Equity and Gain
Is my tax based on my equity or my taxable gain?
Your tax will always be based upon calculations of the taxable gain. Contrary to misconceptions, gain and equity are two separate and distinct items. When determining your gain, you should identify your original purchase price. From that, deduct any previously reported depreciation and then add the value of any improvements, if any, which have been made to the property. The resulting figure is your cost or tax basis. To calculate your gain, subtract the cost basis from your original net sales price.
Deferring All Gain
Is there a simple rule for structuring an exchange where all the taxable gain will be deferred?
If the following actions are performed, all taxable gain on your property is to be deferred.
- A replacement property equal to or greater in value than the net selling price of your relinquished (exchange) property is purchased.
- Equity is move from one property to the other.
Definition of Like-Kind
What are the rules regarding the exchange of like-kind properties? May I exchange a vacant parcel of land for an improved property or a rental house for a multiple-unit building?
If properties are of the same nature or character, regardless of whether or not they differ in grade or quality, they are “like-kind” properties. The two properties must be of the same type, disregarding any improvements made. To clarify, two residential pieces of real estate are “like-kind” towards one another. A residential piece of real estate and a car would not be.
Four most common 1031 exchange misconceptions:
- All 1031 exchanges must involve swapping or trading with other property owners…… (NO)Well before delayed exchanges were codified (by IRS) in 1984, all simultaneous exchange transactions of Real Estate required the actual swapping of deeds plus the simultaneous closing among all parties to a 1031 exchange. In most cases these type of exchanges were comprised of many of exchanging parties, as well as numerous exchange real estate properties. Now today, there’s no such requirement to swap your own property with someone else’s property, in order to complete an IRS approved exchange. The rules have been refined and ratified to the point that the current process is much more indicative of your qualifying intent, rather than the logistics of the Real Estate property closings.
- Its required that all types of 1031 exchanges must close simultaneously……. (NO)There was a time when all types of exchanges had to be closed on a simultaneous (same day) basis, now they (1031) are rarely completed in this type of format any longer. As a matter of fact, a majority of the exchanges executed are closed now as delayed exchanges.
- “Like-kind” means purchasing the same type of property which was sold……. (NO)Often the definition of “like-kind” has been misinterpreted or misunderstood to mean “The requirement of the acquisition of property to be utilized in the same form as the exchange property”. In laymen’s term, hotels are for hotels, apartments are for apartments, farms are for farms, etc. This is all true however, the exact definition is again more reflective of intent than its use. As a result, there are currently only 2 types of properties that qualify as a ‘like-kind’:
– Property held for investment and/or
– Property held for a productive use, as in a trade or business.
- 1031 Exchanges must be limited to 1 exchange and 1 replacement property……. (NO)This statement is a perfect example of another 1031 exchanging myth. Let me repeat, there are no provisions within either the IRS Code or the US Treasury Regulations that can restrict the amount and number of real estate properties that can be involved in an exchange. Thus, in exchanging out of several properties into one replacement property or the vice versa of selling of one property and acquiring several other properties, are perfectly acceptable strategies and uses of a 1031.
Simultaneous Exchange Pitfalls
Is it possible to complete a simultaneous exchange without an intermediary or an exchange agreement?
It is possible to complete an exchange without an intermediary or an exchange agreement, yet is not recommended. In addition, it is very difficult to perform this process due to the Safe Harbor addition of qualified intermediaries in the Treasury Regulations and the recent adoption of good funds laws in several states. As two closing entities cannot hole the same exchange funds on the same day, the Exchanger is left with serious constructive receipt and other legal issues for attempting such a simultaneous transaction.
The main reason for the addition of the intermediary Safe Harbor was to suppress the practice of attempting such marginal transactions. Many tax professionals believe that an exchange that is completed without an intermediary or exchange agreement will not qualify for deferred gain treatment. If such a transaction had already been completed, it would not pass an IRS examination due to constructive receipt and structural exchange discrepancies. As you may have hesitation to invest in a qualified intermediary, we advise you to do so, as in comparison to the tax risk that is associated with attempting this exchange, the investment is easily insignificant.
How long must I wait before I can convert an investment property into my personal residence?
A one-year holding period before investment is advised. As there is no definitive holding period that currently exists, the IRS did propose a one-year holding period before investment property could be converted, sold or transferred, yet it was never adopted by Congress. Please do not misconstrue the failure of the adoption of this proposal as an approval to convert investment property at any time. As the one-year period reflects the intent of the IRS, most tax practitioners advise clients to hold their property at least one year before converting into a personal residence.
As intent is extremely important, we remind you that it should be your intention at the time of acquisition to hold the property for its productive use in a trade or business, or for its investment potential.
What if my property was involuntarily converted by a disaster or I was required to sell due to a governmental or eminent domain action?
If your property is involuntarily converted, reinvestment must occur within 24 months from the end of the tax year in which the property was converted. It is also possible to apply for a 12 month reinvestment extension. This information is addressed within Section 1033 of the Internal Revenue Code for reference.
Facilitators and Intermediaries
Is there a difference between facilitators?
There is most definitely a difference in facilitators. Similar to most professional disciplines, the capability of facilitators will vary based upon their exchange knowledge, experience and real estate and/or tax familiarity.