1031 Exchange Blog

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.

Realtors Should Know Three 1031 Exchange Keys

Posted on | by Tom Gustafson | Leave a Comment on Realtors Should Know Three 1031 Exchange Keys

Realtors are usually one of the first to determine that a 1031 exchange should be considered when an individual, husband and wife or company is selling real estate. “Usually” is the operative word given the seller may not share their intent to replace with another property. Nonetheless, whenever the seller is selling a property that is not their primary residence, the question, “Does a 1031 exchange make sense?” should be asked. Be sure to have a couple of qualified intermediaries to refer who can readily answer questions. As a qualified intermediary (QI), I receive calls from sellers and Realtors who just closed or closed the selling transaction a couple of weeks ago to ask “Is it too late?” Yes, once the seller has access to the net proceeds, the exchange cannot take place unless the transaction is unwound and restarted.

1031 Exchange

A 1031 exchange allows the seller to defer federal and state capital gain and depreciation recapture taxes when selling and replacing with like-kind property. To avoid discussing taxes, the suggestion is for the seller to visit with their CPA to determine the tax consequences of the sale. If the result is not to enter into a 1031 exchange, at least the Realtor has provided the guidance for the seller to determine with the financial counsel whether a 1031 makes sense.

A 1031 exchange is either a forward or a reverse. In a forward, the relinquished or old property is closed on before the replacement property is acquired. In a reverse, the replacement property is acquired before the relinquished property is closed. Improvements to replacement property can be funded from the exchange funds.

Like-kind property means real, tangible or intangible personal property must be replaced with real, tangible or intangible personal property. Real property held in the US, such as a single family residential property held for rent and not primarily for personal use, can be exchanged for any real property in the US. Eligible replacement property includes land, commercial property and oil and gas royalties.

Assignment Language

One of the many Internal Revenue Code 1031 requirements is that the rights, not the obligations of the purchase and sale agreement (PSA) are assigned to the QI. In the relinquished property PSA, the Seller can assign the rights without the written permission of the Buyer unless otherwise stated in the contract to the QI. When the exchangor is buying, the assignment language must be included in the PSA. Many state Realtor Association PSAs have 1031 language already embedded.

Multiple Commission Potential

Once the seller initiates a 1031 exchange and closes on the first leg (commission number one), the 180 calendar day clock begins. The seller must acquire a replacement property or multiple replacement properties or the exchange fails. Given the replacement property is within the market the Realtor serves, the Realtor is in position to sell the replacement property (commission number two) to the client. I have facilitated many 1031 exchanges where multiple properties were sold and multiple replacement properties were acquired with the same Realtor.

A 1031 exchange may appear confusing to the uninformed, but is really where a property is sold and replaced with a property of equal or greater value to the relinquished net sales price. Partial 1031 exchanges are also acceptable. There are many rules and exceptions to apply, but put that burden on the QI to qualify. Realtors are serving and separating themselves from their competition by understanding the value in suggesting to their clients “You should ask your CPA the tax consequences of the sale and whether a 1031 exchange makes sense.” To learn more about what a Realtor should know about a 1031 exchange, click here to receive a free, six page 1031 Exchange Guide for Realtors.

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

IRS Section 721 Exchange and UPREITs

Posted on | by Tom Gustafson | Leave a Comment on IRS Section 721 Exchange and UPREITs

In a recent speaking engagement, I was asked about the relationship between Section 721 and 1031 of the Internal Revenue Code. The answer starts with Real Estate Investment Trusts (REITs) which can be publicly traded companies. REITs buy, sell and hold real estate portfolios consisting of a variety of different commercial properties ranging from shopping malls, apartments, office buildings, hotels, medical facilities and warehouses. Owning shares in a REIT is one way to own real estate.

UPREIT

An Umbrella Partnership Real Estate Trust (UPREIT) is an ownership structure consisting of an operating partnership with a REIT as the general partner and real estate investors as limited partners. Property owners can contribute their property to the operating partnership and receive an interest in the partnership called operating units. The tax free (or tax deferred) contribution of property for partnership interest is known as a 721 exchange or Section 721 of the Internal Revenue Code.

UPREITs represent an exit strategy for property owners of institutional grade property who rather than exchanging for another real property in a 1031 exchange, prefer the benefits of owning an interest in an UPREIT’s operating partnership. These operating units benefit from the REITs capital appreciation and distributions of operating income. At a time determined by the taxpayer, the operating partnership units can be exchanged for shares in the associated REIT. This conversion has tax consequences.

Taxpayers owning commercial property that is not institutional grade, can sell and replace through a 1031 exchange into a tenancy in common (TIC) property investment or acquire UPREIT grade property. Given the UPREIT wants to acquire the property and after holding the property for twelve to eighteen months, the TIC or property can be contributed to the UPREIT in exchange for operating partnership units through the 721 exchange.

Conclusion

Section 721 of the Internal Revenue Code provides an alternative strategy to a Section 1031 exchange allowing the property owner to convert their property into shares of a REIT. Owning shares in a REIT provides the benefit of a diversified real estate holding portfolio, professional management and liquidity.

Securing the counsel of a tax advisor familiar with 721 exchanges and subsequent converting of operating units to shares in the associated REIT is an important step to understanding the tax consequences.

For those who have used 721 exchanges, what do you suggest for those considering the exchanging for operating units rather than using the traditional 1031 exchange for replacement property?

Foreign Property, Virgin Islands and 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on Foreign Property, Virgin Islands and 1031 Exchange

Foreign Property Virgin Islands and 1031 ExchangeAs is often the case during the cold winter months in North America, questions regarding whether a 1031 exchange is applicable to properties in the Caribbean surface for clarification. As a former Rio Mar resident in Rio Grande, Puerto Rico, the question and picture stirs memories of sand, aqua blue waters, a young family, good friends, deserted beaches, lechon asado, Metropol in barrio Hato Rey, Medalla and warm sea breezes.

Foreign Property

In 1989, Section 1031 was amended with Subsection (h)(1) stating that real property located in the United States is not considered like-kind with real property located outside the United States. Foreign real and personal property used predominantly in a foreign country is eligible for 1031 exchange tax deferral treatment when exchanged for real and personal property located in a foreign country.

Virgin Islands

Section 7701 of the Internal Revenue Code (IRC) defines the borders of the United States as all fifty states and the District of Columbia. The Internal Revenue Service defined the borders of the U.S. to include the U.S. Virgin Islands for 1031 eligibility given the Exchangor is:

(1) A citizen or resident of the United States and

(2) Has income derived from sources within the U.S. Virgin Islands, is effectively connected to the performance of a trade or business in the U.S. Virgin Island or files a joint return with an individual who derives an income or is connected to a trade or business within the U.S. Virgin Islands.

Both requirements must be satisfied to exchange real property in the fifty states and real property located in the U.S. Virgin Islands.

Puerto Rico and Guam

Puerto Rico, though a Commonweath of the U.S. is not eligible for 1031 consideration. Guam is eligible for 1031 tax deferrals. It has been suggested that Sections 932 and 935 of the Internal Revenue Code provide special rules that treat Guam and the U.S. Virgin Islands as part of the U.S. while Puerto Rico is not.

FIRPTA

US citizens and foreigners owning real property outside the US defer federal capital gains taxes with a 1031 exchange when replacing with real property located outside the US. Foreigners selling US located real property must comply with the Foreign Investment in Real Property Act of 1980 (FIRPTA).

A nonresident alien individual, foreign corporation (unless a valid election under Section 897(i) has been made), foreign trust, but not a resident alien individual is considered a foreign person according to Regulation Section 1.4445-2(b)(2)(i)(C).

For more information on FIRPTA or a foreign 1031 exchange call us at 850-496-0090.

Business for Sale – Multi Asset 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on Business for Sale – Multi Asset 1031 Exchange


Multi asset 1031 exchanges apply to sales of apartments, motels, dry cleaners, laundromats, gas stations and variety of franchises including self storage facilities, convenience stores, fast food, automotive and technology service providers. Each has in common real and personal property that can be sold and capital gain and recaptured depreciation taxes deferred when real and personal property are replaced in an Internal Revenue Service (IRS) 1031 tax deferred exchange.

Fast Food Franchise

For example, a Chicken Express franchisee may wish to relocate to a better location or different city. When the sales contract is drafted, it is advisable to assign values to the real and personal property. This allows for an allocation of gain to underlying assets. Real property is matched to real property, while personal property is grouped together. Goodwill or going concern value is excluded. Following the closing, identification of the replacement property must be received preferrably by the Qualified Intermediary.

Incidental Rule

The 1031 identification rule requires that real and personal property are identified by the 45th calendar day post closing of the first property in the exchange. Personal property considered incidental to the larger property is not treated separate given the value does not exceed 15% of the aggregate fair market value of the larger property.

  • For example, a self storage facility may have a fence, gate and personal property perhaps associated with the tenant managing the property. Given the value of the personal property sold does not exceed 15% of the gross sales price, the personal property does not need to be itemized on the identification form.
  • If the value does exceed 15%, then the personal property is grouped into one of thirteen like-kind General Asset Classes or North American Industry Classification System (NAICS) and listed as a group of potential replacement property. If three or more properties are to be identified, it is suggested to use the 200% rule when identifying versus the three property rule.

Identification

Utilizing the two hundred percent rule allows four or more properties to be identified. Property identified should not exceed 200% of the relinquished property value otherwise, 95% of what has been identified must be acquired.

In the case of the fast food franchise, the identification may include up to three locations and a fourth identification of personal property group if the value exceeds 15% of the gross sales price.

1031 Benefits

The benefits of an IRS 1031 tax deferred exchange are:

  • indefinite interest free loan of taxable dollars
  • relocation
  • consolidation
  • depreciation
  • diversification
  • replacement of under performing asset.

1031 exchanges provide business owners with the capability to make changes to their overall business structure without the cash outlays for capital gains and recaptured depreciation taxes. The tax obligation is not eliminated, only deferred until the sale of the replacement property.

Conclusion

When exchanging a multi asset property such as a franchise, the personal property does not need to be identified given the 15% incidental rule.

Considering selling your franchise or a business and need to make improvements to the replacement property? An improvement or build to suit exchange is used to make improvements to the parcel.

Tax Implications of Unwinding a 1031 Exchange

Posted on | by Tom Gustafson | Leave a Comment on Tax Implications of Unwinding a 1031 Exchange

Let’s face it. Times have changed. The tumultuous real estate market, renovations over budget, difficult tenants combined with the challenging job environment have resulted in questions about how to unwind a 1031 exchange. Imagine ten years ago, we survived the Y2K scare and were approaching the tech market bubble burst. Real estate appreciation was gaining traction. Washington was promoting regulations to help those interested in securing a home. Ten years is not a lot of time when you are young. But when you have experienced the depths of job loss, foreclosure and declining retirement portfolio your perspective changes questioning why not sell the rental property and cash out.

Three Reasons Why Unwinding a 1031 Exchange Makes Sense Before 2013

Every market is cyclical, which helps cleanse inefficiencies and to adopt new strategies. Adjusting to change is a maturing process requiring us to take note of the whole and the individual pieces. Three reasons why unwinding a 1031 exchange makes sense includes:

  • Historically low federal capital gains rate of 15% will sunset on December 31, 2012 to 20%. In 2013, federal capital gains will increase 3.8% Medicare tax for those earning over $200,000.
  • If in the ten or fifteen percent income tax bracket, your long term federal capital gains tax rate may be even lower than 15%.
  • Divorce and changing partnership interests: it may make sense to consider cashing out the partner and continue the tax deferral in another 1031 exchange if you want to continue holding real property.

Unwinding a 1031 Exchange

The first place to start is talking with your accountant to understand the tax consequences. If you are selling a replacement property purchased in a prior exchange, is you will have two sets of taxes, one due on the replacement property and a second set due on the original property sold. Questions to consider include:

  • What is your current federal income tax bracket?
  • Were the investment properties itemized on Schedule E?
  • Was depreciation taken on Schedule E of your tax return?

Your accountant will look to determine the adjusted basis of each property to determine the estimated recognized gain or tax due. The tax bill may not be as bad as you think. But not understanding the tax implication could also be quite risky.

We Can Help 

Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.

Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.

Three Easy Steps to Tax Deferred Formula

Posted on | by Tom Gustafson | Leave a Comment on Three Easy Steps to Tax Deferred Formula

Capital gains and recaptured depreciation can be determined in three easy steps.  If you are considering a 1031 exchange, the taxes due represent the value of the 1031 exchange or what the IRS will consider deferred if equal or greater replacement property is acquired. It could be considered an interest free loan because the gain is not paid to the IRS but used towards the replacement property.

Step Number One

The first step is adding three numbers together to determine the adjusted basis.

Original purchase price + capital improvements – depreciation taken = adjusted basis

Step Number Two

Sales price – adj basis – selling expenses = realized gain

Step Number Three

Recaptured depreciation (depreciation taken * 25%) =

Federal capital gain (Realized gain – depreciation) * 15% =

State capital gain (Realized gain – depreciation) * __% if applicable =

Add these numbers together and you have determined the tax due. If you initiate a 1031 exchange, this value is deferred gain until the replacement property is sold. Another 1031 exchange can be used to defer the gain and recaptured on the replacement property, exchanging as many times as needed.  There is no limit to the number of times you can use a 1031 exchange.

Conclusion

Now that the tax triggered by the sale is known, be sure the the net equity and retired debt (if any) on the old or relinquished property will be equal to or greater in the replacement property.  If you want to pull out cash tax free, consider a post exchange refinance once the replacement property closes. If you remove cash at the closing of the old property it will be taxable.

The next step is to confirm your numbers with your accountant and decide to initiate a 1031 exchange.