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Market Reports
The following is intended as a primer on the guidelines and
restrictions set forth in Section 1031 of the Federal Tax Code,
along with some illustrations of various types of tax- deferred
exchanges. Hopefully, some common misconceptions about exchanging
will be cleared up and encourage a property owner to take advantage
of the practice. However, the decision to employ any of these
strategies can only be made after an individual's overall tax
"picture" is viewed by their CPA or tax lawyer.
Important Note: Whenever
contemplating a tax exchange all relevant documents, i.e. Real
Estate contracts, must indicate your intent to complete said
exchange.
Tax-Deferred
Exchanges: An Overview
Although most homeowners are aware of the up to $500,000 primary
home exclusion provided under the Federal Tax Code, surprisingly few
real estate investors (many being the same individuals) are aware of
the advantages and significant tax savings afforded by
IRS Section 1031. This is the section
of the code that authorizes and sets forth the requirements for
"tax- free exchanges", also known as "tax- deferred exchanges".
A tax-deferred exchange is a procedure in which a
real property owner trades one property for another without having to pay
any federal income taxes on that transaction. Under normal
circumstances, the selling owner would be taxed on any gain triggered by the
sale of his or her property. However, in an exchange, the tax on the
transaction is deferred until a future event; usually the sale of the newly
acquired property. Rather than a simple sale of one property and purchase of
another, this same sale and reinvestment are carefully structured as an
exchange via an exchange agreement and most often, the services of a
qualified intermediary. The intermediary, for a fee, helps ensure the
exchange is structured property.
Benefits of a Tax-Deferred
Exchange
The most obvious benefit of a tax-deferred exchange is the
ability to settle property without having any present
tax liability. The monies that would have normally been paid to the
IRS, instead, continue working for the taxpayer in the next investment
property. These dollars can be compounded through a series of subsequent
exchanges, with the tax liability ultimately being forgiven upon the death
of the taxpayer and without his or her estate having to pay. Any
heirs would acquire a stepped up basis on the
inherited property, equated to the fair market value at the time of
the taxpayer's death.
Requirements for a
Tax-Deferred Status
The reality of "exchanging" is that the IRS regulations make the practice
relatively simple and inexpensive. However, certain requirements must be met
in order for a transaction to achieve tax-deferred status under Section
1031. The following paragraphs outline the most essential elements.
Real property is the usual asset in a tax-deferred exchange, though not all
real property is eligible for such treatment.
Qualified real property is that which is "held for productive use in a trade
or business or for investment". Essentially any real property other
than one's personal residence or "dealer" property (acquired for the
specific purpose of resale) would pass the litmus test.
An additional and related consideration is how
long a taxpayer must hold the property in order for it to qualify for
tax-deferred treatment. This test applies to both the relinquished
(sold) and replacement (purchased) properties, with their respective holding
periods helping to establish validity of "purpose". If, for example, a
property is acquired and immediately resold, it may be deemed dealer
property and unqualified for tax-deferred treatment. A one year holding
period, on each, always been a general rule-of-thumb.
Further, the replacement property that would be
acquired in an exchange must be of a "like-kind" to the property
being relinquished. Like kind is defined as "similar in nature or character,
notwithstanding differences in grade or quality". Basically, all real
property is like-kind. One property may be exchanged for more than one
property, a duplex may be exchanged for a triples; a single family home may
be exchanged for an office building. The cardinal rule is that
real property may not be exchanged for personal
property, and that the real property be held for business or investment
purposes.
Also, in order for an exchange to be totally
tax-deferred, the replacement property must be of greater value than
the one being relinquished, with all equity being applied towards the
acquisition of the replacement property.
Limitations on
Tax-Deferred Exchanges
Since Section 1031 requires that an exchange rather than a sale and
purchase for cash occur, there are strict limitations on the flow and
handling of funds. The taxpayer cannot actually
receive proceeds in the exchange transaction. He or she may not even
have control of the funds (i.e. credit to his/her account, set aside, or
made available for future access). This principle is that of the
"constructive receipt", and its occurrence would invalidate an exchange.
Even though the taxpayer/exchanger is entitled under Section 1031 to have
security for his or her funds along with any interest earned on them, their
access and control must be "substantially limited and restricted".
This oversight is usually assigned to the qualified
intermediary, who establishes an escrow account pending the
completion of the exchange transaction.
Restrictions on Deferred
or Non-Simultaneous Exchanges
Unlike holding period timing, there are hard fast
time restrictions in any deferred or non-simultaneous exchange.
Closing of old property being sold/relinquished by the taxpayer activate two
time clocks.
First, the taxpayer must
identify (in writing) up to three replacement properties within 45 days of
the sale of the relinquished property.
Secondly, the actual
settlement on the replacement property must take place on the earlier of (a)
180 days after the closing of the relinquished property, or (b) the due date
of the taxpayer's federal income tax return (including extensions) for the
year in which the relinquished property is transferred.
Simultaneous exchanges, although less common, do take place and would not
be subject to these time restrictions. (As the foregoing would suggest, a
normal exchange involves relinquishing one property and replacing it with
another.)
Tax-Deferments on
Reverse Exchanges
Reverse exchanges, on the other hand, allow the
taxpayer to first acquire the new property and then sell the old one, later.
Although Section 1031 does not specifically define rules for a reverse
exchange, they are routinely employed and are structured within the
guidelines and time restrictions of a standard exchange. There are
two basic formats for a reverse exchange, both
of which require an intermediary to take title to at least one exchange
property and also accept the burden of actual ownership (i.e. make mortgage,
tax and insurance payments, collect rents, etc.)
The more common format is to
have the intermediary purchase the new property with funding provided by or
arranged for by the exchanger. The intermediary holds the title
until the taxpayer/exchanger sells the old property, at which closing the
intermediary deeds the new property to the exchanger. The second, less
common type of reverse exchange, is one in which the exchanger purchases the
new property and simultaneously deeds the old property to the intermediary.
When the old property is sold, the intermediary deeds it to the new buyer
and passes the sale proceeds to the exchanger. This scenario requires the
exchanger to place a down payment on the new property approximating the
amount of cash proceeds that would be realized from the sale of the old
property.
The final, less common, and
somewhat more complicated exchange variation is an Improvement Exchange.
It is similar to a reverse exchange in that an intermediary takes title to
the new/replacement property while capital improvements are being made to
it. Once the improvements are completed, title then passes to the exchanger.
Usually, the old/relinquished property will have been sold to fund the
purchase of the improvements to the new one. However, the exchanger could
fund the purchase of and improvements to the new one. However, the exchanger
could fund the intermediary's acquisition and construction of the new
property prior to selling the old one. Both formats would have the
intermediary taking title during construction with disbursements to
suppliers and contractors being facilitated through an escrow account. When
completed, the property would be conveyed to the exchanger from the
intermediary.
Important Note: Whenever contemplating a
tax exchange all relevant documents i.e. Real Estate contracts must indicate
your intent to complete said exchange.
Reverse Exchanges Finally
Blessed by I.R.S.
The Internal Revenue Service issued Revenue Procedure 2000-37 on
September 15, 2000; to provide a safe harbor for
taxpayers engaged in deferred (reverse) exchanges of property. Under
Internal Revenue Code Section 1031, an exchange of like-kind property used
for business or investment purposes is not taxable.
In recognition of the decision of Starker v. United States 602 f.2d 1341
(9th Cir. 1979), The Internal Revenue Code allows reverse exchanges of
property if, at closing (the "Closing"), the taxpayer transfers property
(the "Exchanger Property"), identifies the like-kind property or properties
to the acquired (the "Replacement Property") within forty-five (45) days of
the Closing, and acquires the Replacement Property within one hundred eighty
(180) days of the Closing.
In the past, the IRS has not approved tax-free treatment for "reverse
starker" exchanges. A reverse Starker exchange is one in which a plan exists
to acquire the Replacement Property before the taxpayer transfers the
Exchange Property. Revenue Procedure 2000-37 acknowledges that taxpayers
have engaged in "parking" transactions to facilitate reverse Starker
exchanges. In essence, the taxpayer "parks" the Replacement Property with
another party (the "Accommodating Party"), who holds the Replacement
Property until the taxpayer identifies someone who will acquire the Exchange
Property. Once the acquiring property is identified, the taxpayer engages in
a tax-free exchange with the Accommodating Party, who then transfers the
Replacement Property to the taxpayer.
Accommodation party must Own Property: In
revenue Procedure 2000-37, the IRS held that it would treat a
reverse-Starker exchange as a tax-deferred exchange if and only if the
Accommodating Party obtains sufficient legal rights in the Replacement
Property so as to be treated as the owner for federal tax purposes. The
Revenue Procedure assists taxpayers with a "genuine
intent to accomplish a like-kind exchange" by providing a safe harbor
in which the Accommodating Party will be treated as the owner of the
property for tax purposes. Revenue Procedure 2000-37 requires that the
Accommodating Party enter into a written "qualified
exchange accommodation arrangement" (QEAA) with the taxpayer.
The IRS requires the
following:
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The Accommodating Party must hold legal title to
the Replacement Property and also hold other indicia of ownership.The
Accommodating Party must be taxable. If the titleholder is a partnership
of a corporation, ninety (90) percent of its interests must be owned by
taxable parties.
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When ownership of the Replacement Property is
transferred to the Accommodating Party, the taxpayer must have a bona
fide intent to engage in a tax-free exchange involving that property.
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Within forty-five (45) days after the transfer
of the Replacement Property to the Accommodating Party, the taxpayer
must identify the Exchange Property to be transferred. The taxpayer may
identify alternative and multiple properties.
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Within one hundred eighty (180) days after the
taxpayer transfers the Exchange Property, the Replacement Property must
be transferred to the taxpayer.
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The time period between the Accommodating
Party's acquisition of the Replacement Property and the actual exchange
with the taxpayer cannot exceed one hundred eighty (180) days.
-
Within five days after the Replacement Property
is transferred to the Accommodating Party, the taxpayer and the
Accommodating Party must enter into a QEEA.
:
The Housing Assistance Tax Act of 2008, signed by President Bush on July
30, 2008, includes a modification to the Section121 exclusion of gain on the
sale of a primary residence. This modification may affect taxpayers who
exchange into a residential property, and then later convert the property to
a personal residence, as explained below.
Under Code Section 121, a taxpayer can exclude up to $250,000 ($500,000
for married couples filing jointly) of gain realized on the sale of a
principal (primary) residence if they have owned and occupied the residence
for two years during the five year period preceding the date of sale. Gain
related to depreciation deductions taken on the property since May 6, 1997
is not eligible for exclusion.
Effective January 1, 2009, the exclusion will not apply to gain from the
sale of the residence that is allocable to periods of “nonqualified use.”
Nonqualified use refers to periods that the property is not used as the
taxpayer’s principal residence. This change applies to use as a second home
as well as a rental.
How does this affect 1031 planning? Suppose the taxpayer exchanged into
the residence and rented it for three years, and then moved into it and
lived in it for two years. The taxpayer then sold the residence and realized
$300,000 of gain. Under prior law, the taxpayer would be eligible for the
full $250,000 exclusion and would pay tax on $50,000. Under the new law, the
exclusion would have to be prorated as follows (the example does not take
into account deprecation taken after May, 1997, which is taxable anyway).
Three-fifths (3 out of 5 years) of the gain, or
$180,000, would be ineligible for the $250,000 exclusion.
Two-fifths (2 out of 5 years) of the gain, or
$120,000, would be eligible for the exclusion.
Importantly, nonqualified use prior to January 1, 2009 is not taken into
account in the allocation. Thus, suppose the taxpayer had exchanged into the
property in 2007, and rented for 3 years till 2010 prior to the conversion
to a primary residence. If the taxpayer sold the residence in 2012 after two
years of primary residential use, only the 2009 rental period would be
considered in the allocation. Thus, only one-third (1 out of 3 years) of the
gain would be ineligible for the exclusion.
The allocation rules only apply to time periods prior to the conversion
into a principal residence and not to time periods after the conversion out
of personal residence use. Thus, if a taxpayer converts a primary residence
to a rental, and otherwise meets the two out of five year test under Section
121, the taxpayer is eligible for the full $250,000 exclusion when the
rental is sold.
This rule only applies to periods after the last date the property is
used as a principal residence. Therefore, if the taxpayer used the property
as a principal residence in year one and year two, then rented the property
for years three and four, and then used it as a principal residence in year
five, the allocation rules would apply and only three-fifths (3 out of 5
years) of the gain would be eligible for the exclusion.
If you have any questions about Section 1031 Exchanges or other real
estate tax issues, I recommend getting in touch with George M. Christofely,
CPA. He's the Vice President and General Manager of the Jersey Realty
Exchange Corporation in Ocean City. You can reach George at 609-391-1031 or
888-871-1031 (toll free). Make sure to tell him I sent you his way.
Jersey Realty Exchange Corporation is in their 14th year of providing
consulting services and documentation to real estate investors, their
accountants and tax attorneys. Since our incorporation in 1994, we helped
investors exchange over two billion, two hundred million ($2,201,530,101)
dollars of real estate, saving them vast sums of capital gains taxes.
Following are some of the topics we encounter on a daily basis:
Exchanges of Vacation Homes
Effective March 10, 2008, the IRS issued a Revenue
Procedure providing a safe harbor under which an exchange of a vacation home
will not be challenged. The highlights of this safe harbor are: (1) The
taxpayer owns the relinquish and replacement properties for at least 24
months immediately before/after the exchange and; (a) The taxpayer does not
use the property for pleasure more than 14 days per year (or 10% of rental
period, whichever is greater) in each of the two years before/after the
exchange (repairs and maintenance days do not count towards personal use
days) or; (b) the property is rented to an unrelated party for at least 14
days per year in each of the two years before/after the exchange. (Rentals
to related parties are permitted if the related party utilizes the property
as a principal residence and pays a fair market value rent.) An exchange may
still fall outside the parameters of this safe harbor and meet the
requirements of a Section 1031 Exchange. Taxpayers are encouraged to review
their specific facts and circumstances with us to determine if they meet the
statutory requirements.
Capital Gains Rates
In 2008, if your taxable income, including long term
capital gains, is in the 10 percent or 15 percent brackets, your long term
capital gains will not be taxed. If your taxable income, including long term
capital gains, is in the 25 percent or higher brackets, a portion of the
long term capital gains will be not be taxed and a portion will be taxed at
a 15 percent capital gains rate. In 2008, the 25 percent bracket begins at a
taxable income of $65,200 for married couples and $32,600 for single
individuals. This benefit to low income taxpayers is scheduled to be
repealed at the end of 2008.
Transferable Development Rights and Land-Use
Credits
In a Private Letter Ruling, the IRS, relying entirely
on the classification under the respective state and local law, ruled that
transferable development rights and land-use credits were “like-kind’ to a
fee interest in real estate and therefore, qualified in an exchange with
real property under Section 1031.
Disregarded Entities
In a Private Letter Ruling, the IRS ruled the
acquisition of a membership interest of a single member disregarded entity
did not violate the 1031 prohibition of exchanging into partnership
interests on the basis the sole member taxpayer is deemed to have acquired
an interest in the real property of the disregarded entity and not an
interest in a partnership.
Related Party Exchanges
Several IRS Private Letter Rulings (PLRs) on the
subject of Related Party Exchanges have been issued during the past year.
Within the 1031 regulations, a taxpayer may sell property to a related party
as long as both parties comply with a two-year holding period. A 2002 IRS
Revenue Procedure indicated a taxpayer may not buy replacement property from
a related party. The recent IRS PLRs have resulted in favorable outcomes for
property disposed of within the two year period and for taxpayers wishing to
purchase replacement property from a related party. Although PLRs have no
basis in law, it appears the IRS is allowing exceptions to the related party
rules where it is evident the parties are not “cashing out” or “basis
shifting”. (Related parties include linear relatives and entities in which
the Taxpayer owns more than a 50 percent interest. Not related are aunts,
uncles, in-laws, cousins, nephews, nieces and ex-spouses.)
Mixed Use Property
In 2005, the IRS issued a Revenue Procedure clarifying
the exclusion of tax on properties used for both business/investment use
(Section 1031) and as a principal residence (Section 121). The procedure
provided guidance and examples for mixed use properties consisting of (a)
two separate structures used concurrently, e.g. Duplex, (b) single structure
used concurrently, e.g. Boarding house, and (c) single structure used
consecutively, e.g. converting a principal residence to a rental property.
The benefit of this Revenue Procedure is the exclusion of the principal
residence gain ($500,000 for married couples and $250,000 for single
individuals) under Section 121 before the deferral of the
business/investment gain under Section 1031, hence avoiding all tax
liability upon sale and allowing the taxpayer to obtain tax-free cash.
State Tax Issues
New Jersey - In
September 2006, the New Jersey Administrative Code was amended to state: “A
deed transferring real property from one legal entity to another legal
entity that has common ownership is subject to the realty transfer fee.”
Taxpayers wishing to convey property to/from an LLC, Subchapter
S-Corporation, Partnership, etc. may find themselves subject to a
significant transfer tax.
New Jersey - Nonresident
individuals, estates or trusts selling an investment property in New Jersey
after August 1, 2004, are subject to an estimated withholding tax remitted
to New Jersey at the time the deed transfer is recorded. The estimated tax
is a minimum of two percent of the gross sales price or 8.97% of the gain on
the property. Exemptions to the withholding tax include property held by a
corporation, partnership or LLC, or non-resident individuals, estates or
trusts selling an investment property under a 1031 exchange. Effective
November 16, 2007, nonresident individuals, estates or trusts must make an
estimated tax payment for the fair market value of non like-kind property
received. Examples of non like-kind property in a real estate exchange would
include cash “boot” received by the taxpayer in a partial exchange, seller
financing or property excluded from the real property exchange such as
personal property, goodwill, and covenants not to compete with a fair market
value. If the above circumstances exist, the taxpayer is required to submit
the Residency Form GIT/REP-3 for the like-kind portion exempted under IRC
1031 and also Form GIT/REP-1 for the non like-kind portion of the sale not
exempted under IRC 1031 along with an estimated gross income tax payment.
The Sellers Residency Certification/Exemption form GIT/REP-3 has been
revised to reflect this change. The exemption to the withholding tax for
individuals, estates and trusts is located on the Seller’s Residency
Certification/Exemption form, box 7.
Pennsylvania - All
taxpayers domiciled in Pennsylvania, except C-Corporations, who exchange
real and personal property within the fifty states, must recognize gain on
the sale of the property on their Pennsylvania tax return. The deferral of
gain under Section 1031 still applies for federal taxes and the remaining
forty-nine states.
Maryland - Nonresidents
of Maryland who have not reported rental income in Maryland are being denied
a waiver of the six percent withholding tax when exchanging property.
South Carolina -
Nonresident Taxpayers exchanging property in South Carolina must place an
estimated withholding tax in escrow with a Qualified Intermediary in the
event the exchange fails or results in “boot”. The buyer of the taxpayer’s
property is ultimately responsible for remitting the tax to the South
Carolina Department of Revenue.
Oregon - Beginning
January 1, 2008, nonresident individuals conveying certain real property
will be subject to a withholding tax unless the seller submits an exemption
form to the state. Included as an exemption are Section 1031 exchanges.
West Virginia -
Beginning January 1, 2008, nonresident individuals conveying certain real
property will be subject to a withholding tax unless the seller submits an
exemption form to the state. Included as an exemption are Section 1031
exchanges.
Nevada - Effective July
1, 2007, Nevada signed a law to protect 1031 exchange consumers by placing
the licensing and regulation of Qualified Intermediaries under the Nevada
Department of Business and Industry’s Financial Institutions Division, which
has oversight of state-chartered lending and depository institutions.
For additional no-cost information call:
George M. Christofely, CPA
Vice President and General Manager
JERSEY REALTY EXCHANGE CORPORATION
701 West Avenue * Ocean City, New Jersey 08226
609-391-1031*Toll Free 888-871-1031* Fax: 609-391-0101
This publication is designed to provide accurate
information on tax deferred exchanges. The publisher is not engaged in
rendering legal or accounting services. If legal or tax advice is required,
the services of a competent professional should be sought.
Jersey Realty Exchange Corporation is in their 13th year of providing
consulting services and documentation to real estate investors, their
accountants and tax attorneys. Since our incorporation in 1994, we helped
investors exchange approximately two ($2) billion dollars of real estate,
saving them vast sums of capital gains taxes. Following are some of the
topics we encounter on a daily basis:
Related Party Exchanges
Several IRS Private Letter Rulings (PLRs) on the
subject of Related Party Exchanges have been issued during the past year.
Within the 1031 regulations, a taxpayer may sell property to a related party
as long as both parties comply with a two-year holding period. A 2002 IRS
Revenue Procedure indicated a taxpayer may not buy replacement property from
a related party. The recent IRS PLRs have resulted in favorable outcomes for
property disposed within the two year period and also for taxpayers wishing
to purchase replacement property from a related party. Although PLRs have no
basis in law, it appears the IRS is allowing exceptions to the related party
rules where it is evident the parties are not “cashing out” or “basis
shifting”. (Related parties include linear relatives and entities in which
the Taxpayer owns more than a 50 percent interest. Not related are aunts,
uncles, in-laws, cousins, nephews, nieces and ex-spouses.)
Mixed Use Property
In 2005, the IRS issued a Revenue Procedure clarifying
the exclusion of tax on properties used for both business/investment use
(Section 1031) and as a principal residence (Section 121). The procedure
provided guidance and examples for mixed use properties consisting of (1)
two separate structures used concurrently, e.g. Duplex, (2) single structure
used concurrently, e.g. Boarding house, and (3) single structure used
consecutively, e.g. converting a principal residence to a rental property.
The benefit of this Revenue Procedure is the exclusion of the principal
residence gain ($500,000 for married couples and $250,000 for single
individuals) under Section 121 before the deferral of the
business/investment gain under Section 1031, hence avoiding all tax
liability upon sale and allowing the taxpayer to obtain tax-free cash.
Private Annuity Trusts
The IRS has issued proposed regulations to prohibit
the exchange of highly appreciated property for annuity contracts, hence
making these transactions taxable at the time of the attempted exchange. If
adopted, the regulation would apply retroactively to exchanges taking place
after October 18, 2006. We will keep you apprised of developments as they
occur and highly recommend the taxpayer avoid this type of replacement
vehicle.
State Tax Issues
New Jersey - In
September 2006, the New Jersey Administrative Code was amended to state: “A
deed transferring real property from one legal entity to another legal
entity that has common ownership is subject to the realty transfer fee.”
Taxpayers wishing to convey property to/from an LLC, Subchapter
S-Corporation, Partnership, etc. may find themselves subject to a
significant transfer tax.
New Jersey - Nonresident
individuals, estates or trusts selling an investment property in New Jersey
after August 1, 2004, are subject to an estimated withholding tax remitted
to New Jersey at the time the deed transfer is recorded. The estimated tax
is a minimum of two percent of the gross sales price or 8.97% of the gain on
the property. Exemptions to the withholding tax include property held by a
corporation, partnership or LLC, or non-resident individuals, estates or
trusts selling an investment property under a 1031 exchange. The exemption
to the withholding tax for individuals, estates and trusts is located on the
Seller’s Residency Certification/Exemption form, box 7.
Pennsylvania – All
taxpayers domiciled in Pennsylvania, except C-Corporations, who exchange
real and personal property within the fifty states, must recognize gain on
the sale of the property on their Pennsylvania tax return. The deferral of
gain for federal and the remaining forty-nine states still applies.
Maryland – Nonresidents
of Maryland who have not reported rental income in Maryland are being denied
a waiver of the six percent withholding tax when exchanging property.
Mississippi – Taxpayers
exchanging property from Mississippi to another state are subject to a five
percent tax in Mississippi.
South Carolina – Nonresident Taxpayers exchanging property in South Carolina
must place an estimated withholding tax in escrow with a Qualified
Intermediary in the event the exchange fails or results in “boot”. The buyer
of the taxpayer’s property is ultimately responsible for remitting the tax
to the South Carolina Department of Revenue.
Real Property – What is “Like-Kind”
Exchanging real property within Section 1031 of the
tax code provides a taxpayer with many opportunities to diversify their
investments. Often, the determination of whether a property is “real
property” lies within state law. The more common exchanges may involve an
apartment building for a vacant lot, a duplex for a single family dwelling,
and so on. Less common, albeit viable options, include exchanging the
previously mentioned real property for tenant-in common interests,
conservation easements, leases with terms of 30 years or more, co-operative
apartments, timber rights, water rights, oil, gas and mineral interests,
supply contracts, and many more. Call us for additional information.
Personal Property and Intangibles Too!
“Like-Kind” exchanges are not limited to real
property. Personal property can be exchanged for other like-class personal
property and certain intangibles are exchangeable for other intangibles. The
more common exchanges may involve furniture, fixtures, equipment and liquor
license upon the sale of a restaurant, bar, motel or bed and breakfast inn.
Less common in the Northeast are exchanges of airplanes, fleets of autos,
boats, livestock and copyrights, to name a few. It is imperative to involve
us in the initial contract negotiations to help identify exchangeable versus
non-exchangeable assets. For example, goodwill is not exchangeable and may
result in an unexpected tax liability for the taxpayer.
Frequently Asked Questions
Can 1031 funds be used as a
good faith deposit for replacement property and who is allowed to receive
these funds without disqualifying the exchange? Funds held in a 1031
exchange can be utilized for a good faith deposit on replacement property
providing a signed Agreement of Sale is assigned to the Qualified
Intermediary and the funds are not being forwarded to an agent of the
taxpayer. Title companies and Seller’s agents are generally safe harbors, or
as an alternative, we can issue an escrow letter verifying the amount of
funds held in the 1031 account.
Can my attorney act as a
closing agent in a 1031 exchange? Attorneys acting as closing agents
at the direction of the Qualified Intermediary are common practice. However,
attorneys performing legal services for the taxpayer during the past two
years, other than the exchange transaction, are considered “disqualified
persons” and may jeopardize the exchange. An astute Qualified Intermediary
will suggest an alternative means of completing the exchange.
Do vacation homes qualify for
1031 exchanges? Vacation homes may qualify as investment property
under the definition of Section 1031 if the personal use is minimal, or if
the property is also rented. If the property is held for two or more years,
the IRS evaluates the predominate use of the property and intent of the
taxpayer for the two years leading up to the exchange and the two years
following the acquisition of the replacement property. The evaluation period
is equal to the ownership period where ownership is less than two years.
Can I acquire replacement
property in an exchange prior to selling my property? Under the safe
harbor of Reverse Like-Kind Exchanges, the IRS permits the acquisition of
replacement property prior to selling the relinquish property. However, the
acquisition is made by an Exchange Accommodation Titleholder on behalf of
the taxpayer. The Taxpayer should anticipate additional time constraints,
fees, transfer taxes, and financing costs when desiring to enter into a
Reverse Exchange. Call us for more details.
Can U.S. property be exchanged
for foreign property? Property located within the United States is
not like-kind to property located outside the United States with exceptions
for a few U.S territories, e.g. U.S. Virgin Islands (certain conditions
apply).
For additional no-cost information call:
George M. Christofely, CPA
Vice President and General Manager
JERSEY REALTY EXCHANGE CORPORATION
701 West Avenue * Ocean City, New Jersey 08226
609-391-1031*Toll Free 888-871-1031* Fax: 609-391-0101
This publication is designed to provide accurate
information on tax deferred exchanges. The publisher is not engaged in
rendering legal or accounting services. If legal or tax advice is required,
the services of a competent professional should be sought.
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