Is Big Brother Watching your 1031 Exchange?

One of our clients recently asked the following question: "Can the Minnesota Department of Revenue force your Qualified Intermediary provide them with your private information relating to your 1031 exchange?" This is a common question among taxpayers who are considering a 1031 exchange. Read on to find out whether big brother is watching your 1031 exchange.

Minnesota Statute 289A

In the last few years, Minn. Stat. 289A.12 was amended to include a new subsection #16, which states:

Minn. Stat. 289A.12 Subd. 16. Qualified intermediaries. The commissioner may by notice and demand require a qualified intermediary to file a return relating to transactions for which the intermediary acted to facilitate exchanges under section 1031 of the Internal Revenue Code. The return must include the name, address, and state or federal tax identification number or Social Security number of each of the parties to the exchange, information relating to the property subject to the exchange, and any other information required by the commissioner.

This means that the Minnesota Department of Revenue can require your Qualified Intermediary to provide them with all of the key details of your 1031 exchange and any other information that they want. In other words, big brother is watching your 1031 exchange.

• Start Your 1031 Exchange: If you have questions about your private information involved in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

How Many Replacement Properties can you 1031 Exchange Into?

There are many rules that regulate 1031 exchanges. In this article, we will talk about how many replacement properties you can designate in a 1031 exchange.

Good News, Bad News

The good news is you can in theory purchase any number of replacement properties to complete your 1031 exchange.

The bad news is that there are restrictions on how many replacement properties you can designate or identify in writing during the first 45 day identification period.

Key Restrictions

The key restrictions that are imposed on the number of properties which may be identified as potential replacement properties are listed below. More than one potential replacement property can be identified as long as you satisfy one of these alternative rules:

• The Three-Property Rule - Up to three properties regardless of their market values. All identified properties are not required to be purchased to satisfy the exchange, only the amount needed to satisfy the value requirement.

• The 200% Rule - Any number of properties as long as the aggregate fair market value of all replacement properties does not exceed 200% of the aggregate Fair Market Value (FMV) of all of the relinquished properties as of the initial transfer date. All identified properties are not required to be purchased to satisfy the exchange, only the amount needed to satisfy the value requirement.

• The 95% Exception - Any number of replacement properties if the fair market value of the properties actually received by the end of the exchange period is at least 95% of the aggregate FMV of all the potential replacement properties identified. In other words, 95% (or all) of the properties identified must be purchased or the entire exchange is invalid.

You can read the exact text of the applicable Treasury Regulations in our 1031 Identification Primer.

• Start Your Exchange: If you have questions about how many replacement properties you can exchange into, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Replacement Property Closing Costs

One of the key concepts when you are completing a 1031 exchange and closing on your new replacement property is to re-invest all of your 1031 exchange funds into your new like-kind replacement property, rather than to pay for non-qualifying transactional expenses.

For example in a real estate exchange, if you use your 1031 funds to pay for a car (which is not like-kind to real estate), then the money applied for the car would trigger the recognition of gain.

Qualifying Transactional Expenses

Taxpayers are allowed to pay for some ‘qualifying’ transactional expenses such as real estate agents commissions, attorney’s fees (related to the 1031 and real estate), recording costs, qualified intermediary fees and customary transactional expenses that would normally appear on closing statement in the area where the property is located.

Non-Qualifying Transactional Expenses

As a pointer for 1031 purposes, when a taxpayer is purchasing their new Replacement Property, the taxpayer/buyer should not use 1031 proceeds to pay for non-qualifying transactional expenses. Instead, he or she should give the seller a separate check (from non-1031 funds) for those costs.

Some of the most common non-qualifying transactional expenses are:

• Costs of assuming or putting on new debt, mortgages or deeds of trust (the IRS looks at the debt like it is a separate non-qualifying asset);

• Charges for rent proration (this is typically an operational expense that should be paid with non-1031 funds);

• Charges for property tax proration (this is typically an operational expense that should be paid with non-1031 funds);

• Large amounts of personal property, such as movable items of equipment and furniture (this is not like-kind property)

The key idea is to apply the full amount of the taxpayer/buyer’s 1031 proceeds to pay the purchase price for the like-kind real estate.

• Start Your 1031 Exchange: If you have questions about replacement property closing costs 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

State of Mind Matters & the 1031 Holding Period

This article is all about the 1031 holding period, which is not really a period but more a state of mind. When you acquire a property in a 1031 exchange, you need to have the proper intention, specifically to hold the property for either investment or for use in a trade or business.

How Long Do I Have To Hold the Property?

Many people ask the following question:

"After, I have completed a 1031 exchange, how long do I have to hold the property?"

The answer depends. If you buy the property and immediately list it for sale and try to unload the property, then it seems apparent to me that you weren’t holding the property for investment because you have immediately listed it for sale. This is more indicative of holding the property primarily for resale. Remember that property that you hold primarily for resale is viewed by the IRS as your inventory (your stock in trade). They don’t allow 1031 exchanges on your inventory. So, if you immediately unload the property, it is not necessarily that you violated a holding period, it is that you violated the intention, the (mental) holding requirement.

What are your Intentions?

As a result, it is essential to consider your intentions when you acquire a property during your 1031 exchange. Here's another hypothetical situation:

• You purchase a property, and after you acquire it, someone comes forward with an unsolicited offer.

• You did not have the property listed for sale - this person just came out of the woodwork and offered you a great deal of money - more than what you paid for it.

In this circumstances, it seems to me that even though you ‘held’ the property for just a short time, you had the proper intention when you acquired it. It doesn’t matter that you disposed of the property shortly after acquiring it. What does matter is that you had the proper intention.

1031 Tip: If you receive an un-solicited offer to purchase your 1031 replacement property, you could write a letter to the purchaser saying the following: “Thank you for your offer. When I acquired the property, I intended to hold it for investment purposes, but your unsolicited offer is persuasive, and maybe we can meet a mutually beneficial result. Maybe I will be persuaded it sell it to you.”

• Start Your 1031 Exchange: If you have questions about going into a 1031 exchange with the proper intentions, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Front Leg Reverse 1031 Exchange Options - Switching It Up

Sometimes in a 1031 exchange, it is not advantageous to park your new replacement property. Here are a few potential reasons.

How Do We Structure the Deal So You Can Get Into the New Property as Soon as Possible?

To get you into your new property as soon as possible, we structure the transaction as a front leg reverse exchange (this is also sometimes called an exchange first reverse exchange). That means, we have the exchange accommodation titleholder (the LLC) take title to your old relinquished property. That gets the property out of your name and frees you up. Now you are no longer tied to that (old) property and this allows you to immediately acquire the new replacement property.

After that, you still need to find a (real) buyer for the old relinquished property. The 1031 intermediary holding title through this LLC can only hold on to the property for 180 days (per Rev. Proc. 2000-37).

Rush to Sell Your old 1031 Exchange Property within 180 Days

You will need to market the relinquished property and hopefully a third party purchaser will acquire the property from the intermediary. The Intermediary doesn’t have any money of its own, so it would have borrowed that money from you or from a bank with your guarantee. So, it behooves you to get the intermediary out of title and get the new purchaser in so you or your lender can get paid off and you can be free of the guarantee.

Reverse Exchange Advantages

In a tight market you can’t wait around. You need to seize opportunities when they arise. A reverse exchange is another tool to get the deal done tax deferred. It allows you to purchase a property by having your exchange accommodation titleholder acquire either the new property or alternatively, take title to your old relinquished property, thus freeing you up to immediately acquire this new replacement property. Reverse exchanges are excellent and powerful tools, but they are sophisticated creatures. You need to have your CPA, your tax attorney and all your other advisors on board to get these deals done correctly.

• Start Your Exchange: If you have questions about reverse exchange options, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved