1031 News This Week


The Role of Debt in a 1031 Exchange

The role that debt plays in a exchange is probably one of the most misunderstood areas of 1031 law. Many people (including qualified intermediaries, CPAs, and attorneys) believe that you are required to have debt on your New Property in an amount equal to or greater than the debt that was paid off on your Old Property. This is NOT, In fact, a requirement for a 1031 exchange.

The actual requirement is two fold: you must buy equal or up, and you must reinvest all of the cash. Assume for example that you sell a purple duplex for $100,000 and you buy a replacement property for $90,000. You did not buy equal or up; in fact you bought down. As a result, the $10,000 buy-down is taxable—yes, the entire $10,000 is taxable, and you do not apportion any of the original cost of the duplex to this gain.


What Year is “Boot” Taxable in a 1031 Exchange?

Boot is the term that the IRS uses for the part of an exchange that is taxable. Boot generally arises for one of two reasons: the Seller bought down, or the seller did not reinvest all of the cash from the sale of Old Property. Most of the year, it doesn't matter what caused the boot: it's simply taxable. But when a transaction overlaps the end of the year, the year of taxability becomes important.


Predictions of Things to Come for 1031 Exchanges

Around the end of most years I write a column predicting what you are likely to see in the 1031 arena over the following 12 months. I recently spent an afternoon in a meeting with one of the people responsible for Section 1031 of the tax code for the IRS. Based on that meeting, what follows are my predictions of changes to look for during the next year.

Tightening of the requirements for qualified intermediaries -The IRS knows that they have problems with what they call “Accom-modating Accommodators.” These people are qualified intermediaries (QI) who are pretty loose with the requirements of a 1031 exchange. The problems range from these QIs regularly allowing clients to do 1031 exchanges on fix-and-flips, to their allowing clients to change their identification letter after the 45th day. The IRS knows they are out there, but it is not always easy for them to tell who these intermediaries are.


Capital Gains Without Tax

1031 Exchanges allow you to defer the taxes over capital gains generated on the sale of an old property to be exchanged for a new property. Sooner or later, whoever wishes to make money in the Real Estate market in the United States understands that this is a serious mechanism to consider.

Popular wisdom has many proverbs allusive to the details, in which the part that world investments transactions play can hardly be ignore. Sometimes this transactions looks like angels, sometimes like demons. In the case of Real Estate and in the context of the opportunities that real its boom presents in the South Florida area, thousands or millions of dollars can be spared.


More Partnership and LLC Issues In 1031 Exchanges

One of the requirements of a 1031 exchange is that the entity that sells the Old Property must be the same entity that acquires the New Property. Where the property is owned by a partnership or a limited liability corporation (LLC) with multiple partners, the partnership or LLC is viewed as the exchanging entity.


Partnership and LLC Issues In 1031 Exchanges

One of the requirements of a 1031 exchange is that the entity that sells the Old Property must be the same entity that acquires the New Property. Where the property is owned by a partnership or a limited liability corporation (LLC) with multiple partners, that entity is viewed as the exchanging entity.

A common question posed to our firm involves situations where the property is being sold, but one or more of the partners wishes to take their share of the cash and pay the tax, while the rest of the partners want to stay in real estate and desire to do a 1031 exchange. Let's use the FGH Partnership as an example where F, G, and H each own an equal one-third interest in the partnership. The partnership has entered into a Purchase and Sale contract to sell the Old Property. F and G wish to stay in real estate and have decided they want to do a 1031 exchange. H, however, has decided that it's time to cash out and wants his share of the cash.


Why 'flipping' won't work in a 1031 exchange

In a real estate market that is moving as fast as Florida's, "flipping" property seems to be the favorite pastime for many people. Flipping is when you buy a property with the intent of selling it very soon after the purchase. But can you do a 1031 exchange and defer the gain in a flip situation?

In order 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 refers to intent to hold the property for future appreciation. Used in a trade or business means income producing, like rental property. In a flip, you've never rented the property, so it's not income producing. So the question really is, "Did you hold it for investment?"


Are Contracts Exchangeable?


The “Contract Question” provides more questions than answers...

In certain areas of the country, real estate prices have been skyrocketing. It is not uncommon to see properties double in price over the course of a year -- even before the builder has completed construction! This phenomena has created a situation we are seeing more and more in the 1031 exchange business. Many investors are getting property under contract (pre-construction) and selling that contract prior to closing on the purchase at a substantial profit. In this situation, can they perform 1031 exchange?

As an example, Ivan Investor sees a new condominium development planned for completion in about a year and a half. Ivan plans to buy a unit and rent it out once it is completed. So, Ivan gets a unit under contract for a purchase price of $300,00


What is a “Reverse” 1031 Exchange?

A 1031 exchange is a valuable tax shelter when you sell investment or business property. Instead of just selling, you take the money you had invested in your Old Property and reinvest in a New Property ("exchanging" the Old for the New) through a Qualified Intermediary (or Q.I.), following I.R.S. guidelines.

Pay attention to the term "New." To complete a 1031 exchange that will qualify under the rules, you have to acquire a property that is new to you -- meaning, you can't apply your sale proceeds to a property you already own, or even a property that you have owned any time in the past 18 months. This means you can't have an exchange if you ever own the Old and New Properties simultaneously.


The "Year-and-a-Day" Rule: Great advice, but it's not The Law

Recently we encountered a great deal of confusion concerning 1031 Exchanges and the so-called "year-and-a-day" rule. You've probably heard that you should hold both your Old and New Properties for at least a year-and-a-day prior to and after completing a 1031 Exchange -- and this remains sound advice.

However (and this is a HUGE "however") THE "YEAR-AND-A-DAY RULE IS NOT THE LAW. Nowhere in Section 1031, the regulations, tax court decisions, or any other authority will you find any mention of a "year-and-a-day" rule. The "year-and-a-day" rule is only a guideline divined from a few Tax Court decisions, a non-binding IRS ruling stating that holding property for at least two years in a particular instance was fine, and common sense considerations - for instance, long-term capital gains kick-in after holding property for a year.


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