The 3 Basic Ingredients of a Successful 1031 Exchange

Putting together a 1031 exchange is a little like baking. Get any of the ingredients wrong and you’ll have a mess on your hands. In this article, we will discuss the 3 basic ingredients of a successful 1031 exchange.

Your Property Needs to Be Eligible for 1031 Exchange

First and foremost, before embarking on a 1031 exchange you need to make sure your property is even eligible for 1031 exchange treatment. Specifically, all property involved in the exchange (your relinquished property and your replacement property) needs to be held for investment purposes or for use in trade or business. This means that real estate held for personal use is not eligible for 1031 exchange.

Your Property Needs to Be Like-Kind

Similarly, all property involved needs to be like-kind. That means your relinquished property and your replacement property needs to be like-kind. Thankfully, nearly all real property is considered like-kind so as long as you are exchanging real estate for real estate, you should be OK.

Your Property Needs to Satisfy the Napkin Test

In a 1031 exchange, your replacement property needs to be equal to or greater than your relinquished property in terms of equity, value, and debt. This is often referred to as the napkin test.

Qualified Intermediaries at CPEC1031

At CPEC1031, LLC, our qualified intermediaries have over twenty years of experience facilitating exchanges of all shapes and sizes for our clients. We can put our skills to use on your exchange! Reach out to the qualified intermediaries at CPEC1031 today to learn more about the process of deferring capital gains taxes when selling real property. You can find us at our main office in Minneapolis, or at one of our many satellite offices around the country.

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

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

The Mechanics of a 1031 Tenants-in-Common (TIC) Exchange

Investors have long used 1031 exchanges to defer taxes, while swapping old properties for newer properties. The reasons for swapping real estate vary greatly. In today's market, finding real estate values can be a challenge and individual investors have been somewhat limited to residential properties and small commercial structures.

An IRS ruling in 2002 greatly expanded the pool of available properties, particularly for individual investors. The ruling pertains to joint tenant in common (TIC) legal structures or co-owned real estate (CORE), which allows individuals to own a fractional interest in a property, such as an office building, apartment complex or shopping center. While tenant in common investment ownership has been around for some time, the 2002 ruling allowed investors to feel confident that the IRS would allow the tenant in common structure for 1031 TIC exchanges, and this has ignited a cottage industry.

The ruling, coupled with an increased interest in 1031 TIC properties, has led to a rapid growth in tenants in common and CORE investments. A 1031 TIC structure will allow investors to pool their resources and purchase larger, higher valued and better positioned properties than they might otherwise have access. Typically these more prestigious properties can also open doors to high quality lessees, such as Fortune 500 companies and government entities, reducing owner tenant risk. Real estate firms (Sponsors) organize the properties with professional management, removing day-to-day owner concerns.

TIC 1031 tenant in common exchanges are typically handled through broker-dealers and are under the oversight of the Securities and Exchange Commission (SEC). While there are 1031 TIC sales occurring outside of the SEC supervision, currently there is some controversy over these properties, and there may be a movement by the SEC to pull these properties under their regulatory umbrella.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

Tips for Finding a Real Estate Attorney to Help with Your 1031 Exchange

Finding a real estate attorney is an important aspect before becoming involved in real estate investing or a 1031 exchange. The right one will keep you on track and help lessen your liability in your real estate investments. Here are a few tips for finding a good real estate attorney for your 1031 exchange.

Tips for Finding a Good Attorney

• Talk to friends, family members and co-workers, or your state's Bar Association for referrals.

• Talk to local real estate brokers for referrals.

• Call a local realtors association for referrals.

• Prepare a list of questions pertaining to your situation. Most lawyers will answer simple questions over the phone for free.

• Identify a number of possible attorneys and call each one.

• Ask how much each lawyer charges per hour, and request an estimate of the time required to complete the tasks you require – looking over contracts, handling disclosures, and helping with the closing.

• Choose an attorney.

Questions to Ask

Here are some questions to ask your attorney when considering who to hire:

• What experience do you have in creative real estate investing such as subject to investing The Attorney should be open to and understand creative real estate investing.

• How much of your practice is in real estate? It should be at least 30% to 50%. In smaller markets there would be less need for an attorney to devote all their practice to real estate.

• Do you have other real estate investors as clients? If so, ask if you can contact them for references.

• What are your fees? The price the attorney charges is not as important as how well they work for you. The old proverb you get what you pay for applies here.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

The Danger of Falsifying or Inflating the Value of your 1031 Replacement Property

When you are doing a 1031 Exchange, you generally want to hit three benchmarks called the napkin test. These are generalities that typically bear out to be good indicators of whether or not all of the gains will be deferred in a 1031 Exchange. Here are the benchmarks.

Step One – Equal or Greater Value

One, you typically want to buy a replacement property of equal or greater value than the relinquished property that you gave up. So, we want to go up in value, and get a bigger, better property.

Step Two – Equal or Greater Equity

Secondly, we want to take all of our net equity, all of our proceeds from the disposition, the sale of our relinquished property. Imagine a big stack of poker chips in front of your relinquished property. I want to slide all of those poker chips over into the replacement property. So, I am moving all of my equity from A to B. So, the second rule of thumb is I want to move all of my equity into the replacement property rather than taking any cash or chips off the table, which would be treated as taxable boot.

Step Three – Off-set Your Debt Relief

The last benchmark, the third thing that I am trying to juggle, is that to the extent that I am paying off mortgages and debt on the relinquished property, I need to offset that debt relief with either new debt taken out in conjunction with the replacement property. So, I could take out a new purchase money mortgage, or I could assume the seller’s existing mortgage that would satisfy my debt relief if I acquired a replacement property with at least an equivalent amount of debt. Or, alternatively, I can offset my debt relief by putting more of my own cash into the replacement property. Cash in will also offset debt relief.

Coming Up Short on Sufficient Value

Well, here is where things get a little bit crazy. What if a person wants to acquire a replacement property that is not of sufficient value, but they are willing to gross up that price, fabricate, inflate the value of the price and report the transaction as if they acquired a replacement property of greater value. Let’s say that the real value of the property is $100,000, but the taxpayer grosses up the sale price to $150,000, so that they acquiring a replacement property of sufficient value. Suppose that they are buying from a friend who is willing to go along with it. Perhaps the friend is even willing to split the difference and to send back some of that inflated proceeds to the purchaser. They will give it back under the table. This is not acceptable. Filing a false or fraudulent tax return is a criminal offense. Knowing and willful attempts to evade or defeat income tax due is a crime.

There is a big difference between legally deferring your taxes in a proper 1031 Exchange and stretching the truth to fabricating the value of your replacement property.

Do Not Do the Crime

Section 7201 says that any person who willfully attempts to evade or defeat any tax imposed by this title, or the payment thereof, shall in addition to other penalties provided by law, be guilty of a felony. And, upon conviction thereof, shall be imprisoned not more than five years. Or they may be fined not more than $250,000 for individuals or both together with the costs of prosecution.

Exchange Your Investment Real Estate

Thinking about selling your investment real estate but don’t want to face a capital gains tax burden? Then a 1031 exchange is the tool you need! By reinvesting your sales proceeds into a replacement property, a 1031 exchange allows you to defer 100% of your capital gains taxes when selling real property. CPEC1031 has over twenty years of experience facilitating such transactions. Let us help you navigate the process. Contact us today at our Minneapolis office to get started!

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Safeguard – Adding a UCC-1 Security Agreement

One way to add extra security to your 1031 exchange is to perfect a UCC security interest in both the account held by your FDIC insured bank and in the qualified escrow agreement itself.  You can do this by filing a UCC-1 financing statement with the secretary of state where your 1031 monies are deposited.

That way in the unlikely event that your QI fails to perform, you’re not only a creditor, but you’re a “secured creditor”.  If a problem were to occur, it is always much better to be a secured creditor, because secured creditors have first priority to get paid over all other unsecured creditors.

Make sure your FDIC insured bank acting as your qualified escrow agent consents to the security agreement in writing, otherwise you may not get a properly perfected security interest in the qualified escrow account.

Remember, when your exchange is over, you will need to file UCC-3 to terminate your security interest in the deposit account.

CPEC1031

At CPEC1031, we specialize in facilitating 1031 exchange transactions of real property. Our qualified intermediaries have over two decades of experience working with clients on their 1031 exchanges. We can help you through the like-kind exchange process and make sure all of your documents are in order, and that you completely understand the process every step of the way. Reach out to us today at our Minneapolis office or at one of our satellite offices across the United States.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved