1031 Exchanges & Escrow

It's really sad when we get a call from somebody and they say “I sold my relinquished property two weeks ago and I've just decided to do a 1031 exchange. Can you set me up to do a 1031?”

This call comes in quite frequently, partly because people are ignorant about the requirements of Safe Harbor 1031. They think that they can just keep their money in an escrow account or leave the money with the title company and if they choose to do at 1031 they can set it up after the fact.

Be Prepared

The problem is that in order to do a valid Safe Harbor 1031 you have to have an exchange agreement with a qualified intermediary (or facilitator/accommodator) in place before you dispose of the relinquished property. Furthermore, you have to assign your rights in the purchase agreement with the buyer so that the relinquish property purchase agreement is assigned to the intermediary. The intermediary then directs you to deed that property straight to the buyer.

Notice of Assignment

On top of that you have to give written notice of your assignment to the intermediary to all of the other parties to the purchase agreement (e.g., the buyer of the Relinquished Property). If you don't have all of that in place before the closing occurs on the sale of your relinquished property then you don't have a defensible Safe Harbor 1031. The net result is that closing, when the benefits and burdens of ownership shift to the buyer who has actual or constructive receipt of the money.

Even if you leave your money in an escrow account at the title company, it's still your money. You still have the right to go in and take it out at any time (you have control over the proceeds). The only way to do it under the Safe Harbor regulations is to make sure that you have it set up with a facilitator or intermediary before you go to closing and dispose of that property so that you’re insulated so you don't have actual or constructive receipt of the funds.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can you 1031 Exchange into Stock?

People sometimes ask if they can do a 1031 into stock. Most people are selling real estate and needing to exchange into other like-kind property. Wouldn’t it be great if we could exchange into stock in IBM or Target or another big Fortune 500 company? This article will discuss the issue of 1031 exchanges and stock.

1031 Treasury Regulations

Unfortunately, when the Treasury regulations were written for the tax code relating to Section 1031 Congress excluded stocks, bonds, and other evidences of indebtedness. So paper such as stock, bonds, and notes are all excluded from 1031 treatment. You can’t exchange into it.

Real Estate Investment Trusts (R.E.I.T.)

What you can exchange it into is other real estate. What some people like to do is acquire a piece of real estate that eventually will be contributed to a real estate investment trust.

They’ll hold that piece of property for a year or two and then contribute it in a section 721 contribution so that piece of real estate that they acquired as the replacement property eventually migrates up to the REIT and turns into shares in the REIT itself. So in a strange roundabout way there's a way to piggyback the section 1031 exchange with a 721 contribution to effectively get to a place where you actually acquired at the end of this shares in an interest in a REIT.

There is no mandated bright line rule that I can direct you to for how long you must hold a property before contributing it to a partnership. Both the tax code and the regulations are void of clarity. There are some tax cases on point; however, most of these authorities are older from before partnership interests were excluded from 1031 treatment in IRC section 1031(a)(2)(D) as a result of the Tax Reform Act of 1984, Pub. L. No.98-369, 98 Stat.494.

• Start Your Exchange: If you have questions about stocks or interests in business entities such as corporations or partnerships involving 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can a Principal Residence be 1031 Exchanged?

Can a principal residence be exchanged in order to qualify for Section 1031? We answer that question and more in this article.

Investment or Business Purposes

In a 1031 exchange, the property must have been held for investment or business purposes. Most principal residences are not held for investment or business purposes. They’re held for the antithetical or completely opposite purpose of being your residence. It’s your home and generally speaking you can't do a 1031 on your home. That's usually not a big deal because under IRC section 121 the principal residence exclusion you get to take up to $500,000 of that profit tax return married filing a joint tax return, or $250,000 for single filing.

A Farm Example

But what do you do with a property such as a farm where you got the little farm house situated on 900 acres of tillable ground?

You’ve got one closing for the principal residence on which you take the exclusion under section 121 for the home and then for the rest of the farm (the tillable acreage) it's used for investment or business purposes on that portion of the sale you do a 1031 exchange to get the best result for both situations.

This situation also arises with part-owner occupied duplexes where you can use both section 121 for principal residence exclusion on the home portion and section 1031 on the rental portion.  We once had a 1031 exchange involving a funeral parlor business with the owner’s personal residence on the second floor of the building.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges of principal residences, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

House Flips & 1031 Exchanges

If you are a real estate flipper or rehabber, you are buying and selling properties primarily with the intent of reselling them. And if you're a buyer or a rehabber and you're doing a short term hold, you’re probably doing it in a fashion that is most tax inefficient, which means that you're going to get hammered with the most amount of tax. You're not holding these properties typically for long-term capital gains so you're in the short-term capital gains arena.

Changing your Business Model

Here’s a tax-saving tip -

• Change your business model from flip, flip, flip, to:

• Buy the property, fix it up, and rent it out for a period of time.

That way, instead of being a flipper you're an investor and you’re renting out these properties for a year or more. Now you can say to the IRS that you’re NOT holding these primarily for resale. You’re an investor in these properties and you want to do 1031 exchanges when you ultimately decide to sell that property.

Who can you sell the property to? Well if you have a tenant in the property leasing it, why not give them the springing option at the end of their 12 month lease that says if the tenant complies with all the terms and conditions of the lease they will have the exclusive right to purchase the property for x price.

1031 Exchange Advantages

The advantage for you is that you might have a potential buyer locked in from the outset. Also from a landlord management perspective, if the tenant thinks they have the prospect of buying the property from you, they are more likely to care for and treat the property as if it were their own. They won't be chopping vegetables on the countertop without a cutting board they’ll be careful to take care of those counters. So for many reasons flippers need to think about changing their business model and becoming investors so that they can avail themselves of the tax deferral under 1031 and go from being in the most tax inefficient to perhaps the most tax efficient, deferring those gain indefinitely, perhaps forever.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Safe vs. Non Safe Harbor Exchanges

When the regulations came out for 1031 exchanges, just about everybody gravitated towards the safe harbor exchanges, which allow for a sale to occur to a third party and a purchase to occur within 180 days. The only real curve ball is that under the safe harbor you have to identify in writing your replacement property within 45 days.

Safe Harbor Exchanges

The regulations do not prohibit you from doing a non-safe harbor straight exchange. But in a non-safe harbor exchange it's much more difficult to get the stars into alignment because you don't have the benefit of the deferred exchange timeline. Typically, in a non-safe harbor exchange would have to be a direct swap where you sell your relinquished property to party A and you simultaneously receive your new replacement property from party A (the same party). It’s like the old fashioned horse swap, I'll give you my horse in exchange for you giving me your horse.

Non-Safe Harbor Exchanges

A non-safe harbor exchange does not require you to hire a qualified intermediary but does require that you do a simultaneous swap with the party that you are giving your relinquished property to. For that reason it’s much more difficult to do a non-safe harbor straight exchange and given that the fees and expenses for doing a deferred safe harbor exchange are so minimal most people avail themselves with the protections of the safe harbor even when they are doing a quick or simultaneous exchange because they want the certainty that the safe harbor protections provide.

• Start Your 1031 Exchange: If you have questions about safe vs. non safe harbor exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved