Can I 1031 Exchange a Property that was Originally Intended to be a Rental?

A client of ours recently came to us with the following situation. The client had an investment property that was originally intended to be a rental, but after going through renovations they felt like it might make more sense to sell. Could this qualify for a 1031 exchange?

Maintaining the Right Mindset

The simple answer is yes. If you have maintained a mind-set to hold the property for a qualifying purpose of “investment or business purposes,” then you could continue with a 1031 tax deferred exchange.

There is no minimum required period of time that the relinquished property must be owned. For the IRC 1031 to qualify, you must have had the intention (before closing) of holding property for investment or for use in a trade or business.

Tax Treatment of Repairs and Improvements

The client was also concerned about how all the money they put into the property in repairs and improvements would be treated from a tax perspective.

These amounts may be tax-deductible in the year incurred if they are deemed repairs. Conversely, they may be deemed as capital improvements which would increase the client’s basis in the property and are recouped more slowly through depreciation.

It is always a good idea to talk to your accountant about the proper tax treatment for these expenses. Generally, you are not allowed to reimburse yourself for these repair costs with 1031 funds at closing (without adverse tax consequences).

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Determining Gain with Gifted Property

Determining capital gains taxes on property can be especially difficult when the property in question was a gift. In this article we will explain how to determine your gain when you receive a gifted property, and when a 1031 exchange is a good option.

When Your Father Gifts a Property to You

If your father gifts property to you, then you may take a carry-over basis (his basis) in the property received by gift during his lifetime. See IRC Section 1015 (for intervivos gifts made during the grantor's lifetime, Taft v. Bowers, 278 U.S. 470 (1929)) and also IRC Section 1014 (for inheritance for a deceased person).

You may need to find out how low your father’s basis is, because that may be your basis received in the property if it is made during your father's lifetime.

Gain is generally determined by subtracting your basis from the net sale price (amount realized) on the sale.

1031 Like-Kind Exchange

If you want to defer the gain, you may consider doing an IRC Section 1031 like-kind exchange.

In order to qualify for a 1031 exchange, both the property given up (sold) and the new properties received must be held for investment / business or for use in your trade; so you may need to hold the gifted property for one of these qualified purposes for a period of time before exchanging out of it.  

• Start Your 1031 Exchange: If you have questions about gain with gifted property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Tax Reform & The Importance of the 1031 Exchange

There are a lot of rumblings out there about potential tax reform. President Trump has talked openly about how he wants to lower federal corporate income tax rates from 35% perhaps down to as low as 20%. How do we pay for this reduction in tax and the simplification of the tax code?

1031 on the Chopping Block?

Some pundits have speculated that section 1031 could be a victim of federal tax reform, thinking that Congress will throw it out in an attempt to simplify the code and to create some revenue raisers to offset these reductions in other areas. But throwing out section 1031 would likely have the opposite effect.

Market Stagnation

Let’s start with the assumption that 1031 elimination would result in more tax revenue collection. The result of eliminating 1031 would be stagnation and decreased velocity in the marketplace. I don't care if you lower rates down to 5%, a lot of our clients are just adamant that they don't want to pay any taxes on the sale of their real estate. They do not want to give away their hard-earned equity, and they will stay locked into their current properties and never sell them if they are going to get slapped on the wrist with this disincentive called taxes.

Without 1031 there is no tool to allow people to move their capital to the most advantageous investment. That stimulates property values, job growth, and has an unusual effective of benefiting the entire economy because capital is moving to different geographic areas around the country and into different business segments where it's needed.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Case Study: Paying Down Personal Debt with Sales Proceeds

Recently, we had a client who was looking to do a 1031 exchange on a duplex that they owned. The property was worth roughly $300k, the taxpayer owned $190k and had lived in the upstairs portion of the duplex for 2 of last 5 years. The first question the client had was how to determine the amount of net proceeds he needed to put into the new replacement property?

Half of the Net Proceeds

Assuming that the property is treated as a 50/50 duplex on your prior tax return, half of the net proceeds will go into the 1031 exchange to buy new real estate worth about $150K (maybe a little less due to ½ of transaction costs).

Paying Down Personal Debt

The client also wanted to use the half of the net proceeds that had no capital gains to pay down some personal debt. Here’s the second big question: how much does he need to spend on replacement property to avoid paying taxes on the part that is susceptible to capital gains? Or since the client lived in the property, is the entire thing exempt from capital gains taxes?

Section 121 Exclusion

If you qualify for the Section 121 Exclusion of gain from sale of a principal residence for the portion that you lived in, then you can take half the net proceeds and do whatever you want with that portion.

It’s also important to double-check all of this with your own CPA or accountant.

• Start Your 1031 Exchange: If you have questions about principal residence exclusions 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

Acquiring 1031 Property as an Individual vs. Corporation

If I sell my property that was held in my individual name can I acquire my like-kind replacement property in my corporation? That’s our topic for conversation in this article.

Same Taxpayer Requirement

The short answer is no. Remember that the same taxpayer that sold the relinquished property needs to be the same tax payer that acquires the replacement property.

Oftentimes corporations are viewed as a separate or different taxpayer. They have their own EIN number, the stockholders may be the same as the owner of the relinquished property but they're probably not viewed as a disregarded entity or pass through for the purposes of 1031s.

Individual or Disregarded Entity

A more appropriate purchaser of the replacement property would either be the individual that owned the relinquished property or a disregarded entity such as an LLC that is wholly owned by the individual that sold to relinquished property.

• Start Your 1031 Exchange: If you have questions about corporations, stockholders, 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