The Importance of Not Underestimating the Fair Market Value of Your 1031 Exchange Property

Estimating the fair market value of your replacement property in a 1031 exchange is important. There are several potential negative ramifications if you underestimate the fair market value of your properties during a 1031 exchange. In this article, we'll take a look at a recent case study in which a taxpayer had a failed exchange because he underestimated the fair market value of his property.

Underestimating Fair Market Value

In a recent 1031 exchange audit, the California Franchise Tax Board (FTB) partly disallowed an exchange because the taxpayer identified more than 200% of the value of the property sold.

The taxpayer identified five properties during the 1031 identification period. The total value of the identified properties was 267% of the value of the property sold. The taxpayer acquired two properties during the identification period, and another property after the ID period had expired. The total value of these properties was less than 95% of the value of the properties identified.

1031 Identification Rules

Remember, a 1031 exchange needs to abide by the following 1031 identification rules:

• During the 45-day identification period, a taxpayer can identify up to three properties, regardless of value.

• A taxpayer can identify more than three properties as long as the total value of the identified properties does not exceed 200% of the value of the property sold.

• If both of these rules are violated, the taxpayer will be treated as having failed to identify any properties, except:

  • Any properties actually acquired by the taxpayer during the Identification Period will be considered properly identified; and

  • All properties identified during the Identification Period will be treated as properly identified if the taxpayer actually acquires properties with a total value equal to 95% of the total value of the properties identified.

In this particular case, the two properties acquired during the ID period were properly identified like-kind properties. The property acquired after the ID period was not like-kind property. As a result, the sales proceeds allocated to this third property were disallowed from the 1031 exchange and treated as boot.

•  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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

How Long Does Personal Use Real Property Need to be Used for Business Purposes Before it Can be 1031 Exchanged?

One of the most commonly asked questions about 1031 exchanges is how long do you need to use real property for investment or business purposes before it can be exchanged in a 1031 transaction?

The 1031 exchange holding period is a cognitive test – not an objective time frame. With that in mind, it’s important to discuss it with your CPA, accountant, and other advisors on the specific transaction. When you acquire your replacement property in a 1031 exchange, your intention must be to hold that property for investment or for use in your trade of business. That’s the requirement.

Safe Harbor

There is a safe harbor that is applicable to VRBO, Airbnb, or other intermittent rental properties. If a client buys a replacement property and puts it into an intermittent rental plan, the IRS under their safe-harbor tests two twelve month periods. In other words, after acquiring such a property, they examine two twelve month periods to ensure that you are using the property for investment or business purposes.

Since we know that the IRS has this standard for intermittent rental properties, some tax advisors use this standard (a minimum of 24 months) for other types of 1031 exchange.

I’ve had clients get audited who have moved into their replacement property. In one instance the client won the audit. She had rented the property to a tenant in an arms-length lease and documented receipt of rent checks for 18 months. Another client of mine moved into their replacement property after three months. This did not go over well with the IRS.

Intent Matters

At the end of the day, it’s your intent that matters. Things can change in the future, or course, but it’s your initial intention when purchasing the property that the IRS looks at when determining whether or not you are abiding by the regulations.

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

How to Use a Contract for Deed to Acquire 1031 Exchange Replacement Property

Let’s say you’re at day 170 of your 180 day 1031 exchange period and you don’t have your new replacement property lined up and ready to go. What happens? Are you forced to pay the capital gains taxes and not do a 1031 exchange?

Cutting it Close in a 1031 Exchange

We’ve had clients who have gone right down to the wire on their 180 day exchange time frame. In one instance, it was caused by a snafu with the bank. For whatever reason, the bank could not get the financing approved. The seller was willing, the buyer was willing, but the bank had some sort of difficulty. Without the bank’s money, it’s hard to close on the replacement property. So we said to the client: “why don’t you approach the seller and offer to buy the property on a short term contract for deed, under which the buyer receives equitable title.”

Purchasing a property via a contract for deed is a clever way to get a deal done so that the client can identify their identified replacement property within the 180 day time frame.

In the Midwest, land contracts and contracts for deed are very popular. This particular client that we were working with was in New York, where they don’t do a lot of contracts for deed. So depending on your geographical location, the local customs and practices may dictate the extent of your options.

Contact a Qualified Intermediary

If you’re considering a 1031 exchange, contact a qualified intermediary at CPEC1031 today to work through the details of your transaction. Contact our qualified intermediaries today at our office in Minneapolis to get your 1031 exchange off the ground!

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Overlapping Timelines

Timelines are very important in any 1031 exchange of real estate. You want to always be cognizant of your deadlines so you don’t accidentally miss any and jeopardize your exchange. In this article, we are going to talk about overlapping timelines with forward and reverse 1031 exchanges.

Forward 1031 Exchange

When you’re doing a forward 1031 exchange that means you’ve sold the relinquished property first. The day of the closing of the relinquished property is day zero. You have 45 days thereafter to make your identification. At midnight of the 45th day the exchange will fail if there has been no identification made. According to the regulations, your replacement property identification must be sent by midnight of the 45th day.

Reverse 1031 Exchange

If you’re doing a reverse exchange, then you’re not identifying the replacement properties. Rather, you’re identifying the relinquished properties you’re going to be disposing of in the exchange.

Overlapping Timelines

There can be a situation in which you do a reverse exchange, followed by a forward exchange. In that scenario, you may park one property (let’s say a $200,000 piece of land that was previously purchased). Then you sell your relinquished property for $500,000, so you get the proceeds from that $500,000 sale. The qualified intermediary then immediately transfers the initial replacement property to the exchachor. Concurrently, the taxpayer has a forward exchange going and they can identify additional replacement properties within the 45 day identification period and receive them within the 180 day exchange period. So you can, as in this scenario, have two overlapping linear timelines.

Start Your 1031 Exchange

Considering a 1031 exchange? Contact a qualified intermediary to work through the details of your transaction. Our intermediaries have over two decades worth of experience facilitating exchanges of all shapes and sizes. Contact our qualified intermediaries today at our office in Minneapolis to get your 1031 exchange off the ground!

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Estate Planning & Real Estate: What is a Stepped-Up Basis at Death?

Under the current estate tax laws, when an individual dies all of his or her assets are revalued to their fair market value - the value that the estate tax is imposed upon. The trade-off that the current tax regime contemplates is that, except for a few categories of assets like your retirement funds or other installment sales, all of your assets are given a new basis which is the value that is used to determine the gain that you incur when a sale takes place.

So if you owned an apartment building for a long period of time and depreciated that down to a very low value, but then owned that property at death, the value of that asset would be stepped up.

Consider Your Tax Situation

If you turned around the day after death and sold that property, your capital gains and other gains on that transaction would be zero if you sold it for that new stepped up basis. The other advantage of the stepped-up basis is that with real estate under certain circumstances you will be able to re-appreciate that asset again after the step up. In other words, you'll be able to take a depreciation deduction a second time. Those are some very significant advantages to utilizing the 1031 exchange in an estate planning scenario.

Contact a Qualified Intermediary

If you’re thinking about availing yourself of the tax-saving benefits of a 1031 exchange, contact a qualified intermediary to work through the details of your transaction. Contact our qualified intermediaries today at our office in Minneapolis to get your 1031 exchange off the ground!

• 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.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved