it, they have to pay for expenses related to the property; they just want to get rid of it. So they’ll sell it at a deep discount - a discount below its actual value just to get it off their books. If you want to acquire that property, you have to move fast before another investor moves in and takes it away from you.  A strong cash offer will ensure you are the successful bidder.

CPEC1031, LLC

If you’re looking for help with your next 1031 exchange, contact CPEC1031, LLC today. Our team of qualified intermediaries can help you through all aspects of your 1031 exchange. You can reach us at our primary office located in downtown Minneapolis.

• Start Your Exchange: If you have questions about taking advantage of downturns in the Minnesota real estate market, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved