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Supreme Court lets stand decision that using qualified intermediary cannot avoid §1031 related party rule

Wednesday, February 24th, 2010 by Moore McLaughlin
Supreme Court of the United States of America

Supreme Court of the United States of America

The Supreme Court has declined to review a Ninth Circuit holding that a taxpayer could not avoid the Code §1031 like-kind-exchange related-party rule by using a qualified intermediary (QI). Teruya Brothers, Ltd. & Subsidiaries , (CA 9 2/11/2009) 104 AFTR 2d ¶ 2009-5345 , cert denied 2/22/2010.

Background. If statutory identification and replacement period requirements are met, gain or loss is not recognized currently on the exchange of property held for productive use in a trade or business or for investment for property of like kind that will be held for productive use in a trade or business or for investment. (Code §1031) QIs may be used to structure like-kind exchanges. However, under Code §1031(f), gain or loss on an exchange between related persons (under Code §267(b) or Code §707(b)(1)) must generally be recognized if either the property transferred or the property received is disposed of within two years after the exchange. Nonrecognition treatment under the like-kind exchange rules does not apply to any exchange that is part of a transaction or series of transactions structured to avoid the purposes of the related party exchange rule. (Code §1031(f)(4)) However, under Code §1031(f)(2)(C), a disposition will not trigger the related party bar if it is established to IRS’s satisfaction that neither the original transaction nor the later disposition had as one of its principal purposes the avoidance of federal tax.

Facts. Teruya Brothers Ltd. (Teruya) owned 62.5% of the common shares of Times Super Market Ltd (Times), so the two entities were related.  In 1995, in one series of planned transactions, Teruya transferred Real Property 1 to TGE, a QI, which then sold it to an unrelated third party. TGE used the sale proceeds, as well as additional funds from Teruya, to buy like-kind Replacement Property 2 for Teruya from Times, and then transferred Replacement Property 2 to Teruya. In another series of planned transactions, Teruya transferred Real Property 3 to TGE, which sold it to an unrelated party. TGE used the sale proceeds from Real Property 3, plus some cash from Teruya, to buy like kind Replacement Properties 4 and 5 from Times.

Teruya realized a $1.3 million gain on Property 1 and a $10.7 million gain on Property 3. Times realized and recognized a $1.3 million gain on Property 2 and a $2.2 million gain on Property 5, but these gains were offset by a large net operating loss. Times realized a $6.4 million loss on Property 4, but did not recognize it because of the Code §267 related-party restriction on loss recognition.

Teruya treated its transactions as tax-deferred like-kind exchanges under Code §1031, but IRS said the transactions ran afoul of the Code §1031(f)(4) related-party rule and hit Teruya with a $4 million deficiency.

Tax Court. In 2005, the Tax Court held that the transactions were economically equivalent to direct exchanges of properties between Teruya and Times (with boot from Teruya to Times), followed by the sales of the properties by Times to unrelated third parties. The interposition of a QI couldn’t obscure the end result.

Observation: In 2009, the Tax Court applied its Teruya reasoning and decision to rule against another taxpayer on the QI- Code §1031(f) issue (see Ocmulgee Fields, Inc., (2009) 132 TC No. 6).

Ninth Circuit. In 2009, the Ninth Circuit concluded that the Tax Court did not err in determining that the transactions were structured to avoid the purposes of Code §1031(f)(4). It rejected Teruya’s contention that the economic consequences of the transactions to Times were irrelevant, and that Teruya’s continued investment in real property was dispositive. Code §1031(f)(1)(C)(i) disallows nonrecognition treatment if a related party disposes of exchanged property within two years, regardless of whether the taxpayer does as well. Thus, examining the taxpayer and related party’s economic position in the aggregate is often the only way to tell if Code §1031(f) applies.

The legislative history indicating Congress’s desire to bar like-kind exchange treatment where related parties have, in effect, cashed out of the investment, confirmed that a taxpayer and a related party should be treated as an economic unit to see if Code §1031(f) applies. The Ninth Circuit pointed out that the changing economic positions of Teruya and Times readily showed that the related parties used the exchanges to cash out of an investment in low-basis real property. Before the exchanges, Teruya owned Property 1 and Property 3, and Times owned Properties 2, 4, and 5. After the exchanges, Properties 1 and 3 had been sold, Teruya owned Properties 2, 4, and 5, and Times had the cash from the sale of Properties 1 and 3 (along with boot from Teruya). All in all, Teruya and Times decreased their investment in real property by approximately $13.4 million, and increased their cash position by the same amount. By allowing Teruya and Times to cash out of a significant investment in real property under the guise of a nontaxable like-kind exchange, the Ninth Circuit concluded that the transactions were undoubtedly structured to contravene Congress’s desire that nonrecognition treatment only apply to transactions where a taxpayer can be viewed as merely continuing his investment.

The Ninth Circuit said Teruya could have exchanged its properties directly with Times, followed by Times’s selling Property 1 and Property 3 to the third-party purchasers, but this would not have had a tax-free result, since direct exchanges between related parties are ineligible for nonrecognition treatment when the exchanged property is sold within two years. Instead, Teruya employed TGE; the latter’s involvement as a QI served no purpose besides rendering simple, but tax disadvantageous, transactions more complex in order to avoid Code §1031(f)’s restrictions.

The Ninth Circuit also affirmed the Tax Court’s conclusion that Code Sec. 1031(f)(4) applied because improper avoidance of federal income tax was one of the principal purposes of the transactions.

Late in 2009, Teruya appealed the Ninth Circuit’s decision to the Supreme Court. However, on February 22, 2010, the Supreme Court declined to review the decision.

For more information on 1031 exchanges, or to ask specific questions regarding the related party rule of §1031, please contact Alexandra L. Hart, CES® at All States 1031 Exchange Facilitator, LLC by e-mail at AHart@AllStates1031.com or Moore McLaughlin, Esq., CPA, CES® by e-mail at FMM@AllStates1031.com or either of them by phone toll-free at 877-395-1031 extension 217.

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Posted in 1031 News, Choosing a Qualified Intermediary, FAQs, Qualifying Properties

What do I do if my TIC is in trouble?

Saturday, February 20th, 2010 by Moore McLaughlin

Alexandra L. Hart, CES® and I have been asked this question almost every other day for the past several months.  With the national commercial real estate and financial markets in turmoil, many investments that seemed solid only a year or two or three ago are now floundering.  Lenders are beginning foreclosure proceedings or are negotiating with the owners to take back a deed in lieu of foreclosure.  Buildings are being sold in so-called short sales.  And, lenders are selling off the promissory notes at deep discounts.  In other instances, the banks are not taking any immediate action, but the sponsors are offering to buy out investors for the amount of their investment.  Sometimes, individual investors are concerned and want to sell their interests, thus giving the other co-tenants an opportunity to buy a larger percentage for a small amount.tic-foreclosure

The question that we are continually asked is “What is my tax exposure?”  As a tax lawyer, I have been trained to answer “Well, it depends.”

In every TIC I know of, the property is encumbered by non-recourse debt.  Non-recourse debt is a loan made by a lender (could be a bank, an insurance company, a pension plan or some other type of lender) which debt is secured only by the property.  The key feature of non-recourse debt is that no one is personally liable for the debt and the lender can look only to the property for repayment.  As long as the rents are able to cover the expenses of the property and make the mortgage payments, then the lender typically feels comfortable.  However, if the cash flow only covers the expenses and the investors do not receive any distributions, then the investors are not comfortable.  Once the cash flow fails to cover the expenses, then the trouble really begins. 

Sometimes the sponsor or property manager will make a cash call.  If one or more of the owners is not willing or able to contribute enough cash, then the tenant-in-common agreement generally provides that the non-contributing owner either has to sell his or her interest, or the property has to be sold.  In any event, if there is insufficient cash to cover the expenses, the lender will eventually take action.

In most of these cases, the TIC investors do not contribute additional cash.  Thus, the lender starts the process of taking back or selling the property.  Because the debt is non-recourse, the lender cannot go after the TIC owners, and cannot force the TIC owners to pay any money.  So, the TIC owners generally lose the property, and their investment, but that is the extent of their losses.

These investors are convinced that they have sustained a loss for tax purposes.  In almost every instance, that is not the case.  For tax purposes, if a property that is encumbered by non-recourse debt is foreclosed upon or transferred back to the lender by a deed in lieu of foreclosure, the investor is treated for tax purposes as if he or she sold their interest in the property for their share of the non-recourse debt.  For tax purposes, this is known as the amount realized.  Taxable gain is calculated as the amount realized minus the adjusted tax basis of the property.

So, the next issue is to determine the investors’ adjusted tax basis in the property.  Most of the TIC owners acquired the TIC interest as a replacement property in a 1031 exchange.  If so, then their adjusted tax basis in the TIC interest is determined, in whole or in part, based on their adjusted tax basis in the property or properties that they sold in the 1031 exchange(s).  If the investor traded up in value on the 1031 exchange, then the investor may have added to his or her adjusted tax basis.  Any investor facing this dilemma should consult a qualified CPA or tax attorney who can make these complicated calculations.

Non-recourse debt that is forgiven does not result in cancellation of indebtedness income (”COD income”).  COD income can be generated only from recourse debt.  COD income is subject to a completely different set of tax rules.  So, investors should not become confused with how the COD income rules operate.

The character of the gain on the foreclosure or deed in lieu of foreclosure of a TIC interest is likely to be capital.  The holding period of the TIC interest is determined, to some extent, based upon the holding period the investor had in his or her relinquished property or properties from the 1031 exchange.  However, if the investor traded up in value, he or she could have a split holding period.  In order to enjoy the lower long-term capital gains tax rates, the property has to have been held for more than twelve months.  In calculating the 12-month holding period, the investor may be able to tack on the holding period from his or her relinquished property.  Again, any investor in this situation needs to consult a qualified CPA or tax attorney.

Remember also that there is no bright-line test for how long a property has to be held to qualify as “held for investment” for purposes of section 1031.  There is no 2-year rule, 1-year rule or any other hard and fast rule.

In summary, the investor is treated as having sold the TIC interest in an amount equal to his or her share of the non-recourse debt.  The investor will recognize gain or loss on this deemed sale based on his or her adjusted tax basis.  In addition, the investor must determine his or her holding period.

The good news is that for investors facing a large tax bill, they may be able to defer the tax by effectuating another 1031 exchange.  Click here for more information about “coffin or “no equity” exchanges.

For more information about these issues, or to ask questions about a specific scenario, please contact Alexandra L. Hart, CES® by e-mail at AHart@AllStates1031.com or by phone toll-free at 877-395-1031 ext. 217.

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Posted in 1031 Exchange Basics, 1031 News, FAQs, Other, Qualifying Properties, Tenants-in-Common

1031 Exchanges Become More Valuable in Rhode Island

Sunday, December 13th, 2009 by Moore McLaughlin

1031 exchanges gained significant value recently in Rhode Island thanks to the state legislature and the Governor.  The leaders of Rhode Island determined that raising the Rhode Island tax rate on capital gains from 1.67% to 9.9% was good for the economic viability of the state.  These leaders did not really explain the basis for such a determination, they just passed the bill.  This enormous rate increase will take effect for sales after December 31, 2009.

So, in order to avoid this additional tax, a 1031 exchange should be considered.  See our website for the basics of 1031 exchanges and the types of properties that are eligible.  But, for the right types of properties and for the right investor, the 1031 exchange will allow the Rhode Island tax to be deferred.

For more information on the Rhode Island tax, contact All States 1031 Exchange Facilitator, LLC owner F. Moore McLaughlin, IV, Esq., CPA, CES at 877-395-1031 or by e-mail at fmm@AllStates1031.com.

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Posted in 1031 Exchange Basics, 1031 News, Qualifying Properties

Dealer Property defined in Oregon case

Sunday, October 18th, 2009 by Moore McLaughlin

In order for property to qualify under section 1031, the property must be held for productive use in a trade or business or held for investment.  Property that is held primarily for sale is disqualified under section 1031.  One of the most uncertain areas of the law under section 1031 is whether a particular piece of property is held for investment.  The IRS has never given any hard-and-fast rules.  Taxpayers must rely on a hodge-podge of cases and rulings.

A recent case from a state court in Oregon addresses the issue of whether a parcel is held for investment or held primarily for sale. In Bahr v. Oregon Department of Revenue, Oregon Tax Court - Magistrate Division, TC-MD 080525B (2009), the Oregon Tax Court ruled that a bulk sale of raw land, originally acquired for investment, which was subdivided into lots, partially improved and sold to a builder was held as an investment and therefore qualified for tax deferral under Oregon law which follows IRC §1031 for state income tax purposes.Oregon

In Bahr, taxpayers (a husband and wife) were in an informal partnership with their sister and brother-in-law.  In 1996 the partnership acquired five acres of raw land in a §1031 exchange for a duplex.  At the time of this initial exchange the partnership was considered an investor in the property.   In 2001-2002 the other partners built a personal residence on a portion of the property.  In March 2004 partnership applied to subdivide the land into 27 individual lots.  At the time this application was submitted, the partnership agreed to sell 22 of the lots to a developer.  The partnership’s subdivision application was approved in 2004.  Pursuant to their agreement with the developer, the partnership immediately began infrastructure improvements on the lots including placing roads, underground utilities, excavation, engineering, permits and other indirect costs.  The first lots were sold to the developer in early 2005.  The decision implies that the taxpayers acquired replacement property in an otherwise valid §1031 exchange to defer gain on the lots sold to developer. 

The Oregon Department of Revenue argued that the partnership’s investment intent changed after it received the offer from the developer and subdivided the land into individual lots.   Accordingly, it asserted that the land was held “primarily for sale” as opposed to for “investment” thus disqualifying it from §1031 treatment.

In determining whether the land was held primarily sale the court listed factors considered in §1221 (capital gain) cases: (1) purpose for which the property was initially acquired; (2) purpose for which the property was subsequently held; (3) extent to which improvements, if any, were made to the property by the taxpayer; (4) frequency, number and continuity of sales; (5) extent and nature of the transactions involved; (6) ordinary business of the taxpayer; (7) extent of advertising, promotion or other active efforts used in soliciting buyers for the sale of the property; (8) listing of the property with brokers; and (9) purpose for which the property was held at the time of sale.  The court concluded based on the length of time the property was held and the taxpayers’ lack of experience in subdividing and selling lots that these factors weighed in favor of investment intent.  The court appeared to weigh heavily that the taxpayers engaged in the development activities to maximize their return on their initial investment and that they only did the minimum necessary to complete the sale.

Because the case was decided by the Oregon Tax Court this decision cannot be used as authority in IRS audits, and it is presumably of little precedential value outside of Oregon.  However, it does show that according to this court at least, subdivision of land, even coupled with substantial land improvements, is arguably not enough to convert a property owner from an investor into a dealer where there was no actual building, active marketing of the subdivided property, or establishment of a sales organization.

Please contact attorney F. Moore McLaughlin, owner of All States 1031 Exchange Facilitator, LLC, by e-mail at fmm@allstates1031.com or Alexandra L. Hart by e-mail at ahart@allstates1031.com for more information about this case or about a particular scenario.

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Posted in 1031 Exchange Basics, 1031 News, Qualifying Properties

Dispelling 1031 Myths, part 5

Monday, October 12th, 2009 by Moore McLaughlin

MermaidIn our continuing effort to help investors understand the rules of 1031 exchanges, we present two more common myths.  Avoiding these myths and misconceptions will allow investors to maxmimize the return on their investments by reducing the amount of taxes they pay.

Myth No. 9

I only have to reinvest my gain.  Or, I only have to reinvest my cash proceeds.

If Alexandra and I have heard this once, we have heard it a million times.  The general rule of 1031 exchanges is that the exchanger must buy a replacement property that is equal to or greater in value than the relinquished property.  The 1031 rules require the exchanger to reinvest their adjusted sales price, not just their gain or cash equity.  The reason is because Section 1031 requires an exchanger to receive like-kind property.  Luckily, all United States real estate is like-kind to all other United States real estate, regardless of the type or grade. Non-like kind property (called boot) typically consists of cash or debt relief.  To the extent that an exchanger trades down in value (i.e. buys a replacement property of less value than the relinquished property), than the exchanger receives boot, in the form of cash or debt relief equal to the amount of the trade down. Net boot received will always be taxed, to the extent of the taxpayer’s gain. However, often times, paying some tax is better than paying all the tax if no exchange is completed.

So, the easy rule to remember is for the exchanger to buy a replacement property or properties of equal or great value than their relinquished property or properties.  The good news, though, is that once these rules are understood, the exchanger realizes that he or she can trade down in value a little without blowing up the whole exchange.  Instead, a small amount of gain is recognized, while the balance of the gain is deferred.  Thus, the 1031 transaction is still worth doing. To learn more about partially tax-deferred exchanges or taking some cash at the closing, please click here.

Myth No. 10

I can exchange my primary residence tax-free under section 1031.

A primary residence does not qualify under section 1031.  In order for a property to qualify under section 1031, the property must be held for the productive use in a trade or business or held for investment.  Under these rules, a primary residence is held for personal use, therefore it is not deemed to be held for investment.  Thus, a primary residence generally does not qualify under Section 1031.

However, Section 121 provides for gain exclusion on the sale of a principal residence, if certain criteria are met.  If these criteria are satisfied, up to $250,000 of gain may be excluded (up to $500,000 for joint returns).  The basic rule of section 121 requires that the seller own and occupy the property as a primary residence for at least 2 out of the previous 5 years.  However, if the property was acquired as part of a previous 1031 exchange (and the taxpayer converted it from a rental property to their primary residence), than the taxpayer must own the property for 5 years and live there as a primary residence for at least 2 out of the 5 years before they may be eligible for the 121 exclusion. Furthermore, effective January 1, 2009, an amendment to the 121 exclusion will affect the amount of gain exclusion allowed for primary residences with a rental history (AKA “non-qualifying use”). In the event that the gain exceeds this exclusion amount, capital gain must be recognized and cannot be deferred even if a replacement primary residence is purchased.  If you are interested in learning more about the tax consequences of the sale of your home, you should consult an experienced tax attorney or CPA to learn more about section 121. It is especially important to consult with your tax advisor if your primary residence has or had an investment or business-use component (i.e. a home office or rental unit). Certain combination or consecutive use properties may allow for the combination of section 121 and section 1031, thereby maximizing the potential tax exclusion and deferral.

So, even for those lucky homeowners who say “…but my home is the best investment I ever made,” I say, “That may be true, but generally, it does not qualify under section 1031.” We continue dispelling as many 1031 myths as we can.  Stay tuned for more 1031 myths in the near future; or call us toll free at 877-395-1031 or contact Alexandra L. Hart by e-mail at ahart@allstates1031.com.

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Posted in 1031 Exchange Basics, 1031 myths, FAQs, Qualifying Properties

Dispelling 1031 Myths, part 4

Monday, September 28th, 2009 by Moore McLaughlin

Loch Ness MonsterAlexandra Hart and I are still amazed that we hear so many of the same myths and misconceptions every week about 1031 exchanges, what properties qualify and how exchanges work.  Unfortunately, many of the myths result in someone not exchanging when a 1031 would have saved a significant amount of taxes.  Here are two more myths that we hear as reasons not to do an exchange.

Myth No. 7

In order for a 1031 exchange to work, I have to find someone who has property I want and who wants my property.

Not true.  The IRS has allowed so-called delayed or deferred exchanges for many years.  For a number of years, no guidance existed on how to handle deferred exchanges.  In the late 1970’s, the Starker case held that a 1031 exchange did not have to be simultaneous.  Subsequently, the tax law was changed which allowed deferred exchanges, subject to certain limitations.

Now deferred exchanges are the norm.  We very rarely see direct swaps of property, although they are certainly allowed.  Most exchanges are effected by exchangers who sell their relinquished property to an unrelated third-party buyer and then purchase the replacement property from someone who is unrelated to either the exchanger or the buyer of the relinquished property.  In fact, in many cases neither the buyer of the relinquished property nor the seller of the replacement property are doing 1031 exchanges.  Although, in many cases they are.

The deferred exchanges must meet several simple rules.  The exchanger must acquire the replacement property within the earlier of 180 days from the sale of the relinquished property or the due date of the tax return (including extensions).  The exchanger must identify the potential replacement properties within 45 days from the sale of the relinquished property.  And, lastly, the exchanger should use a qualified intermediary (QI) or other safe harbor to avoid receipt of the sales proceeds from the sale of the relinquished property.  Following these rules, and a few others, will ensure a valid 1031 exchange.

Myth No. 8

If I fail to identify property within 45 days or if I fail to acquire sufficient replacement property during the exchange period, I will lose my money or be hit with severe penalties by the IRS.

Failure of an exchange results in no penalties and you will not lose your money.  An exchanger who fails to identify any property during the 45-day identification period will have his or her exchange proceeds returned on Day 46.  Likewise, an exchanger who fails to acquire any property during the exchange period will receive the exchanges funds on Day 181.  Please click here to read more about at what points during the exchange period the exchanger is allowed to get their money back.  The only economic loss is the fee charged by the intermediary, which is typcially minimal compared to the potential tax savings.

A failed 1031 exchange is treated merely as a sale of the relinquished property, subject to whatever taxes would have been imposed had a 1031 exchange not been attempted.  Even better, the exchange that begins in one tax year and fails in the subsequent tax year is treated as an installment sale with the possibility of significant tax deferral.  Click here for more information on the tax treatement of a failed exchange.

In any event, once sellers become aware of these realities, most realize that they have nothing to fear from a failed exchange and decide to enter into the exchange to preserve the right to defer taxes.

Stay tuned for more posts exposing the myths of 1031 exchanges that keep investors from saving taxes.

For more information on 1031 exchanges, contact Moore McLaughlin by e-mail at fmm@allstates1031.com or Alexandra L. Hart at ahart@allstates1031.com or by call toll-free at 877-395-1031.

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Posted in 1031 Exchange Basics, 1031 myths, FAQs, Test Your Exchange IQ

Dispelling 1031 Myths, part 3

Monday, August 31st, 2009 by Moore McLaughlin

UnicornThe following are two additional myths that trip up investors and cause them to pay more taxes than they should.  This post is a continuation of my previous posts where I am trying to help investors understand the power of 1031 exchanges and not fall into certain misunderstandings.

 Myth No. 5

 I can’t do a 1031 exchange because I am purchasing the Replacement Property and I haven’t sold my Relinquished property yet.

A reverse exchange is the “flip side” of a deferred exchange, where an investor directly or indirectly acquires a like kind replacement property before disposing of a relinquished property. Once the replacement property is acquired, the investor has 180 days from that date to close on the sale of their relinquished property (or until the due date of their tax return, including extensions). In the current real estate market, owners of real estate often face the prospect of losing the opportunity to acquire a desirable replacement property when the seller of such property is unwilling or unable to wait while the investor completes the disposition of a relinquished property. Sellers in today’s market may have a hard time estimating how many days their relinquished property will be listed on the market for sale before the deal will actually close. Furthermore, it is taking buyers more time than usual to secure financing and get to the closing table. However, in the meantime, perhaps the seller has found the perfect replacement property, or a property that has just been reduced and now the price is right and they need to act quickly. Or perhaps a business owner who is relocating may desire to purchase their new office space before selling their current office space to accommodate a smooth transition of employees and daily operations. A reverse exchange is perfect for these scenarios.

 On October 2, 2000 the Internal Revenue Service (”IRS”) issued Revenue Procedure 2000-37 providing guidance on structuring reverse exchanges to avoid IRS challenge.  The Revenue Procedure describes a safe harbor for reverse exchanges if certain requirements are met.  All States 1031 has been a leader in structuring and implementing reverse exchanges, and has formed an affiliated company, All States Reverse Exchange Facilitator, LLC, to handle the high volume of transactions. Taxpayers contemplating a reverse exchange also need to consider their financing options in advance. It is important to note that if a taxpayer wishes to defer taxes with a reverse exchange, they must contact a Qualified Intermediary like All States 1031 before they close on the purchase of their replacement property. Anyone considering the purchase or sale of investment property is encouraged to call Alexandra L. Hart at All States 1031 toll free at (877) 395-1031 for a complimentary consultation.  Planning ahead is the best way to ensure a seamless 1031 exchange, so call today!

 Myth No. 6

 My partners don’t want to exchange, so I’m going to exchange my partnership interest.

 Exchanges of partnership interests generally do not qualify for non-recognition treatment under IRC § 1031.  Therefore, when partners want to end their relationship, they cannot each exchange out of their partnership interests into another partnership interest or real property under IRC § 1031. Such transactions can be structured as 1031 exchanges, however, by converting the partnership interest into a real property interest. Once the partners dissolve their partnership and hold the property as tenants in common, they can each defer taxes with their own 1031 exchange(s), or some partners can take cash at closing and pay tax on their portion. The various structures include partnership split-ups, split-offs, buy-outs and formations. Such transactions are often referred to as “drop & swaps” or “swap & drops.” Structuring these transactions is not without tax risk, and requires the advice of an experienced tax professional. When partners are selling investment property and no longer want to stay in the partnership, the key to structuring a successful exchange is to plan ahead. Once the partnership has signed a legal contract to sell, it may be too late to structure a 1031 exchange, since the name on the contract should not be the partnership entity, unless the partnership is staying together to buy the replacement property. However, with proper planning, it is possible for each partner to get exactly what they want out of the sale. The owner of All States 1031, F. Moore McLaughlin, IV, Esq., CPA, CES®, is a licensed tax attorney and nationally recognized educational speaker on this subject. To start planning ahead for a partnership exchange, please call Attorney McLaughlin toll free at (877) 395-1031 for a complimentary consultation.

Educate yourself and don’t fall for these common myths. 

Check back for more posts dispelling other myths about 1031 exchanges.  In the meantime, click here for more 1031 myths or contact me or Alexandra L. Hart at 877-395-1031 or by e-mail fmm@allstates1031.com or ahart@allstates1031.com.

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Posted in 1031 Exchange Basics, 1031 myths, FAQs, Qualifying Properties, Reverse Exchanges

Dispelling 1031 Myths, part 2

Thursday, August 20th, 2009 by Moore McLaughlin

The following is a continuation from a previous post regarding some common myths surrounding 1031 exchanges.  Taxpayers who understand the rules of section 1031 and do not fall for the many myths will save more taxes and see better returns from their investments.  Here are two more of the tops myths that Alexandra and I hear daily.Bigfoot

Myth No. 3

 I heard that 1031 exchanges are only for the big investors.

 Actually, anyone who owns investment property should consider a §1031 exchange before selling.  The property size and value do not matter when considering a 1031 exchange. All that matters is the gain and the tax consequences. It’s fair to assume that about a quarter of the gain will go to the IRS in taxes if no exchange is completed. If the property has a low basis or has appreciated in value, the owner should seriously consider a 1031 exchange before selling. IRS code section 1031 is the only legal way to defer taxes on the sale of investment or business-use property. Currently, real estate sales are taxed at the 15% federal long-term capital gains tax rate, plus the state tax rate, plus 25% tax on any depreciation deductions taken. Furthermore, with tax rates rising steeply, it gives investors an even greater reason to do a 1031 exchange and defer that tax. The more taxes that are deferred, the more money the investor can retain to work for them in their next investment. Whether they are selling a small rental unit or an office building, they can simply pay the gain and throw away their hard earned money, or effectuate a §1031 exchange, preserving their capital and building their wealth. Any investor should consult a tax adviser who is familiar with §1031 exchanges to determine the most beneficial strategy.

 Myth No. 4

 I’ll just have my attorney hold the sales proceeds in escrow while I look for Replacement Property.

IRS regulations specifically exclude the investor’s agent, broker, attorney, accountant, most family members and other related parties or agents who have acted on the investor’s behalf within the previous two years from acting as the exchange facilitator or Qualified Intermediary (QI) for a tax-deferred exchange. To ensure compliance with the latest IRS regulations and updates, the investor should choose a well established full-time Qualified Intermediary, not someone who merely “dabbles” in exchanges. Generally, companies who are exclusively devoted to structuring and facilitating 1031 exchanges have streamlined the process and offer the most competitive fees. Typically, the fee for a QI can range from $750 - $7,500, depending on the QI and the complexity of the exchange. Furthermore, the QI should have instituted financial safeguards such as a fidelity bond and insurance to protect the sales proceeds during the exchange. Ideally, the QI will set up a separately segregated dual signatory exchange account for each exchange client, not a co-mingled or sub-account. Furthermore, sale proceeds should be deposited in a liquid money market account at a stable financial institution or back to ensure preservation of principal and liquidity of funds. Click here to learn about how All States 1031 secures clients’ funds. Finally, be sure to ask the QI certain due diligence questions to make sure that the owners and operators of the company have a comprehensive understanding of the tax code, preferably with tax attorneys, CPAs, and Certified Exchange Specialists® on staff.

Don’t fall for these common myths.  You will save money in the long-run and be a smarter investor.

Check back for more posts dispelling other myths about 1031 exchanges.  In the meantime, click here for more 1031 myths or contact me or Alexandra Hart at 877-395-1031 or by e-mail fmm@allstates1031.com or ahart@allstates1031.com.

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Posted in 1031 Exchange Basics, 1031 myths, Choosing a Qualified Intermediary, FAQs, Qualifying Properties, Reverse Exchanges

FHA to improve condo lending guidelines

Monday, August 17th, 2009 by Moore McLaughlin

According to Dan Hartman, Senior Mortgage Advisor, Province Mortgage Associates, Inc. located in Providence, Rhode Island, the FHA will Dan Hartmanissue new guidelines affecting condo lending.  The new guidelines will be more favorable to allowing commercial space in the development, will reduce the minimum number of units required to just 2, and will permit phasing.  These and other changes will have a positive impact of those seeking to do 1031 exchanges.  Click here to read Dan’s full article.

While dealer property will not qualify for 1031 exchanges, many people own single condos that have been used to produce investment income, some people convert their primary residence to rental, and some people convert a vacation condo to rental.  Remember that pure vacation homes, and second homes, do not qualify for 1031 exchange treatment.  When buyers have more options for financing, they can more easily close on the condo of their choice.  Alexandra Hart and I see many situations where a seller and a buyer want to close a deal, but the buyer is unable to secure financing.  These new FHA guidelines could help condo buyers obtain financing more easily and close more deals.

Furthermore, the new lending guidelines may help finance a reverse or construction exchange.  Reverse exchanges are increasingly popular in the current market when it takes an exchanger longer than expected to close on the sale of their relinquished property.  In the meantime, the exchanger may need to act quickly to buy a replacement property that has just been reduced to a great price.  Another great tool in the current market is the construction or improvement exchange.  With a large inventory of short sale and foreclosure properties available, an exchanger may want to acquire a “rehab project” that is of a lesser value than their relinquished property.  Instead of paying tax on the “buy down” difference, they can put that money towards improvements to their replacement property tax-free.  Construction exchanges can also be used for demolition or if the exchanger wants to raw land and build a new structure.

If you are interested in learning more about these new FHA guidelines, or if you have any financing questions, please contact Dan Hartman directly at 401-263-8655 or by e-mail at DHartman@provincemai.com.

For more information about forward, reverse or construction 1031 exchanges or the types of property that qualify, please contact Alexandra L. Hart at 877-395-1031 ext. 217 or by e-mail at AHart@AllStates1031.com.

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Posted in 1031 Exchange Basics, Construction Exchanges, Qualifying Properties, Reverse Exchanges

Dispelling 1031 Myths, part 1

Monday, August 10th, 2009 by Moore McLaughlin

ufoOver the next few posts, I will be dispelling many of the common myths surrounding 1031 exchanges.  The confusion and misunderstandings caused by the myths has resulted in many taxpayers paying more taxes than they should.  By paying the excess taxes, the non-exchangers have reduced the amount that they can reinvest, thereby needlessly reducing their income.

Myth No. 1

I sold a single-family rental property, thus I must buy a single-family rental property.

Alexandra and I hear this all the time.  Similarly, we hear “I can only trade raw land for raw land” or “multi-family for multi-family” or “Massachusetts property for Massachusetts property.”  In actuality, Section 1031 requires an exchange of “like-kind” property.  When dealing with real estate, “like-kind” is defined as any interest in real property.  Therefore, an exchanger can trade a single-family rental property for a commercial building.  Raw land can be exchanged for developed land.  Massachusetts real estate can be exchanged for Florida real estate.

Fractional interests can be exchanged for fee simple (or undivided) interests.  Likewise, fee simple interests can be exchanged for tenants-in-common interests.  Often times we see exchangers selling fee simple interests in Rhode Island property and buying TICs in other states.

Conservation easements, development rights, air rights and other intangible real estate rights can qualify as real property and be exchanged for fee simple interests, TICs and other real estate investments.

In summary, real estate is broadly defined.  Tax courts look to local law in determining if an interest is “real property”.  If the interest is real property, then the exchanger has a very wide array of options

Myth No. 2

My property is not worth enough for the trouble of a 1031 exchange.

Nothing could be further from the truth.  First of all, 1031 exchanges are very easy, especially with All States 1031 Exchange Facilitator, LLC.  We handle all the paperwork to satisfy the stringent requirements of the IRS and hold your hand throughout the entire process.  Our experience and knowledge of the tax law and the 1031 exchange process allows us to simply everything for you.

Second, the key in determining the value of the 1031 exchange is to look at the amount of taxes that will be deferred, not the selling price of the relinquished property.  The amount of the tax that will be deferred is based on the amount of gain that will be recognized if you do not complete an exchange.  Your CPA or other tax return preparer can help you with the exact calculation or use our capital gains calculator to determine an estimate of your tax.  In any event, even for a low selling price, a taxpayer who has owned the property for many years or who otherwise has a low adjusted tax basis may be staring at a large tax bill.  the other component of determining your tax is the tax rate.  The federal long-term capital gains rate is currently 15%.  However, under several proposals, this rate could increase to 20%, 28% or higher.  Don’t forget that any depreciation you have taken gets taxed at 25% currently.  And, for some of you, various states will impose taxes.  For example, Rhode Island just increased its tax on long-term capital gains from 1.67% to 9.9%.  By exchanging real estate in a 1031 exchange, all of these taxes can be deferred, and the tax money reinvested in your new property.

So, even a relatively low selling price of $300,000 by a person with an adjusted tax basis of $100,000 could result in a tax of over $50,000.  Instead of sending that money to the government, why not reinvest it and reap the rewards of the larger investment?

In summary, understand the facts of 1031 exchanges and don’t fall for these common myths.  You will save money in the long-run and be a smarter investor.

Check back for more posts dispelling other myths about 1031 exchanges.  In the meantime, click here for more 1031 myths or contact me or Alexandra Hart at 877-395-1031 or by e-mail fmm@allstates1031.com or ahart@allstates1031.com.

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Posted in 1031 Exchange Basics, 1031 myths, FAQs, Tenants-in-Common

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