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Archive for the ‘1031’ Category

Is a 1031 exchange needed?

Posted by taxguru on July 9, 2007


My parents are both deceased and I am presently under contract to sell the farm.  I have made my intention to perform a 1031 exchange known to the potential purchaser.
I would like for you to advise me on the best course of action involving this matter.  My desire is to reinvest the  portion of the sale which would be subject to capital gains tax.
As a brief history; the farm was purchased in 1995, my mother died in May 2002, my father in  November 2003.
I have always lived here since 1995. 
I don’t know how to establish  the new value basis for the farm or how the exemption on the sale of my primary residence  will affect my overall tax liability.
The purchase price will be substantially more than average requiring, I believe, an exchange to avoid capital gains tax.
As it stands now the closing date could be anywhere from September  of this year to February of next year.  An investment group is purchasing the farm and other adjacent properties for a commercial venture and there are certain contingencies which make it impossible to know the exact closing date. 
So I  basically need to know where I stand so I will be prepared if the sale concludes as expected. 




It’s critical that you consult with a professional tax advisor because there are a number of issues that need to be considered.

First is the determination of your cost basis in the property in order to determine how much potential profit you would be looking at with a sale.  This depends on how you acquired legal title to the property, which wasn’t clear in your email. The three most common ways to acquire title would be by purchase, gift or inheritance.  Each one gives a very different cost basis amount.

For example, if you purchased it from them while they were alive, that would be your cost, plus improvements and less depreciation.

On the other hand, if they gifted the property to you while they were alive, their cost basis carries over to you even though Gift Tax returns are based on the property’s fair market value at the time of the gift.  If you received the property as a gift, you would start with their adjusted cost basis and add in any capital improvements and subtract any depreciation you have claimed to arrive at your current cost basis.

Finally. if the title to the property was transferred to you as a result of your parents’ death, your cost basis in it would be its fair market value as of the date they passed away, or an alternative date (usually six months later) if that was used on their estate tax return. 

If you did inherit the property, with the cost basis being established based on its value in 2003, your potential gain shouldn’t be as high as it would be if you had purchased the property or received it as a gift.

The other big issue that you need to work on with a professional tax advisor is how much of the property qualifies as your primary residence so that the sale price can be properly allocated between it and the farm portion.  As you probably know, up to $250,000 of gain from the sale of a primary residence is tax free; $500,000 if you are married.  I have a full explanation of this extremely useful tax break on my website.

I hope these points are useful in deciding if you have a tax problem to worry about, in which case a 1031 exchange would be a wise move.

Kerry Kerstetter




Posted in 1031 | Comments Off on Is a 1031 exchange needed?

Be careful when choosing 1031 service

Posted by taxguru on May 25, 2007

I can’t help using the old cliche –  Penny Wise, Pound Foolish – to describe how so many supposedly intelligent people can risk literally millions of dollars in order to save a few hundred.

It’s no secret that my wife owns and operates a company to handle Section 1031 like kind exchanges for real estate investors.  She frequently mentions that potential clients try to get her to lower her fees based on lower rates being charged by newbies who don’t know what they are doing.  Of course, she is just like I am and refuses to participate in such a “whore’s market” and doesn’t work with anyone who doesn’t understand that quality comes with a price.

As these articles covered by Paul Caron indicate, cutting corners on a 1031 fee can end up costing much more in the long run, as several 1031 facilitators have filed bankruptcy while holding 151 million dollars of investor funds.  I wonder how many of those investors chose to use those companies based on lower fees than what reputable firms charged. They are each now looking at the very likely prospect of losing hundreds of thousands of dollars because they wanted to save a few hundred dollars.    

This reminds me of a similar situation when I owned an exchange company back in the Bay Area.  We were losing a lot of exchange business to a new company that wasn’t charging anything for its services, supposedly as a means of getting a foot-hold in the area’s real estate market.  The fact that they were operating out of a motel room should have been a dead tip-off to the end result.  The slime-balls amassed a few million dollars of investor funds and then skipped town.

I hate to sound cruel, but anyone who is willing to entrust his/her real estate equity with a stranger rather than someone who has been successfully handling 1031 exchanges for decades, just to save a few hundred dollars on the service fees, doesn’t have much chance of being considered a “sophisticated investor.”  Short-sighted fool would be the more appropriate description of such a person.  

1031 Tax Group files for Chapter 11

1031 Group bankruptcy a muddle


Firm files bankruptcy owing $151 million





Posted in 1031 | Comments Off on Be careful when choosing 1031 service

Sec. 1031 & 121

Posted by taxguru on May 15, 2007


Subject: Exchange Question


We are considering doing a 1031 exchange on a single family rental, which has been held for 32 years, and is owned free and clear. 


The idea would be to exchange this rental home for TWO single family homes, and use them as rentals (like/kind).  Then, after 3 years, move into one of the rentals and live in it for two years,  meeting the five year holding requirement & 2 year residency requirement …. Then we would sell new Rental Property #1 as a personal residence, and then move into the Rental Property #2 as a permanent residence, and live in it indefinitely.


Each of the newly exchanged properties would be rentals – the first one for 3 years (then move in for 2 years), for a total of 5 … and the next exchange property would be a rental for 5 years until we could meet the time requirements.


This is hard for me to explain, but I hope you can get a grasp of what I’m trying to do.  Trade one rental for two, and live in the two rentals (over a period of five years before moving into rental #2) so as not to pay capital gain taxes.    Would these time lines work? 



That plan could work, assuming our rulers in DC don’t mess with the tax laws over the next five years to change any of the timing details, which you have correct for the laws as they stand now.

I have one very big word of caution for you.  Keep your intention to reside in one of the new rentals to yourself. Blabbing around to a lot of people that you had that plan from the beginning could jeopardize your 1031 exchange because an aggressive IRS agent could classify the house as personal at the time of the exchange.  I have seen and heard of cases where people shot themselves in the foot by bragging about plans such as yours.  All it takes is one jealous person to turn you in and you’re cooked.  The decision to move into the rental has to appear to be made long after you take ownership of it.

Other than that, it sounds as if you are looking at things creatively, which is what makes the tax game so much fun.

Good luck.

Kerry Kerstetter





Posted in 1031, 121 | Comments Off on Sec. 1031 & 121

1031 of LLC Property

Posted by taxguru on May 6, 2007


Subject: Exchange Question

Dear Tax Guru,

I own a residential rental property in AZ under an LLC with a partner. We are in the process of selling it after two+ years of ownership.

Am I able to do a 1031 exchange with the proceeds of this sale into a commercial property that I am looking to invest in under a different LLC with another partner?

Thanks for your help.


It depends on the official ownership title for the property. If it’s in your individual names, you can each use your share of the proceeds for whatever you want, 1031 exchange or taxable sale.

If the property’s title is in the name of the LLC, and you don’t all want to reinvest into new property, you will need to get your share out of the LLC’s name and into your own name before the disposal, so that you can do a 1031 with your share of the proceeds. This is a common event and any experienced title company or abstract attorney can handle this.

You also need to coordinate with your and the LLC’s tax preparers to keep track of the property’s cost basis, the distribution to you, and the reporting of the 1031.

Good luck.

Kerry Kerstetter

TaxCoach Software: Are you giving your clients what they really want?

Posted in 1031, LLC | Comments Off on 1031 of LLC Property

Jointly Owned Property

Posted by taxguru on May 6, 2007


Subject: Sale of home question

Hi Tax Guru,

Found your website while browsing for an answer to my question about a sale of a home I own with my parents. Here’s the situation:

Here are the circumstances:

My brother and I own a property with my parents. We are all on title as joint tenants (1/4 undivided interest to each of us and 50% undivided interest to my parents). The house was bought in 2000, my parents supplied the down and my brother and I have payed for the mortgage and taxes since. We’ve split the deductions every year between the two of us. My parents have used this as their primary residence since 2000 while my brother and I do not. We have considered it our 2nd home as we each own our own primary residence. We are now interested in selling the home and are wondering what is the best way to reduce the tax implications for everyone. I estimate the capital gains on the home to be approximately 300K.

Since my parents use it as their primary residence, would they be able to “claim” all the capital gains (300K) or do the gains have to be divided equally among the 4 owners? If it has to be divided, is there any way to get off the title so that my parents can take advantage 500K exemption without triggering gift tax consequences for my brother and I? Any suggestions on how we can either structure the title or the sale such that taxes are minimized for all parties? My parents income is low while my brother and I are in much higher brackets if we had to pay taxes.

Appreciate any insight you might have on mitigating the tax burden.

Thanks very much!


This is an issue that you all really need to work on with the assistance of an experienced professional tax advisor because there are a number of ways in which it can be handled and several factors that need to be considered, such as the following.

It is obvious that your parents can qualify for the Section 121 tax free exclusion of the gain on their one half of the home’s net gain. The gain on the half that you and your bother own is a much more complicated issue.

Let me address the gifting option. You and your brother could gift your shares of the home to your parents. However, this would require you both to file gift tax returns to report it and either pay gift tax or use up part of your million dollar lifetime exclusion. Your parents would assume your cost basis in the 50% of the home they are given and would essentially be accepting full responsibility for your and your brother’s gain.

The half of the home that your parents are given will not qualify for the Section 121 tax free exclusion because the law requires the seller to both own and occupy it is their primary residence. While your parents have obviously met the occupied test, they would fail the ownership test and would thus be required to report the gain on their “new” 50% share as taxable long term capital gain (LTCG). Because they had been using all of the home for personal purposes, its sale cannot be structured as a Section 1031 like kind exchange, which is only available for business and investment property.

If you and your brother keep your share of the house, the gain is potentially taxable, depending on how you and he are classifying its ownership, which should be consistent with how you have been reporting the deductions for interest and property taxes on your 1040s.

If you have been treating the home as investment property, you can structure your disposal of your share of the home as a Section 1031 like kind exchange, which will require you to use the services of a neutral third party facilitator to reinvest the proceeds into new (to you) business or investment property within 180 days. These rules are all explained at

If you have been reflecting that you have been personally using the home, it will not qualify for Section 1031 and you will have a taxable LTCG.

You and your brother don’t necessarily have to report this in exactly the same way. The strategy for each of you and your brother could be different depending on your unique situations. For example, one of you may qualify for a Section 1031 exchange, while the other may not.

The actual tax hit on any taxable gain could be spread out over several years under the installment method if part or all of the sales price is carried back. Your personal professional tax advisor can show you how that would work with your numbers and sales terms.

I hope this gives you some idea of the various details that you all need to be evaluating with your personal professional tax advisors.

Good luck.

Kerry Kerstetter

Posted in 1031, 121 | Comments Off on Jointly Owned Property

Informing Clients About 1031 Exchanges

Posted by taxguru on March 14, 2007


Subject: Exchange Question
I was never informed by my Realtor of this 1031 rule. Now, after the exchange, I was just notified by my accountant that I owe a large amount of money. Has anyone won lawsuits against Realtors for mistakes made by not even mentioning that I should contact a tax specialist when asked if we are doing everything correctly in this transaction?


That’s a very interesting question because in all of my speeches and seminars to Realtors over the past decades, I have always made a big point of stressing that if they ever smell any possibility of a 1031 exchange being relevant with a client’s property, they should advise that client to consult with his/her personal professional tax advisor to see if in fact the deal should be structured as a 1031. 

It is not the Realtor’s job to actually advise on the feasibility of a 1031 for a particular client because that is well outside their area of expertise and responsibility, and they couldn’t possibly have enough specific information to render a competent analysis. 

I always warn Realtors that if a client were to learn after the fact about 1031s, and that subject was not mentioned, s/he could try to sue the Realtor for the taxes that had to be paid.  Many Realtors accused me of being an alarmist by discussing this possibility; but I assured them that it was based on real life situations that I have seen, as well as calls and emails such as yours. 

I am not a big believer in litigation for every little thing that happens; so only you can decide if it’s worth it to you.  Over the past 30 years, I have seen instances where Realtors have been sued for this kind of alleged negligence.  The results have been all across the board.  In some cases, the judges awarded nothing because they believed that the taxes would have been due some time anyway and that the clients were at fault for not being smart enough to consult with their own tax advisors before selling a highly appreciated property.  In some cases, Realtors were required to reimburse clients for some or all of the taxes they had to pay because Section 1031 wasn’t used.  In other cases, there were out of court settlements for compromised amounts. 

I am not an attorney, but my understanding of the current trend in regard to this kind of issue is that, since 1031s have been around for so long now, it is becoming more difficult to convince a court that an experienced real estate investor has never heard of it.  You would most likely have a better case of winning if you can convince the court that you are not a frequent real estate seller and are not very knowledgeable in tax saving strategies.  If it is true that you have just now learned about 1031 exchanges for the first time, that must be the case. 

There is no way to know how your case would turn out.  You will need to discuss the merits of your case with an attorney and/or the managing broker in the office of your listing Realtor.

Good luck.

Kerry Kerstetter





Posted in 1031 | Comments Off on Informing Clients About 1031 Exchanges

1031 Identification Deadline Is Firm

Posted by taxguru on February 8, 2007


Subject: Exchange Question
New question from a client, that I have not encountered before. If 3 prospective replacement properties were identified for an exchange within 45 days of the sale of a property and none of the 3 remain available for purchase, can my client substitute a replacement prospect, close on it within the 180 day time frame and still defer the capital gains tax consequence?



Based on the way in which you described your client’s situation, the answer is a very big NO. 

The only statutorily eligible reasons for an extension of either the 45 or 180 day deadlines are when the property has been affected by a Presidentially declared disaster or if the taxpayer is on active duty in a combat zone.

If the taxpayer just dawdled and let other people buy up those listed properties, IRS has no sympathy for him. 

This is why we have always advised working diligently on the acquisition phase of the exchange as early in the process as possible; ideally while the disposition phase is still in progress.

Hopefully, this lesson won’t be too expensive for your client and he will be more on top of things the next time he attempts an exchange.  If the potential tax bill is substantial, your client may want to make the new owners of the properties substantially increased offers so that he can still acquire them within the 180 day deadline.

Kerry Kerstetter



Posted in 1031 | Comments Off on 1031 Identification Deadline Is Firm

Tax free sales of rental homes

Posted by taxguru on January 6, 2007



Subject: Tax Question
Hi Kerry – 
I was wondering if you could help me with a residence tax question.  I currently live in a Primary Residence in MI, and have a condo in AZ that I am renting out.  If I sell the house in MI and move into the condo after the current renters lease is up, and live in the condo for 2 years, can I avoid capital gains?  It is currently a rental property for me.  If not, do you have any idea how I could avoid capital gains on the condo?


Ever since the current law regarding residence sales was enacted in May 1997, this has been a very common strategy; to convert rental homes into primary residences and sell them tax free after two years, again and again.  I used to call it the “conversion game.”  Others have called it “serial home selling.”

This strategy is still available today, except in the case of rental homes that had been acquired as replacement property for a 1031 exchange.  As I explained in my blog, you need to have owned the home for at least five years in order to use the Section 121 tax fee exclusion, in addition to meeting the two year residency test.

Most of these issues are explained on my website.

As always, before implementing any tax saving strategy such as you are proposing, you must consult with an experienced tax professional to ensure that you do everything properly and don’t shoot yourself in the foot. 

Good luck.

Kerry Kerstetter




Posted in 1031 | Comments Off on Tax free sales of rental homes

ACAT’s Year End Tax Tips

Posted by taxguru on December 4, 2006


I just received an email from ACAT with an attached doc file of tax tips to be shared with clients and local media outlets.  Since this blog is my local media outlet, I am sharing those tips here.


The Twelve Tips of Business Year-End Tax Planning


Before business owners celebrate the Twelve Days of Christmas, they should first take a moment to review these Twelve Tips of Business Year-End Tax Planning. These could save the average business thousands of dollars!

It’s important to act quickly – once the bell tolls for the New Year, these opportunities for potential savings will be gone!

1.      Accelerate deductions from 2007 into 2006. A business can do this by making payments this year for expenses such as office supplies, repairs, maintenance, and advertising.

2.      Consider setting up a qualified retirement plan. It is one of the best ways for businesses to save on taxes. There are many options, so picking the right plan for your business is the key. Some plans are required to be set up by year end.

3.      Reduce or defer year-end income. For cash basis businesses, deferring billing for services until the end of December or January can shift the income into the next year, as the income is reported in the year it is actually received. Also, delaying shipping of merchandise until January moves income into the next year.

4.      Accelerate purchase of equipment. If you anticipate business income to be higher in the current year versus next year, it makes sense to accelerate the purchase of equipment and other assets into this year. The benefits of Section 179 depreciation can mean large tax deductions, thus making the tax savings significant. Businesses can elect to “expense” part or all of qualified assets purchased during the year, up to the annual limit of $108,000 for 2006. There is a limit based on taxable income and an annual purchases threshold amount to qualify.

5.      Review fringe benefit plans. A Section 125 “cafeteria” plan can benefit both the employee and employer with pre-tax savings for health and dental insurance, out-of-pocket medical costs, dependent care, and other benefits.

6.      Write off bad debts. Businesses that use the accrual basis method of accounting may have uncollectible past-due accounts. These businesses can deduct these bad debts when they become partially or totally worthless. These accounts should be identified before year-end and the business should keep a detailed record of the debt-collection efforts.

7.      Write off old inventory. Review the business inventory for obsolete and un-sellable items. A business may write down inventory below market if in the regular course of business the company has offered the merchandise for sale at below-market prices.

8.      Review building depreciation. If your business has purchased or substantially renovated a building in the last 10 years, conduct a Cost Segregation Study. The study analyzes the components of a building or renovation to gain larger depreciation deductions based on shorter depreciation lives.

9.      Explore like-kind exchanges. If you are considering replacing old equipment or buildings with newer ones, take advantage of the like-kind exchange rules. Trading assets is one of the best tax shelters available to businesses and investors. The section 1031 like-kind exchange rules are very strict and must be followed exactly.

10.  Review your business entity classification. Check to see if your business classification (sole proprietorship, C-corporation, S-corporation) and your accounting method options (cash basis vs. accrual basis) are the most advantageous for your business. Tax laws change constantly and reviewing the alternatives could significantly impact your taxes. Any change in ownership of the business is also a good time to review your options.

11.  Finalize the budget. Compare income and expenses for the current year to the previous year and prepare a budget for the coming year. A budget will help a business reach its goals.

12.  See your accountant or tax advisor. There are many ways to save tax dollars and consulting with a tax professional who is experienced and familiar with the latest tax law changes can help you minimize taxes and maximize your bottom line. Effective tax planning can make a material difference in your company’s cash flow.

         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.





Heed the Top Ten Year-End Tax Tips To Save on 2006 Taxes


“If I had only known about that new tax law, I would have done something before the end of the year!” This common lament of taxpayers is often the result of simply not staying on top of the latest changes to the increasingly complex tax laws. But it doesn’t have to be that way!

Avoid surprises and maximize tax savings with these “Top Ten Year-End Tax Tips”:

1.      Take stock of your stocks. Review your current year stock and mutual fund sales to determine if you have a net gain or loss. If you have a net gain, then selling stocks that would produce a net loss may make sense. A net capital loss of up to $3,000 can be deducted against other income, such as salary. Any excess losses can then be carried forward to future years.

2.      Watch out for the estimated tax penalty. The IRS requires individuals to pay their taxes throughout the year with quarterly estimates, tax withholding, or both. If you don’t pay enough during the year, you can be hit with an estimated tax penalty, which is equal to the interest rate for underpayments. Although it may be too late for this year, adjusting your income tax withholding can eliminate or reduce the penalty.

3.      Consider stock donations. If you want to donate to your favorite charity but are short on cash, check out your stock portfolio. If you own stocks that would produce a large capital gain, consider donating them before you sell them. You can deduct the market value of the stock as a charitable contribution and you pay no tax on the appreciation.

4.      Reducing the tax on Social Security benefits. People who receive Social Security benefits can be taxed on a high percentage of their benefits. Investing in T-Bills or CDs that don’t mature until next year can lower the provisional income in the current year and lower the tax rate. Also, investing in growth stock that produces little income can have the same result.

5.      “Kiddie Tax” update. The new tax law raises the age threshold for the “kiddie tax.” For 2006, any unearned income (interest, dividends, capital gain, etc.) received by a child under age 18 (previously age 14) that exceeds $1,700 is subject to federal tax at the parents’ top marginal tax rate. You might want to shift investments into growth stocks that produce little income, tax-free municipal bonds or municipal-bond funds, Series EE bonds, or CDs that mature in the next year.

6.      Installment sale of property. If you are considering the sale of real estate property that was held for investment purposes, you could spread out the tax hit over several years with an installment sale. If you structure the sale into two payments, one in December and one in January, you spread the tax over two years instead of one. The second benefit may come from a lower adjusted gross income.

7.      Shift timing of deductions. Consider maximizing your itemized deductions by “bunching” deductions. In order to get a tax break from itemizing deductions, you must have more in deductions than the standard deduction allowed by the IRS. For 2006, this is $10,300 on a joint return and $5,150 on a single return. If you are close to the standard deduction each year, consider accelerating all possible deductible expenses into every other year. Shift payments of medical expenses to the year they will exceed 7.5 percent of your adjusted gross income, pay two years of personal property tax and real estate tax in one year, or double up on your charitable contributions into one year.

8.      Watch business expenses. If you deduct employee business expenses, your deduction is reduced by 2 percent of your adjusted gross income and you may lose the deduction totally because of the alternative minimum tax (AMT). The best strategy is to set up an “accountable plan” with your employer to cover all your business expenses in lieu of wages for the same amount. The reimbursements you receive will be tax-free, not subject to payroll taxes or alternative minimum taxes.

9.      Defer income until next year. If it is possible to defer receiving income until the next year, you not only defer income tax on that income for another year but you may increase the value of your deductions for the current year if you have adjusted gross income limitations. Consider postponing bonuses, investment gains, or elective distributions from retirement accounts.

10.  See your tax professional. Make an appointment with your tax professional before year end. Opportunities missed can mean cash in the bank. Don’t be one of the many taxpayers that look back and say, “If I only knew about this before the year end.”

Tax laws change every year, so it’s always a good idea to review all your options while there’s still time to take action,” explains Paul V. Thompson, EA, ABA, ATA, ECS, Senior Tax Manager for Shaw & Sullivan, P.C., Alexandria, VA.  “You should also not assume that your tax withheld from your W-2 wages or the tax estimates you are paying are enough to cover your tax liability or avoid a penalty.”

         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.



The best book on QuickBooks Premier Editions



Posted in 1031, 179 | Comments Off on ACAT’s Year End Tax Tips

Converting Rental To Residence

Posted by taxguru on November 30, 2006



Subject: Exchange question

What is the test of intent in an exchange. Suppose someone exhanges an apartment rental building for a single family home, their true intent is to eventually turn the home into a personal residence.  They have told numerous people city building officials that their intent is to remodel the home for their use as a personal residence.  Before they purchased this replacement property, they arrange with the broker and seller of the property to convert the property to a rental in order to qualify as a rental property under 1031 rules.  This seems like a scam the IRS would frown upon.


You are absolutely right that somebody who announces right up front the intention to personally occupy the home is setting himself up for serious problems with IRS accepting that property as proper like kind for a 1031 exchange

Conversion from a rental to personal use is allowed, but it has to appear that the decision to do so took place after the completion of the exchange.  I have long advised people who have a long-term goal of exchanging into a rental home and later on converting it to personal usage to keep that plan to themselves. The more they announce that intention to other people, the more damage they are doing to their case for a valid 1031.  Loose lips sink ships, etc.

As a tax practitioner, I always keep in mind the way in which everything would play out in real life.  Any audit by IRS of a 1031 exchange would normally be a few years after the actual exchange took place.  If the taxpayer is already occupying that home when the audit occurs, it will be a much tougher case to make that it was acquired with the intention of being for rental usage.  That wouldn’t be an impossible argument to win; but each bit of evidence the IRS auditor could find indicating prior intent to occupy it, the more difficult it would be.  Obviously, the more people who had been told of this previous intent, the more damaging the evidence against the validity of the 1031 exchange.

The moral of the story is that anyone stupid enough to be bragging around about his intention to only appear to be acquiring a rental property probably deserves to lose the tax savings from a 1031 exchange.

Thanks for writing.

Kerry Kerstetter





Posted in 1031 | Comments Off on Converting Rental To Residence