Who Should Sign the Purchase Agreement for the Replacement Property?

Taxpayers doing a 1031 exchange, especially a reverse exchange, often ask “who should sign the purchase agreement for the replacement property?” That’s our topic for this 1031 education article.

1031 Purchase Agreement

The easiest way to tackle this issue is to have the name of the taxpayer that owned the old relinquished property enter into the new replacement property purchase agreement.

That way when we need to switch the name of the purchaser right before the closing of the replacement property to an exchange accommodation title holder, which is typically an LLC owned directly by the qualified intermediary, we have the right under the purchase agreement to assign the purchase agreement to that actual purchaser.

Modifications & Amendments

However, all of that time before closing it will be the taxpayer who is on the purchase agreement, so if there needs to be a modification to the purchase agreement or some amendment needs to be made, the taxpayer that originally signed the purchase agreement is in the driver's seat to make modifications and to make negotiations that change the purchase agreement right up until the moment before closing.

• Start Your 1031 Exchange: If you have questions about the 1031 purchase agreement, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

What is a Related Party When it Comes to a 1031 Exchange?

The IRS is paranoid of related party transactions and they're more so concerned about your buying your 1031 replacement property from a related party. So what is a related party in a 1031 exchange?

Blood Relatives

A related party can be related to you by their business affiliation or blood relationship. So your mother, your father, your sister, your brother - these are all people that are related to you by blood. Under the statutes, if you are acquiring the property from them you need to disclose that on form 8824 and there are complications that stem from your acquisition of the property from a related person.

First you have to hold the property for 2 years and there cannot be an intent to avoid the imposition of the tax which really means it can't be part of a scheme to avoid taxes.

Business Affiliates

Now the other way a person could be related to you is by business affiliation. So you could be buying your replacement property from a partnership that you are the majority partner in or a corporation that you're the majority shareholder in.

There are other situations in which the seller would be considered to be a related party. Here is a listing of what the IRS considers “related parties”:

• Members of a family, including only brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.);

• An individual and a corporation when the individual owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• Two corporations that are members of the same controlled group as defined in §1563(a), except that "more than 50%" is substituted for "at least 80%" in that definition;

• A trust fiduciary and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• A grantor and fiduciary, and the fiduciary and beneficiary, of any trust;

• Fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts;

• A tax-exempt educational or charitable organization and a person who, directly or indirectly, controls such an organization, or a member of that person's family;

• A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest, or profits interest, in the partnership;

• Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation;

• Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation; or

• An executor of an estate and a beneficiary of such estate, except in the case of a sale or exchange in satisfaction of a pecuniary bequest.

• Two partnerships if the same persons own directly, or indirectly, more than 50% of the capital interests or profits in both partnerships, or

• A person and a partnership when the person owns, directly or indirectly, more than 50% of the capital interest or profits interest in the partnership.

Start Your 1031 Exchange: If you have questions about related parties 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

Piggybacking the 121 Exclusion with a 1031 Exchange

Let's say that you do a 1031 exchange - you sell an investment or business property and you buy a property that is a single family rental and you rent that property out for a number of years to substantiate the property for investment or business purposes to qualify it for 1031.

Well after you’ve held the property for a substantial period of time it may occur to you that you could see yourself living in it as your principal residence.

So sometimes folks will kick the tenants out of that investment or business property and move into it as their principal residence. Timing and intention are important factors to consider in this scenario.

Timing & Intention

First you probably want to wait a year or two before you kick the tenants out so that you satisfy the requirements of 1031 that you were actually holding the property for investment or business purposes.

Section 121 Exclusion

Then after you kick the tenant out you can move into the property and make it your personal residence. Now there's an interesting interplay between section 121 of the Internal Revenue Code and section 1031 that says you must wait 5 years after completing the exchange before you can avail yourself of the section 121 principal residence exclusion on the sale of your principal residence.

Furthermore you don't get the entire exclusion, you get a fraction of it based on the qualifying used as your personal residence as a ratio against the time that it was used for rental purposes.

So theoretically if you rented the property for 2 years and you lived in it as your personal residence for 3 years you would be entitled to three fifths of the exclusion. For married couples the exclusion is normally $500,000, but in this situation you would be entitled to three fifths of that or $300,000 which is pretty good exclusion amount.

Depreciation

One consideration is that under section 121 you're not allowed to exclude the depreciation. So to some degree it's a partial victory because you still have to deal with the un-recaptured depreciation that may have carried over into the property and also the depreciation on the current principal residence.

Nevertheless this is an awesome tax planning technique and if you look at the interplay between section 121 and 1031, this is a rather frequently used combo of piggybacking the 1031 exchange with the 121 exclusion and putting them together after 5 years.

• Start Your Exchange : If you have questions about the interplay between section 1031 and the 121 exclusion, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

How to Unwind a 1031 Exchange

Sometimes taxpayers contemplating a 1031 exchange will say “what if we don't identify any replacement properties, or what if we can't jump through the hoops - how do we unwind a 1031 exchange?”

Set Up the Exchange

At the beginning of this process you may not have all of the mysteries solved, but you know that you want to keep your options open and you want to keep them open as long as possible.

So the first thing to do is to set up the 1031 exchange before the sale of your old property so that the proceeds don't go to you and become taxable immediately, but instead go to the qualified intermediary.

Then you have 45 days to identify replacement properties. So you can use all of the time before closing and 45 days thereafter to figure out if this is something you want to do. If it's something you want to do, you’ll identify replacement properties to keep hope alive for the remaining 135 days in your exchange period.

If You Don't Identify

If you don't identify no big deal. We'll return the exchange funds to you on the next business day after the 46th day and get you your exchange funds back and you'll just pay taxes on it as if it was a taxable sale. The most you're out is a little bit of brain damage and the minimal exchange fee that we would have charged at the first closing.

Keep all of your options open as long as possible. Investigate all of these potential outcomes and hopefully you get the most tax-efficient result at the end of this process.

• Start Your Exchange: If you have questions about unwinding 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

When is a 1031 Exchange NOT a Good Idea?

We talk a lot about when and how to successfully execute a 1031 exchange to defer your taxes. However, 1031 exchanges are not a good idea in every situation. Here are some situations in which it is NOT a good idea to do a 1031 exchange.

Personal, Resale & Foreign Property

If you are trying to exchange property that doesn't qualify under 1031 because it was either your personal use property (such as a second home), or property that used primarily for your personal or recreational use, then you can't do a 1031 exchange. Also 1031 does not apply to property that’s held primarily for resale - what we call your inventory or your stock-in-trade. Those types of properties are outside of the strike zone for 1031. Also foreign property is not like kind to us property so it's not a good idea to try to sell foreign property and exchange it into the US.

Investment or Business Property

The primary thing to remember is that 1031 is for property that has been held for investment or for use in your trade or business. If it's not eligible for 1031 because it hasn't been held for a qualified purpose then it's not a good candidate for 1031.

Also bear in mind that the exchange has to be for like-kind property. In the realm of real estate that's very broadly construed to mean just about any other real property in the United States. If you don't intend to acquire like-kind property it's not a good idea to do a 1031 exchange.

• Start Your Exchange: If you have questions about when 1031 is not a good idea, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved