1031 Exchange Lowdown

Partnerships In 1031 Exchange

By Priya Jestin, Staff Writer

A few weeks back, I had written about the importance of holding title to a property. One of the basic requirements of a 1031 exchange is you have to take title to the new property in the same manner that you held title to the old property. This may sound a simple enough concept, but it has caused a whole lot of problems for investors.

A large number of people own property in partnerships, corporations and limited liability companies (LLCs). While this may seem a safe and profitable way of holding property, it can also cause you enough headaches. There are three scenarios in this case. Today, we’ll discuss the first one:

For instance, if you own a one-third interest in a partnership, which owns a property worth $150,000. If the partnership has decided to sell the property, can you take your share ($50,000) and exchange in another property in your name alone? Now this is where the problem arises. You belonged to a partnership that owned the old property, so the tax return is also in the name of the partnership, and not your name. This means, only the partnership can do the exchange.

And if for some reason your partners don’t want to do a 1031 exchange, but want to sell the property and pay taxes instead, you have no choice but to abide by the common decision AND pay your taxes too.

Know more about the Foreign Investors Real Property Tax Act

Ever bought a property that belonged to a foreign national? Beware -- there are rules you would be better off knowing about before you involve yourself in such transactions. The IRS constantly tries to identify patterns of noncompliance or abusive transactions involving foreign investment in US real estate. The aim is also to warn tax payers and real estate professionals about such issues. Bayview1031.com reports:

The IRS believes that, in some instances, whether intentionally or through lack of knowledge on the part of foreign investors and U.S. real estate professionals, transfers of real estate purchase contracts are being conducted by foreign investors without FIRPTA withholding or filing of federal income tax returns to report the gain and pay any additional tax due.

Read more: FIRPTA (Foreign Investors Real Property Tax Act)

Swap Trap?

By Priya Jestin, Staff Writer

Are you one of the many people who believe that you cannot complete a 1031 exchange unless you can find someone to ‘swap’ your property with? Wonder why despite the growing importance of 1031 transactions, people still don’t know much about this section of the IRC.

The swap game for instance was probably the way how exchanges were originally structured. But over time, as the game got more complicated, the rules changed. Today, you can sell your property to anyone you choose and buy from anyone else. In other words, most exchanges are structured just like any other typical sale and subsequent purchase.

Clearing Misconceptions

Tax-deferred exchanges have become an increasingly important part of real estate transactions. Just about everyone who has bought or sold property has had a brush with 1031 exchanges – that is if they wanted to defer capital gains taxes. Surprisingly, despite its increasing popularity, there are still some deep-rooted misconceptions about Section 1031 of the Internal Revenue Code.

What’s worse, some of these misconceptions could lead to real estate investors losing their chance to take advantage of the tax savings afforded by structuring their transactions as an exchange. Nreionline.com reports:

Taxpayers must complete the 1031 exchange in one completely simultaneous transaction: By virtue of a favorable ruling to the taxpayer in the now famous case of Starker v. United States in 1979, taxpayers have the ability to complete an exchange on a delayed basis so long as they purchase replacement property within 180 days of selling their first relinquished property. Other structures, including reverse exchanges and improvement exchanges, afford taxpayers other types of flexibility during the exchange time frame.

Read more: Five Misconceptions of 1031 Exchanges

Why TIC

By Priya Jestin, Staff Writer

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. Joint tenant in common (TIC) legal structures or co-owned real estate, allows individuals to own a fractional interest in a property, such as an office building, apartment complex or shopping center.

Tenant in common investment ownership has been around for some time; it is only now that it has become a popular option. A 1031 TIC structure allows investors to pool their resources and purchase larger, higher valued and better positioned properties than they might otherwise have access.

An Alternative To 1031 Exchange

If you want to do a 1031 exchange but cannot find a property within the set time frame, you could go in for a structured sale annuity or ‘ensured installment sale. A Structured sale Annuity is a capital gains tax deferral tool that enables the seller to gain benefits that other sales and capital gains deferral methods do not offer. Wikipedia.org reports:

A structured sale is a special type of installment sale pursuant to Internal Revenue Code Section 453. Installment sales permit sellers to defer gains on the sale of a business or real estate to the tax year in which the related sale proceeds are received. Structured sales allow the seller of an asset to pay taxes over time while having the payments guaranteed by a high credit quality alternate obligor, who accepts assignment of the buyers periodic payment obligation. Transactions can currently be done as small as $100,000.

Read more: An alternative to the 1031 exchange

Make Money In Real Estate

By Priya Jestin, Staff Writer

The real estate market is anything but constant. It keeps changing with the current financial trend and many people wonder how they can make money in this field. While many people will vouch for the fact that real estate is an extremely productive placement of investment dollars over time, others may have burnt their fingers in their attempts to make money off it. Before you enter this field, it is important to know the rules of the game.

One of the ways you can make money off real estate is through 1031 exchanges. But unless you know how to play the game, you could be in trouble. So, what exactly is a 1031 Exchange? According to Section 1031 of the Internal Revenue Code, a real property owner who sells his property and then reinvests the proceeds in ownership of like-kind property is able to do so and defer any capital gains tax.

For a property exchange to qualify as a like-kind exchange, it must be done in accordance with the rules set forth in the tax code and treasury regulations. Frequently, the most difficult component of a 1031 Exchange is identifying replacement property within the first 45 days following the sale of the relinquished property. The IRS is very strict in not allowing extensions.

Want To Avoid Depreciation-Recapture Tax? Then Die

By Priya Jestin, Staff Writer

You buy a rental condominium in a 1031 exchange as a holiday home, and then decide to covert it into your primary residence. In such a case, does Section 121 principal residence sale tax apply to the depreciation-recapture tax?

I know, this sounds a bit convoluted, but who ever said Section 1031 dealings were easy. To get back to the question, you can avail of Section 121 principal-residence-sale tax exemption of up to $250,000 (up to $500,000 for a qualified married couple filing jointly). But it does NOT apply to the depreciation-recapture tax. So, how do you avoid this dreaded tax? The only way (according to experts) is to die while still owning the property. Now, that’s really taxing, what says?

Steps To A 1031 Exchange

By Priya Jestin, Staff Writer

I think I’ve gone too much into the intricacies of 1031 exchanges and steps to avoid unnecessary taxation. It’s time we took a deep breath and just simply jotted down the various little steps we must take to complete a 1031 exchange.

1. The first thing required is that you must have some kind of investment property that you want to sell and do a 1031 exchange.
2. Next, you contact a qualified intermediary and enter into an agreement.
3. Then you put your investment property on the market. Once a suitable buyer contacts you, the QI accepts and signs the property’s purchase offer.
4. Next, the escrow for the sale is opened, and a preliminary title report is produced.
5. The QI sends required exchange documents to the escrow closer for signing at property closing after which the escrow closes.
6. Once the escrow on the sale closes, you have 45 days to identify like-kind replacement properties.
7. You can zero in on three properties for purchase. You have to make your final decision and finish the entire process within 180 days after the close of escrow on the sale of the relinquished property. This is called the "Exchange Period". This completes the exchange.

Know Your Terms

By Priya Jestin, Staff Writer

A 1031 exchange is already a very complicated kind of transaction. What makes it even more difficult to understand are the various terms used in the business. While the intricacies cannot be simplified beyond a point, the terms can be easily explained. Here are a few of the more common ones:

• Real Property Use: Your old and new properties must qualify as investment or business use. If both properties pass this test, then only can you can exchange.
• 45-Day Period: You have 45 days from the closing of your sale to list the properties you may want to buy. There are no exceptions to the deadline.
• 180-Day Period: Once you close the sale, you have 180 days from that date to close on the purchase of one or more properties from the 45-day list. There are no exceptions to this deadline either.
• Qualified Intermediary (QI): As per IRS diktat, you must use a QI to prepare the legal documents for your exchange. It is important that the QI be independent, and it cannot be your friend, employee, broker, or even your accountant or attorney.
• Proper title holding: You must purchase and take title to your new property exactly as you held title to your old property.
• Reinvestment Requirement: If you want to defer all of your capital gain tax, you must buy a property equal or higher in value than the one you sold. You must also reinvest all the cash proceeds from your sale.