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Archive for the ‘1031’ Category

1031 Carryover Calculations

Posted by taxguru on October 18, 2006

 

Q:

Subject: Exchange Question

How do I determine the basis of the new property with consideration of both properties being mortgaged?  (Increase in net or decrease in net)

 Is there a gain realized if the property’s FMV I am receiving is less than that of the property I disposed of?

 Thanks,

A:

When you prepare the 8824 to report the exchange to IRS, it will end up with the basis of the new replacement property.  The 8824 is a complicated and convoluted schedule; so most tax prep software programs have worksheets to assist in putting the right figures in the right place, including the amounts of debt on both the original and replacement properties. 

Some other programs also have handy 1031 worksheets, such as the TaxTools program from CFS.  There are links to both the 8824 and a separate worksheet here.

Depending on the amount of exchange expenses incurred in the deal, it possible that trading down may or may not result in a currently taxable gain on the exchange. The 8824 and worksheets will give that result.

Kerry Kerstetter

 

 

Posted in 1031 | Comments Off on 1031 Carryover Calculations

Residence Converted To Rental

Posted by taxguru on October 12, 2006

 

Q:

Subject: capital gains on principal home
 
Aloha Tax Guru!
        I have a question for you.  We purchased our Lahaina Hawaii home 12 years ago for $240,000.  We had to move to Lanai (another island) for work, but had plans to move back to Lahaina.  We have been renting a house here and renting out our home in Lahaina.  We now want to sell our home in Lahaina and buy one in Lanai.  We found out homes in the Lahaina area are going for $650,000. If we sell, we would make a profit of $410,000, well under $500,000 allowed for married couples.  However, does our home we are selling count as a primary residence if:
        !)We are renting a home to live in on Lanai
        2)We are renting out our home in Lahaina
        3)We only own one home.
Mahalo for your help! 

 

A:

You left out the most critical bit of information in determining whether or not you can use the tax free sale of your former residence.  Specifically, how long ago did you move out of that home and convert it to rental? 

As is explained on my website and in the referenced links, if it was less than three years prior to the sale, you should be able to use the Section 121 tax free exclusion.  If it was longer than that, you are no longer eligible and will be selling a rental property.

You absolutely must work with a professional tax advisor on this matter.  If you do qualify for the exclusion, there will still be some depreciation recapture to pay tax on.

If you don’t qualify for the exclusion, your advisor can hopefully help you reduce the tax hit via something like a Section 1031 exchange or an installment sale.

Good luck.

Kerry Kerstetter

 

 

 

Posted in 1031 | Comments Off on Residence Converted To Rental

Carryover Cost Basis

Posted by taxguru on September 7, 2006

 

Q:

Subject: 1031 Cost Basis vs. Actual Price – Accounting Question
 
Dear Guru:
 
I would appreciate ANY help you could spare!  My question is this:
 
My corproation bought “Vacant Lot A” in 2003 for $5,000.00.  In 2005 my corporation sold “Vacant Lot A” for $40,000.00, using a 1031 Exchange.  With the 1031 Exchange proceeds, my corporation bought another investment property, “Vacant Lot B” for $40,000.00.   What is the “book value” I should show as my corporation’s asset for “Vacant Lot B”?  Would it be the cost basis of $5,000.00 or the actual purchase price of $40,000.00??   
I don’t know who else to ask!  I would greatly appreciate you pointing me in the right direction!

A:

If you’ve ever read any of my blog postings, you should already know in what direction I will be pointing you; into the arms of a professional tax advisor.  It is crazy and downright irresponsible for you to attempt to operate a corporation without the appropriate guidance of trained professionals.  I’m assuming that you are the 100% owner of this corp because any co-owners could bring an action (lawsuit) against you for fiscal malfeasance if you have been risking their investment without proper professional support services.

The terminology in your email also raises some concerns about the validity of your 1031 exchange.  To be valid, your corp should not have actually received any of the proceeds form the first property, but had them held by a neutral third party exchange facilitator.  Hopefully, you had an exchange facilitator and didn’t try to handle the 1031 sale and reinvestment on your own, in which case, there would have been a taxable sale.

Assuming there was a valid 1031 exchange via an appropriate facilitator, there is a tax form (8824) that needs to be attached to your corporate tax return documenting the details of the 1031 exchange.  Part of that form includes a calculation of the cost basis of the new replacement property.  This calculation takes into account the cash given, the cash received, the debt assumed or paid off on the old property, the debt assumed on the new property, as well as the adjusted cost basis of the old property. 

Using simplistic numbers and assuming that you essentially swapped one property for another that was worth $40,000, the adjusted basis of the replacement property on the corp books will be the exact same basis as the old property. In this case, that means it would be $5,000.  A 1031 like kind exchange is technically a tax deferred exchange.  This means that if you were to sell (not exchange) the new replacement property for $40,000, the gain from the original property would pop up and be taxable.

This is a very basic principle which any competent professional tax advisor should have no problem explaining to you.

Good luck.  I hope this helps.

Kerry Kerstetter

 

Posted in 1031 | Comments Off on Carryover Cost Basis

Residence Converted From Rental

Posted by taxguru on August 20, 2006

 

Q-1:

Subject: 1031/primary residence
 
Dear Mr Kerstetter,

I very much enjoy reading your information and I have a question about Primary/1031 combo.

We moved into one of our rentals just over one year ago (7/05) and now my husband has a job offer in TX.

My tax man says if we sell now we must recapture $27K and have a cap gains around $100K . Since we have not had the property for 5 years. Since we have not lived in it for 5 years the 2 year exemtion does not even come into play, not even a portion.

Is this your take on the IRS ruling?  If not what is the ruling?

More Info Please:

Was the former rental property that you are now living in acquired as a replacement property in a 1031 exchange

The answer to that will determine my response to your query.

Kerry Kerstetter

Q-2:

Mr. Kerstetter,

Yes we did a 1031 in 7/03 then moved into the house in 7/05.

I did read your information on resident/1031 and see that it agrees with our accounting that we need to keep it 5 years. So here is the final link to the question. Since we will be moving out before our 24 months in the property due to a new job in TX and this does fit into the exclusion. How long is the exclusion recognized. Can we move out before our 24 months under the exemption and then keep it until our 5 years is up and then sell it and use the exemption at that time? Or do we need to rent it and then 1031 into another rental.

 

A-2:

You are feeling the effect of the recent law limiting the use of the Section 121 exclusion for homes that were originally acquired as part of a 1031 exchange.  This means that the home you are currently occupying is statutorily ineligible for the tax free exclusion if it is sold any time before July 2008, five years after you acquired it.  This provision of the law does not allow for the pro-rated exclusion, which would be available to you if you had just purchased the home directly instead of as a part of a 1031.

As I’m sure your tax advisor showed you, a sale of this home before that date would not only subject the gain on this home to taxation, but all of the previously deferred gains from the earlier properties as well.  This will include the higher rate on depreciation recapture, as well as California state taxes.

There are some different options for you to consider.  Holding onto the house until July 2008 and then trying to use the Section 121 exclusion is a slight possibility; but not a completely safe one.  As you can see in IRS Pub 523,  most of the language describing qualifications for the reduced exclusion mention a job related sale and not a job related change in occupancy.  It’s obviously a fine distinction, but one that could cause problems with a sale so long after you vacate the home.

Depending on how much your gain is, the pro-rated exclusion maximum may not be enough to shelter all of the profit.  However, if the Texas gig doesn’t last long and you move back into the Calif home, you have a potential to meet the 2 out of 5 year rule for real.

You would also still have some depreciation recapture to pay taxes on.  You also need to decide what you will do with the Cal home while you wait out the time until July 2008.  If you rent it out, you will add to the depreciation recapture, plus make the property’s character more positively appear as rental than personal.  For example, if you were to sell it in late 2008, looking back five years previously, most of the time would have it used as rental, with a small percentage as your primary residence.

If, on the other hand, you leave it empty as a personal second home, you may have a cash flow problem if there are mortgage payments to make.

While there is obviously no perfect answer to this quandary, you may want to give serious consideration to converting your home back to rental and then disposing of it via a 1031 exchange into rental property or properties in Texas, which will be easier for you to manage.

Anyway, those are the thoughts that came to me as I reviewed your emails.  I hope they help you work out a suitable strategy.  Good luck.

Kerry Kerstetter


Q-3:

Good Morning Mr. Kerstetter,

My husband and I are amazed at how simply and complete you have made the explanation so we can understand our options. Thank you.

Now maybe I have one other option. The house is free and clear! I am a real estate broker here in CA, so I list the property but it does 
not sell for 1.8 years. As you know our market is very slow. In my neighborhood we have only had one closed escrow this year.So before we move I list the property and rent it to a tenant with the understanding that it is on the market for sale. But do to the market the house does not close escrow until July or Aug of 2008. Would that show our intent to sell the house upon acceptance of the job but market trend did not allow us to sell. Would that show intent to keep the use of Section 121?

Even if the job in TX does not last we intend to keep TX as our primary do to no State Tax we are both 58 and our $$ is in bank accts. and not all our rentals have been 1031 into TX. We will come back and buy a condo in CA for a 2nd home in a few years when the market settles.

PS. Are you sure you don’t have room for one more client. My tax man says I am always coming up with situations that challenge him.

A-3:

You can try that approach; but you had better maintain extra tight documentation of the fact that you were honestly trying to sell the home for a reasonable price for the area.  As you should know, the burden of proof that you are entitled to use the reduced Sec. 121 exclusion rests completely with you; so you need to feel very confident that you have plenty of documentation to support your case.  Your tax advisor should be able to help you compile that documentation so that it is sufficient to provide him/her with the confidence to be able to claim the exclusion.

You should clarify with your current tax pro the meaning behind his comment.  A good tax advisor should welcome challenging issues such as yours.   They are what help us learn and grow as tax practitioners.  I learn new things about the tax laws every single day, from work with my clients, as well as from emails from readers.  If your current advisor is telling you that because he doesn’t want to have to deal with anything new, it is time to find a new tax pro.  If he is saying that to point out that you are making him stretch his brain, that’s not a reason to be concerned.  I say that a lot to some of my clients whose transactions force me to delve into new and interesting areas of taxation that I would never otherwise be involved with.

Good luck.

Kerry Kerstetter

Follow-Up:

Thank you for all your advise and information.
 
 

Posted in 1031 | Comments Off on Residence Converted From Rental

Posted by taxguru on August 16, 2006

Popularity of 1031 Exchanges Surges With Market Decline

 

Posted in 1031 | Comments Off on

1031 & Residence

Posted by taxguru on August 5, 2006

 

Q:

Subject: 1031 as primary residence

I recently sold my rental as 1031 exchange.  I had separated from my spouse and was living in an apt. My husband did not want to reconcile the marriage.  since I have a chronic sickness, I can only work parttime as a substitute teacher.  thus I had to give up my apt and move into the 1031 as my primary residence 3 months after selling it.  I know I have to pay taxes to the state and Fed geovernment, but I do not have the money.  How do I ciontact the government and tell them about my situation?  Who and where do I contact them?  Will they allow me to pay on installment?  Please let me know. 

 

A:

There are far too many issues to go over for me to be able to cover everything that needs to be addressed; so you should be working with an experienced tax professional.

Unfortunately, we don’t have anyone to whom we could refer you. If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you.

Your email is a bit confusing in regard to the actual chain of events.  It can be interpreted in different ways.  if you did a 1031 exchange and then moved into the replacement property, effectively converting it into your primary residence, that event doesn’t constitute a taxable event.  If you then sold that property, there would be some taxes to worry about; but if you still own it, there would be no taxes at stake.

If you were in the middle of a 1031 exchange and cancelled it because of your marital problems, that would create a taxable event.

A good tax pro can untangle what really happened and help calculate your taxes to be the lowest legally required.  If that result ends up with a balance owing to the IRS and/or State, they will accept installment payments (with interest added) until you are paid in full.  The absolute worst thing to do is not file an income tax return because you don’t have the money to pay. 

Your email doesn’t say in which year you sold the property; so I don’t know whether this tax issue is a current one (sale in 2005 or earlier) or a future one (2006) that you will have plenty of time to prepare for since 2006 taxes aren’t due until April 16, 2007

I wish I could be of more assistance; but I wish you the best of luck.  

Kerry Kerstetter

 

Posted in 1031 | Comments Off on 1031 & Residence

SUV Trades & Sec 179 Recapture

Posted by taxguru on August 4, 2006

 

From a Reader:

Subject: suv
 
I have spent 2 days trying to nail down the answer with my accountant and on the internet.  You have a question posted on your website that’s similar to my question-but of course not quite.  I think this is a problem that a lot of people are going to be coming up with because of gas prices.
 
I have an SUV, over 6000 lbs purchased in 2003 for $50,000 using the section 179 SUV 6000lb deduction.  I now would like to trade it in for another SUV that does not weigh 6000+lbs.  If I trade the car in, it will be traded in for about $30,000 and the new SUV will be purchased for $22,000 with the left over trade in value (after p/o of loan) going towards the $22,000.  Will I have to pay recapture on the full $30,000 (trade in value), or just on the difference between the $22,000 and the trade in value?
 
Sincerely,


KMK:

I need a little more clarification before I can provide an answer.  You have Section 1031 issues here, as well as possible Section 179.

What is the current loan balance on your 2003 SUV?

What is the total purchase price of the new SUV – $22,000 or $52,000?

What will be the total of the loan you assume on the new SUV?

What percentage of the miles you drive the new SUV this year will be for business?

Kerry Kerstetter

Reader:

Thanks for replying.  I filled in the answers below.
 
 Sincerely,

What is the current loan balance on your 2003 SUV? $24k

What is the total purchase price of the new SUV – $22,000 or $52,000? The new suv would be $22k

What will be the total of the loan you assume on the new SUV? I will receive $8k for the trade in and that will be put towards the new suv-making the loan amount $14k

What percentage of the miles you drive the new SUV this year will be for business? 100%  I have a second car that’s used for personal miles

I read on the internet that you cannot trade in a 6000lb suv for one under 6000lb as a like kind exchange-is that true as well?

 
KMK

Thanks for the additional info. 

It sounds as if you are under the impression that there could be Section 179 recapture based on one or both of the following.

1.  Trading a vehicle that weighs more than 6,000 pounds for one that weighs less because the lighter one only qualifies for a much lower maximum Section 179 deduction.  That on its own would not trigger a recapture unless the new vehicle were to be used less than 50% for business.  What would happen is the zero rollover basis from the old SUV would leave very little to nothing available for future 179 or depreciation on the new one.

2.  Trading a vehicle that weighs more than 6,000 pounds for one that weighs less because they are not considered to be like kind for full Section 1031 deferred gain treatment.  This is also not true.  Vehicles less then and over 6,000 pounds are considered to be like kind by IRS.  Whoever told you otherwise was wrong.

However, from the figures you provided, there will be approximately $10,000 of Sec. 179 recapture because you are failing to meet the equal or higher cost requirement for your trade.  You are essentially selling your old SUV for $32,000 ($24,000 loan payoff + $8,000 equity) and reinvesting only $22,000.  The remaining $10,000 of unreinvested proceeds will be taxable as Section 179 recapture.  Looked at in a slightly different way, with the exact same results, your $24,000 relief of debt is $10,000 lower than the new debt you are taking on, triggering a taxable recapture.

I’m not sure how locked in you are to the $22,000 SUV.  While I am not an advocate of spending money just to increase deductions, it is a fact that many people in this situation would seriously consider buying a new vehicle that costs at least $32,000 so that there would be no taxable recapture to worry about.  You should have your personal tax advisor crunch some numbers to estimate how much Federal + State tax that $10,000 recapture will probably cost you.  The actual taxes will be based on your expected tax brackets.
 
I hope this helps.  Good luck.

Kerry Kerstetter

Reader:

Hi Kerry,
Thank you so much!  I really appreciate your time to answer my question.  I feel a bit better-though disappointed I can’t get the car I want.  To funny-
considering I’m going from a Volvo to a Honda element.  So basically I have to choose a car that costs more.  Who would’ve thought.  Anyway, I forwarded your info on to my accountant and will have him run numbers for me so I make the best decision.  One thing I did consider was buying 2 of the elements, but I’ll talk to my accountant about that.  Thank you again and have a cool summer!
 
Sincerely,

KMK:

Fully tax free exchanges have always required acquiring replacement property costing at least as much as the net sales price of the old one.

There is no requirement to go from one vehicle to one.  You can exchange into multiple ones.  However, you have to be careful that each of the replacements is used more than 50% for business or else it will trigger some Sec. 179 recapture.

Good luck.

Kerry

Reader:

Kerry,
Do you do taxes for people in Maryland? 
 
Sincerely,

KMK:

I wish I could help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time. 

Unfortunately, we don’t have anyone to whom we could refer you. If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you.

I wish I could be of more assistance; but I wish you the best of luck.  

Kerry Kerstetter


Reader:

Thank you Kerry,
And I will be sure and save you in the favorites!
 
 Sincerely,

 

Posted in 1031, 179 | Comments Off on SUV Trades & Sec 179 Recapture

Retroactive Exchange?

Posted by taxguru on August 3, 2006

 

Q:

Subject: Exchange Question
 
Do you know whether a 1031 exchange can be made retroactively,  assuming both parties agree?  I have searched and cannot find 
anything specific to this issue.  It appears as though it is likely  to be ok, as long as the relinquishment of property has not yet occured.
 
Thanks,

My Reply:

You need to be a little more specific with the situation you are trying to describe.

If a property was already sold and the seller received the proceeds, then it is impossible to go back and change that transaction to a 1031 exchange.

If the disposal transaction is still in escrow and title hasn’t passed yet, the deal can be converted into a 1031 exchange.

Let me know if neither of those situations cover what you are faced with.

Kerry Kerstetter

Follow-Up:

Kerry,
 
Thank you for the quick reply.  The property has not bee sold and is  not in escrow currently.  Basically my company and the seller would 
like to back date (for lack of a better explanation) the transaction,  as if the 1031 took place earlier this year.  I’m not aware of any  other details.  It sounds to me like this is reasonable, as long as  both parties agree to “backdating” within the requirements of 1031 &  reg 1.1031(k)-1(b).

A:

You obviously must have some reason for wanting to do this. However, pretending that a transaction took place before it actually did sounds too much like fraud to me to be able to accept it as proper.  Just because both parties agree to it doesn’t make it any more legitimate. I can’t see the IRS ever accepting this as valid either.

You would be best to do the swap now and use the current date.

Good luck.

Kerry Kerstetter

 

Posted in 1031 | Comments Off on Retroactive Exchange?

Posted by taxguru on July 27, 2006

Does a Vacation Home Qualify For a 1031 Exchange? – The WSJ looks at a questions that I receive quite often.

 

Posted in 1031 | Comments Off on

Second Homes & 1031 Exchanges

Posted by taxguru on July 13, 2006

 

Q:

Subject: Exchange Question
 

Can you do a Like Kind Exchange for second home (non primary residence) if it had never been rented?

 
A:

There are a lot of gray areas in this simple question.

If the property was only used for purely personal reasons, it does not qualify for a 1031 exchange and any gain on its sale will be taxable.

If the case can be made that it was used for either investment or business purposes, it would be eligible for a 1031 exchange.

The fact that the property appreciated in value (or else why would you even consider a 1031?) does document that it was a good investment.  However, if IRS were to challenge it, they would question whether investment was the main motivation for holding onto the property or was it for personal pleasure. Whether it truly qualifies or not could hinge on how often it was used for personal pleasure.  If it sat vacant most of the time, with occasional maintenance visits, a good case could be made for considering it to be Investment Property.  If it was constantly being used by family and friends, that would be a harder argument to defend.

I’m sorry not to have a cut and dried answer; but this is the best that can be done with this topic.

Good luck.  I hope this helped at least a bit.

Kerry Kerstetter

Follow-Up:

Yes thank you very much.
 
 

Posted in 1031 | Comments Off on Second Homes & 1031 Exchanges