Is my tax based on my equity or my taxable gain?
Your tax will always be based upon calculations of the taxable gain. Contrary to misconceptions, gain and equity are two separate and distinct items. When determining your gain, you should identify your original purchase price. From that, deduct any previously reported depreciation and then add the value of any improvements, if any, which have been made to the property. The resulting figure is your cost or tax basis. To calculate your gain, subtract the cost basis from your original net sales price.
Your tax will always be based upon calculations of the taxable gain. Contrary to misconceptions, gain and equity are two separate and distinct items. When determining your gain, you should identify your original purchase price. From that, deduct any previously reported depreciation and then add the value of any improvements, if any, which have been made to the property. The resulting figure is your cost or tax basis. To calculate your gain, subtract the cost basis from your original net sales price.
Is there a simple rule for structuring an exchange where all the taxable gain will be deferred?
If the following actions are performed, all taxable gain on your property is to be deferred.
1) A replacement property equal to or greater in value than the net selling price of your relinquished (exchange) property is purchased.
2) Equity is move from one property to the other.
What are the rules regarding the exchange of like-kind properties? May I exchange a vacant parcel of land for an improved property or a rental house for a multiple-unit building?
If properties are of the same nature or character, regardless of whether or not they differ in grade or quality, they are “like-kind” properties. The two properties must be of the same type, disregarding any improvements made. To clarify, two residential pieces of real estate are “like-kind” towards one another. A residential piece of real estate and a car would not be.
- All 1031 exchanges must involve swapping or trading with other property owners...... (NO)
Well before delayed exchanges were codified (by IRS) in 1984, all simultaneous exchange transactions of Real Estate required the actual swapping of deeds plus the simultaneous closing among all parties to a 1031 exchange. In most cases these type of exchanges were comprised of many of exchanging parties, as well as numerous exchange real estate properties. Now today, there's no such requirement to swap your own property with someone else's property, in order to complete an IRS approved exchange. The rules have been refined and ratified to the point that the current process is much more indicative of your qualifying intent, rather than the logistics of the Real Estate property closings. - Its required that all types of 1031 exchanges must close simultaneously....... (NO)
There was a time when all types of exchanges had to be closed on a simultaneous (same day) basis, now they (1031) are rarely completed in this type of format any longer. As a matter of fact, a majority of the exchanges executed are closed now as delayed exchanges. - "Like-kind" means purchasing the same type of property which was sold....... (NO)
Often the definition of "like-kind" has been misinterpreted or misunderstood to mean "The requirement of the acquisition of property to be utilized in the same form as the exchange property". In laymen's term, hotels are for hotels, apartments are for apartments, farms are for farms, etc. This is all true however, the exact definition is again more reflective of intent than its use. As a result, there are currently only 2 types of properties that qualify as a 'like-kind':-- Property held for investment and/or-- Property held for a productive use, as in a trade or business. - 1031 Exchanges must be limited to 1 exchange and 1 replacement property....... (NO)
This statement is a perfect example of another 1031 exchanging myth. Let me repeat, there are no provisions within either the IRS Code or the US Treasury Regulations that can restrict the amount and number of real estate properties that can be involved in an exchange. Thus, in exchanging out of several properties into one replacement property or the vice versa of selling of one property and acquiring several other properties, are perfectly acceptable strategies and uses of a 1031.
Is it possible to complete a simultaneous exchange without an intermediary or an exchange agreement?
It is possible to complete an exchange without an intermediary or an exchange agreement, yet is not recommended. In addition, it is very difficult to perform this process due to the Safe Harbor addition of qualified intermediaries in the Treasury Regulations and the recent adoption of good funds laws in several states. As two closing entities cannot hole the same exchange funds on the same day, the Exchanger is left with serious constructive receipt and other legal issues for attempting such a simultaneous transaction.
The main reason for the addition of the intermediary Safe Harbor was to suppress the practice of attempting such marginal transactions. Many tax professionals believe that an exchange that is completed without an intermediary or exchange agreement will not qualify for deferred gain treatment. If such a transaction had already been completed, it would not pass an IRS examination due to constructive receipt and structural exchange discrepancies. As you may have hesitation to invest in a qualified intermediary, we advise you to do so, as in comparison to the tax risk that is associated with attempting this exchange, the investment is easily insignificant.
How long must I wait before I can convert an investment property into my personal residence?
A one-year holding period before investment is advised. As there is no definitive holding period that currently exists, the IRS did propose a one-year holding period before investment property could be converted, sold or transferred, yet it was never adopted by Congress. Please do not misconstrue the failure of the adoption of this proposal as an approval to convert investment property at any time. As the one-year period reflects the intent of the IRS, most tax practitioners advise clients to hold their property at least one year before converting into a personal residence.
As intent is extremely important, we remind you that it should be your intention at the time of acquisition to hold the property for its productive use in a trade or business, or for its investment potential.
What if my property was involuntarily converted by a disaster or I was required to sell due to a governmental or eminent domain action?
If your property is involuntarily converted, reinvestment must occur within 24 months from the end of the tax year in which the property was converted. It is also possible to apply for a 12 month reinvestment extension. This information is addressed within Section 1033 of the Internal Revenue Code for reference.
Is there a difference between facilitators?
There is most definitely a difference in facilitators. Similar to most professional disciplines, the capability of facilitators will vary based upon their exchange knowledge, experience and real estate and/or tax familiarity.
Should fees be a factor in selecting a facilitator?
Fees should be a factor in selecting a facilitator, however, they should be considered only after first determining each facilitator's ability to complete a qualifying transaction. This can be accomplished by researching their reputation, knowledge and level of experience. It is recommended that fees are not considered first as you may get a good price, yet not good quality.
Do the exchange rules differ between investment properties and personal residences? If I sell my personal residence, what is the time frame in which I must reinvest in another home and what must I spend on the new residence to defer gain taxes?
The previously stated rules that dictated that you had to reinvest the proceeds from the sale of your residence within 24 months before or after the sale, and that you had to acquire a property which reflected a value equal or greater than the value of the residence sold, have been discontinued with the passage of the 1997 Tax Reform Act. These were formerly found in Section 1034 of the Internal Revenue Code. Currently, if a personal residence is sold, provided that residence was occupied by the taxpayer for at least two of the last five years, up to $250,000 (single) and $500,000 of capital gain is exempt from taxation.
May I exchange my equity in an investment property and use the proceeds to complete an improvement on a vacant lot I currently own?
Although the attempt to move equity from one investment property to another is essential to tax deferred exchanging, unfortunately, you may not exchange into property you already own.
May I exchange into a property which is being sold by a relative?
Unfortunately, you cannot exchange into a property being sold by a relative. An Exchanger may sell to a related party; however, the related party will then be subject to a two-year holding period.
I am married and I am going through a divorce, can I still do a 1031 exchange?
This is a very difficult question to explain because there is no clear answer set forth with the IRS and very little case law, on the subject. In most cases it is recommended that the title be switched to the person in need of a 1031 exchange (before the divorce is complete). The problem comes into play with the joint ownership of the property. What is needed is to get the property into ONE name and simplify things. This can be achieved in a number of different ways. First, you can simply execute a "quit claim deed" to get the property into one single name. Second, you can have your spouse simply buy out the other person involved and get sole title into ONE name. Another option is that you keep the property in both names and then buy the new property in both names - execute a 1031. Then once the 1031 is complete, split up the property, so that in this case taxes are deferred by both husband and wife. There is no clear answer on this subject so you have to speak with your accountant or attorney for legal or tax advice.
If I am an owner of investment property in conjunction with others, may I exchange only my partial interest in the property?
Yes you may. Partial interests qualify for exchanging within the scope of Section 1031 of the Internal Revenue Code. However, if your interest is not in the property but an interest in the partnership which owns the property, your exchange would not qualify. This is because partnership interests are excluded from Section 1031. But don't be confused! If the entire partnership desired to stay together and exchange their property for a replacement, that would qualify.
Another caveat, those individuals or groups owning partnership interests who desire to complete an exchange, and have for tax purposes, made an election under IRC Section 761(a) can qualify for deferred gain treatment under Section 1031. This can be a tricky issue! See elsewhere in this publication for more information. Then, only undertake this election with proper tax counsel and only with the election by all partners!
Are reverse exchanges considered legal?
Yes, reverse exchanges are considered legal. Although reverse exchanges were deliberately omitted from Section 1031, the Internal Revenue Service issued the addition of Revenue Procedure 2000-37 in September, 2000 which provides a safe harbor for reverse exchange transactions.
I am selling my business, can I execute a 1031 exchange?
Yes, but it is important to determine first what portion of the business is actual property and what portion is deemed "business" or "good will". Only the portion that is deemed "property" can be applied to a 1031 Exchange.
I own a Condo or Co-OP, can I still do a 1031 Exchange?
Yes, In the state of New York, even a Co-Op is deemed Real Property and is qualified for a 1031 Exchange.
Why are the identification rules so time restrictive? Is there any flexibility within them?
The current identification rules represent a compromise which was proposed by the IRS and adopted in 1984. Prior to that time there were no time-related guidelines. The current 45-day provision was created to eliminate questions about the time period for identification and unfortunately, there is absolutely no flexibility written into the rule and no extensions are available.
In a delayed exchange, is there any limit to property value when identifying by using the Two Hundred Percent Rule?
Yes. Although you may identify any three properties of any value under the Three Property Rule, when using the Two Hundred Percent Rule there is a restriction. When identifying four or more properties, the total aggregate value of the properties identified must not exceed more than 200% of the value of the relinquished property.
There is an additional exception for those whose identification does not qualify for either the Three Property or Two Hundred Percent rules. The Ninety-five Percent Exception allows the identification of any number of properties, provided the total aggregate value of the properties acquired totals at least 95% of the properties identified.
Should identifications be made to the intermediary or to an attorney or escrow or title company?
Identifications may be made to any party listed above. On many occasions, however, the escrow holder is not equipped to receive your identification if they have no yet opened an escrow. Therefore it is easier and safer to identify through the intermediary, provided the identification is postmarked or received within the 45-Day Identification Period.
What is a "Master Lease" and how does it work?
The master lease is a management structure where a single entity is known as the "master lessee". The management company leases the entire property from the owners in return for a stipulated rent. This means that the owners [the investors] have a single tenant and predictable, stable rent, which will be stated in the prospectus accompanying the offering. Under the "triple net lease", the master lessee is responsible for all aspects of management, maintenance, repairs and leasing; and furthermore is responsible for paying expenses associated with the property, including real estate taxes and assessments, insurance and all maintenance and repair costs (excluding capital expenditures). Should these costs increase, the master lessee is obligated to pay them without reducing the rent due the owners.
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