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Archive for the ‘1031’ Category

1031 Exchanges out of California

Posted by taxguru on December 9, 2013

As I discussed previously, the PRC is trying to keep tabs on real estate investors who use IRC Section 1031 to defer their profits to non-California property.

While all of the forms and procedures are not yet established, the FTB just posted this update on how this is supposed to work, effective for disposals after 12/31/2013.

 

Posted in 1031, Calif, CapGains | Comments Off on 1031 Exchanges out of California

For 1031s out of California

Posted by taxguru on November 1, 2013

Under IRC Section 1031, it has always been allowable to defer gains from the sale of property in one state by replacing it with like kind property in another state.  However, if that replacement property is ever sold, the gain that was deferred from the first state is supposed to be reported and paid to that state.  That has pretty much been handled on the honor system for sellers to voluntarily report to the previous state.

It appears that the rulers in Sacramento don’t much trust this honor system for former investors in California property and are now instituting new requirements for those sellers to keep in touch with the FTB every year until the replacement property is sold. Because the replacement property may be exchanged for another like kind property, and on and on, this could go on for several decades. In fact with the popular “swap til you drop” technique of investing, it is possible that there will never even be a taxable sale of the replacement property.

 As explained in this article from the most recent FTB newsletter, this rule takes effect as of January 1, 2014; but they are still working out the details as to the exact forms and procedures for the annual notification filing. Since this situation applies to many of our clients, who disposed of California property and reinvested into other states, this is something that I will be dealing with for a long time to come; so I will be commenting on any interesting new developments as I learn of them.

TaxCoach Software: Finally! Plain-English Tax Planning That Builds Your Business!
 

 

Posted in 1031, Calif | Comments Off on For 1031s out of California

Home conversion not a taxable event…

Posted by taxguru on November 26, 2008

Q:

Subject:  1031 Exchange

Back in 2005 we sold a vacant property and had a gain of $130K and bought a $180K house using a 1031 exchange..  We have had it for a rental for 4 years. 

Due to our financial situation, we have to sell our primary residence at a loss of $40K and move into our 1031 rental house and make it our residence house.
 
Do we have to pay taxes on the original deferred gain on our rental house?    .

A:

Converting a business asset to personal use is not a taxable event, so no tax will be due for the year of the conversion.

However, down the road when you sell this property, you will need to possibly pay tax on some of the gain.  The law was recently changed to require a five year look-back period.  If you occupy the home as your primary residence for a full five years before selling it, you will be allowed to exclude up to $500,000 of profit on its sale.  If you sell the home after less than five years of personal occupancy, the tax free gain will be prorated according to the amount of time it was used as a primary residence.

Your own personal professional tax advisor should be able to explain this to you in more specifics for your unique circumstances.

Good luck.

Kerry Kerstetter

 

 

Posted in 1031 | Comments Off on Home conversion not a taxable event…

Exchanging businesses?

Posted by taxguru on October 7, 2008

Q:

Subject:  Exchange Question

can I exchange a retail business for another retail business?

 

A:

It is a little trickier than just selling one business and reinvesting into another one.

When a business is sold, the sale price is allocated between the different assets being transferred, such as real estate, fixtures, equipment, goodwill, inventory and covenant not to compete.

The profits from some of those assets can be deferred via a Section 1031 exchange if that portion of the proceeds is used to acquire like kind assets of equal or higher value within the statutory 180 day reinvestment period.

For example, if $100,000 of your sale price was allocated to the business real estate, you could defer the gain on your original real estate by acquiring $100,000 or more of new (to you) investment or business real property.

The like kind rules and definitions are also a little tricky.  Real estate has the widest scope of like kind status, with any kind of investment or income producing property being eligible on both sides of the exchange.  Equipment and fixtures have to be the same kind.

Goodwill in one business cannot be classified as like kind for goodwill in any other business; so it is not possible to defer any of that profit.

Same thing for a covenant not to compete.  That will be taxable income as it is received and cannot be exchanged tax free for anything else.

This is why, if you are considering reinvesting business sale proceeds into another business, it is critical that you work with your own professional tax advisor ASAP to have the gains and possible taxes calculate for each type of asset involved and to assist you in negotiating the allocation with the buyer of your old business and seller of your new one.  The allocations you use must be reported consistently on everyone’s books.

This is a quick and dirty answer to your questions   Your own personal professional tax advisor should be able to give you more specific advice with your actual figures.

Good luck.

 Kerry Kerstetter 
 

 

 

Posted in 1031 | Comments Off on Exchanging businesses?

Possible restrictions on 1031s for real estate?

Posted by taxguru on March 29, 2008

As a means of saving huge amounts on taxes, 1031 exchanges of real estate have always been in the cross-hairs of our rulers looking to generate more tax revenue.  Rather than completely repeal Section 1031, the more likely approach is to whittle away at its usage.  I recently came across two such attempts that are in the works.

Federal regarding farm land:   1031 Proposal In The Farm Bill Update

In California, a frequently proposed idea has resurfaced, to disallow referral of gain on the disposal of Calif. property when the replacement property is not also in Calif.  Some other states have already implemented this kind of restriction, and if Calif does this, we can only expect many more states to follow.

We recently received the following news item in an email from Wachovia Exchange Services

Hello friends,

I recently received some information about California that might interest some of you.  Hopefully, we will never see this proposal get
enacted.  And I would hate to think that it might give any other states the same idea.

California, like a number of states, is faced with a severe budget shortfall. The legislature is therefore looking at a number of proposals
to raise revenues and reduce expenditures. As part of this effort, the California Legislative Administrative Office has proposed a revenue
raiser wherein an exchange of California property for out-of-state commercial property would not be eligible for deferral as a like-kind
exchange.

California currently has a claw-back regime where California property is exchanged for non-California property. In such case, while the gain is deferred, if the replacement property is subsequently sold, the deferred gain is subject to California tax. The reason for the proposal is the administrative difficulty in taxing the gains once the property has left the state.

This is just a proposal at this time; however, it should be noted that California has a history of non-conformity with the federal tax rules,
so it would not be out of character for it to have different rules for like-kind exchanges.

 

 

 

Posted in 1031 | Comments Off on Possible restrictions on 1031s for real estate?

Unreinvested Exchange Proceeds

Posted by taxguru on February 15, 2008

Q:

Subject: Exchange Question

Will I invalidate the 1031 exchange if I don’t use all the money held in escrow to buy replacement property? 


A:

Not reinvesting the full amount of your disposal leg proceeds won’t invalidate the 1031 exchange if everything else has been done properly.

However, it will, in most cases, not allow you to roll all of the gain from the original property into your replacement property.  The actual calculation for the Form 8824 worksheet is a little messy; but the quick and dirty way to look at is that the unreinvested funds will be taxable in the year that you receive them.  For example, if your disposal leg happened in 2007 and the 180 day reinvestment period expires in 2008, and you are sent the remainder of the funds in 2008, the taxable portion of the gain will be shown on your 2007 tax return as a deferred installment sale, with the actual gain subject to tax on your 2008 tax return.  If both ends of the exchange happened inside the same tax year, the unreinvested potion will be subject to tax on that year’s tax return.

The tax rate that the unreinvested funds will be hit with will be the highest rate applicable to the property’s disposal.  This normally works out to be the 25% Federal depreciation recapture rate, plus the comparable state rate, if you or the property are located in a taxable state.

I hope you’re picking up on the fact that the actual tax calculations are very tricky and are not something you should even think about attempting on your own.  The services of an experienced professional tax  preparer will more than pay for themselves in a case like this.

Good luck.  I hope this helps.

Kerry Kerstetter

 

 

Posted in 1031 | Comments Off on Unreinvested Exchange Proceeds

IRS to Tighten Enforcement of Like-Kind Exchange Rules

Posted by taxguru on February 13, 2008

Courtesy of the most recent email bulletin from ACAT.

If you are considering a like-kind exchange (also known as a Section 1031 or Starker exchange), you need to review the IRS regulations that apply…and do it right.

 

Like-kind exchanges allow investors to defer taxes when they dispose of property they currently own and replace it with similar property.  However, the Internal Revenue Service plans to increase audits and enforcement of these exchanges beginning mid-2008.

 

Usually when a business or investment property is sold, the seller must pay tax on any profit.  The tax varies depending on the type of income and the current tax rate.  For example, if you purchased land for $100,000 and sold it for $200,000, you could expect to owe $15,000 federal income tax on the transaction, assuming a current capital gains tax rate of 15%.

 

With a like-kind exchange, it is possible to purchase property for $100,000, sell it for $200,000, buy another like-kind property for at least $200,000, and avoid income taxes on that sale.  But you have to follow the IRS rules precisely, and this requires planning prior to the transaction.

 

First, the property sold and the replacement property must be “like-kind.”  IRS rules and regulations offer guidance to help determine what qualifies as like-kind property.  For example, you can exchange a single-family home for an office building, or an apartment complex for a shopping center. But you can’t exchange your home for an oil well and you can’t exchange real property for a business. 

 

Second, many like-kind exchanges will require the assistance of a qualified intermediary in order to comply with all of the requirements for a tax-free exchange.  You can usually find a qualified intermediary in your area by checking the Yellow Page listings under “Title Companies.”

 

All like-kind exchanges must be reported to IRS by filing Form 8824 with your federal income tax return.

 

Sounds confusing?  Studies by the IRS and the Government Accounting Office have found consumers don’t understand the rules.  But help is on the way.

 

The IRS has updated Publication 17 “Your Federal Income Tax” to better tell taxpayers about like-kind exchanges.  Additional information about the like-kind exchange process is found in IRS Publication 544 “Sales and Other Dispositions of Assets,” and in the instructions for Form 8824.

 

There are significant savings you can realize. But the best advice is to get your accountant involved at every step.

 

This information is provided as a public service, and should not be construed as individual accounting or tax planning advice.  For information on how these general principles apply to your situation, please consult an accounting or tax professional.

 

 

Posted in 1031 | Comments Off on IRS to Tighten Enforcement of Like-Kind Exchange Rules

Selling gifted property

Posted by taxguru on January 14, 2008

Q:

Subject: Tax Question

 

Kerry,

First, thanks for your blog.  You’re a great resource for all of us out there.  I have a question regarding some gifted property- I’m grasping at straws at this point, but I’m hoping that you can help:

First, my wife and I live in California and make ~$150K/year.  We just bought our first house and we have no children.  Just in case these detail help.

 Now to our “problem” – in Nov. 2005, my wife’s parents gifted us a piece of land worth ~$700K on which to build a home.  This is bare land, purchased in ~1978, and has a basis of ~$10K.   After spending ~$60K on permits, engineering, and architecture we decided against building a home on the land.  We’re now planning to sell the land and we’re trying to minimize our tax exposure.

 I think that we did this in the worst possible way, as I think we’re going to take the cap. gain hit on the delta between my in-laws’ basis and the sales price (minus our expenses) and my in-laws estate will be hit for the full $700K against their $2M of tax free estate (yes, they’re likely to exceed that $2M).  Other than a 1031, is there any way to minimize either the taxes or the amount counted toward my in-laws estate?  Are there creative ways to minimize the state or federal tax exposure?  Is there anything that would allow us to invest any/all of this money in a tax-free retirement account?  I know that I’m grasping at straws.

 Is there anything we can do????

 Thanks,

A:

If you have been reading my stuff for any length of time, you should know that you need to be working directly with a professional tax advisor to ensure that you do things properly.

You do have a bit of a messy situation here in regard to the built in capital gain you accepted from your in-laws.

You do really need to review various scenarios with a tax pro to see if any of them could assist. 

A 1031 exchange could possibly be appropriate if you can make the case that the old property was used for investment and not personal purposes.  You would then have to work with an exchange accommodator to use the proceeds to acquire new business or investment real estate; not personal use property.

I’m a little confused by your wording as to the status of your in-laws.  Are they still alive or have they passed away?  Another option that you may want to explore if they are still alive is to give the property back to them and possibly have them sell the property to you rather than gift it.  That could get messy; so their professional tax advisor would definitely need to be in on those discussions.  There are special tax breaks for them and you if they were to sell the property to you on the installment basis (carryback note) and then have that note as part of their estate after they pass away.

If you do sell the property, another way to spread the tax bite out is to carry back as much of the price as you can so that taxes can be spread out over the years in which you collect the payments.

These are just a few of the issues that you all need to discuss with your own professional tax advisors.

Good luck.

Kerry Kerstetter

 

 

Posted in 1031, CapGains, realty | Comments Off on Selling gifted property

Selling mixed use property

Posted by taxguru on November 28, 2007

Q:

Subject: Exchange Question

 

My wife and I live in the front house. When does the rental back house cease becoming a 1031?  Does not receiving rent make it no longer a 1031(for how long)? Is there a statute of limitations for it to qualify as exempt?  I don’t want to pay a capital gain tax on it when I sell this 2on1 Calif. property.

Tx,


A:

This is the kind of thing you really need to be handling with a professional tax advisor to ensure that you are doing things properly.

From your very short description, it sounds like you have what’s called a mixed use property; part residential and part rental.  For IRS purposes, it is treated the same as two separate properties, with the personal residence portion of interest and property taxes deducted on your Schedule A and the expenses for the rental portion on Schedule E.  The actual allocation of joint expenses may not be 50/50 if the two halves of the property are not equal in size and/or value.  An experienced tax pro can help you come up with an appropriate allocation between the two halves.  The cost basis of the property also needs to be allocated between the personal residence and rental portions, with deprecation claimed on the rental portion, which will reduce its cost basis (aka book value).

In regard to the treatment of a sale of the property, the portion of the sales price that is allocated to your primary residence will be treated as a Section 121 possibly tax free sale, as I have explained on my website.  

The portion of the sales price allocated to the rental half will not be eligible for the tax free exclusion, and will need to be set up as a Section 1031 exchange if the taxable gain warrants it.

If I’m reading into your question properly, and you are asking how long it will be until the rental portion of the property can become eligible for the tax free Section 121 treatment, the answer is never, as long as it is being rented.  If the tenants leave and you convert the rental part to be an extension of your own primary residence, the clock can start on the personal use test, which is generally two years.

You didn’t say how you acquired this current property.  As an added twist, if you acquired it via a 1031 exchange, you will have had to own it for at least a full five years prior to its sale in order to be able to utilize the Sec. 121 tax free exclusion.  Again, an experienced tax pro can assist you with this rule.

I hope I hit on your situation.  Working directly with a professional tax advisor will result in more usable numbers for your precise situation than the generalities I have to use.

Good luck.

Kerry Kerstetter

 

 

Posted in 1031, humor, realty | Comments Off on Selling mixed use property

Posted by taxguru on October 13, 2007

IRS Steps Up Scrutiny On Popular Tax Strategy – Thanks to an alert reader for the heads up on this article about upcoming IRS scrutiny of 1031 exchanges.  A big stumbling block for IRS will be in educating its agents on the proper application of 1031 rules, especially the fact that different kinds of real estate qualify as like kind.  I’ve lost track of the number of IRS agents I’ve had to train on this and other 1031 related issues. 

 

 

 

 

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