Section 1031 for Professionals Materials Pa… · • Exchangor must identify qualified Replacement...

Real Estate Law DayNovember 14, 2014

Section 1031 for Professionals

John D. Hamrick, VP Edmund & Wheeler, Inc. 603-336-3190 [email protected]

Your clients are eligible for interest free loans from the US and State Governments…

…for as long as they’d like.

…for as many times as they’d like.

Shhhhhhhh………..

Don’t Tell anyone.

Of the approximately $300 Billion in investment real estate

transactions during 2014, it is estimated that 25-40% could have

benefited from Section 1031 treatment.

Only 3% did.

What’s In It For You?

• Absolutely Part of Your Fiduciary Responsibility – Tax Ramifications on the Sale of Investment/Trade or Business

Property are Key!!

• Clients Will Appreciate Your Resourcefulness & Knowledge 1031 Savvy Professionals are HEROS!

• Section 1031 has Wide Applicability in Your Practice – Help your clients strategize the sale and repurchase of their holdings. – Property portfolios may be realigned tax free. – An EXCELLENT Wealth Building Strategy Using Uncle Sam’s Money – Extraordinary estate planning Tool – Stay in the RE Class!

What’s In it For Your Clients?

• Section 1031 Is NOT Just for Commercial Investors and the Wealthy: Many individuals have Exchangeable Assets… – Raw Land – Excess Land (What is customary?) – Second Homes (If planned correctly) – Any Real Estate that is NOT Personal use or Dealer!

• Mixed Use Properties (B&B’s, Home Offices & Mixed Use)

• Personal Property – Horses/Livestock – Coin Collections – Airplanes & Coin Collections – Heavy Equipment Used For Business

What’s In it For Your Clients?

About Our Firm

• Practice began in 1981; incorporated in 1987 by George Foss • Acquired by CenterPoint in 2012 • Exchanges are our exclusive line of business

– Thousands of Exchanges almost $1Billion in transaction value – Over $400 Million in DEFERRED TAXES

• Vermont Resource – Chris Brown • Dedicated & Knowledgeable Staff • Experts in Replacement Options • Many Industry Leading Partners • Member of Federation of Exchange Accommodators • Nationwide practice; 49 states and counting…

www.cpointadvisors.com

Today We Will Explore…

• What is Section 1031? • Section 1031’s misconceptions • How to recognize when to use Section 1031? • Who qualifies for an Exchange? • What Qualifies For an Exchange? • How to report an Exchange • How states handle Exchanges

Today We Will Explore…

• Exchanges – • Partnerships • Trusts • Corporations • Swap & Drop - Drop & Swap

• Real-life Examples of Our Exchanges

• Alternative Exchange Strategies • Conversion to Personal Use • Passive Real Estate • Path’s to Cash • Relieving Mortgage Boot

Primary Objectives of This Course

• Provide a Basic Section 1031 Education

• Provide Tools & Information Enabling You to Better Serve Your Clients - How can it be used to benefit their overall financial objectives and estate planning.

• Assist You In Recognizing the Strategic Applications of Section 1031

• Explore Alternative ReplacementStrategies

• Create HEROS

What Is An Exchange?

• Method to sell Investment and/or Trade or Business Property and replace it with New Property that doesn’t trigger tax.

• The Client must: • Give a Deed (or a Bill of Sale) • Get a Deed (or a Bill of Sale) • Not Handle Cash

The Five Critical Elements

1. Intent

2. Form and Documentation

3. Control of Funds

4. Like-Kind Properties (Real or Personal)

5. Time Limits

Section 1031(a)(1)

“No gain or loss shall be recognized on the exchange of property held for productive use in trade or business or for investment if such property is exchanged solely for property of like kind which is held either for productive use in a trade or business or for investment.”

Section 1031 Works ONLY with Investment/Trade or Business Property YOU MUST PROVE INTENT!

DEALER REAL ESTATE

• House Flippers • Land Developers • Property held

for resellPERSONAL USE ESTATE

• Primary Residence • Second Homes • Vacation Rentals

INVESTMENT REAL ESTATE

• Renal Property • Commercial Property • Farms - Businesses • Raw Land

An Exchange at a Glance

Exchange Documents

Relinquished Property • Exchange Agreement • Assignment of Contract • Notification of Assignment • Settlement Instructions • Wiring Instructions

Replacement Property

• Assignment of Contract • Notification of Assignment • Settlement Instructions • Wire Funds

QI

Exceptions to Section 1031 (Sec.1031(a)-(2))

• Stock in trade or other property held primarily for sale • Stocks, bonds or notes • Other securities or evidences of indebtedness or

interest • Interests in a partnership • Certificates of trust or beneficial interest • Choses in action (litigation rights) • Real Estate Investment Trusts • Basically all Paper Assets

What is Investment Purpose?

• Investment is the passive holding of property for more than a temporary period with the expectation of appreciation

• Real estate (even if unproductive) held by a non dealer for future use or increment in value is held for investment and not primarily for sale (Reg. 1.1031(a)-1(b))

• Thus property held for sale in the immediate future is not held for investment (Dealer Property)

What Are the Benefits of an Exchange?

1. Full capital gains tax deferral (Exchange goes Even or Up in Value)

2. The ability to use Uncle Sam’s money to enhance holdings

3. Compounding Effect

4. Estate Planning (Step-up)

5. Exchange into passive holdings

7. Increase cash flow reduce effort

8. As long as taxpayers remain in the Real Estate Class……Capital Gains will NEVER be due!

SWAP UNTIL YOU DROP

Three Essential Elements

Like-Kind Requirement:

• The term “like-kind” refers to the nature or character of the property and not to its grade or quality (Reg 1.1031(a)-1(2)(b))

• Real property cannot be exchanged for personal property (Reg 1.1031(a)-1(2)(b))

• Qualifying personal property can be exchanged for property of a similar character (NAICS (formerly SIC) Codes must match; the Code must fall within Sector 31, 32 or 33 of NAICS; last digit cannot be a 9.) (Regs 1.1031(a)-2, et seq.)

Anything that is classified Real Estate in the 50 US States

Forward Exchange

Reverse Exchange

ImprovementExchange

Personal Property Exchange

Mixed Asset

Exchange

Simultaneous Exchange

(A-B)

Exchange Types

Delayed Exchange

Exchange Types

• Close Relinquished in an Exchange with Exchange Agreement in place.

• Net Funds (less cash taken) to QualifiedEscrow Account.

• ID Replacement in 45 Days

• Close in 180 Days

• Funds Delivered for ReplacementProperty

Regs 1.1031(k)-1, et seq.

Reverse Exchange

Exchange Types

• Close Property (old or new) in Special Purpose Entity.

• ID in 45 Days (what are you selling / buying).

• Close in 180 Days.

• Reconvey Property to Exchanger from SPE.

Rev. Proc 2000-16 & 2004-51

ImprovementExchange

Exchange Types

• Close Property in Special Purpose Entity.

• ID in 45 Days (what are you selling).

• Close Relinquished in an Exchange.

• Improve Replacement Property (180 Days).

• Reconvey Replacement Property as Improved.

Reg 1.1031(k)-1(e), et seq.

Personal Property Exchange

Exchange Types

• Convey Property with Bill of Sale withan Exchange Agreement in Place.

• Net Funds to Qualified Escrow Account.

• ID in 45 Days (what are you buying).

• Close in 180 Days

• Funds Delivered for ReplacementProperty

Mixed Asset

Exchange

Exchange Types

• A Combination of Real Property and Personal Property

• Accomplished in Single Exchange Agreement

• Detailed Asset Class Analysis & Valuation

Simultaneous Exchange

(A-B)

Exchange Types

• Deed for a Deed.

• Values Must Match, or Boot.

• No Qualified Intermediary Required Unless Money Changes Hands.

• Exchange Language in Contract.

• Consulting with Qualified Intermediary Recommended.

SINGLE FAMILY RESIDNCE

RAW LAND APARTMENT BUILDING

BOAT DOCK IN NEW HAMPSHIRE

CELL TOWER LEASE > 30YRS

CONSERVATION EASEMENT

SUBSURFACE WATER RIGHTS

EXCESS LAND OF PRIMARY RESIDENCE

PARTIAL INTERST (TIC)

GROUND LEASE >30YRS

SUBSURFACE MINRAL RIGHTS

MOBILE HOME IN NEW HAMPSHIRE

CO-0P IN MANHATTEN

DELEWARE STATUTORY TRUST

CALIFORNIA LAND TRUST

HORSE FARM

CATTLE FARM WITH HOMESTEDAD

BED & BREAKFAST MONOCO APARTMENTS

DND FRANCHISE

EWI REAL ESTATE EXCHNAGES

More Examples of Like-kind

• Improved real property for Unimproved real property (Reg 1.1031(a)-1(2)(b))

• Lease for >30 years (Reg 1.1031(a)-1(2)(c)

• Partial interest for a whole interest

• One property for more than one property and vice versa

Like Kind

Like Kind Also Includes:

•NNN Leased Property •Fractional Ownership •DSTs •Oil & Gas (Subsurface) •Water Rights •Leasehold > 30 Years

• Cell Towers • Billboard Easements • Conservation

•UP-REIT

What is Like Kind?ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER

REAL PROPERTY IN THE 50 US STATES

MOLITAR STRADIVARIOUS

HELICOPTER FISHING BOAT

LOADERS & EXCAVATORS

AUTO COLLECTION

HERD OF DAIRY COWS IN VT

PAINTINGS IN NYC

FCC BROADCAST LICENCE

BEACHCRAFT BONANZA

BEDROOM FURNITURE & FLAT

SCREEN TVs

INTANGIBLES &

GOODWILL

CELLO FOR A PSA MUSICIAN

EWI PERSONAL PROPERTY(Regs 1.1031(a)-2, et seq.)

Same General Asset Class or Product Code North American Industry Classification System

WWW.CENSUS.GOV/NAICS

Timing is everything!

• The Exchange Period begins on the transfer of the Relinquished Property – This is Day #0

• Exchangor must identify qualified Replacement Property within 45 days of closing (the “Identification Period”)

• Exchangor must acquire within 180 days, or due date of the tax return (counting extensions) for the tax year of the sale (the “Exchange Period”) (Reg 1.1031(k)-1(b), et seq.)

• There are no extensions unless a federal disaster is declared in the vicinity of the taxpayer or the property.

Replacement Property Rules Reg 1.1031(k)-1-(c)(4)

• The Three Property Rule The Exchangor may identify up to three (3) properties, without regard to value; or

• The 200% Rule The Exchangor may identify more than three properties, provided their combined fair market values does not exceed 200% of the value of the Relinquished Property; or

• The 95% Rule The Exchangor may identify any number of properties, provided the Exchangor acquires 95% of those properties (by value).

• Properties received before the 45th day do not have to be identified, but must appear on one of the ID’s after Day 45.

Can Anyone Handle An Exchange?

• No! It must be a “Qualified Intermediary”(QI) as defined by regulation: see Regs 1.1031(k)-1(k), et seq.

• Cannot Be the Exchangor or a Relative (Sec. 267(b) or Sec. 707(b)(1))

• Cannot be an Agent of the Taxpayer – One who has acted as employee, attorney, accountant, investment

banker, broker or real estate agent within the past 2 years – The QI Handles All Aspects of the Exchange and Should be

Involved EARLY in the Process

What does a QI do? Regs 1.1031(k)-1(g)(4), et seq.

• Creates Exchange Agreement; signed by Taxpayer.

• Has Legal Standing in the transaction

• Notice of the Assignment required to be given to Buyer and Seller, with Closing Instructions to both Settlement Agents.

• Banking, Safeguarding & Delivery of Exchange Funds

• Assurance of Critical Deadlines Including the 45 & 180 Day Deadlines

• Final wind-up package for tax purposes

What does EWI do?

• Early involvement with client strategies.

• 1031 Consulting and Team Participation – Accountant – Attorney – Financial Planner – Real Estate Broker – Passive Replacement Sponsor

• 1031 Transactions – QI

• Replacement Property Consulting – Referral Partners – Today’s Sponsor – Rockwell

Straight Talk About Section 1031 & the QI Industry

• Several failures during 2008-2010 costing taxpayers MILLIONS in Exchange funds.

• QI’s are unregulated therefore EXTREME due diligence is required.

• BIGGER IS NOT BETTER

• A few bad apples….

Are They Kidding?From a recent Webinar given by a national, well known Qualified Intermediary.

• Client's funds in segregated accounts using their own taxpayer ID.

• Client has online access to their own account.

• Client MUST log in and approve funds transfers, EWI can NOT move money without this approval.

• Surety bond and E&O insurance.

Who Qualifies for an Exchange?

Owners of investment property and business property may qualify for a Section 1031 deferral. Individuals, C Corporations, S corporations, partnerships (general or limited), limited liability corporations, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031.

www.irs.gov

The Five Most Common Section 1031 Misconceptions

1 All 1031 Exchanges must involve swapping or trading with other property owners......


2 It’s required that all types of 1031 exchanges must close simultaneously......


3 "Like-kind" means purchasing the same type of property which was sold.......


4 1031 Exchanges must be limited to 1 exchange and 1 replacement property.......


5 A Section 1031 is NOT a path to cash.

What about the States?

• All states but PA allow a Section 1031 within or outside the state

• Most states follow the Federal rules closely.

• Some states require a Waiver of withholding

• Other states w/ income taxes don’t bother

• Some states have a formal Waiver; others permit a Seller Affidavit

• California enacted clawback in 2014

What about Vermont?

• Follows the FEDS rules and regs

• Out of state owners must file waiver • Takes 4 business days • QI must remit if failed

• Land Gains Tax in VT • Old & New properties must be in-state;

New Property takes Old Holding Period

What is “New Money” (Basis Additions):

• The Taxpayer picks up new basis for all “New Money” that is added to the transaction.

• “New money” = Net new cash + Net increase in debt

• “Strike Price” = Sales price - Allowable Expenses

• Taxpayer gets increased basis if the New property + acquisition costs = or exceeds the Strike Price

• You can offset a mortgage with cash butyou CAN’t get cash from a newmortgage.

What is “Boot?

• If the Price + costs of the New Property is less than the Price – costs of the Old, Boot results.

• Boot can be avoided by exchanging even or up

• Boot is property of an Unlike Kind; Cash Boot is net cash; Mortgage Boot is less net debt.

Boot Triggers TAX…

…The Exchange Could Still Work!

IRS Form 8824 – Reporting an Exchange

Property Information & Exchange Dates

Related Party - Sec. 267(b) or Sec. 707(b)(1)

123 Main Street, City, State; 4 Family Rental

456 Main Street, City, State; Single Family Rental

1 2 1997

6 1 2008

7 16 2008

11 28 2008

Part IIPart III

Related Party? YES Line 8, NO Line 12

08

Related Party Information

Must remain NO for two tax years

Joe Related Taxpayer Brother XXX-XX-XXXX

789 Main Street, City, State, Zip

If 9 or 10 is YES, 11 C is most probable answer (attach statement)

Related Party - Sec. 267(b) or Sec. 707(b)(1)

Multi-asset Exchanges

“Boot”FMVOld basis +

“New money”

Exchanges That Cross 2 Tax Years:

• Reported for the year of the sale of the Old Property

• July 5 + 180 days (or Nov. 17 + 45 days) = Jan. 1st

• Election under Reg. 1.1031(k)-1(j) (Coordination of Sec. 1031 & 453):

• Provided the Client had a bona-fide intention to exchange at the start of the Exchange Period

Can a Failed Exchange Be Fixed?

• IRS Regulations allow a sale to be rescinded within the same tax year if the parties are restored to their original positions (Rev Rule 80-58)

–Un-close with the Buyer.

–Re-close with the Buyer properly, using a Q.I.

• Can make buyer nervous, will want compensation.

• Very difficult with banks involved.

HIDEND DANGERS OF PARTNERSHIPS AND A 1031 EXCHANGE“We own the property in a partnership”

NO

HIDEND DANGERS OF PARTNERSHIPS AND A 1031 EXCHANGE“We own the property in a partnership”

Evaluate

Section 1031 Exchanges for Partnerships

• Exchange Must be at the Entity Level • Drop & Swap Technique Does Not Work • IRS Is Now Asking on Form 1065:

“At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or

other undivided interest in partnership property?”

Question #14

Section 1031 Exchanges for Partnerships (2)

• Swap & Drop Technique Does Not Work Either • IRS Is Also Asking on Form 1065

“Check this box if, during the current or prior tax year, the partnership distributed any property received

in a like-kind exchange or contributed such property to another entity (including a

disregarded entity)” Question #13

Section 1031 Exchanges for Partnerships – What to Do?

• Identify Partners Who Want To Depart • Close on the Asset, Reserve Boot • Departing Partners -> Cash • Remaining Partners -> Like-Kind Replacement Property • This Preserves the Partnership EIN# and Holding Period

MOVE FORWARD WITH ENTITY IN TACT

Section 1031 Exchanges for Partnerships – What to Do?

• What are the Members Goals & Objectives? • How well are Members Communicating? • Can Members Agree to Strategize with 1031?

MOVE FORWARD WITH ENTITY IN TACT

Section 1031 or Section 1033?

• Section 1031 Can Be Used in concert or as a Substitution for Section 1033

• Section 1033 Has Strict Guidelines for Replacement

• Section 1031 Has Shorter time Frames for Performance, and;

• Is More Flexible in Choices of Replacement Property

• Before Cash is Accepted, Call a QI!!

The Power of Section 1031

What happens when both participate in 3 typical real estate transactions…

…with radically different approaches?

Hypothetical Example Assumptions

Courtesy of Grubb & EllisCommercial Real Estate Services

Section 1031 for Professionals Materials Pa… · • Exchangor must identify qualified Replacement...

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