|
|
 |
|
Cityfeet Resources
|
|
The information contained in these FAQs are for informational purposes only and does not
constitute tax, legal or accounting advice. You are advised to seek appropriate
professional advice regarding your facts and circumstances.
|
 |
In a 1031 Exchange, property must be exchanged for Like Kind property? This
means that the property purchased must be Like Kind with the property sold. In
real estate exchanges, all property is Like Kind with all kinds of property. As
you can see, an office building is like kind with raw land, a farm is like kind
with a motel. Even a 30-year lease is considered real property, and like kind
with all other real property. Therefore, all real estate is like kind with all
other real estate. For personal property, the Like Kind rules are much
stricter. A twin-engine airplane must be exchanged for a twin-engine airplane,
not a single engine jet. A computer can be exchanged for a printer, since they
both fall within the same asset class, but a computer cannot be exchanged for a
desk.
The Economics of a Condo Conversion. Why convert your apartment units into
condominiums? Several economic reasons are making it more lucrative to convert
units into condominiums, including: (1) the escalating sales prices of the past
few years; (2) developers paying substantial premiums to acquire and transform
both large and small rental properties into condos; (3) apartment owners
finding their apartment units are worth much more if divided and sold as
condos, rather than marketed as a single apartment complex; (4) rents falling
behind the increasing sales prices for the apartment units in many parts of the
U.S.; and (5) the existence of many more potential unit buyers than buyers of
entire buildings. Some of the leading regional markets for conversions are
those in resort areas and in growing retirement areas, as the baby-boom
population continues to age and increase their leisure options.
First, the investor or developer purchases the property, or the existing
landlord of the apartments makes the decision to convert and sell the units on
their own behalf. Then the building owner/developer obtains the necessary
approvals to sell individual condo units from the municipality in which the
project is located. Usually, certain improvements will be required so that each
individual unit can be operated as a separate unit, rather than as one part of
a larger operation. With permits and improvements in hand, the owner/developer
can begin to sell the units.
The condo developer or building owner normally wants to receive capital gains
treatment on each individual unit. Capital gains are presently taxed at a 15%
federal tax rate, plus the taxpayer's state tax rate, which vary from zero to
11%. In the case of real estate that has depreciated, some or all of the
depreciation is taxed as "depreciation recapture", which is generally at a 25%
federal tax rate. For sales of property that do not qualify for long-term
capital gains, the maximum federal tax rate is 35%. In high tax states, the
combined effective tax rate can approach 46% on the taxpayer's gain on his or
her real estate.
Tax deferred exchanges under Internal Revenue Code Section 1031 permit the
condo seller to delay paying any tax on the sale of his property until he sells
his "replacement property", rather than at the time the converted units are
sold. You must carefully plan and structure your transaction in order to
qualify to rollover. First the property must have been held for a "reasonable
time". What exactly constitutes a "reasonable time"is a question of fact, but
should be held at least more than a year and one day. Second, the condominium
seller must not be considered a "dealer"in apartment units. If he is considered
a dealer, then his gains are taxed similar to sales of inventory (generally at
the highest tax rate) and his sales are not eligible for tax deferral.
Many of the cases originated with farmers or speculators who subdivided,
improved and sold their properties. The relevant issues concerning condo
conversions do not differ significantly from those that apply to land by
farmers, speculators or developers. The Internal Revenue Code, Regulations and
court decisions focus on separating speculators, developers, and dealers who
are in the business of developing and selling real property, from those
property owners who do not purchase the relinquished property with the intent
of subdividing, improving and selling off individual units. The theory is that
persons who are in the business of selling real property should be taxed as if
the properties that they are selling are "inventory". In practice, the result
is that someone who is classified as a dealer for capital gains purposes is
ineligible to utilize Internal Revenue Code Section 1031 to roll-over his or
her gain and therefore defer the payment of tax.
The test as to whether an exchange will be classified as made by a dealer or
alternatively as an investor, revolves around the taxpayer's intent at the time
of the exchange. Sometimes a taxpayer changes his intent during the period that
he or she holds the property prior to the exchange. Determining the taxpayer's
intent is a question of fact, and therefore all of the facts and circumstances
involved in the transaction are considered in determining the taxpayer's
intent.
The test as to whether an exchange will be classified as made by a dealer or
alternatively as an investor, revolves around the taxpayer's intent at the time
of the exchange. Sometimes a taxpayer changes his intent during the period that
he or she holds the property prior to the exchange. Determining the taxpayer's
intent is a question of fact, and therefore all of the facts and circumstances
involved in the transaction are considered in determining the taxpayer's
intent.
You cannot purchase the replacement property with the intent to move into it as
a personal residence. If, however, you hold the replacement property for a
sufficient time to establish the requisite intent for a 1031 Exchange, then you
may move into the property and thus change the nature of the use of the
property.
After moving into the property, a taxpayer may look to take the Section 121
exemption for personal residences. Under the recently enacted law, to gain the
121 exemption, the property must not have been the subject of a 1031 exchange
in the previous 5 years (5 years from the purchase of the replacement
property).
A TIC is a type of tenancy-in-common that is offered as a replacement property
investment to 1031 exchangers. TIC's have Sponsors that purchase the property
and apply for financing on the property. The properties are generally
triple-net with A-rated tenants. TICS are sometimes sold as securities and
sometimes as real estate. The SEC classifies TIC's as securities (if not both
securities and real estate). As a security, they can only be sold by a
securities broker-dealer, and investors are given special disclosures and
protections. Some TIC companies rely on legal opinions that TIC's are real
estate and not securities. Securities TIC's are sold only by the securities
broker-dealers and not directly by the Sponsor. TIC's are generally considered
as a possible replacement property by investors that have managed a property
(the relinquished property), but are looking for less active management in
their replacement property.
You cannot purchase the replacement property with the intent to move into it as
a personal residence. If, however, you hold the replacement property for a
sufficient time to establish the requisite intent for a 1031 Exchange, then you
may move into the property and thus change the nature of the use of the
property.
After moving into the property, a taxpayer may look to take the Section 121
exemption for personal residences. Under the recently enacted law, to gain the
121 exemption, the property must not have been the subject of a 1031 exchange
in the previous 5 years (5 years from the purchase of the replacement property).
As long as the taxpayer does not use the property substantially for personal
use, a vacation home can qualify. In other words, the taxpayer can have minimal
personal use and rent it out for the remainder of the year and still qualify
for Section 1031 tax deferral purposes. A vacation home will not qualify if the
taxpayer personally uses the vacation home the greater of 14 days or 10% of the
days during the year that the unit is rented.
Real Estate that has been or will be held for income production (rental),
investment or used in a trade or business will qualify for 1031 tax deferral.
Generally, any type of real estate may be traded for another type of real
estate. That means, Hotels, Rental Homes, Multi-Family Dwellings, Commercial
Office Buildings, Farmland, Raw Acreage, Leases for more than 30 years may all
be exchanged for another type of Real Estate.
IRS will disallow 1031 tax deferral and re-characterize it as a taxable sale
resulting in capital gains taxes should a taxpayer (Exchanger) receive the
proceeds of a sale. The Treasury Regulations allows a middle man (Qualified
Intermediary) to act as an accommodator, receiving the proceeds and then
disbursing the proceeds on the subsequent transaction (Replacement Property).
The Qualified Intermediary must be an independent entity who is not the
Exchanger or a related party to the Exchanger.
The exchange period begins on the date the taxpayer transfers the relinquished
property and ends at midnight of the 180th day thereafter or the due date
(including extension) of the taxpayer's tax return for the taxable year in
which the transfer of the relinquished property occurs.
The code and the regulations do specifically state a holding period for either
of the relinquished or replacement properties.
The key factor is "investment intent".
IRS has taken the position that property, which was recently purchased before
the exchange, was purchased for the purpose of disposing of the property and
therefore not held for productive use in a trade or business.
In a private letter ruling, IRS states that property held for two or more years
would qualify for the minimum holding period. There is, however, case law
stating a shorter time period.
Certainly, the longer the property is held before or after the exchange, the
more likely IRS will agree that the property was held for investment purposes.
Many investors want to consolidate the numerous properties they own into one or
two properties while, some investors want to diversify their investments into
multiple properties.
 1031 exchanges allow the
investor to leverage equity in the existing investment and replenish with a
more expensive property, thereby potentially gaining a greater appreciation on
the new investment.
Exchanging non-income or
low-income property for higher-income producing property creates greater cash
flow for the investor.
Numerous investors are ready
for retirement and prefer to have their investment property within close
proximity to where they retire allowing for.
The main reason taxpayers use Section 1031 to complete a tax deferred exchange
is their ability to use the equity they have in their present property to
invest in another investment property, while at the same time deferring the
payment of any capital gains taxes that might be due. This provides taxpayers
with the advantage of having more funds with which to purchase a replacement
property, especially a property of greater value.
Yes it does. Sometimes taxpayers who have accumulated a number of properties
decide they would be better off, especially from a management viewpoint, if
they exchanged their numerous properties and replace them with a single
property. Some taxpayers decide just the opposite, they own one property and
would rather have a diversification of their investment into two or more
properties. In today's marketplace, taxpayer's are using Section 1031 to defer
their taxes and consolidate or diversify their investments.
In many cases, taxpayers who have sold their properties find out after their
sale that they could have avoided paying capital gains tax if they had
completed a Section 1031 Exchange. Many taxpayers mistakenly believe that the
parties must swap their properties, which is not true. The taxpayer may
exchange his or her property with someone who is not participating in a 1031
Exchange, but rather is selling their property.
An identification of replacement property can be revoked any time before the
identification period ends. The identification period ends at midnight on the
45th day after the closing of the relinquished property.
The identification period of time begins on the date the taxpayer transfers the
relinquished property and ends at midnight on the 45th day thereafter.
Therefore, the taxpayer has 45 days from the date of the relinquished property
transfer to identify a possible replacement property.
The following properties will not qualify for Tax-Deferral Treatment:
(a) Stock in a trade or property primarily held for sale
(b) Stocks, bonds or notes
(c) Other securities or evidences of indebtedness or interests
(d) Interests in a partnership
(e) Certificates of trust or beneficial interests
(f) Chooses in Action
(g) Personal Residence
Real Estate that has been or will be held for income production (rental),
investment or used in a trade or business will qualify for 1031 tax deferral.
Generally, any type of real estate may be traded for another type of real
estate. That means, Hotels, Rental Homes, Multi-Family Dwellings, Commercial
Office Buildings, Farmland, Raw Acreage, Leases for more than 30 years may all
be exchanged for another type of Real Estate.
|
|
|
|
|