The real estate market over the past year has been impacted due to a number of reasons including the media, political climate, and the economy. During these times it is very important to expand your business by learning alternative ways to help people buy and sell houses. A few of them are through 1031 exchanges, purchasing homes using your IRA, and through understanding how to do short sales and foreclosures.
One of the very basic guidelines in doing a 1031 exchange is that you have to exchange property for like property. Like kind real estate means any other investment real estate other than your personal residence. That can mean exchanges from land to condos to commercial property or anything in between as long as it is investment property. A 1031 exchange allows you to be in what type of real estate that you want to be in. This program allows the purchaser to defer from paying capital gains tax at the time of the exchange. The depreciation recapture is taxed at 25% and a 1031 exchange allows the tax payer to defer the depreciation recapture as well. A 1031 exchange works well for people that want to diversify their estate and it can also help people simplify their lives.
The general rules are as follows; the tax payer can never control the money during the transaction. It must go through an intermediary. The intermediary will prepare all of the paper work and verify that the purchaser has the right intent, has performed all the functions and has followed all the deadlines properly. They also hold the funds beyond the taxpayers control which is one of the rules. At the closing, the intermediary receives the funds and then disburses them to the new property closing. The owner never touches the money.
The deadlines are very firmly enforced and the only extensions are due to natural disasters when the IRS might give a blank extension to properties or taxpayers impacted by the disaster. No extensions are granted for weekends or holidays. The taxpayer will have 45 days from the day of closing to identify the new property and 180 days to close on the replacement property (the 180 days is actually the shorter of (i) 180 days or (ii) the date the taxpayer’s tax return is due, including extensions). The 45 day indentifying period is a part of the 180 day deadline to close. If the taxpayer has not identified a property on the 46th day or closed on the replacement property by day 181 the taxpayer will receive the exchange’s proceeds and will not qualify for the delayed tax benefit.
The property must be identified so that it can be located. You cannot describe the property generally as a lot or in a subdivision or a unit in a condominium project. It must be identified specifically in detail such as an address, unit number or lot number.
The indemnification rule is that the taxpayer can identify up to three properties without having to list a value on the identification. There is also the 200% rule. If you want to identify more than three replacement properties then you have to list a fair market value next to each property and the aggregate value together cannot be more than 200% more than the property that you have sold. So, if you have sold something for $200,000 and you want to purchase 4 properties then the aggregate value cannot be more than $400,000. Finally, there is the 95% rule that comes in effect if the taxpayer is unable to comply with the previous two rules. It states if you go over the three properties and over the 200% then you have to purchase 95% of the market value of properties that you identified.
To fully defer your capital gains taxes until you sell the property you need to trade equal or up in value, equity and debt. You have to sell something at a lower value than what you purchase and transfer the equity to the new purchase and also replace the debt of the old property either with new debt or cash that you’re putting in to the new property.
Anything that you get with an exchange that is not like kind property is called taxable boot. If you take cash out either upfront or at the end it is called boot. You can also have mortgage boot if you are paying off the property that you’re selling and you are not offsetting it with another mortgage or cash greater than the sale.
The requirement for the contract using a 1031 Exchange is that it is assignable to the intermediary and the parties are made aware of it. The contract actually gets assigned by the seller to the intermediary on the relinquished property. This is normally not a problem because the contract does not prohibit the seller from assigning it. It is advised that you include in the contract verbiage that states “Buyers to participate in sellers’ 1031 like-kind exchange transaction at no expense to buyer” On the new purchase it is important to have the language in the contract notifying the seller that it will be assigned to an intermediary as part of a 1031 exchange and will not affect the seller because most contracts prohibit the buyer from assigning the contract to anyone else.
I wanted to touch briefly on TICS. They are Tenants in Common Interest Sales that are purchased through a 1031 exchange. The dealers must be licensed as security dealers and they are sold like stock. Up to 36 people can do a deal together. It might be an option if you want to get away from traditional tenant and instead invest in a shopping strip or a big project.