|
Thank you for visiting my vacation home section!! Below you will
find alot of information, if you have any questions or are interested
in receiving a list of homes available within your criteria please
feel free to fill
out this information form
or call me directly at (772) 240-2589
10 Steps to the
Perfect 2nd Home • Vacation
Homes Gain Footing as Investments • Why
Vacation Homes are Still Hot! • Section
1031 Exchanges - General Info • VACATION
HOMEPAGE
--------------------------------------------------------------------------------------------------------------------
ALSO VISIT THESE SECTIONS: Home
Building • Investment
Homes
--------------------------------------------------------------------------------------------------------------------
INTRO TO 1031 TAX EXCHANGE
Introduction To 1031 Exchanges
A 1031 Exchange Is A Powerful Tax Deferral Opportunity
The Advantages Of A 1031 Exchange
The Disadvantages Of A 1031 Exchange
Exchange Techniques
The Basic Rules For A 1031 Exchange
The Exchange Property Must Be Qualifying Property
Property Which Is Not Qualified
The Replacement Property Must Be Like Kind
Boot Received Will Be Taxable
The Basic Types Of Exchanges
Simultaneous Exchanges
Delayed Exchanges
Reverse Exchanges
Improvement Exchanges
Delayed Exchanges - The Exchange Process And Time Clocks
The Basic Approach
The 45-Day Rule
Three-Property Rule
200% Rule
95% Rule
The 180-Day Rule
Reverse Exchanges ? The Exchange Process And Time Clocks
The New 5-Day Rule For Reverse Exchanges
The New 45-Day Rule For Reverse Exchanges
The New 180-Day Rule For Reverse Exchanges
The Role Of The Qualified Intermediary
The Role Of The Qualified Intermediary Is Essential
Definition Of The Qualified Intermediary
What The Qualified Intermediary Does
The Qualification Requirements
The Rules of "Boot" In A Section 1031 Exchange
Types Of Boot
Boot Offset Rules and Netting
Rules Of Thumb
Seller Carrybacks And Dispositions
Basic Incompatibility With 1031 Exchanges
Possible Dispositions and Salvage Of 1031 Exchange Treatment
Related Party Exchanges
The Two-Year Holding Period Requirement
Selling To A Related Party
Purchasing From A Related Party
Who Are Related Parties Under The Rules
Multiple-Asset Exchanges And Personal Residences
Types Of Multiple-Asset Exchanges
Exchanges Or Sale Of Property Including Personal Residences
Partnership And Co-Ownership Issues
Partnership vs. Co-Ownership
Tax-Planning For Partnership Split Ups
--------------------------------------------------------------------------------
Introduction To 1031 Exchanges
A 1031 Exchange (Tax-Deferred Exchange) Is One Of The Most Powerful
Tax Deferral Strategies Remaining Available For Taxpayers. Anyone
involved with advising or counseling real estate investors should
know about tax-deferred exchanges, including Realtors, lawyers,
accountants, financial planners, tax advisors, escrow and closing
agents, and lenders. Taxpayers should never have to pay income
taxes on the sale of property if they intend to reinvest the proceeds
in similar or like-kind property.
The Advantage of a 1031 Exchange is the ability of a taxpayer
to sell income, investment or business property and replace with
like-kind replacement property without having to pay federal income
taxes on the transaction. A sale of property and subsequent purchase
of a replacement property doesn't work, there must be an Exchange.
Section 1031 of the Internal Revenue Code is the basis for tax-deferred
exchanges. The IRS issued "safe-harbor" Regulations
in 1991 which established approved procedures for exchanges under
Code Section 1031. Prior to the issuance of these Regulations,
exchanges were subject to challenge under examination on a variety
of issues. Since issuance of the 1991 Regulations, tax-deferred
exchanges are easier, less expensive and safer than ever before.
The Disadvantages of a Section 1031 Exchange include a reduced
basis for depreciation in the replacement property. The tax basis
of replacement property is essentially the purchase price of the
replacement property minus the gain which was deferred on the
sale of the exchange property as a result of the exchange.
Exchange Techniques. There is more than one way to structure
a tax-deferred exchange" under Section 1031 of the Internal
Revenue Code. However, the 1991 Regulations established safe harbor
procedures which include the use of an Intermediary, direct deeding,
the use of qualified escrow accounts for temporary holding of
"exchange funds" and other procedures which now have
the official blessing of the IRS. Therefore, it is desirable to
structure exchanges so that they can be in harmony with the 1991
Regulations. As a result, exchanges commonly employ the services
of an Intermediary with direct deeding.
Exchanges can also occur without the services of an Intermediary
when parties to an exchange are willing to exchange deeds or if
they are willing to enter into an Exchange Agreement with each
other. However, two-party exchanges are rare since in the typical
Section 1031 transaction, the seller of the replacement property
is not the buyer of the taxpayer's exchange property.
The Basic Rules For A 1031 Exchange
The Exchange Property Must Be Qualifying Property. Qualifying
property is property (or equipment) held for investment purposes
or used in a taxpayer's trade or business. Investment property
includes real estate, improved or unimproved, held for investment
or income producing purposes. Property used in a taxpayer's trade
or business includes his office facilities or place of doing business,
as well as equipment used in his trade or business.
Property Which Does Not Qualify For A 1031 Exchange includes ?
A personal residence
Land under development
Construction or fix/flips for resale
Property purchased for resale
Inventory property
Corporation common stock
Bonds
Notes
Partnership interests
As explained below, common stock may (or may not) include ditch
stock which is sold with farm land.
Replacement Property Title Must Be Taken In The Same Names As
The Exchange Property Was Titled.
The Replacement Property Must Be Like-Kind. For real estate exchanges,
like-kind replacement property means any improved or unimproved
real estate held for income, investment or business use. Improved
real estate can be replaced with unimproved real estate. Unimproved
real estate can be replaced with improved real estate. A 100%
interest can be exchanged for an undivided percentage interest
with multiple owners and vice-versa. One property can be exchanged
for two or more properties. Two or more properties can be exchanged
for one replacement property. A duplex can be exchanged for a
four-plex. Investment property can be exchanged for business property
and vice versa. However, as referenced above, a taxpayer's personal
residence cannot be exchanged for income property, and income
or investment property cannot be exchanged for a personal residence,
which the taxpayer will reside in.
Any Boot Received In Addition To Like Kind Replacement Property
Will Be Taxable (to the extent of gain realized on the exchange).
This is okay when a seller desires some cash or debt reduction
and is willing to pay some taxes. Otherwise, boot should be avoided
in order for a 1031 Exchange to be completely tax-free.
The term "boot" is not used in the Internal Revenue
Code or the Regulations, but is commonly used in discussing the
tax consequences of a Section 1031 tax-deferred exchange. Boot
received is the money or the fair market value of "other
property" received by the taxpayer in an exchange. Money
includes all cash equivalents plus liabilities of the taxpayer
assumed by the other party, or liabilities to which the property
exchanged by the taxpayer is subject. "Other property"
is property that is non-like-kind, such as personal property received
in an exchange of real property, property used for personal purposes,
or "non-qualified property." "Other property"
also includes such things as a promissory note received from a
buyer (Seller Financing).
A Rule Of Thumb for avoiding "boot" is to always replace
with property of equal or greater value than the Exchange Property.
Never "trade down." Trading down always results in boot
received, either cash, debt reduction or both. Boot received is
mitigated by exchange expenses paid. See The Rules Of Boot In
A Section 1031 Exchange for a detailed explanation of these rules.
Th Basic Types Of Exchanges
A Simultaneous Exchange is an exchange in which the closing of
the Exchange Property and the Replacement Property occur on the
same day, usually back - to - back. There is no interval of time
between the two closings. This type of exchange is covered by
the Safe Harbor Regulations.
A Delayed Exchange is an exchange where the Replacement Property
is closed on at a later date than the closing of the Exchange
Property. The exchange is not simultaneous or on the same day.
This type of exchange is sometimes referred to as a "Starker
Exchange" after the well known Supreme Court case in which
ruled in the taxpayer's favor for a delayed exchange before the
Internal Revenue Code provided for such exchanges. There are strict
time frames established by the Code and Regulations for completion
of a delayed exchange, namely the 45-Day Clock and the 180-Day
Clock (see detailed explanation below). Delayed exchanges are
covered by the Safe Harbor Regulations.
A Reverse Exchange (Title-Holding Exchange) is an exchange in
which the Replacement Property is purchased and closed on before
the Exchange Property is sold. Usually the Intermediary takes
title to the Replacement Property and holds title until the taxpayer
can find a buyer for his Exchange Property and close on the sale
under an Exchange Agreement with the Intermediary. Subsequent
to the closing of the Exchange Property (or simultaneous with
this closing), the Intermediary conveys title to the Replacement
Property to the taxpayer. The IRS has issued new safe-harbor guidance
on Reverse Exchanges (click here)
An Improvement Exchange (Title-Holding Exchange) is an exchange
in which a taxpayer desires to acquire a property and arrange
for construction of improvements on the property before it is
received as Replacement Property. The improvements are usually
a building on an unimproved lot, but also include enhancements
made to an already improved property in order to create adequate
value to close on the Exchange with no boot occurring. The Code
and Regulations do not permit a taxpayer to construct improvements
on a property as part of a 1031 Exchange after he has taken title
to property as Replacement Property in an exchange. Therefore,
it is necessary for the Intermediary to close on, take title and
hold title to the property until the improvements are constructed
and then convey title to the improved property to the taxpayer
as Replacement Property. Improvement Exchanges are done in the
context of both Delayed Exchanges and Reverse Exchanges, depending
on the circumstances. The IRS has issued new safe-harbor guidance
on Reverse Exchanges (including title-holding exchanges for construction
or improvement) (click here)
Delayed Exchanges - The Exchange Process And Time Clocks
A taxpayer desiring to do a 1031 Exchange lists and/or markets
his property for sale in the normal manner without regard to the
contemplated 1031 Exchange. A buyer is found and a contract to
sell the property is executed. Accommodation language is usually
placed in the contract securing the cooperation of the buyer to
the seller's intended 1031 Exchange, but such accommodation language
is not mandatory.
When contingencies are satisfied and the contract is scheduled
for a closing, the services of an Intermediary are arranged for.
The taxpayer enters into an Exchange Agreement with the Intermediary
which permits the Intermediary to become the "substitute
seller" in accordance with the requirements of the Code and
Regulations.
The Exchange Agreement usually provides for:
An assignment of the seller's Contract to Buy and Sell Real Estate
to the Intermediary.
A closing where the Intermediary receives the proceeds due the
seller at closing.
Direct deeding is used. The Exchange Agreement will comply with
the requirements of the Code and Regulations wherein the taxpayer
can have no rights to the funds being held by the Intermediary
until the exchange is completed or the Exchange Agreements terminates.
The taxpayer "cannot touch" the funds.
An interval of time where the seller proceeds to locate suitable
replacement property and enter into a contract to purchase the
property. The interval of time is subject to the 45-Day and 180-Day
rules.
An assignment of the contract to purchase replacement property
to the Intermediary.
A closing where the Intermediary uses the exchange funds in his
possession and direct deeding to acquire the replacement property
for the seller.
The 45-Day Rule for Identification. The first timing restriction
for a delayed Section 1031 exchange is for the taxpayer to either
close on Replacement Property or to identify the potential Replacement
Property within 45 days from the date of transfer of the exchanged
property. The 45-Day Rule is satisfied if replacement property
is received before 45 days has expired. Otherwise, the identification
must be by written document (the identification notice) signed
by the taxpayer and hand-delivered, mailed, faxed, or otherwise
sent to the Intermediary. The identification notice must contain
an unambiguous description of the replacement property. This includes,
in the case of real property, the legal description, street address
or a distinguishable name.
After 45 days, limitations are imposed on the number of potential
Replacement Properties which can be received as Replacement Properties.
More than one potential replacement property can be identified
under one of the following three conditions:
The Three-Property Rule - Any three properties regardless of
their market values.
The 200% Rule - Any number of properties as long as the aggregate
fair market value of the replacement properties does not exceed
200% of the aggregate FMV of all of the exchanged properties as
of the initial transfer date.
The 95% Rule - Any number of replacement properties if the fair
market value of the properties actually received by the end of
the exchange period is at least 95% of the aggregate FMV of all
the potential replacement properties identified.
Although the Regulations only require written notification within
45 days, it is recommended practice for a solid contract to be
in place by the end of the 45-day period. Otherwise, a taxpayer
may find himself unable to close on any of the properties which
are identified under the 45-day letter. After 45 days have expired,
it is not possible to close on any other property which was not
identified in the 45-day letter. Failure to submit the 45-Day
Letter causes the Exchange Agreement to terminate and the Intermediary
will disburse all unused funds in his possession to the taxpayer.
The 180-Day Rule for Receipt of Replacement Property. The replacement
property must be received and Exchange completed no later than
the earlier of 180 days after the transfer of the exchanged property
or the due date (with extensions) of the income tax return for
the tax year in which the exchanged property was transferred.
The replacement property received must be substantially the same
as the property which was identified under the 45-day rule described
above. There is no provision for extension of the 180 days for
any circumstance or hardship.
As noted above, the 180-Day Rule is shortened to the due date
of a tax return if the tax return is not put on extension. For
instance, if an Exchange commences late in the tax year, the 180
days can be later than the April 15 filing date of the return.
If the Exchange is not complete by the time for filing the return,
the return must be put on extension. Failure to put the return
on extension can cause the replacement period for the Exchange
to end on the due date of the return. This can be a trap for the
unwary.
Reverse Exchanges - The Exchange Process And Time Clocks
After promising to do so since 1991, the IRS issued safe-harbor
guidance and recognition for Reverse Exchanges on September 15,
2000. Rev. Proc. 2000-37 officially sanctions Reverse Exchanges
that are structured to comply with the procedures outlined in
the Revenue Procedure. The new safe-harbors are effective for
Reverse Exchanges occurring on or after September 15, 2000.
Reverse Exchanges occur when a taxpayer arranges for a Exchange
Accommodation Titleholder (EAT) (usually the Intermediary) to
take and hold title to Replacement Property before a taxpayer
finds a buyer for his Exchange Property. Sometimes the exchange
accommodation titleholder will take and hold title to the Exchange
Property until a buyer can be found for it. Reverse Exchanges
have been common and have been preferred in circumstances where
a taxpayer has been compelled to close on Replacement Property
before an Exchange Property could be sold and closed or where
the taxpayer desired ample time to search for suitable Replacement
Property before selling an Exchange Property which started the
well-known 45 and 180-day clocks for Delayed Exchanges.
Reverse Exchanges have also been common where a taxpayer wanted
to acquire a property and construct improvements on it before
taking title to the property as Replacement Property for an exchange.
The Reverse Exchange gave the taxpayer extra time to get the improvements
constructed in addition to the 180-day clock referred to above.
The new safe-harbor procedures impose compliance requirements
on Reverse Exchanges that are new and require analysis for impact
and planning that can be summarized as follows ?
The 5-Day Rule. A "Qualified Exchange Accommodation Agreement"
must be entered into between the taxpayer and the exchange accommodation
titleholder (qualified intermediary in most cases) within five
business days after title to property is taken by the exchange
accommodation titleholder in anticipation of a Reverse Exchange.
The 45-Day Rule. The property to be "relinquished"
(the exchange property) must be identified within 45-days. More
than one potential property to be sold can be identified in a
manner similar to the rules of delayed exchanges (i.e., the three-property
rule, the 200% rule, etc.)
The 180-Day Rule. The Reverse Exchange must be completed within
180-days of taking title by the exchange accommodation titleholder.
The 180-Day Clock ? As with Delayed Exchanges where the exchange
must be completed within 180-days, Reverse Exchanges now must
be closed under the new procedures within 180-days. This is a
new requirement. In the past, since there has been no statutory
limitation of time in which to be in title, it has been common
for the Exchange Accommodation Titleholder to be in title on the
parked property for a year or more during which the taxpayer would
find a buyer for his Exchange Property or during which time the
taxpayer would have improvements constructed on the property being
held by the Titleholder.
180-days may be a suitable time for a buyer to be found for the
Exchange Property. But, 180-days is a problem with respect to
construction/improvement exchanges. The 180-day time limit within
which to complete a safe-harbor Reverse Exchange is probably insufficient
for most large "build to suit" exchanges.
What if the taxpayer has not yet found a buyer for his Exchange
Property by the end of 180-days? In this case, the taxpayer can
discontinue his attempt to accomplish a Reverse Exchange and take
deed to the Replacement Property. Or the taxpayer may decide to
extend his Reverse Exchange outside of the protection of the safe-harbor
procedures. The safe-harbor guidance issued by the IRS is optional,
not mandatory. Reverse Exchanges that do not comply with the requirements
of Rev. Proc. 2000-37 stand or fall on their own merits and should
be considered risky now that guidelines have been issued for safe-harbor
exchanges.
Rev. Proc. 2000-37 imposes new responsibilities and burdens on
the Exchange Accommodator Titleholder. The Accommodator is now
required to report for federal income tax purposes the "tax
attributes" of ownership of the property it is in title on.
It is possible that the Accommodator will be required to depreciate
the property just as a true owner would be required to do. Rents
and expenses attributed to ownership of the property may have
to be reported by the Accommodator. There has been no specific
requirement requiring Accommodators to do this prior to Rev. Proc.
2000-37.
Failure to comply with these new reporting requirements by the
Accommodator could invalidate the safe-harbor protection to the
client. In addition to these new responsibilities, Accommodators
will now have to track the new "time clocks" that apply
to Safe Harbor Reverse Exchanges.
Compliance with these new requirements and responsibilities will
impose new administrative burdens and responsibilities on the
Accommodator and may contribute to increased fees for this service.
Reverse Exchanges may very well become the preferred way to manage
and transact 1031 Exchanges as a result of this new official blessing
by the IRS. The 45-Day identification period of Delayed Exchanges
and related pressure to find suitable replacement property are
often so burdensome that taxpayers are unable to successfully
take advantage of the tax-deferral potential of a delayed 1031
exchange. The risks of Reverse Exchanges have been mitigated into
reasonable commercial risks with the new safe-harbor guidelines.
The Role Of The Qualified Intermediary
The role of the Qualified Intermediary is essential to completing
a successful and valid delayed exchange. The Qualified Intermediary
is the glue that puts the buyer and seller of property together
into the form of a 1031 Exchange. Where such an intermediary (often
called an exchange facilitator) is used, the intermediary will
not be considered the agent of the taxpayer for constructive receipt
purposes notwithstanding the fact that he may be an agent under
state law and the taxpayer may gain immediate possession of the
money or property under the laws of agency.
In order to take advantage of the qualified intermediary "safe
harbor" there must be a written agreement between the taxpayer
and intermediary expressly limiting the taxpayer's rights to receive,
pledge, borrow or otherwise obtain the benefits of the money or
property held by the intermediary.
A qualified intermediary is formally defined as a person who
is not the taxpayer or a disqualified person who enters into a
written agreement (the "exchange agreement") with the
taxpayer and, as required by the exchange agreement, acquires
the relinquished property from the taxpayer, transfers the relinquished
property, acquires the replacement property, and transfers the
replacement property to the taxpayer. The qualified intermediary
does not actually have to receive and transfer title as long as
the legal fiction is maintained.
The intermediary can act with respect to the property as the
agent of any party to the transaction and further, an intermediary
is treated as entering into an agreement if the rights of a party
to the agreement are assigned to the intermediary and all parties
to the agreement are notified in writing of the assignment on
or before the date of the relevant transfer of property. This
provision allows a taxpayer to enter into an agreement for the
transfer of the relinquished property (i.e., a contract of sale
on the property) and thereafter to assign his rights in that agreement
to the intermediary. Providing all parties to the agreement are
notified in writing of the assignment on or before the date of
the transfer of the relinquished property, the intermediary is
treated as having entered into the agreement and, upon completion
of the transfer, as having acquired and transferred the relinquished
property.
There are no licensing requirements for Intermediaries. They
need merely be not an unqualified person as defined by the Internal
Revenue Code in order to be qualified. The Code prohibits certain
"agents" of the taxpayer from being qualified. Accountants,
attorneys and realtors who have served taxpayers in their professional
capacities within the prior two years are disqualified from serving
as a Qualified Intermediary for a taxpayer in an exchange.
The Rules of "Boot" in a Section 1031 Exchange
A Taxpayer Must Not Receive "Boot" from an exchange
in order for a Section 1031 exchange to be completely tax-free.
Any boot received is taxable (to the extent of gain realized on
the exchange). This is okay when a seller desires some cash and
is willing to pay some taxes. Otherwise, boot should be avoided
in order for a 1031 Exchange to be tax free.
The term "boot" is not used in the Internal Revenue
Code or the Regulations, but is commonly used in discussing the
tax consequences of a Section 1031 tax-deferred exchange. Boot
received is the money or the fair market value of "other
property" received by the taxpayer in an exchange. Money
includes all cash equivalents plus liabilities of the taxpayer
assumed by the other party, or liabilities to which the property
exchanged by the taxpayer is subject. "Other property"
is property that is non-like-kind, such as personal property received
in an exchange of real property, property used for personal purposes,
or "non-qualified property." "Other property"
also includes such things as a promissory note received from a
buyer (Seller Financing).
Boot can result from a variety of factors. It is important for
a taxpayer to understand what can result in boot if taxable income
is to be avoided. The most common sources of boot include the
following:
Cash boot taken from the exchange. This will usually be in the
form of "net cash received", or the difference between
cash received from the sale of the exchange property and cash
paid to acquire the replacement property or properties. Net cash
received can result when a taxpayer is "trading down"
in the exchange so that the replacement property does not cost
as much as the exchange property sold for.
Debt reduction boot which occurs when a taxpayer´s debt
on replacement property is less than the debt which was on the
exchange property. As with cash boot, debt reduction boot can
occur when a taxpayer is "trading down" in the exchange.
Sale proceeds being used to service costs at closing which are
not closing expenses. If proceeds of sale are used to service
non-transaction costs at closing, the result is the same as if
the taxpayer received cash from the exchange, and then used the
cash to pay these costs. Taxpayers are encouraged to bring cash
to the closing of the sale of their property to pay for the following
non-transaction costs:
Rent prorations.
Utility escrow charges.
Tenant damage deposits transferred to the buyer.
Any other charges unrelated to the closing.
Excess borrowing to acquire replacement property. Borrowing more
money than is necessary to close on replacement property will
cause cash being held by an Intermediary to be excessive for the
closing. Excess cash held by an Intermediary is distributed to
the taxpayer, resulting in cash boot to the taxpayer. Taxpayers
must use all cash being held by an Intermediary for replacement
property. Additional financing must be no more than what is necessary,
in addition to the cash, to close on the property.
Loan acquisition costs with respect to the replacement property
which are serviced from exchange funds being brought to the closing.
Loan acquisition costs include origination fees and other fees
related to acquiring the loan. Taxpayers usually take the position
that loan acquisition costs are being serviced from the proceeds
of the loan. However, the IRS may take a position that these costs
are being serviced from Exchange Funds. This position is usually
the position of the financing institution also. There is no guidance
in the form of Treasury Regulations on this issue at the present
time which is helpful.
Non-like-kind property which is received from the exchange, in
addition to like-kind property (real estate). Non-like-kind property
could include the following:
Seller financing, promissory note.
Sprinkler equipment acquired with farm land.
Ditch stock in a mutual irrigation ditch company acquired with
farm land (possible issue).
Big T Water acquired with farm land (possible issue).
Acquisition of ditch stock or Big T water is a possible issue
with the IRS. Most taxpayers report their exchanges of farm land
by taking the position that water on the farm land is indistinguishable
from, and the same thing as real estate. The IRS has been known
to have a different view.
Boot Offset Rules - Only the net boot received by a taxpayer
is taxed. In determining the amount of net boot received by the
taxpayer, certain offsets are allowed and others are not, as follows:
Cash boot paid (replacement property) always offsets cash boot
received (exchange property).
Debt boot paid (replacement property) always offsets debt-reduction
boot received (exchange property).
Cash boot paid always offsets debt -reduction boot received.
Debt boot paid never offsets cash boot received (net cash boot
received is always taxable).
Exchange expenses (transaction and closing costs) paid (exchange
property and replacement property closings) always offset net
cash boot received.
Rules of Thumb:
Always trade "across" or up. Never trade down. Trading
down always results in boot received, either cash, debt reduction
or both. The boot received can be mitigated by exchange expenses
paid.
Bring cash to the closing of the Exchange Property to cover charges
which are not transaction costs (see above).
Do not receive property which is not like-kind.
Do not over-finance replacement property. Financing should be
limited to the amount of money necessary to close on the replacement
property in addition to exchange funds which will be brought to
the replacement property closing.
Seller Carrybacks and Dispositions
A Seller Financed Sale is usually incompatible with a desire
to do a Section 1031 Exchange of real estate. The reason is that
a promissory note is property received which does not meet the
requirement that real estate be exchanged solely for other like-kind
property (real estate). If seller financing is necessary due to
circumstances, and if a delayed exchange with the use of an Intermediary
is employed, it is possible to salvage Section 1031 Exchange treatment
by one of the following procedures:
The Intermediary can take and hold the promissory note as part
of the exchange proceeds and hold the note until a disposition
occurs. At the closing of the Replacement Property, the Intermediary
conveys ownership of the note to the taxpayer and the taxpayer
brings a like amount of money to the closing table in exchange
for the note. This is equivalent to "buying" the note
from the Intermediary. Otherwise, it is a distribution of "boot"
to the taxpayer by the Intermediary which is offset by "boot"
paid by the taxpayer at the Replacement Property closing table.
Under the Rules of Boot, cash boot paid by a taxpayer offsets
cash boot received, and hence, under the boot netting rules, there
is no net boot received by the taxpayer.
The seller could loan the buyer money prior to the real estate
closing and then take a deed of trust on the property at closing.
The Intermediary could sell the promissory note to a financial
institution or investor and use cash received to acquire qualifying
replacement real estate for the seller under the Exchange Agreement.
The Intermediary could use the promissory note in his possession
as consideration for the acquisition of replacement property.
A problem with this is that in the hands of the seller of the
replacement property, the note is a third-party note not eligible
for installment sale reporting under IRC §453. Accordingly,
there is disincentive for the seller to take the note as part
of the consideration to be received from the sale of his property.
This problem is compounded if the seller is also trying to do
a 1031 Exchange of his property.
These dispositions are not covered by the 1991 Regulations and
are not protected by the safe-harbor provisions. Therefore, potential
tax issues are always possible under an examination by the IRS.
Related Party Exchanges
(Two-Year Holding Period Requirement)
There is a special rule for exchanges between related parties
(§1031(f)), which provides that related taxpayers who directly
or indirectly exchange property must hold the exchanged property
for at least two years after the exchange for the exchange to
qualify for nonrecognition treatment. If either party disposes
of the property received in the exchange before the running of
the two-year period, any gain or loss that would have been recognized
on the original exchange must be taken into account on the date
that the disqualifying disposition occurs.
Often, a taxpayer will sell to a related party but receive Replacement
Property from an unrelated party. Tax and Exchange Professionals
do not perceive this type of transaction to be a "related
party exchange."
Also, a taxpayer will often desire to sell to an unrelated party
and receive Replacement Property from a related party. This type
of related party transaction does not work according to the IRS.
The IRS issued a Technical Advice Memorandum (TAM 9748006) in
1997 that says that this type of related party transaction is
equivalent to conveying the Exchange Property to the related party
with a deemed subsequent resale by the related party to the unrelated
party (a disqualifying disposition). Rev. Rul. 2002-83 issued
in 2002 confirmed this position by the IRS. Accordingly, taxpayers
should not receive Replacement Property from a related party.
Related parties under the rules are the following -
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.
A disqualifying disposition does not include dispositions by
reason of the death of either party, the compulsory or involuntary
conversion of the exchanged property if the exchange occurred
before the threat or imminence of the conversion, or dispositions
where it is established to the satisfaction of the IRS that neither
the exchange nor the disposition had as one of their principal
purposes the avoidance of federal income tax.
Multiple-Asset Exchanges And Personal Residences
A Multiple-Asset Exchange occurs when a taxpayer is selling/exchanging
a property which includes more than one type of asset. A Common
example is a farm property including a personal residence, farm
land and farm equipment.
The Treasury Department has issued Regulations which govern how
multiple-asset exchanges are to be reported. The Regulations establish
"exchange groups" which are separately analyzed for
compliance with the like-kind replacement requirements and rules
of boot. Farm land must be replaced with qualifying like-kind
real property. Farm equipment must be replaced with qualifying
like-kind equipment. A personal residence is not 1031 property
and is accounted for under the rules applicable to the sale of
a personal residence.
The Multiple-Asset Regulations are ambiguous concerning how the
personal residence portion of a multiple-asset exchange should
be accounted for. However, it is common practice for the closing
on the Exchange Property to be bifurcated into two separate closings;
one for the personal residence and the other for the remainder
of the property. The proceeds applicable to the sale of the personal
residence are usually disbursed to the taxpayer and not retained
by the Intermediary in the exchange escrow. The balance of the
proceeds is disbursed to the Intermediary for use in acquiring
like-kind replacement property under the Exchange Agreement.
Another common example of multiple-asset exchanges is a real
property sale that includes personal property (i.e. furniture
and appliances). Rental properties including this type of personal
property are multiple-asset exchanges. Hotel properties are a
good example of a multiple-asset exchange including real and personal
property.
Even a sale/exchange of a rental property includes a combination
of real and personal property. In practice, the value of the personal
property that is transferred with a rental property is commonly
disregarded for calculation and income tax reporting purposes.
However, there is no de minimis rule which permits a taxpayer
to disregard the value of personal property, even if it is nominal.
The Multiple-Asset Regulations are complex and require the services
of a tax professional for analysis purposes and income tax reporting.
The tax professional is essential and will help in determining
values, allocations of sale price and purchase prices to the elements
of the transaction. Exchanges that include personal property of
significant value should reference the personal property in the
exchange agreement and be completed in a manner that complies
with all of the exchange rules concerning identification, etc.
Partnership And Co-Ownership Issues
Investment real estate is commonly owned by co-owners in a partnership
containing two or more partners, or by co-owners as tenants in
common. An exchange of a tenant in common interest in real estate
poses no problems and is eligible for 1031 Exchange treatment.
However, an exchange of an interest in a partnership is not permitted
under the Code and Regulations.
If a partnership owns property and desires to sale/exchange the
property, then the partnership is the entity that is the Exchanger
and party to the Exchange Agreement. The partnership will take
title to the Replacement Property.
Frequently, individual partners in a partnership desire to take
their share of the proceeds of sale of the partnership property,
replace with qualifying 1031 replacement property in their own
names and end their relationship with the partnership. This presents
problems that require careful planning and is not without tax
risk.
If a two-partner partnership wishes to discontinue the partnership,
sell the property and go their separate ways with either the cash
or a 1031 Exchange, it is necessary for the individual partners
to receive deed to the property from the partnership in advance
of the sale of the property. This is done in the context of a
distribution of property from the partnership to its partners.
The individual partners are then generally required to hold the
property as tenants in common for an unspecified period of time
(decent interval of time) in order to comply with the "holding"
requirement of 1031 Exchanges that requires a taxpayer to have
"held" qualifying property for business or investment
purposes prior to the exchange.
If a partnership with multiple partners wishes to exchange property
but some of the partners want to "cash-out" or go separate
ways, it is common for the partnership to do a "split-off."
The partnership distributes tenancy in common title to a portion
of the partnership property to those individual partners who wish
to proceed in separate directions, and the partnership (and its
remaining partners) proceed with an exchange in the name of the
partnership.
The services of a tax professional is essential for tax planning
and structuring for successful exchanges of partnership and co-ownership
interests in real estate.
Equal Housing Opportunity. Copyright © 2006. All rights reserved.The
information that is provided is deemed reliable, however no guarantee
is warranted. The laws governing Florida prohibit such representation.
NOTE: Florida Real Estate laws require that we make full disclosure
at this time; the office of Picket Fence Realty, Simon Conway
and Jon White, collectively, or as individuals, have no representation
to you as a buyer. However, our office prefers to work as a transaction
broker (at no cost to the buyer). A final decision can be made
at the time of our first encounter regarding agency. All prices
are subject to change without notice. Figures provided are for
comparison only.
|
