1031 News This Week


Dealer-Developer Issues Can Jeopardize Your 1031 Exchange

If you do a number of 1031 exchanges every year, you should be aware of the Dealer/Developer issues. To qualify for a 1031 exchange, a taxpayer must be able to prove their “intent” at the time of purchase was to hold the property for investment.

According to the I.R.S., real estate held as “stock in trade or other property primarily for sale” is excluded from the tax benefits of Section 1031. Listed here are some factors the IRS uses to determine if there was intent to hold property for investment:

• Length of Ownership The nature and purpose for buying the property.

• Consistent with Investment Activity Has the tax-payer’s investment income and expenses on tax returns been consistent with investment activity? (It’s a good idea to NOT file a Schedule C for the 1031 property, or classify it as “inventory” or “held for development.”)


Can You 1031 Exchange A Fix and Flip Property?

Once again, it seems that many real estate investors are buying distressed properties, fixing them up, and putting them back on the market right away. And then they call us and want to do a 1031 exchange and roll the gain over into the next property. But can they?

To qualify for a 1031 exchange, (which rolls the gain from the sale of the Old property to the New), both properties have to be held as an investment or used in a trade or business. Held for investment means holding the property for future appreciation. Used in a trade or business means income producing, such as used in a business or used as a rental property. Typically with a fix and flip, you’ve never rented the property, so it’s not income producing. So the critical question then becomes: “did you hold it for investment?”


Have Your Cake and Eat It Too: Converting 1031 Property into Your Personal Residence

Suppose several years ago you did a 1031 exchange and bought a charming rental property in a nice urban area as your replacement property. Now you’re planning retirement and are considering downsizing, making your rental property your residence. Will the IRS let you? If so, are there strings attached?

...Now you’re considering downsizing. Will the IRS let you? If so, are there strings attached...?

Section 1031 allows you, subject to certain rules, to sell an investment property and roll the gain over to a replacement investment property. The new property must be an investment property, so no – you couldn’t sell your rental and buy a different house that would be more comfortable for you to immediately move into.


A 1031 Exchange Could Save You a Ton of Tax!

I'm constantly amazed at how many millions, probably billions, of dollars are paid in taxes each year by people who could avoid all of the tax on the sale of their property by taking a few simple steps. Section 1031 is such a beneficial part of the Internal Revenue Code that it’s a shame most tax and legal professionals don’t know about it. And many of those who are aware of it don’t really understand it.

Section 1031 is a code section—its law, not some theory or gimmick. It allows you to roll the gain from the sale of your “old” investment property into the purchase of your "new" investment property. In other words, you defer the gain until some point in the future when you are ready to pay the tax. And yes, there are ways that will result in you having to never pay the tax.


Handling Debt in a 1031 Exchange: It’s Easier Than You Think

One of the most confusing and misunderstood parts of Section 1031 is how debt is handled in an exchange. Recently some of our clients have had to deal with the pain of overleveraged property and, not surprisingly, want as little a debt as possible when they make a new purchase. And because loans are harder to get right now, some lenders require much larger down payments. The net result is that questions about the required amount of debt on the new property are common.

Someone, after Congress rewrote Section 1031, made the statement that the debt on the new property had to be at least equal to the debt that was paid off on the sale of the old property. History doesn’t reveal to us who first said it, but it has since been repeated so many times it’s now considered ‘fact’ by many exchange professionals, including many CPAs and attorneys.


Reviewing the 1031 Identification Rule


Section 1031 is an IRS code section that lets you defer tax (in some cases a LOT of tax). Of course, they don’t make the deferral easy, but it's not impossible, either.

One of the rules that causes a lot of angst, especially in a fast-moving real estate market like we have now, is the requirement that within 45 calendar days you must identify a list of properties you might want to buy. Whatever you buy to complete your exchange must be on this list. The identification is made on a form provided to you by your Qualified Intermediary (the 1031 specialist that the law requires you use to guide you through this process).


The Future of 1031 Exchanges In A Trump Congress

Although Donald Trump has been President for less than 50 days (as I write this), certain things about him and his agenda are becoming clear: he has a very clear vision about what he wants to accomplish, and he is very determined to push his changes through. 

Tax reform is high on his agenda, and because he has a Republican majority in both the House and the Senate, it’s likely there will be some form of tax legislation proposed later this year. Since I’m a retired CPA and I make my living in the Section 1031 tax arena, I’m very concerned about the possibility of changes to this Code Section and how these changes would impact my clients. 


Can I 1031-Exchange My Tiny House?

Wikipedia defines a small house as one ranging from 400 to 1,000 square feet.  A tiny house is one that is less than 400 square feet.  Do people really live in spaces that small? Actually, yes – and they’re more common and popular than you might imagine.  I don’t know if they’ve always been out there and I just never noticed (probably), or if it’s a completely new trend that just popped up and made popular by the numerous TV programs that have sprung up recently.


Handling Closing Costs in a 1031 Exchange

A 1031 exchange rolls the gain from the sale of your old property over to your new property. To qualify for an exchange, both the old property you’re selling and the new property you’re buying have to be investment property, so oftentimes rental property is what’s being sold and/or bought in the exchange. When you’re dealing with investment property in a transaction, you’re effectively buying or selling two things: the property itself, and the rental business. The money you receive (if you’re selling) for these two items, or pay (if you’re buying) is handled differently for tax and 1031 exchange purposes. To get to the proper handling of each item on a settlement statement, it’s helpful if you think in terms of selling or buying the property versus buying or selling the rental business.


Turning 1031 Exchange Property into Your Personal Residence

When you sell your personal residence (the house you live in), the IRS says $500,000 of the gain ($250,000 if you’re single) is tax free. There are some things that you have to do to qualify for this benefit, the most important of which is that you must live in the house for at least two of the last five years.

There is a different code section, Section 1031, that says if you sell a house that’s been a rental for at least the last year (or two years in some situations), you can roll the gain from the old house to the new house and defer the tax on the gain until you sell the new house.

Sometimes these two IRS rules overlap. For example, when you sell your residence, it has to have been your residence for two of the last five years. Two of the last five… so what was happening during the other three years? Well, if you’ve lived in the house for all five years there’s no problem – just sell the property and $500,000/$250,000 of gain is forgiven.


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