Exchange Authority �1031 Blog

From FEA-Rental Equipment Fails to Qualify

Wed, 14 Jul 2010 00:00:00 -0500

IRS Concludes that Rental Equipment Fails to Qualify for Exchange Treatment

On June 25, 2010 the National Office of the Chief Counsel of the IRS issued Chief Counsel Advisory (CCA) 201025049 which concluded that taxpayer’s rental equipment did not qualify for depreciation under IRC § 167 or for like-kind exchange treatment under IRC § 1031.

Taxpayer is in the business of selling, renting, servicing, and financing equipment. When it orders equipment from the manufacturer, it designates that equipment as either for sale or for rent. When it receives rental equipment, it capitalizes the cost, which is depreciated pursuant to IRC § 167.

Equipment initially designated as rental may be subsequently sold to a renter or other purchaser. There is no prior agreement with renters as to what portion, if any, of rental payments will be credited toward purchase. If the renter elects to purchase equipment, the price is negotiated. When rental equipment is sold, it is exchanged for new rental equipment through a QI pursuant to an LKE program.

During the year examined 91% percent of taxpayer’s revenue came from sales and 9% came from rentals. There was no discussion in the Advisory of a separate allocation for repairs and financing.

The IRS examined sample transactions. Of the transactions that were examined, many items designated as being held for rental purposes were disposed of shortly after they were acquired and none of the items were rented prior to disposition. Overall, 40% of taxpayer’s rental equipment was disposed of during the year and half of those dispositions occurred within 90 days of receipt.

Based on these facts, Chief Counsel concluded that equipment designated as rental was not held for that purpose. Rather, the equipment was inventory, ineligible for depreciation under IRC § 167 and like-kind exchange treatment under IRC § 1031. The later by reason of IRC § 1031(a)(2)(A) (exclusion for stock in trade or other property held primarily for sale). Chief Counsel noted that temporarily withdrawing property from inventory or incidental use of inventory (such as an automobile dealer using a car as a demo) does not convert the property from inventory into property used in the ordinary course of business.

The Advisory states that resolution of this issue is heavily dependent on the specific facts. The determination of whether property is held for use in trade or business must be made on a property-by-property basis. Different or additional facts might change the conclusion.

A Chief Counsel Advisory is not binding on the IRS, on any court, or on any party (including the taxpayer under discussion). However, it provides insight into the current understanding of the IRS concerning the subject that is discussed.

Clarification: FEA Update - Chief Counsel Advice Concludes Equipment Held Primarily for Sale

To clarify the FEA Update issued on Thursday July 1, 2010, Chief Counsel Advice 201025049 found that the equipment in question was not “held for use in a trade or business or for investment� but rather the equipment was held primarily for sale. As such, the property was deemed ineligible for depreciation under IRC Section 167 and for tax-deferral under IRC Section 1031.

As noted, a Chief Counsel Advice is heavily dependent on the specific Taxpayer’s facts and circumstances. It is not binding on the IRS and may not be used or cited as precedent.

New Hampshire Governor signs SB 483 into law

Wed, 14 Jul 2010 00:00:00 -0500

From FEA:

The FEA has received confirmation that the New Hampshire Governor has signed SB 483 into law in that state. The new law amends prior law which would deprive taxpayers Section 1031 tax deferral on a state level if they purchased replacement property in the name of a new entity, notwithstanding that the acquiring entity was a disregarded entity. The typical situation would be that in which a taxpayer was required by a lender or TIC sponsor to acquire a replacement property in the name of a new single member LLC. The State of New Hampshire began disallowing exchange treatment on those transactions in 2008 and began to audit previously closed transactions as far back as 2004, without notice either to taxpayers or to the professionals in the industry.

The new law makes it clear that exchange treatment will not be affected by taking title in the new entity as long as the entity is a single member LLC, revocable trust or other entity which is disregarded for federal income tax purposes. The amendment eliminates the “claw back� efforts to 2004. Thanks are due FEA member George Foss and George’s allies at the New Hampshire Association of Realtors including Robert Quinn and Lynne Merrill. This matter is another excellent example of how one FEA member with “an ear to the ground� and an excellent network of state and local relationships can make a huge impact on our industry.

�1031 Frequent Topics of Interest

Tue, 22 Jun 2010 00:00:00 -0500

Revenue Procedure 2008-16: Conversions to or from vacation homes and 2nd homes
Revenue Procedure 2010-14: Relief for taxpayer reporting gain due to bankrupt QI
Amended 121: New rules for properties converted to primary residence from rental or 2nd home status then sold
Amendment to Partnership Form 1065: Affecting property owners in partnerships ansd multi-member LLCs
Tony R. Goolsby, et ux. v. Commissioner, 2010 TC Memo 2010-64: Tax Paper, full court case available upon request

Recent Extensions for National Disaster-Is your area affected?

45 and 180 day Extensions for disaster areas in Massachusetts and Rhode Island
- Massachusetts: Bristol, Essex, Middlesex, Norfork, Plymouth, Suffolk and Worchester
- Rhode Island: Kent, Newport, Providence andWashington
45 and 180 day Extension disaster areas in Oklahoma and Connecticut
- Oklahoma (May 10): Carter, Cleveland, Creek, Garvin, McIntosh, Okfuskee, Oklahoma, Pottawatomie and Seminole
- Connecticut (March 12) Fairfield, Middlesex, New Haven, New London and Windham

Attention CPAs and Attorney's are you looking for an exciting place to visit and the availability to obtain your much needed credits? Consider joining Exchange Authority in Las Vegas at the Flamingo Hotel and Casino on September 24^th and 25^th for the Quest for Quality: The 2010 FEA Annual Meeting. CPE, CLE and CES credits will be available. For more information call Exchange Authority at (978) 433-6061.

From FEA - 45 and 180 Day Extensions

Wed, 26 May 2010 00:00:00 -0500

45 and 180 Day Extensions for Disaster Areas in Massachusetts and Rhode Island
The IRS has issued extension Notices for the following disaster areas (the Covered Disaster Areas) for storms beginning on March 12^th (disaster date):

Massachusetts: Bristol, Essex, Middlesex, Norfolk, Plymouth, Suffolk and Worcester Rhode Island: Kent, Newport, Providence and Washington

[Note that the IRS may add additional areas later as FEMA adds them. If you are near the Covered Disaster Area, you should check the disaster announcement website for updates. The FEA will not issue announcements if more areas are added.]

Both of the following criteria must be met to get the extension under Revenue Procedure 2007-56, section 17:

(1) The taxpayer is located in the Covered Disaster Area or is otherwise an affected taxpayer as defined in the Notice, regardless of where the relinquished property or replacement property is located, or otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2007-56, section 17; AND

(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before the disaster date listed above.

IF the taxpayer meets these criteria, THEN any 45 day or 180 day deadline that falls on or after the disaster date is extended to 120 days from such deadline. Note the date may not be extended beyond one year or the due date (including extensions) of the tax return for the year of the disposition of the relinquished property (typically, if an extension was filed, 9/15 for corporations and 10/15 for other taxpayers)).

Please see Revenue Procedure 2007-56, Section 17, and the notice below for further details.

http://www.irs.gov/newsroom/article/0,,id=108362,00.html

From FEA-Intent Matters

Mon, 19 Apr 2010 00:00:00 -0500

Goolsby v. Commissioner (April 1, 2010); T.C. Memo. 2010-64

The Tax Court held that property acquired by taxpayers in a Section 1031 exchange did not qualify as replacement property when the taxpayers moved into the property two months after acquiring it. Taxpayers were also held liable for the accuracy-related penalty.

In October 2002 taxpayers signed a purchase agreement to acquire a single family property in Georgia (the Pebble Beach property). The purchase agreement was contingent upon sale of taxpayers’ personal residence in California. In February 2003 taxpayers sold their principal residence in California and began living with their in-laws in Georgia. In March 2003 taxpayers sold rental property located in California and used a QI to structure an exchange. Taxpayers purchased the Pebble Beach property as replacement property.

The court ruled that taxpayers did not intend to hold the Pebble Beach property for productive use in a trade or business or for investment at the time of exchange, and therefore it was not valid replacement property. The court first noted that taxpayers moved into the Pebble Beach property two months after acquiring it. Further, they did not move into it temporarily until renters could be found. Their efforts to rent the Pebble Beach property were minimal. They merely placed an advertisement in a neighborhood newspaper for a few months, and no further efforts were made to gain more exposure for the Pebble Beach property. Moreover, taxpayers began preparations to finish the basement of the Pebble Beach property, having a builder obtain permits for construction, within two weeks of purchase.

The court surmised that taxpayers were contemplating use of the Pebble Beach property as a personal residence before the exchange. It noted that taxpayers made purchase of the Pebble Beach property contingent upon sale of their personal residence in California. They sought advice from the QI regarding whether they could move into the property if renters could not be found. Taxpayers did not research whether covenants of the homeowners association would allow for rental of the Pebble Beach property before the exchange. They also did not research rental opportunities in the area prior to the exchange.

Taxpayers contended that purchase of the Pebble Beach property was not extravagant when compared to costs of California properties. The court responded that the relative values of properties were irrelevant. Taxpayers also argued, as evidence of their intent not to reside at the Pebble Beach property that they lived with their in-laws upon their move to Georgia. The court dismissed this argument as non-persuasive.

The court also found the taxpayers liable for the accuracy related penalty due to a substantial understatement of tax. Taxpayers failed to present any evidence that they acted with reasonable cause and in good faith. The taxpayers did not use counsel and represented themselves.

This case highlights that taxpayers should not be too quick to move into property acquired in an exchange. They should make substantial efforts to rent the property and avoid evidence of intent to use it as a residence. The taxpayers asked the QI if they could move into the property if renters could not be found. You probably get this or similar questions from clients frequently. Be careful with your answers and let the client know about the fate of the Goolsbys.

MYTHS about IRC �1031

Fri, 09 Apr 2010 00:00:00 -0500

Copied directly from Exchange Authority's "Trade Secrets of Exchanging".
"People often fail to consider Exchanges as an investment strategy because they are misinformed about the requirements of Exchanging. However, once their misconceptions have been cleared up, property owners usually find that IRC §1031 is worth considering . . . Here are a few other common misconceptions about Exchanges:
MYTH: Exchanges require two parties who want each other's properties.
Fact: Two-Party Exchanges are possible, but in reality, such two-party swaps rarely occur. Today, an Exchange is accomplished with the help of a Qualified Intermediary and usually involves four principal parties: the exchanger (taxpayer), a buyer for the relinquished property, a seller of the replacement property, and the Qualified Intermediary. The parties often do not know each other, and their properties may even be located in different states.
MYTH: The like-kind requirement limits a taxpayer's options.
Fact: Property must be exchanged for "like-kind" property. But like kind simply means that real property must be exchanged for real property. All real property is like kind, so a fee simple interest may be Exchanged for a tenancy in common interest; one property may be Exchanged for more than one property; a duplex may be Exchanged for a four-plex; a single family may be Exchanged for a motel; vacant land may be Exchanged for an office building, etc. However, real property may not be exchanged for personal property, and both the real property given up and the real property received must also satisfy the Purpose Requirement, which will be discussed later.
Personal property may be exchanged for other personal property. However, in an exchange of personal property the definition of like-kind is not as liberal as for exchanges of real property.
Myth: In an Exchange, title to the exchanged properties must pass simultaneously.
Fact: The properties do not have to close at the same time. However, the replacement property must be received by the taxpayer within 180 days after closing on the relinquished property. When the two transactions do not close at the same time, the Exchange is called a deferred Exchange."
- "Trade Secrets of Exchanging", Pages 5-6 of 26

Double or Triple potential incoming rent/leases without increasing debt

Mon, 01 Mar 2010 00:00:00 -0600

There has been a frenzy of interest of a process that I came up with for real estate investors. Here is the breakdown:

- double or triple potential incoming rents
- without increasing debt
- without increasing your total FMV of your existing holdings
- keep your current ownership model (aka no outside investors needed)
- AND take the management of the properties out of your hands
- AND stay within your general area, i.e. within 0-4 hour drive

- OR go outside your comfort zone (general area) and potentially increase potential incoming rents by 4 or 5 times and beyond!

You are probably thinking "What's the catch?� The catch is that you have to have some equity left in your existing property ("left" as in hopefully you are not close to or are upside down because of the market) and it doesn't work that well, if at all, with an owner-occupied investment property. You can do this starting with either Commercial or Residential investments.

Interested in learning the process for free?

Email me at mcouture@exchangeauthority.com to work out a day and time to talk.

**** Exchange Authority and Mark Couture are not tax, legal, or financial advisors, so please speak with your tax, legal, and financial advisor before making any investment decisions. ****

What Every Real Estate Investor Should Know

Mon, 01 Feb 2010 00:00:00 -0600

NOTE: we are not tax or legal advisors; this is just information for consideration when forming an entity to own investment property. I have come across many instances of this over the passed few weeks and with more investors looking to buy the cheap properties that are out there, this situation needs to be address at the beginning.

When dealing with 1031s, partnerships are a pain. Here is a common scenario, you have 3 people in a partnership and they want to sell a property. 2 want out and 1 wants to continue the investment, but does not have the funds to buy out the other 2 partners. The 3rd partner is out of luck and has to pay the tax on the sale of the property. We used to do what is called a Drop-n-Swap where we deed out to the partners as Tenants-in-Common, the 2 other partners get their cash/pay their taxes, and the 3rd partner does the 1031 exchange. The IRS has taken this to federal court 3 times and lost; HOWEVER, they are very persistent and are adding 2 questions to the partnership form 1065 – although a final draft has not come out yet, the questions will elude to whether or not the partnership ever did an exchange or if any of the partners have been deeded out as Tenants-in-Common.

The easiest solution next to buying out the other partners – dissolve the partnership, create multiple single member LLCs as Tenants-in-Common (not a TIC interest through a TIC company, rather a setup of ownership) and then wait 1-year, we recommend at least 2. That way, there are 3 separate tax paying entities that can do a 1031 exchange for their share of the property and are not fully tied to a partnership. There are some other options, but this one is one of the easiest. Let me know if you are a situation like this and we can work with your attorney on the structuring and language.

IRC �1031 Overview and Strategy for Artwork

Fri, 23 Oct 2009 00:00:00 -0500

IRC §1031 is for differing capital gain or loss for “property productively used in a trade or business or held for investment". Keep in mind; however, when an artist produces a piece, typically the “piece" is dealer property to be sold, not to be “held". Therefore, keep in mind that this is intended for collectors of art, not producers of art.
EXAMPLE: an actual client of Exchange Authority owned part of Andy Warhol’s Self Portrait with a very low “basis". It was sold for millions and would have resulted in a significant capital gains tax for our client. However, our client did a §1031 exchange, differed hundreds of thousands of dollars worth of taxes and purchased more paintings.
Again, think of the 401K rollover into an IRA. No taxes as long as it is structured properly, handled by a qualified person, and re-invested into a like-kind investment.
You bought a painting for $10,000 and years later you are able to sell for $50,000. You have $40,000 in gain, not including depreciation (see your accountant). You will be taxed on the $40,000 at 28% Federal “Collectibles" Long Term Capital Gains Tax + whatever the State tax is. Unless you do a §1031 exchange and defer your taxes into more paintings.
LIKE-KIND: “like-kind" is stricter for artwork than it is for real estate. You are able to do paintings for paintings, sculptures for sculptures, but not Paintings for sculptures.
STRATEGY (See the “NOTE" at the bottom before considering): you or your client owns $500,000 worth of paintings that were purchased decades ago for a low price. They are now interested in selling the paintings, but are not to keen on having to pay significant taxes on the hundreds of thousands of dollars worth of gain. One of many options could be to sell the paintings, do a §1031 exchange into a single, but very popular painting, that a museum will lease out from you to hold it in their collection or for special exhibits. You now turned your $500,000 “dust collectors� in your home into a cash-flowing* asset. Granted, you will have to pay taxes on the income, but at least you are potentially netting a significant positive compared to netting ZERO while the paintings hang in your house.

What do you mean I can't exchange my husband?

Tue, 18 Aug 2009 00:00:00 -0500

One of our clients called regarding an exchange on some rental property she and her husband owned, and during our conversation she asked me if it was possible to keep the property and exchange her husband instead. I contemplated how great it would be if that were possible. After we hung up I started thinking about the other day when I was eating dinner with my husband and he somehow kept missing his mouth. At first I thought something must be wrong with him because I don’t recall him ever missing his mouth before. Then there was the conversation about the few extra pounds he had gained. So I was thinking how great it would be if I could simply exchange him for a lighter, richer, younger model, He just looked at me and said “only if I can do an exchange going out of you and into two half your age" It’s so cute isn’t it how they think they are so funny sometimes? But then after some careful consideration we both decided it wasn’t each other we should be exchanging it was the children, yes it was definitely the children, we needed to exchange out of the children we now have and acquire just 1 who didn’t wreck the family vehicles, didn’t think the world revolved around only them and didn’t borrow money every other day. Yes when that can be done someone needs to call us right away we’ll be ready…

Don't Let The IRS Crash Your "Related Party" Exchange

Wed, 29 Jul 2009 00:00:00 -0500

Related Party issues are very significant in the world of IRC §1031 exchanges. So significant in fact that you have to disclose a related party exchange on FORM 8824 when filing your taxes.

Let's be clear, you ARE able to do related party exchanges, you just have to follow follow a couple of very clear parameters. For example; you own an investment property separate from your brother who owns investment property. You decide that you want to sell your property, do an IRC §1031 exchange and buy your brothers property. In order for the exchange to be valid, your brother has to do an IRC §1031 exchange out of his property. He cannot "go to cash". If you are doing a related party exchange, none of the related parties can sell without immediately doing an exchange; however, after a 2-year period, the related parties may sell their properties without failing their exchanges.

So who is a related party? A related party is defined in §267(b) and §707(b)(1), namely siblings, spouse, ancestors, lineal descendants, grantor and fiduciary of trust, two corportations with more that 50% of the stock owned by the same parties, and the list goes on. If you have any related party concerns, feel free to give us a call at (978) 433-6061.

Could Maine's New Licensure Requirements be the Beginning of a Trend?

Mon, 13 Jul 2009 00:00:00 -0500

Now that the Maine Legislature has enacted and signed on April 30, 2009 regulation requiring Exchange Facilitators to be licensed effective September 12, 2009, I am left to ponder this; Is this going to be the beginning of a trend that other states will follow? Maine will require annual licensure of any person acting as QI for relinquished property in the state of Maine and also require fidelity bonding, E&O coverage and of course prohibit commingling of exchange funds with the QI operating funds. It also requires that the funds be invested in a manner that ensures liquidity and preservation of the principal. Do I think that licensure requirements are a bad thing? Not at all, but I do however think that if this does become the trend that it may be more cost effective and controllable to require licensure across the board rather than state by state. Click the comments button below and tell me your thoughts.

Dealer or No Dealer?

Fri, 19 Jun 2009 00:00:00 -0500

The Tax Court recently held that the sale of subdivided lots qualified for Capital Gains and Loss treatment. The case involves a husband and wife who purchased a large parcel of property to build their residence on. The property was only available for purchase as a single unit. While they initially wished to keep the entire property for themselves, they eventually decided to subdivide and sell the excess lots over a number of years.

The court decided that the excess lots were held for investment purposes and the proceeds of their sales resulted in capital gains and losses. The Court looked at several facts in determining that their primary intent was more characteristic of investors than dealers. The couple had day jobs, had never sold real estate (outside of their residence), they hired consultants for every step of the process and sold less than a lot a year. The moral of the story is that a taxpayers original intent when purchasing a property plays a critical role in whether or not a property qualifies for 1031 Exchange treatment. (See: Rice, TC Memo 2009-142)

I Have to Hold the Property How Long?

Fri, 12 Jun 2009 00:00:00 -0500

As a Qualified Intermediary we are often asked about the holding period in a 1031 Exchange. Investors who are taking advantage of short-sales, foreclosures and REO’s need to be especially mindful of the 1031 Exchange rules.

Since 1031 is for deferring Long Term Capital Gains (LTCG) taxes, some advisors feel that holding a relinquished property for a minimum of one year is sufficient as LTCG is a holding period of more than a year. Additionally, if a property is held for over a year it will show up on two tax returns. The IRS takes a much more conservative approach in a Private Letter Ruling stating that a holding period of two years would be a sufficient. The IRS also created a Safe harbor for vacation home exchanges in a recent Revenue Procedure which includes a two year holding period for both the relinquished and replacement properties.

Given the IRS’s decisions in the above rulings most advisors prefer to see a holding period of two years. Holding period needs to be addressed on a case by case basis, taking into account investment intent as well as the facts and circumstances of an investor’s particular situation.

Is the reduction of mortgages in an exchange taxable?

Tue, 09 Jun 2009 00:00:00 -0500

Yes in many cases but not all. The amount of mortgage relief in an exchange is called "mortgage boot received" and is taxable to the extent it is less than the realized gain had the property been sold. However, if the exchangor adds cash to the transaction, gives cash boot, the cash boot given will offset the mortgage boot received and may reduce the tax liability to zero.

This potential tax liability is independent of the type or nature of the debt given or received. The debt may be new mortgages or mortgages taken subject to or assumed by the other party, may be recourse or non recourse or may be purchase money mortgages financed by the seller. Also, mortgages given up and mortgages taken on may be in first position or may be subordinate to one or more other mortgages.

The amount of mortgage relief is the difference between the mortgages given up on the disposition of the relinquished property and the mortgages taken on with the acquisition of the replacement property. If mortgages taken on are less than mortgages received then there is net mortgage boot received which may be subject to a gains tax.

Conversely, if mortgages received exceed mortgages given up, the difference is mortgage boot given which adds to the substitute basis of the replacement property.

It is important to structure the payoff and discharge of the mortgages on the taxpayers' relinquished property so that they are not paid off for the benefit of the taxpayer. If the transaction is structured incorrectly, the payoff of mortgages may be interpreted as constituting constructive receipt by the taxpayer which will violate the provisions of Section 1031.

Whenever mortgages are to be paid off in an exchange the taxpayer should hire the services of a qualified exchange intermediary to properly structure the payoff and protect the taxpayer benefits of the exchange.

Exchanges Are Not Just for Real Estate

Tue, 02 Jun 2009 00:00:00 -0500

Did you know that under IRC §1031 you can defer capital gains taxes on the sale of personal property? Although the majority of exchanges involve real estate, the exchange of “personal property� is also possible and presents a substantial tax deferral opportunity for business owners. In a single asset exchange, the “like kind� requirement is usually met easily, with both the relinquished and the replacement property being the same “General Asset Class� or the same “Product Class�. These classifications are used to determine the recognition or non-recognition of gain upon the sale.

General Asset Classes:
1.    Office furniture, fixtures and equipment
2.    Information systems, such as computers
3.    Non computer data handling equipment
4.    Airplanes, helicopters, air frames & engines
5.    Buses
6.    Automobiles
7.    Light general purpose trucks
8.    Heavy general purpose trucks
9.    Over the road truck tractor units
10.    Trailer & Trailer mounted containers
11.    Railroad cars and Locomotives
12.    Vessels, barges, tugs & marine transportation equipment
13.    Industrial steam & electric generation & distribution systems

Under the regulations, personal property may be “like kind� even if it is not “like class� or within the same product class under the safe harbor. However, the like kind standard is less broad than for exchanges of real property and requires properties to be of the same “nature or character�, as shown here in these examples:

1.    Copyrights of Novels are like kind to other copyrights of novels – not like kind to copyrights of songs
2.    Major league player contracts are like kind to other major league player contracts
3.    Livestock (of the same sex) stallion for stallion, mare for mare
4.    FCC television licenses for FCC radio licenses
5.    Fishing permits for fishing permits (regardless of species or fishery location

It is important to note that the IRS’s position that “goodwill� and “going concern value� of a business does not qualify and is not considered “like kind� to “goodwill and going concern value� of another business. In addition to the more specific requirements discussed in this article, a delayed exchange of personal property must also comply with the general requirements of the Qualified Intermediary “safe harbor� provided by the regulations, including the use of an independent third party as the Qualified Intermediary, time deadlines (45 & 180 days) for the identification and the receipt of replacement property, etc.

The regulations require that the identification of the replacement property to be received in an exchange, be specifically described and signed by the taxpayer. For example, an exchange of two automobiles, an unambiguous description of the replacement vehicle would describe the specific make, model and year of the automobile. Other general rules of identification also apply to personal property; they are the 3 property rule, the 200% rule and the 95% rule. Of course it is always wise to consult with both your legal and tax advisor prior to beginning an exchange.

Direct Deeding and the 1031 Exchange

Wed, 27 May 2009 00:00:00 -0500

Most Qualified Intermediaries will authorize the taxpayer to deed the relinquished property directly to the buyer and to receive the deed for the replacement property directly from the seller for the purpose of avoiding duplication of transfer taxes and in many states withholding taxes which may be imposed on the sale of property by a non-resident of the state.

The authority for direct deeding is granted by virtue of Reg. §1.1031(k)-1(g)(4)(iv) and Reg §1.1031(k)-1(g)(4)(v). Pursuant to Sub-Section (iv), a Qualified Intermediary is treated as acquiring and transferring title if: 1) The Intermediary acquires legal title to the relinquished property from the taxpayer or legal title to the replacement property from the seller and subsequently transfers the relinquished property title to the buyer and the replacement property title to the taxpayer; or 2) if the Intermediary enters into an agreement with a person other than the taxpayer, (the buyer), for the transfer of the relinquished property to that person and, pursuant to the agreement, the taxpayer transfers the relinquished property to the buyer; and 3) if the Intermediary enters into an agreement with a person other than the taxpayer, (the seller), for the transfer of the replacement property and, pursuant to the agreement, the seller transfers the replacement property to the taxpayer.

Pursuant to Sub-Section (v) an Intermediary is treated as entering into an agreement if the rights of the taxpayer are assigned to the Intermediary or before the date of transfer and all parties are notified in writing of the assignment.

In the typical exchange, the Intermediary, taxpayer and buyer of the relinquished property will execute an assignment or novation agreement assigning the taxpayer’s rights under the agreement to the intermediary. The assignment may contain a notice given by the Intermediary authorizing the buyer to transfer legal title directly to the taxpayer or the notice of direct deeding may be given in a separate document.

Additionally, on or before the date of transfer of the replacement property, (the closing), the Intermediary, taxpayer and seller of the replacement property will execute an assignment and notice of direct deeding, in one or several instruments, assigning the taxpayer’s rights under the agreement to the Intermediary and authorizing the seller to transfer Legal title directly to the taxpayer.

In each case, the Intermediary is treated as having acquired and transferred title to the property in accordance with the requirements of Reg. §1.1031(k)-1(g)(4)(iii).

Do I Have To Use an "Exact Entity" in a NH 1031 Exchange?

Tue, 19 May 2009 00:00:00 -0500

When selling property as part of a 1031 Exchange in NH it's important that investors use the exact same name on the replacement property that they used on their relinquished property. NH treats each entity, even the federally recognized "disregarded" Single Member LLC (SMLLC) as a separate and distinct entity for state tax purposes. The state’s position will cause difficulties for exchangers when an investor wants to sell real estate out of one disregarded entity and purchase replacement property in a new disregarded entity. NH is the only state that ignores the disregarded entity rule.

All disregarded entities, including SMLLC's, disregarded limited partnerships, and grantor trusts doing business in NH with gross income in excess of $50,000 are required to report and pay business profits tax. Because the business profits tax is assessed on an entity by entity basis, NH asserts that in order to enjoy Section 1031 deferral, the exact same entity that sold the relinquished property must subsequently purchase the replacement property. Investors must plan accordingly so that there are no surprises when exchanging NH property.

What Can I Do with Payment Received on a Property Taken By Eminent Domain?

Sun, 17 May 2009 00:00:00 -0500

A client recently asked how to treat an upcoming payment for a property with substantial gain that was about to be taken through eminent domain. While the property may qualify for a 1031 Exchange, a 1033 “Involuntary Conversion� may be more advantageous in some situations. Typically, the events that result in an involuntary conversion in which you can defer gain recognition are theft, damage resulting from an “act of God� (i.e., a casualty) or the government's taking of your property for a public use.

If the property is involuntarily converted into other property which is similar or related in use, the gain is automatically deferred. But that doesn't happen too often. Normally, the lost property is converted into cash (insurance proceeds or a condemnation award) or into other property which isn't similar or related in use; in those situations, the gain is recognized unless the owner decides to do a 1031 Exchange. In a 1031 Exchange the investor must be careful not to take constructive receipt of the funds and to follow IRS guidelines for the 1031 Like Kind Exchange.

If you replace the involuntarily converted property with property that is similar or related in use within the specified time period, you can elect to defer the capital gains tax. To qualify, the replacement property must generally be purchased within two years of the close of the tax year in which the gain was realized. A three-year period applies for condemned property. Also, taxpayers can apply to the IRS for extensions of the replacement period. Even if you elect to defer your gain, you still must recognize gain to the extent that the replacement property costs less than the amount you received as compensation. The same 1031 exchange “equal or greater than� rule exists with the Involuntary Conversion. Additionally, you must reduce your basis in the new property by the amount of gain deferred. While the definition of “like kind� is more restrictive with the 1033 Involuntary Conversion, the timeframes are much more advantageous and the funds do not need to be held by an intermediary.

Note that the deferral rules don't apply to losses with Involuntary Conversions. In most cases, losses are deductible as casualty losses, subject to the limitations and special rules that apply to casualty losses.

Seller Financing & the 1031 Exchange; Powerful Tools for Today

Fri, 08 May 2009 00:00:00 -0500

A powerful sales tool when negotiating and structuring real estate transactions in this distressed real estate market is to have the seller carry back a promissory note alongside their 1031 Exchange. With “Seller Financing� the seller acts as a lender by lending money to the buyer and taking back an installment note secured by the property. We are frequently asked if it’s OK to carry a note on a relinquished property and also defer taxes through a 1031 Exchange. This can be done if structured properly by using one of two methods. The first option is to keep the note with the seller outside of the exchange and have the balance of the sale proceeds go to the Qualified Intermediary (QI) for the 1031 Exchange. The note would be treated on an installment sale basis and the seller may qualify for a partial 1031 Exchange.

The second option is to sell the property, carry back an installment note and complete a 1031 Exchange with the note assigned to the QI along with any cash proceeds from the sale. Then exchanger then has three additional options; (1) assign the note to the replacement property seller as part of the purchase price, (2) sell the note for cash at a discount with the proceeds used to fund the acquisition of the replacement property or (3) add cash equal to the face value of the note (buy your own) note to complete the exchange.

Check back next week for another strategy in a difficult selling environment; the Reverse 1031 exchange. In addition to reverse exchanges we will also be discussing Vacation Home exchanges and the new Home Exclusion (Section 121) rules in upcoming posts. As always, we recommend that investors seek counsel from their accountant or attorney to discuss all of their options when buying or selling property.

When is a Loss not a Loss but a losing gain?

Tue, 05 May 2009 00:00:00 -0500

With the collapse of the real estate market over the last year a many people feel that they do not have any capital gain issues on a sale because the properties have declined in value since their high in 05 and 06. However, the actual purchase price and the circumstances may make this loss a taxable event. Here are some examples:

Example 1: Definite loss
If a taxpayer bought an income property in 2006 for $800,000 and is now going to sell it for $600,000 today, they have a loss of $200,000; less depreciation that may be applied to offset future gain.

Example 2: Definite loss
If the taxpayer had placed a loan of $640,000 in 2006 on the $800,000 value and the property is now being sold for $600,000; the seller will have to pay $40,000 out of pocket at closing. They would still have a loss of $200,000 if it had been a straight purchase in 2006.

Example 3: Actual Gain
Now let's assume that in 2006 the seller had exchanged into the $800,000 property from a property that had been acquired in 1996 for $200,000. Let's assume they had taken $65,000 in depreciation leaving a basis in 2006 of $135,000 and a gain of $665,000.

The property purchased at $800,000 through a §1031 exchange in 2006 is now being sold for $600,000. The basis is $135,000 and thus they still have a $465,000 taxable gain; not a loss of $200,000. (They can do another IRC §1031exchange).

Example 4: Actual Gain
If the taxpayer had refinanced the exchange property in 2006 for $640,000 and now they are selling for $600,000 they will have to pay $40,000 out of pocket at closing. Additionally, there is still a gain of $465,000 (Sale of $600,000 minus basis of $135,000).

If the bank accepts the loss of $40,000 the taxpayer has a forgiveness of debt. The forgiveness of debt is taxable and gets added to the basis of $135,000 giving us a new basis of $175,000.

   $40,000.00 (forgiveness of debt) taxable
   $425,000.00 (gain) taxable ($600,000.00 minus stepped up basis of $175,000.00)
   $465,000.00 taxable at Long Term Capital Gains rates

Example 5: Actual Gain
A property was purchased in 2000 for $500,000 and in 2007 the investor refinances at the appraised value of $800,000. Now the taxpayer decides to sell for $600,000. His basis is $500,000, minus depreciation. If we assume depreciation of $70,000 our basis would be $430,000. There is not a loss of $200,000 ($800,00 minus $600,000) rather there is a taxable gain of $170,000. ($600,000 sale price - $430,000 basis).

It is important to note that if a seller uses this property in a §1031 exchange they would be able to defer their taxes. Beware all may not be as it appears! A perceived loss may still be taxable.

Are My 1031 Escrow Funds Safe?

Fri, 01 May 2009 00:00:00 -0500

The recent financial meltdown, 1031 regulatory changes, government intervention and recent failure of a national Qualified Intermediary (QI) are causing many would be 1031 exchangers to ask the question “how safe are my funds if I do a 1031 Exchange�?

As a custodian of exchange funds, a QI must invest in a manner that provides sufficient liquidity and preserves the principal of all funds held in escrow. Maintaining insurance, bonding, cash deposits and/or letters of credit would be the absolute minimum requirements. A Fidelity Bond and Errors & Omissions policy will protect exchangers from theft, embezzlement of funds and human error but not bank failure or a QI bankruptcy. Maintaining a Fidelity Bond, an E&O policy and segregating operating expenses from exchange funds are the minimal requirements in the Model Laws for QI’s. For maximum protection; deposits need to be held in segregated (by exchanger), dual signature, fully insured, FDIC/SIF protected bank accounts, with the bank named as the escrow agent. With segregated bank deposit accounts, exchangers have the benefit of FDIC insurance and no risk that their exchange funds are being commingled with other exchangers’ funds or the QI’s operating account. Funds held in segregated bank accounts may also come with additional protection through state insurance programs such as the MA Share Insurance Fund (SIF) which offers depositors a 100% guarantee on all funds in excess of the FDIC limit for member banks. SIF coverage is extremely important as the majority of exchange deposits exceed the $250,000 FDIC guarantee limit.

Exchangers along with their advisors need to perform due diligence on their prospective QI to make sure that they are dealing with a reputable firm and that the funds held during the exchange process are secure. If a QI has 50 exchanges going on at once and all 50 suddenly need to close tomorrow on the replacement properties using all funds held, can the QI provide all the funds?

Will Rogers once said, “I am more concerned about the return of my money than the return on my money.� Exchange Authority continues to offer the maximum amount of protection available in the §1031 Exchange industry and is proud to offer all exchangers a 100% guarantee on all funds held in the Qualified Escrow safe harbor with Fidelity Bank and through multiple layers of protection so that when it’s time to release funds - they are guaranteed to be returned.