1031 News This Week


A reverse exchange could be your solution in this current real estate market

The One problem that comes up in almost every conversation I have with clients right now is how hard it is to find a replacement property. There’s very little inventory, and worthwhile properties get scooped up immediately. As a result, many of my clients are afraid to pull the trigger on their sale. A reverse exchange could be their solution in this dilemma.

Just as its name implies, a reverse exchange allows you to take advantage of the tax benefits of a 1031 exchange, but instead allows you to purchase your new property before you sell your old one. In a reverse exchange, your qualified intermediary takes title to the new property and holds it until you close the sale of your old property. This allows you to tie down the purchase of your new property before you pull the trigger on the sale of the old.


What's the future of 1031 exchanges?

There is still talk coming out of Washington, DC, concerning tax reform of some type that might yet happen during the two and a half years Obama has left in his term. Certainly the landscape has changed now that the Republicans control both the House and the Senate, and yet the talk continues. It seems unlikely at this point that Congress and the White House would ever agree on any type of individual tax reform; however there seems to be some middle ground for reforms involving entities (corporations, partnerships, trusts, etc.).


Refinancing 1031 Property In An Exchange


To refinance or not to refinance: this is the common question many 1031 exchangers ask.

By refinancing, exchangers are usually hoping to pull money (cash) out of their sale transaction to use for purposes other than investing in new 1031 property.

To answer the question, we need to understand the timing of the refinance. Based on the whether you, the taxpayer, are pulling money from the old relinquished property or from the new replacement property, the IRS has varying positions. 

When refinancing the old property, a key 1031 exchange requirement drives the IRS’ position. The taxpayer cannot receive, touch or control the funds generated from the sale of the old property during the period until the purchase of the new property. Does refinancing the old property right before the exchange constitute “receiving money”?


1031 Exchanges on Property with Passive Activity Losses

Prior to 1986, taxpayers bought real estate for their tax losses as much as for their investment potential. I remember those days and it seemed that in many cases the investor was only interested in the amount of loss that a property could throw off. High-income individuals used these losses to reduce the tax on their high personal income.


California puts teeth in their 1031 Exchange Claw-Back rule

Several years ago, the State of California adopted a claw-back rule for 1031 exchanges when the sale property is in the State of California and the replacement property is in a different state.

Like most states, California does not tax sales of real estate when the taxpayer does a 1031 exchange and rolls the gain over to a replacement property. Typically, when you sell a property in one state and buy in another state (doing a 1031 exchange), the selling state loses the tax revenue that would have resulted from the sale if it were not a 1031 exchange.

Several years ago California broke with that tradition and revised their 1031 law to hold that when the taxpayer ultimately sells the property in the replacement state in a taxable transaction, the taxpayer must report the original gain to California and pay tax on it. For example, Sue sells a rental property in California and rolls a gain of $100,000 into a property in Denver, Colorado by doing a 1031 exchange.


A Look At Ownership Issues in a 1031 Exchange

A basic rule of 1031 exchanges is that the taxpayer who owns the old property must be the one that does the exchange and takes title to the replacement property. For example, if Fred Jones owns the old property, Fred Jones must be the one who takes title to the new property—he can’t take title as Jones Investment Corporation because the corporation is a different taxpayer.

While that seems fairly straight forward, there are some aspects that can be confusing. For example, suppose Sue owns a rental condo before she and Fred got married but she didn’t add Fred to the title after they were married. Now she’s selling the condo and wants to exchange into another rental property and add Fred to the title of the new property. This exchange would be disallowed because the IRS could rule on audit that she only bought half of the new property (and Fred bought the other half).


A NEW LOOK at who can do a 1031 exchange

I’m getting a lot of questions right now about who can do a 1031 exchange, so let’s take another look at the rules. Section 1031 says that the taxpayer is the one who sells the old property, buys the new property and reports the exchange. It sounds simple, but what does this mean?


Renting 1031 Exchange Property to a Relative

A common question I get is whether you can rent an exchange property to a relative. Most typically the client wants to buy a replacement property that they can rent to their son or daughter. The answer is yes you can – provided that you strictly follow two basic rules: 1) the rent you charge has to be fair market value for that type of property, and 2) your rental agreement must be in writing and you must enforce the terms of the agreement (most importantly the clause dealing with the late payment of rent).

By far, the most important of the two rules is the fair market value requirement, and a recent court case shows just how important this rule is. 


1031 Bifurcation - it also works on the Buy side

I've written a couple of articles over the years about bifurcating a sale into at least two parts so that you can take advantage of Section 1031 and roll the gain over to a replacement property. “To Bifurcate” means to split something into two parts. For example, separating the sale of a ranch between the residence portion (which does not qualify for a 1031 exchange if you live in the residence) and the ranch land and outbuildings, which in most cases do qualify for a 1031 exchange.

But bifurcation also works when you buy a property. You can sell a rental house and use the 1031 exchange proceeds to buy ranch land and outbuildings as your replacement property, and use personal funds to buy the residence portion of the property to live in. Similarly, you could sell the rental house and buy a percentage of a large property (like an office building) as your replacement property, while a partner buys the balance of the property. 


Crystal Ball Gazing - 1031 Exchanges in 2013

Again, at this time of year, I'm writing my usual end-of-the-year prediction on where I see the 1031 exchange industry going in the coming year (which in this case is 2013).


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