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1031 Explained - 1031 Exchange Podcast

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1031 Exchange Explained - Podcast text

Welcome to the 1031 Alternatives Group podcast on “The 1031 Solution…a tax deferral strategy for highly appreciated real estate.”

If your investment real estate is currently highly appreciated due to years of ownership, and perhaps you have depreciated your property completely. Or maybe, your property is management intensive, you are under or over diversified, and your property is just not providing you enough cash flow….then maybe it is time to consider some options.

As an investment property owner, you have several options to choose from:
You can simply do nothing. You can sell your property, pay the taxes and reinvest the net equity into standard investments such as stocks, bonds or mutual funds. Or better yet, you may exchange your property for “like kind” real property utilizing IRS Section 1031 Exchange to defer your tax liability. Or you can exchange your property via a 1031 exchange into professionally managed property by utilizing a tenant in common 1031 exchange.

Now let’s take a more in depth approach to IRS section 1031 exchange.

» Continue reading "1031 Exchange Explained - Podcast"

1031 Alternatives Group has recognized that a major issue facing real estate owners and occupiers of commercial properties today is the increased attention on measurement, containment and reduction of greenhouse gas emissions. Our investors can feel comfortable knowing that several of the sponsor firms we work with are doing their part to help protect the environment and reduce their impact on global warming. We provide our clients with the opportunity to deal with real estate sponsors that choose to operate with a “Green” philosophy with some of the following attributes listed below.

- Understanding the real estate issues our clients are facing today in the areas of energy efficiency, sustainability and other smart building practices.

- Recognizing the importance of treating the environment with care in all that they do. They believe it is their responsibility to treat natural resources with the greatest respect so that they will be available to future generations the world over.

- Recognizing that their actions speak louder than words – for the offices that they occupy, and on behalf of our clients, the locations they seek, the projects they construct and the buildings that they manage.

- Recommending to our clients sustainable building alternatives and build out strategies to extend their corporate culture in an environmentally responsible manner.

- Operating their buildings to maximize energy efficiency, to recycle materials, to limit waste, and we use green cleaning practices to limit the impact on the surrounding community and environment.

- Believing that as stewards of our clients’ assets and as a responsible, caring employer, it is to their mutual benefit to act responsibly to preserve and protect the environment for all to enjoy.

Demographic Investing is a strategy designed to target the regions around the country with the greatest potential for growth and invest in the goods and services that the country’s largest population groups are likely to consume.

There are 3 major population groups to take into consideration when discussing Demographic Investing:

1. Seniors – represent about 12% of the US population (roughly 34 million Americans).  These individuals are 65 and older, the parents of the Baby Boomers, and are living much more active and longer lives than the generations in the past.  According to the Society of Certified Senior Advisors, “The population aged 85 and over is currently the fastest growing segment of the older population…this is of great importance because of additional assistance needs and healthcare that is required.”


2. Baby Boomers – represent about 27% of the US population (roughly 78 million Americans) and are born between 1946 and 1964.  Baby Boomers are now starting to reach retirement and control about ¾ of the financial assets in the US.  They are spending a great deal of money on preventative and elective healthcare (i.e. cosmetic treatments).  The children of this generation are approaching adulthood, so condos and luxury apartments are common places for these empty-nesters to move into.  According to the Department of Health and Human Services, “From 2010 to 2030, the population aged 65 and over is expected to grow by 75% to over 69 million.”


3. Echo Boomers – represent about 26% of the US population (roughly 76 million Americans) and are born between 1982 and 1994.  These are the children of the Baby Boomers.  They are now just starting their own households and bring a strong demand for apartments.  According to Multi-channel News, “Within the next few years, Echo Boomers will take over 25% of household purchasing budgets.”

Where are these groups going?

According to the US Census Bureau, “Between 2000 and 2030, 88% of the nation’s population growth is projected to occur in the South and West.”  The Southern and Western United States has seen the largest population increases for seniors.  The Echo Boomers are fueling new demand for apartments in the South as they are starting new households and enter adulthood.  The top ten fastest growing states are Arizona, Nevada, Idaho, Georgia, Texas, North Carolina, Colorado, Florida, and South Carolina.

How can you capitalize on these trends?

There are great opportunities for investors to reap the benefits of these trends by matching up the needs of these groups with the best growth markets around the country.  Housing and healthcare are basic goods and services consumed by these groups and continue to provide opportunities to capitalize on these major demographic trends. 

Class A apartment housing is in great demand for these populations groups in certain regions of the country and the children of the baby boomers (echo boomers) will be coming of age in next decade and enhance the demand for rental units.  In areas experiencing rapid growth, the supply of housing will be unable to accommodate the rising number of young households.  There is an even bigger increase in the number of older renters (55 and up) than younger renters (under 35) and the majority of this demand will take place in the South.

Healthcare is another essential industry with long-term fundamentals.  As America’s population continues to expand and grow older with baby boomers entering their 60’s, investor can find ways to take advantage of this shift.  Since these boomers are living longer than generations in the past they are more likely to use more healthcare services. 

Many investors are zoning in on these trends by investing in demographic-favored products and services by purchasing stock in related companies or by owning the buildings in which they operate.

Remember all investment strategies carry elements of risk. Demographic investing is no different and carries with it market risks as well as specific investment risks.

Since 2002, when the IRS issued official guidance in Revenue Procedure 2002-22 on how Tenant In Common investments would qualify for replacement property under Section 1031, the TIC Industry has exploded into a multi-billion dollar a year business. However, ever since 2002, the vast majority of TIC investments have been sold through the securities industry by licensed securities representatives and broker-dealers, not though the traditional means of licensed real estate professionals. Needless to say since 2002, the National Association of Realtors (NAR) and the real estate community has felt left out on these transactions and on October 11, 2007, NAR issued an exemption letter to the SEC on behalf of it’s 1.3 million members. This exemption request to the SEC would grant commercial real estate professionals with “substantial experience” in commercial real estate transactions, exemption from broker-dealer registration requirements of Section 15(a)(1) of the Securities Exchange Act of 1984. This exemption, if adopted in its current form would permit the real estate professional to obtain an advisory fee from the purchaser of a Tenant In Common securities investment that would be offered and sold together with other arrangements that would cause it to be deemed a security under federal securities law.

Click Here to view the NAR/SEC Exemption Letter in its entirety

As the TIC Industry and its new regulations evolve 1031 Alternatives Group remains committed as your Tenant In Common (TIC) strategic planning partner. Our website www.1031alternatives.net will be available to bring you the latest news and updates on this proposed exemption.

As a cooperative effort to educate the professional real estate community on the benefits and risks associated with TIC investments, 1031 Alternatives Group would be honored to conduct either an in-office educational presentation or a personal/small group consultation on TIC investments. Please feel free to contact our offices directly 866.405.1031 to schedule a date and time.

1031 Alternatives Group’s leading Tenant In Common (TIC) real estate sponsors Triple Net Properties and its parent company NNN Realty Advisors took over 50-year old Grubb & Ellis Company in a reverse merger to become the first publicly traded TIC Corporation. The merger was completed on December 10, 2007 as the result of Grubb & Ellis and NNN Realty Advisor majority shareholder approval.

The deal transpired in May when Grubb & Ellis agreed to merge with NNN Realty Advisors through a stock swap deal that gave NNN Realty Advisors’ stockholders 59% interest in the new company. Grubb & Ellis issued 0.88 shares of common stock for each outstanding share of NNN Realty Advisors common stock. The combined company has retained the name Grubb & Ellis Company and relocated its international headquarters from Chicago, IL to Santa Ana, CA. Grubb & Ellis will remain listed on the New York Stock Exchange under the ticker symbol “GBE”.

“The merger combines one of the largest and most recognized real estate investment services providers with one of the most innovative and successful sponsors of real estate investment programs, creating a new Grubb & Ellis poised to pursue growth and to provide a broader range of services to a global client base,” said newly appointed Grubb & Ellis President and CEO Scott D. Peters. “This merger combines two complementary firms to create a new company that is greater than the sum of its parts.”

Peters added, “Grubb & Ellis has exceptional name recognition and a nationwide presence. NNN Realty Advisors’ investment platforms can leverage the Grubb & Ellis brand and maximize the traditional services offered by the company. Together, the new Grubb & Ellis is a greater, stronger and more dynamic company.”

Tony Thompson the new chairman of Grubb & Ellis and original pioneer of the Tenant In Common (TIC) industry added, “The merger with NNN Realty Advisors is a transformational event in the 50-year history of Grubb & Ellis. This is essentially the creation of a new company that is equipped to pursue both domestic and international growth in order to better serve our clients and investors throughout the globe.”

About Grubb & Ellis Company

Grubb & Ellis Company (NYSE – “GBE”) is one of the largest and most respected commercial real estate services companies. With more than 130 owned and affiliate offices worldwide, Grubb & Ellis offers property owners, corporate occupants and investors comprehensive integrated real estate solutions, including transaction, management, consulting and investment advisory services supported by proprietary market research and extensive local market expertise.

Grubb & Ellis and its subsidiaries are leading sponsors of real estate investment programs that provide individuals and institutions the opportunity to invest in a broad range of real estate investment vehicles, including tax-deferred 1031 tenant-in-common (TIC) exchanges; public non-traded real estate investment trusts (REITs) and real estate investment funds. As of September 30, 2007, nearly $3 billion in investor equity has been raised for these investment programs. The company and its subsidiaries currently manage a growing portfolio of more than 214 million square feet of real estate. In 2007, Grubb & Ellis was selected from among 15,000 vendors as Microsoft Corporation’s Vendor of the Year.

The act of selling a property and walking away from the closing table empty handed can be uncomfortable for anyone new to 1031 Exchanges. Remember that the Qualified Intermediary will be responsible for the safety and management of your sales proceeds for up to 180 days, so you should make sure to be informed and comfortable as to how your money will be held. The IRS makes it very clear that the taxpayer cannot have receipt of funds, actual OR constructive, to qualify for tax deferral under §1031, so transparency is key with your 1031 Exchange. Here are some factors to consider and discuss in the planning stages of the transaction.

• Will my exchange have its own account or will my funds be mingled with other exchanges?
• Is the account a demand account with sufficient liquidity to fund quick escrow deposits for my replacement properties?
• How many signers from the intermediary are required to withdraw funds from my exchange account?
• Will the bank have a copy of my exchange agreement and authorized signature?
• At the end of the exchange can I receive a statement from the bank itemizing all account activity?

1.Make decisions based on concrete numbers. Capital gains tax and the motivation to defer those taxes using a 1031 exchange is a complex decision that should be made with as much information as possible. A taxpayer should consider their entire tax scenario, not just the property they are selling, before making a decision to exchange. There may be losses in other business lines to offset the gain on sale and this could decrease the motivation to exchange. Depreciation recapture is often not considered as a tax on sale and could be a motivation to utilize a 1031. Speak to your accountant, compile your true tax situation, and then make decisions based on those numbers.

2.Trust your trusted advisors. There is misinformation about 1031 Exchanges and it is important to know and trust sources of information when researching and planning the transaction. Much of the industry is based on interpretation of tax code from court cases and private letter rulings and requires background knowledge to make educated decisions. Knowing the experience level of your qualified intermediary and your tax advisors can help avoid tax pitfalls. The taxpayer is responsible for the accuracy of their exchange in an audit, not the person offering the advice.

3. Plan ahead. The 45 day deadline in particular makes many investors feel rushed to find suitable replacement property within the strict time frame. This pressure can result in the purchase of less than ideal replacement property or in a failed exchange with taxes due to the IRS. One way of avoiding this scenario is searching for replacement property and backup properties prior to the close of the sales property. Even if the exchangor plans on buying a single replacement property it is suggested to locate and identify a suitable alternative as early as possible. Working with a Tenant In Common or TIC dealer can provide numerous options for cash flowing, management free, real estate investments to identify within the 45 day timeline.

4.Make sure the left hand knows what the right hand is doing. A typical real estate transaction involves multiple parties including realtors, attorneys, accountants, and closing agents. In an exchange the intermediary is also in the loop and it is very important that there is open communication during the process. Delays are common when information is not available to everyone involved and an easy solution is the sharing of contact information during the planning phases. It is also important to alert the buyers of the exchange property and the seller of the replacement property by putting a 1031 addendum in both your sale and purchase contracts agreements.

5.Read and understand your exchange agreement. This document is the backbone of a 1031 Exchange and the composition can vary drastically among qualified intermediaries. There are no regulations on processing 1031 Exchange documentation, so each company must compile their own exchange agreement which leads to a wide variation industry wide. Before signing the exchange agreement at closing, be certain to understand the taxpayer rights and limitations during the exchange period and after. There are several safe harbors outlined in section 1031 of the IRS code and they should be addressed in the exchange agreement to assure a secure exchange.

What do subprime lending, supply and demand, foreclosures, echo boomers, empty nesters, escalated building costs, unaffordable housing, job growth, resort style amenities, immigration and growth markets have in common? They are all factors driving the increased demand for Class A apartment buildings across the United States.

With interest rates at record lows in conjunction with the tech bust of the early 2000’s, many investors were convinced to pull their assets from the stock market and funnel these dollars into real estate investments, specifically the U.S. housing market. This trend, combined with lenders willing to loan money to the most risky of borrows (subprime), led to a decreased demand for rental apartments across the country as many of the markets elite renters were now able to own a home rather than rent a unit.

Naturally, this real estate frenzy brought in the latest speculators and condo converters seeking to make a quick buck. The problem though is that many markets, like South Florida for example, were and remain artificially inflated with speculators and subprime loans. As the demand for home building and purchasing decreases, many speculators are now stuck with illiquid investments that they are either forced to carry or foreclose on. Adding fuel to the fire, many subprime mortgages are re-setting after their teaser 1% introductory periods expire, leaving many first-time owners compelled to rent.

These negative circumstances consisting of foreclosures, the elimination of subprime borrowers, and the vast supply of multi-family units that the condo converters removed from the market place, shared with recent and future demographic trends have created the “perfect storm” for rental apartment buildings. Many are well aware that over the next 20 years, 78 million baby boomers will be entering into retirement. Many of these boomers will become empty-nesters possibly seeking to downsize their need for larger family housing allowing them to potentially direct their primary resources towards other activities. The children of these boomers, known as the “echo boomers”, have a population size nearly that of their parents, about 76 million people. Born between1982 and 1994, the echo boomers are just beginning to graduate from college and enter the work force. This demographic segment may be the number one driving factor for rental living over the next 12 years as these boomers are currently seeking jobs, geographic relocation, and moving away from home. It may be difficult in today’s environment for these 21 year old young adults to afford a hefty down payment in order to purchase a single family home.

Affordable housing for both the baby and echo boomers, which is currently over 50% of the U.S. population, is expected to significantly boost the demand for rental apartment buildings over the next 12 to 20 years. Landlords are now able to push rents in many markets, resulting in rapid capital appreciation of apartments. In fact a Harvard University study issued in June 2007 stated that “The long-term outlook for residential investment remains strong.” As it relates directly to apartments, the report mentions, “The children of the baby boomers coming of age in the next decade [echo boomers] will reinforce the demand for rental units.” The Harvard study concludes that, “In fast-growing areas, the existing housing stock will be unable to accommodate the rising number of young households.”

It is important to understand the inverse relationship between rental real estate and direct real estate ownership. When it is an ideal time to purchase a home, the demand for rentals is driven downward. By the same token, when the demand for home purchases is down (today’s environment), usually rental growth is on the rise. 1031 Alternatives Group, through our real estate sponsor firms, has established an investment philosophy that emphasizes the aforementioned demographic trends, in this case as it specifically relates to apartment investments. For further information on these programs, please contact our offices directly for a complimentary brochure on “Demographic Investing”.

Over the past few months the U.S. debt markets have been extremely volatile. We are all aware of the “Sub-Prime” mortgage debacle that has taken our country’s headlines by storm as it pertains to the residential housing market, but many are unaware of what affect that this crisis has played in the commercial real estate market.

For clarification, the commercial real estate market is extremely strong at this point and runs an entirely different cycle as residential real estate. Many investors believe the phrase “Real Estate Bubble” refers to real estate in general, when in most cases the so called “bubble” pertains primarily to the U.S. housing market. It is important to realize the differences between both sectors and what the driving factors are that differentiate them. In fact, a recent Wall Street Journal article states that “The national office market, which cratered after the tech bust in 2000, has recovered and is the strongest it has been in five years.”

Though the commercial fundamentals still remain positive, the commercial lending market, more specifically commercial mortgage back securities (“CMBS”), have recently experienced some rough waters. CMBS’s are commercial mortgages that are packaged upon origination and sold to investors on Wall Street. The recent instability of the residential markets and sub-prime concerns has positioned many commercial lenders to “tighten their reigns” on the commercial side. Many of these lenders have some sub-prime residential exposure and are increasing their spreads (what they charge for loans), some up to 200 basis points to hedge their risk. These lenders are also doing away with some other benefits that many investors have grown to enjoy, such as higher loan to value ratios and interest only financing. In turn, these factors ultimately affect the yields paid to the investors because the borrowing costs have increased. To improve these issues, sellers will have to lower pricing expectations which will ultimately lead to the reversal of the cap rate compression era that we have seen in recent years. Only time will tell what is in store for the future U.S. real estate marketplace. Many sectors like Medical Office and Multi-Family remain extremely optimistic.

Grant Conness, Director 1031 Alternatives Group was recently quoted in The Wall Street Journal in an article titled “Land Boom to Skirt Credit Woes?” The article discusses the benefits and increased popularity of using the Tenant In Common (TIC) structure to purchase raw land in a credit tightening environment.

Though land investments generally do not produce the current income streams that most 1031 Exchange – TIC investors are seeking, they might be a good play “for a younger investor with a longer-term horizon”, as Grant Conness mentions in the article. It may also be a unique opportunity for investors seeking asset class diversification or those in the quest of, “all cash” or no leverage deals.

For the investors that may be turned away from land TICs because they lack current income, some sponsors have taken an approach to set up these land TICs with option payments which provide current returns. The sponsor may in turn purchase the property at certain strike prices in future years. This strategy may now provide land investors not only the opportunity of capital appreciation but also the current income that most land investments lack.

Some home builders and developers are at a point where they are looking to get out of certain projects that were put together late in the housing boom. This may be an opportune time for TIC investors to receive some attractive pricing in terms of land costs with the expectations that 5-10 years down the road the housing slump recovers and these land owners may liquidate their holdings for a significant capital gain.

Please click here to view the Wall Street Journal article “Land Boom to Skirt Credit Woes?” in its entirety.

Many people have been entering the real estate market as investors for the first time and have been exploring the benefits of tax deferral using a 1031 Exchange.  Speaking with a trusted tax advisor is key to learning the requirements, but many investors have questions about how an exchange will affect their sale and how the process actually works.  Every 1031 Exchange company operates differently, but here is a sample outline of a standard delayed exchange.

Prior to Sale:

• Investor decides to sell, contracts a real estate agent, receives and accepts an offer.
• Add intent to do an exchange to the sales contract.
• Contact the qualified intermediary and authorize them to initiate the exchange.
• The intermediary will request documents from the title/closing company.  These will be used to prepare the exchange agreement.
• At closing the exchangor will sign the 1031 Exchange documents along with the other closing paperwork.
• The sales transactions closes, funds are wired to the qualified intermediary, and the 45 and 180 deadline starts.

45/180 days:

• The closing statement prepared by the closing agent will be sent to the intermediary and will indicate the exact date of sale; this will be the basis for the 45 and 180 day calculations.
• From the closing date of the sales property, the exchangor has 45 days to identify potential replacement property, in writing, to the qualified intermediary. 
• Replacement property must be purchased no later than 180 days after the sale.

Purchase:

• When the replacement property has been selected the contract for purchase should be amended to state that the purchase will be part of a 1031 Exchange. 

• The 1031 company will request documents from the title/closing company that they need to produce exchange documents for the purchase.
• The closing agent requests funds to be wired from the exchange account. 
• Client signs closing and exchange documents and takes ownership of the replacement property.  This completes the transaction.
• When the exchangor is filing their income taxes they will complete form 8824 to file their 1031 Exchange with the IRS.

§1031 Exchanges are also called tax-deferred exchanges which means the tax basis from the sales property is not eliminated but carried over to the property that is purchased. While the tax deferral benefits of exchanging are only allowed on investment property, Section §121 of the code has a permanent tax deduction that can be taken on the sale of a primary residence. As long as the taxpayer has lived in the property for a total of two years out of the previous five, they can claim a $250,000 deduction ($500,000 for joint filers) from their income tax. With planning, these two tax strategies can be combined to exclude the capital gains from the sale of investment property.

If an exchanger acquires a property, rents it for a number of years, moves into the property as a primary residence for at least 2 years, it is possible to then sell that residence and exclude up to $250,000 of gain ($500,000 if filing jointly) from their taxes.
In late 2004, Section §121 was revised to add a five-year holding period before a taxpayer can exclude gain under Section §121 when selling a primary residence that was acquired initially as investment property in a §1031 Exchange. For example: if the property acquired in the §1031 Exchange is rented for three years, then used as a primary residence for two years, the taxpayer will be able to sell it and exclude up to $250,000 of the gain pursuant to Section §121. The residence was owned for a minimum of 5 years and used as a primary residence for 2 out of the last 5, meeting all the requirements of the updated tax law. Thus, with careful planning, the tax deferral of §1031 Exchanges can be converted to permanent tax exclusion by combining these two tax strategies.

We have two sources of guidance for the application of Section 1031 to vacation homes -- a letter ruling and a tax court case. In 1981 the IRS issued a Letter Ruling (Ltr Rul 8103117) that allowed a 1031 exchange on a vacation home that was sold and replaced with another vacation home. The Old Vacation Home that was sold had not been rented for the six or seven years prior to the exchange, and had been held for both "personal enjoyment" and as a "sound real estate investment." The New Vacation Home that was purchased was also intended to be held for the same personal enjoyment and investment intent.

All of these questions appear to have been answered in a recent U.S. Tax Court case (Rivera v. Commissioner). This case is significant because the U.S. Tax Court is, if you will, "The Supreme Court" of tax law, so the weight of this decision is heavy. (Although that being said, this is a Summary Opinion and carries only persuasive support -- albeit a strong one -- and not the actual precedence of law.)

The property involved in this case is a vacation home near the Lake Tahoe ski and vacation area of Truckee, California. The property had very little rental activity during the two years of the case, as well as the five or six prior years. And most of those days were personal use days by the owners; rental activity was minimal.

News of two exchange companies mishandling client 1031 funds has been in the news recently and has caused concern among users of the popular tax deferral strategy. The negative actions of a few are overshadowing the success and responsible approach of the many. It is important to note that 1031 Exchanges have been around for over 85 years and were intentionally established by the IRS with clear guidelines allowing taxpayers to defer gain on their investments.

Although not representative of the industry as a whole, these cases do highlight the importance of researching the company you choose to process your 1031 Exchange. As with any important decision, know whom you are choosing to do business with. Some questions to ask when researching a potential 1031 company:

Will my money be held with a large bank with online viewing of my funds
Is the money in a segregated account or mingled with other funds
Do disbursements of exchange proceeds require more than one signature
Are you bonded and insured to cover both intentional and unintentional wrongdoing
What is your experience with 1031 Exchanges and the tax code
How long has your company been in business

While not a comprehensive list, questions like these will help you know the company you will be working with and trusting to process your exchange in accordance to IRS guidelines and ethical business standards.

1031 Exchanges are also called tax-deferred exchanges which means the tax basis from the sales property is not eliminated but carried over to the property that is purchased. While the tax deferral benefits of exchanging are only allowed on investment property, Section §121 of the code has a permanent tax deduction that can be taken on the sale of a primary residence. As long as the taxpayer has lived in the property for a total of two years out of the previous five, they can claim a $250,000 deduction ($500,000 for joint filers) from their income tax. With planning, these two tax strategies can be combined to exclude the capital gains from the sale of investment property.

If an exchanger acquires a property, rents it for a number of years, moves into the property as a primary residence for at least 2 years, it is possible to then sell that residence and exclude up to $250,000 of gain ($500,000 if filing jointly) from their taxes.

In late 2004, Section §121 was revised to add a five-year holding period before a taxpayer can exclude gain under Section §121 when selling a primary residence that was acquired initially as investment property in a §1031 Exchange. For example: if the property acquired in the §1031 Exchange is rented for three years, then used as a primary residence for two years, the taxpayer will be able to sell it and exclude up to $250,000 of the gain pursuant to Section §121. The residence was owned for a minimum of 5 years and used as a primary residence for 2 out of the last 5, meeting all the requirements of the updated tax law. Thus, with careful planning, the tax deferral of §1031 Exchanges can be converted to permanent tax exclusion by combining these two tax strategies.

1031 Exchanges are also called tax-deferred exchanges which means the tax basis from the sales property is not eliminated but carried over to the property that is purchased. While the tax deferral benefits of exchanging are only allowed on investment property, Section §121 of the code has a permanent tax deduction that can be taken on the sale of a primary residence. As long as the taxpayer has lived in the property for a total of two years out of the previous five, they can claim a $250,000 deduction ($500,000 for joint filers) from their income tax. With planning, these two tax strategies can be combined to exclude the capital gains from the sale of investment property.

If an exchanger acquires a property, rents it for a number of years, moves into the property as a primary residence for at least 2 years, it is possible to then sell that residence and exclude up to $250,000 of gain ($500,000 if filing jointly) from their taxes.

In late 2004, Section §121 was revised to add a five-year holding period before a taxpayer can exclude gain under Section §121 when selling a primary residence that was acquired initially as investment property in a §1031 Exchange. For example: if the property acquired in the §1031 Exchange is rented for three years, then used as a primary residence for two years, the taxpayer will be able to sell it and exclude up to $250,000 of the gain pursuant to Section §121. The residence was owned for a minimum of 5 years and used as a primary residence for 2 out of the last 5, meeting all the requirements of the updated tax law. Thus, with careful planning, the tax deferral of §1031 Exchanges can be converted to permanent tax exclusion by combining these two tax strategies.

Despite the recent housing turndown foreign investors still consider the US market quite stable and are buying properties at a record pace.  The combination of a buyers market and the weak US dollar has created a surge in overseas investors that has helped soften the market downturn in some hard hit states like Florida.  These investors have a huge opportunity with combination of 1031 Exchanges and Tenant In Common (TIC) investment properties. 

The primary benefit of 1031 exchanges is the deferral of capital gains tax and depreciation recapture on the sale of investment property.  A less known tax consequence for foreign investors is the addition of a foreign investor, or FIRPTA, withholding of 10% applied to all properties sold in the United States by nonresident individuals or corporations.  The good news is that the FIRPTA tax is also deferrable under section 1031 and when combined with the capital gain and recapture taxes can result in very significant tax savings.

TIC investments are an increasingly popular option for 1031 investors because they allow smaller investors to purchase institutional quality properties without the management headaches.  That passive ownership distinction is doubly important if the owner is located outside the country and makes the combination of 1031 Exchanges and Tenant In Common (TIC) ownership a great way to maximize real estate investments. 

Turn on the television these days and you will see numerous reality programs following the lives of people who ”flip” properties for profit. This involves purchasing a property, doing repairs, and quickly selling, hopefully, for a profit. If you analyze this practice from a 1031 Exchange perspective it can be used to illustrate an important requirement for a successful exchange: the properties must be of like-kind.

A property that is flipped can be considered inventory property, or property intended for resale, and is therefore not like-kind to investment property, property held for use in business or trade, or for appreciation. Someone who actively buys and sells real estate may be considered a dealer by the IRS, and the inventory they are trading are the properties. If an investor was to purchase the same property as a dealer, do the same repairs, but then rent it for a length of time, it could be classified as investment property and qualify for a 1031 exchange.

There are many factors to consider when making the determination of like-kind and I will go into greater detail in future entries.