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Bifurcating Closings Can Add Flexibility to Your 1031 Exchange
"bi‚fur‚cate:
verb, meaning to divide into two parts."
"Bifurcate"
in real estate terms means to divide into two
closings. Bifurcating your closing can
result in some serious 1031 benefits for you. In
the correct situation it can really supercharge
your exchange.
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by
Gary Gorman
Founding Partner,
The 1031 Exchange Experts |
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Let's
take a hypothetical situation and let me show you
how this works: Let's say that you are selling a
large piece of land for $10 million. This land is
composed of two parcels: one 20 acre and one 30
acre for a total of 50 acres.One
of the requirements for a 1031 exchange is that
within 45 days you have to identify a list of properties
you might buy. If your list has three properties
or less, there are no limitations. However, if your
list exceeds three properties, you are subject to
the "200 Percent Rule" of Section 1031, which requires
that the combined total purchase price of everything
on your list can not exceed twice the selling price
of the Old Property.
...In
the correct situation, Bifurcating can
really supercharge your exchange... |
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In
other words, if you only place three properties
on your list, and the purchase price of each property
is $25 million, you're okay. But if you put four
or more properties on the list, the total
combined price of all the properties can not exceed
$20 million (i.e. $10 million x 2).
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appeared in... |
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August
4, 2004 |
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problem you have in this robust market is it can be
tough to find three properties that meet your criteria
and can survive your due diligence. Another problem
is that $10 million is a big chunk to reinvest, and
you may have to settle for several smaller properties
in order to meet the $10 million "equal-or-up" target
imposed by Section 1031. Wow! A hot real estate market
where properties move fast; value vs. pricing challenges;
and reinvesting to satisfy a larger equal-or-up requirement
-- these are difficult issues! So, how do we tackle
these problems?
This is where bifurcating the closing can work to your
advantage. Let's say you split the contract into two
different closings: $4 million for the 20 acre parcel
and $6 million for the 30 acre parcel. The two separate
closings create two separate exchanges, which gives
you three unlimited identifications for each closing,
for a total of SIX. This also means
you are working with two smaller exchanges which can
make finding replacement property easier.
So
what happens if you find two replacement properties
"A" and "B," each for, say, $5 million? This is not
a problem for the 'little' sale, because your equal-or-up
target ($4 million) is less than the purchase price
of either of the two New Properties. But the 'bigger'
sale ($6 million) is a problem because to avoid paying
tax you need to exceed the purchase price of either
$5 million lot.
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The solution is to identify "Property A" for $5 million,
IN ADDITION TO 20% OF "PROPERTY B," as your replacement
for the $6 million property so you can defer all the
tax. Then identify 80% of "Property B" to replace the
$4 million property.
...This
also means you are working with two smaller
exchanges which can make finding replacement
property easier... |
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How does the IRS view bifurcating your sale? There are
indeed cases disallowing an exchange where they decide
that bifurcation is being used to accomplish the things
I've talked about above. The best way to avoid this
is to have separate contracts for each lot. Secondly,
try and have the closings on two different days. And
thirdly, see if the buyer of one part of
your sale is willing to purchase the other part
of your sale as a different entity, like an LLC. How?
In most cases the same buyer will buy both properties,
but if the buyer is accommodating, you might be able
to get him to set up a single member LLC to take title
to one of the properties.
Choosing an experienced Qualified Intermediary for this
strategy is essential.
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