Over the past 17 years, we have had the pleasure of guiding thousands of Exchangors through the 1031 Exchange process. Our Blog draws from that experience and includes content ranging from the basics of an Exchange for first time Exchangors to detailed commentary on complex exchanges for the expert investor. If you do not find the topic or specific question you are looking for, reach out to us via email at info@atlas1031.com or call our office to speak with our team at 1 800 227 1031.
For the uninformed, 1031 exchanges can be confusing, yet for those who have initiated them, they are an effective strategy to defer the federal and state capital gain and depreciation recapture. Some believe that all that is needed is for someone to hold the exchange funds. Nothing could be farther from the truth. If that is what you are being told you are potentially headed for trouble.
If you are a tenured investor who has built a portfolio of diverse properties, a 1031 exchange is an exceptional tool to assist in continuing to add to, diversify or consolidate your holdings. A common misconception exists around 1031 exchanges that a single investment property must be exchanged for a single like kind investment property. This is incorrect. In fact, the ability to trade a single investment property for multiple properties, or in reverse; multiple properties for a single property gives the savvy investor the flexibility to adjust their portfolio according to their needs. Continue reading
One of the many questions that people ask a Qualified Intermediary of 1031 tax deferred exchanges is how long the relinquished property needs to be held to qualify for a 1031 exchange? The answer represents one of many ways to develop a fact pattern that supports a 1031 exchange. As you recall, a 1031 exchange allows the taxpayer to defer or postpone the payment of federal and state capital gains and depreciation recapture taxes, when real property held for the production of income for a business or investment is replaced with real property of equal or greater value than the relinquished property’s net sales price. What is not eligible for tax deferral treatment is a primary residence, Section 121 transaction, or second home.
Dwelling Unit
The IRS released Revenue Procedure 2008-16, effective March 10, 2008, to provide a safe harbor test for dwelling units, vacation homes, and second residences that the IRS will not challenge if the home qualifies for a 1031 exchange. A dwelling unit is defined as real property with improvements such as a house, apartment, or condominium (which accommodates the standard requirements of a kitchen, sleeping room, and bathroom).
Hold Time
The safe harbor test is that the taxpayer must own the relinquished property for at least 24 months prior to the exchange, and in each of those two years, the property must be rented for at least 14 overnights, or 10% of the yearly overnights if greater than 14 personal overnights (including when friends and family stay without paying fair market rent). The replacement property must also be held for 24 months with personal use being no more than 14 overnights each year. One must also rent the property for at least 14 overnights, or 10% of the rental nights if greater in each of the two years. For time used while performing repairs and maintenance, the full day does not count towards personal overnight use.
The 1031 code does not state a hold time. When asked, the IRS said that a two-year hold is sufficient (Rev. Proc. 2008-16 provides the hold time). What about dwelling units held outside the safe harbor? There is limited authority that supports vacation homes or dwelling units that do not meet the 14 rental overnights. Regulation Section 1.1031(a)-1(b) states unproductive real estate that is held by a non-dealer for future use or appreciation is held for investment. Tax court case Newcombe v. Commissioner of Internal Revenue, 54 T.C. 1298, 1302, 1970 WL (1970) supports the taxpayer who “believes that the value of the property may appreciate and decides to hold it for some period after the abandonment of personal use in order to realize, upon such anticipated appreciation, the property can be held for production of income.”
The suggestion is to hold the relinquished property for at least one year and a day to qualify for long-term capital gain. Holding for a shorter period triggers a short-term capital gain tax or the taxpayer’s ordinary income tax rate.
Long thought of as the retirement capital of the United States, Florida is reinventing itself as the new national destination for real estate investment. According to a February 2018 Forbes article, “Best Buy Cities: Where to Invest in Housing in 2018” by Samantha Sharf, Orlando is ranked first in the country for value in real estate investment. Sharf and the team at Forbes highlight Orlando’s 7.1% job growth over the last two years as well as the 7.6% population growth over the past three years as strong factors in addition to their Local Market Monitor’s speculation that the prices of homes in Orlando could increase another 35% by 2021. With Orlando’s average home value still sitting roughly 22% below the national average, the opportunity for first-time and long-time investors to build or expand their portfolio has never been better.
President Trump signed into law the Tax Cut and Jobs Act taking effect January 1, 2018, changing the 1031 tax deferred exchanges that were first imposed in 1921. The major change to the 1031 code is the removal of tax deferral treatment for tangible and intangible personal property, including assets such as collectible cars, aircraft, gold and silver bullion, equipment, cars and trucks, franchise fees and licenses. Tax deferred exchanges for real property were maintained.
A 1031 exchange defers the federal and state capital gain when a taxpayer sells real property held for rental outside the US and replaces with like-kind real property of greater value internationally. Navigating the social norms with attorneys, banks and closing entities can be a huge challenge given those entities know very little if anything of a 1031 exchange. When the words, Internal Revenue Service are mentioned, many entities may elect to not participate or say no to the accommodator’s requests. Continue reading