A 1031 exchange is not for everyone. The question is often asked “Should I do a 1031 exchange?” It depends. What are the tax consequences of the sale? Do you want to own replacement property? Are your long term goals appreciation, cash flow or possibly converting the rental property into your primary residence?
Given the property titleholder is subject to US federal capital gain taxes, a foreign 1031 exchange is a recognized tax deferral strategy that both the foreign and domestic taxpayer should utilize when replacing like kind real, tangible and intangible personal property. For example, a US taxpayer selling a property held in the productive use of a business or investment in China can exchange for property held in the productive use of a business or investment in Japan. Property held outside the US is considered like kind with any property held internationally. US property predominantly held in the US is not eligible for replacement property held outside the US and vice versa. Israel is experiencing an appreciating real estate market with many 1031 exchanges being initiated selling and replacing with Israeli real property.
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Stan Johnson Company is pleased to offer for sale to qualified investors a 1031 exchange eligible single tenant retail property located in Martinsville, Virginia. The property is leased to Mattress Firm, Inc. who operates a brand new NN lease with Ten (10) years on the term and Two (2), Five (5) year renewal options. The lease term contains 10% rental increases, every Five (5) years, throughout the primary term and option periods. The Mattress Firm is located adjacent to Liberty Fair Mall on Martinsville’s major retail corridor. The subject property is currently undergoing renovations and is estimated to open at the beginning of December, 2014.
The asking price is $2,269,500 with a capitalization rate of 6.50 percent.
The Treasury Department Office of Tax Analysis published a paper on the 1031 like kind exchange discussing rationale, history and thorough review of use by market vertical for fiscal years 2007 and 2010. Included in the analysis is an interesting perspective from the Joint Committee on Taxation quantifying the value while the Federal Budget does not consider the 1031 exchange a tax expenditure. Why this of particular interest is that given the drive for tax reform including the removal of the 1031 code, the analysis is deficient in quantifying the macro economic impact. 1031 exchanges provide the liquidity to sell and replace assets from real estate to equipment, especially vehicles. Eliminating 1031 exchanges as the paper recognizes, would “freeze” the replacement of real and personal property, resulting in a slower frequency of replacement, subsequent decrease in real estate sales, closings, tax revenues, potential decrease in sales of cars, aircraft and equipment with higher costs of replacement being passed on to the consumer.
Maintenance, personal and related party use issues surface when owning an investment property either acquired in or when owning a relinquished property with the intent to initiate a 1031 exchange when selling. Proper 1031 intent is to hold the real property, in the productive use of a business or for investment versus holding primarily for personal use. Facts support the investment intent such as how the property is reported on the taxpayer’s federal tax return, was the property in a rental pool and whether personal use exceeds the 14 overnights or ten percent of the rental days per year for real property.
An Internal Revenue Code (IRC) Section 1031 tax deferred exchange allows the taxpayer to defer the federal, state capital gain and recaptured depreciation taxes triggered when selling property held primarily in a business or for investment when replaced with property of equal or greater value held in a business or for investment. The tax deferral has many rules, such as the same taxpayer requirement, 45 and 180 calendar day timeframes and g(6) limitations of the code, requiring a qualified intermediary to hold the exchange funds in a manner such that the taxpayer does not receive, pledge, borrow or otherwise obtain the benefits of the exchange proceeds other than towards the purchase of replacement property. If exchange funds remain post completion of the 1031 exchange, the funds are conveyed to the taxpayer and taxed accordingly.
In Revenue Procedure 2008-16, applicable for exchanges on or after March 10, 2008, the Internal Revenue Service (IRS) provides a safe harbor test for vacation properties and second homes that should the taxpayer satisfy, the IRS will not challenge whether the vacation home qualifies as property held for productive use or investment. If outside of the safe harbor test, the taxpayer should be prepared to decisively substantiate that profit is the primary motive for owning the vacation property.
IRC Section 280A(d)(2), the IRS qualifies personal use as when a dwelling unit (real property defined as a house, apartment, condominium or improvements that include living accommodations such as cooking, sleeping and bathroom facilities) is used principally for personal purposes. The code further stated that the taxpayer has used the property if it is used by (i) the taxpayer or any other person who has an interest in such unit, or, by any member of the family of the taxpayer or such other person; (ii) by any individual who uses the unit under an arrangement which enables the taxpayer to use some other dwelling unit (whether or not a rental is charged for the use of such other unit); or (iii) by any individual, unless it is rented for fair rent, as determined by the facts and circumstances.
Related party use is considered to be taxpayer personal use. A related party includes the taxpayer’s family, such as brothers and sisters independent whether whole or by half blood, spouse, parents and lineal descendants, but not aunts and uncles, nephews and nieces, in-laws, stepparents or domestic partners. The exception is that a related party can rent property as their principal residence per Section 280A(d)(3) at fair market value. Consequently, a taxpayer’s child or family member can rent as their primary residence, but not as a vacation property without impacting the taxpayer’s personal use even at fair market value.
Though regulations have not been issued for maintenance, Section 280A(d)(2) provides that the Secretary of Treasury will establish regulations for use of unit for repairs and annual maintenance. Should the taxpayer be employed to provide repair and maintenance for the entirety of any day, the IRS will not treat as being used for personal use by the taxpayer independent if the property is rented.
Exchanges are recognized by the IRS as an approved strategy to defer capital gain tax. If you are considering the sale and replacement of property and have questions regarding how your tax deferred exchange would work, contact our office or click on the button above to ask a question or being your consultation.
The Internal Revenue Service (IRS) has ruled the Federal Communication Commission (FCC) television and radio licenses with spectrum rights containing bandwidth differences are like-kind, or eligible for a 1031 exchange, because they were not different in nature and character, but merely grade and quality, per Private Letter Ruling 200532008. Television (TV) stations are assigned licenses with different frequency bandwidths. These licenses are being auctioned by the FCC along with other actions to free up more spectrum for broadband users by incentivizing license holders for certain TV stations to sell their rights in a FCC auction. When sold, the sole underlying property is the assigned frequency of the electromagnetic spectrum known as a FCC TV license. In Technical Assistance Memorandum 200035005 and Private Letter Rulings 8321127 and 8340041, the IRS allowed the exchange of a TV license for a radio license.