Q-1:

Subject: our stocks

Kerry –

We’re considering selling what stock we have left in all our portfolio and using those losses to help offset earnings for this year (2005) and re-investing what money we realize that same day in another stock.  We have at lease $12,500 in unrealized losses.  What do you think?  We were considering Walgreen’s for re-investment, would you have any other ideas for a company to invest in?

A-1:

One thing to be careful of when dealing with capital losses is the fact that they can only be used to offset capital gains and only $3,000 can be used to offset other kinds of income. 

I don’t have any stock buying secrets.  In fact, nobody does, which is why I have always believed that real estate is the best investment and have never actually bought any stocks.

Kerry

Q-2:

Subject: End of the Year 2005

 

Dear Kerry:

Please do not lump us in with “those spooked EOY” folks who worry about taxes.  But two actions occurred that may have some consequences. We sold some rental properties and failed to do 1031 exchanges. 

Stock broker says we have a $321.00 loss and we may want to SELL stock for a loss.

Whatchathink?  Go for more losses?

A-2:

Selling stock just to generate tax losses is not the best way to manage an investment portfolio.  Stocks that have no potential for future gain and possible loss should be dumped and the proceeds put into something more productive.  If the stock has good upward potential, you should keep it.

The tax savings of losses would be about 20%, counting both Federal & State.  A $321 loss would save you only about $64 in taxes.  Selling them just to show a loss wouldn’t save enough to cover much more than the commission you would have to pay to your stockbroker.

Another thing to keep in mind in regard to generating capital losses with stocks is that IRS has what’s called the “wash sale rule” which prevents anyone from deducting losses on stocks that are repurchased within 30 days of the sale.  This is to prevent people from capitalizing on downturns in stock values to generate paper losses, and then buying the stock back to ride it back up.

Kerry

 

Q-1:

Subject: Exchange Question

 

State:  CT

 

My parents own our business building.  It is a corporation I believe.

 

Are corporations not allowed to do the exchange thing.

 

If they sell the original big building and buy a smaller building can the save tax money with the 1031 exchange?

 

Lets say they sell the building for 1 million.

 

Buy a smaller building for 300,000

 

Can they save on taxes for the 300,000

 

I assume they are on the hook for the 700,000 difference.

A-1:

Corporations can do 1031 exchanges just as individuals can. 

The rule to avoid all of the tax is to replace with like kind property costing at least as much as the net sales price of the old property.  When you trade down, you are required to report as taxable income the unreinvested portion or the actual gain, whichever is lower.

In your example, you left out a crucial figure, the adjusted cost basis (after depreciation) of the old property.  Basically, if it is less than $300,000, acquiring a $300,000 replacement property would result in some of the gain being deferred (rolled into the new property). 

If the adjusted basis is over $300,000, such an exchange would make no sense tax-wise, because the overall profit would be less than $700,000.

Something else to keep in mind is the fact that 1031 exchanges don’t require a one for one swap.  The corporation could acquire multiple properties totaling more than $1 million and defer all of the profit.

The corporation’s tax accountant should be able to work the various what-if scenarios, using the actual numbers, most efficiently for you.

Good luck.

Kerry Kerstetter

Q-2:

Thanks Kerry.

Do you do phone meetings for 15-30 minutes type thing for a fee?

Further details:

Parents have a realty company called T&J Realty.

They own the building.  Bought in 1975.  Mortgages all paid off.

I am pretty sure it is depreciated big time.

If they bought it for $300,000 back then.  What is the tax savings for this:

Building sells for 1.4 million in March 2006.

They buy smaller building for $300,000 in April 2006.

I know they get whacked by the state plus uncle sam big time on capital gains.  Over 30 % I think.

A-2:

Unfortunately, we are still too backed up to be able to accept any new paying tax or consulting clients.

The best person to do calculations such as you are requesting would be their normal corporate tax accountant, so that s/he can properly take into account the depreciation on the building, as well as any possible operating or capital loss carry-forwards that might offset some of the potential gain. 

Another option that should be considered is an installment sale, where a good portion of the sales price is carried back in a note.  This will allow the taxable capital gain to be spread out over the next several years; ideally keeping it in lower tax brackets than would be the case if all of the money is collected in the first year.

Kerry Kerstetter

 

Some interesting items from the WSJ’s free RealEstateJournal:

Mortgage Options Available To Buyers of Second Homes

Avoid These Errors In 1031 Exchanges

Buying a Rental Property That Will Generate Cash

U.S. Home Markets That Are The Most and Least Affordable

Investors Start to Retreat From the Housing Market

Strategies to Avoid Paying Private Mortgage Insurance – PMI has always been a big scam.

Q:

Subject: Exchange Question

 

I’m purchasing a primary residence that I will be closing on within the next two weeks. This is new construction and I have been waiting since early this year to close on the property.

In the few months since deciding to purchase the condo, my situation has somewhat changed. My boyfriend and I have decided we are going get married and want to purchase a home together most likely within a year. I should mention that I am purchasing the above property as my own, sole and separate property.

I know about the $250,000 exclusion from taxes once you’ve lived in the property for at least 2 of the last 5 years, but what do I do if I decide I want to sell in say in the next 3-12 months. I don’t want to keep any of the profit for myself, I just want to roll it over into the purchase of a larger primary residence.

I’ve also looked into doing a 1031 exchange, but it seems that they are only available for investment and rental property, but not for primary residences.

Please help!

Sincerely,

A:

1031 exchanges are not allowed for personal residences.

You didn’t say how much profit you are anticipating on the sale, after deducting the selling costs and fully accounting for your purchase price, capital improvements and other additions to the cost basis, such as appliances and furniture you will be leaving with the home.  If the pro-rated tax free gain of $342.47 per day of ownership and occupancy isn’t enough to cover your net gain, you could consider delaying the sale.  I have heard of people locking up buyers, but with delayed closings just for this reason.

Any gain above the tax free portion will be considered short term capital gain, subject to ordinary income tax rates.  What you do with the sales proceeds will make absolutely no difference whatsoever.

You can see much more on this on my website.
   
As always, it would be a very wise move to consult with a tax pro on this and the myriad of other tax twists due to your upcoming marriage.

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,

Thank you very much for the information. I am actually trying to find a good CPA in my area, but I keep getting hooked up with people who dont return my calls!

Just one other question… I expect my profit to be somewhere in the 15,000-30,000 range when I sell. Don’t you have to qualify for some type of special circumstance, or “unforseen event” to be able to obtain the prorated tax-free gain?

Thanks again for your advice, I really appreciate it.

Also, I did read up on your site and it was quite helpful. Thanks for posting such useful information for the rest of us.

Sincerely,

My Reply:

Change in marital status is one of the special circumstances that qualifies a home seller for the pro-rated exclusion.

Your profit should be small enough to be excluded.

Good luck.

Kerry Kerstetter

 

This is also from March 2005:

Q-1:

Subject: Exchange Question

 

I just ran across your site and found it very interesting.  I was wondering if you could help us with this question.  My husband and I purchased a home in 1987.  We lived there until 1994.  We are a military family and have been stationed away from this home ever since.  It has been rented from 1994 until now.  We plan to sell it.  It is in Florida.  We plan to move to Branson, Missouri.  We were wondering if we could reinvest in a small hotel type business, for example 10 rooms or a B&B type business  and or a 4-plex.  We would wish to live in the business.  We would like to use the proceeds to pay off existing mortgage, car, and college loans, while financing the business with a modest down payment.  Is any of this possible without paying huge chunks of taxes?

Thank you for your advice.

 

Sincerely,

A-1:

To have a valid tax deferred exchange, you will need to reinvest all of the cash proceeds from the disposal of your Florida rental property into new like kind property, which could be a hotel type property in Branson, as long as enough of that purchase price is allocated to the real property portion of the property to meet or exceed the selling price of the Florida property.

Any portion of the new property that will be used as your primary residence cannot be counted.

No part of the cash proceeds can be used for non-reinvestment things, such as paying off other debts that are not secured by the Florida rental.  It is possible, after you have taken title to the Branson property, to refinance it and use the new loan proceeds to pay off other debts without any tax consequences.

You really need to consult with a tax pro to work out the best strategy for your plans and circumstances.

Good luck.

Kerry Kerstetter

Q-2:

Kerry,

Thank you so much for your advice.  Since it appears that we have to move in this direction, we were wondering about buying another house for rental purposes.  We plan to sell our home in Florida for a net of $167,000.  We are looking at houses in the Branson area and are considering purchasing one and paying cash in the neighborhood of $120,000 and then purchasing a small hotel/live in business with the remainder of the proceeds acting as the down payment for the investment. This would be making an exchange with two properties in mind.  Is this possible? If so of the $167,000, $120,000 goes to pay in full for rental property with a remainder of 47,000 or so toward the purchase of the hotel units.  Since the hotel that we are looking at is around $215,000, there is no way to pay for this business in full, but we would rest easy knowing at least one property is completely paid in full and with the opportunity to bring in income. 

Another question is, can you count closing costs in the transactions of the $167,000 or must the entire amount go into the properties themselves?  And am I understanding what I’ve read on the internet correct in that we need an Accommodator for these transactions?  If so, which would be best, to obtain one from Florida where we are selling or from Branson, where we are moving?

I know I have a lot of questions and I do so appreciate your time.  Thank you so much.

Sincerely,

A-2:

You have me a bit confused here.  Is the home you are planning to sell for $167,000 your primary residence or a rental?

If it’s your primary personal residence, there is no replacement requirement.  You can see all of the rules on my website.
 

Kerry Kerstetter

Q-3:

Kerry,

This house which was our primary residence for seven years,(due to military orders), became a rental property and has been for the last 10 years.

Thanks again for the help. 

A-3:

Thanks for the clarification.  Terminology is critical; so describing it as “our home” muddies the issue tremendously. 

After ten years as a rental, it long ceased to be your primary residence and a 1031 exchange would be necessary to avoid any taxation of the profit you will be having.

Another ambiguous term that you used is “net of $167,000.”  If you are referring to the cash after paying off existing loans, you are off track.  The requirement for a completely tax free exchange is the net sale price after deducting the direct selling costs, such as commissions and escrow fees. Payments of loans and operating costs, such as interest and property taxes, do not lower the target replacement price. 

That said, the answer to your original question about using the proceeds to acquire two replacement properties is yes.  That is quite common.  As long as the total combined cost of the new properties meets or exceeds the net sale price of the old property, you are covered.  The only thing you would need to be concerned with is that you can’t count the cost of the property in which you will be living as suitable like kind.  This means that you will need to allocate the purchase price of that property between the business portion and the primary residence portion to see if you are reinvesting an adequate amount.

You can count the closing costs on the acquisition legs as part of the reinvestment.  Anything that would normally be capitalized as part of the property cost qualifies.

You do need to use an exchange accommodator to hold the proceeds and prepare the proper documentation for all legs of the exchange.  If you touch any of the money yourself, even for a split second, you will be taxed on it, even if you do apply it to the new property. 

You can use an accommodator anywhere in the country.  It really doesn’t matter.  For example, most of the exchanges my wife’s company, Tax Free Exchange Corporation, handle are not even close to Arkansas, and are between states all over the country.

Good luck.  I hope this helps. 

Kerry Kerstetter

Q-4:

Thanks Kerry for all the valuable information.  Before we clicked on your site, we were clueless about what all was involved in selling and reinvesting.  My husband is retiring from the military and we are leaving Germany is a few weeks and are really looking forward to getting involved in the business side of things.  Thanks so much for your help.

The Costs of Buying Real Estate In Mexico – A short look at some of the aspects of US citizens buying property down there.  One point not covered, for anyone considering using 1031 exchanges with Mexican property, is the fact that the tax code defines “like kind” in regard to real property in terms of its nationality.  USA real property can be exchanged for other USA real property.  Mexican real property can be exchanged for other Mexican real property.  You can’t use 1031 to swap between Mexican and USA properties in either direction.

Here is the website of Julie Kershner, the Realtor quoted in the WSJ Q&A who has a lot more info on Mexican real estate. 

I received the following from a Texas CPA:

Subject: suggestion

i know how tough things can get before Oct 15th but, since your blog has been helpful to me at times, especially re: 1031, i would like to suggest that when you get a chance, that all the 1031 related questions [ current, and from the past ] be grouped together on another link maybe.

 

anyway, thank you for your hard work.

best wishes,

My Reply:

That is a feature, identifying each post with a category name, that I have long wanted to have; both for my own benefit, as well as for that of readers.  I have really liked having that capability with the SocialSecurityChoice.com blog, which uses the Movable Type blogging software. 

Unfortunately, my Blogger software doesn’t have that capability.  After being one of the first blogging programs on the market, Blogger has been left behind in terms of formatting features by other programs.  Blogger has been slowly adding similar features, and I know that the ability to have categories is one of the most often requested upgrades by me and other users; so I am hoping it will be available soon.  I realize I will then have to go though each post and assign a category name; but I think the end result will be worth it. 

I have considered switching software, but am worried about the ability to safely transition the six years of content that is already formatted with Blogger.  Horror stories from other bloggers who have tried to switch make me hesitant.

In the meantime, you will have to make do with the standard search tool.  I have actually had much better success with the Google tool-bar‘s  “Search Current Site” than with the Feedster search tool at the top of my blog when I need to look up past postings. 

I appreciate your taking the time to write and suggest this improvement.  Please feel free to pass along any additional comments you feel may be helpful.

Kerry Kerstetter

 

Q:

Let me say I saw your web site and blog for the first time just now and I found it very interesting and well done.

Can I ask you a question?   Is there a fee to answer questions?

We bought 3 lots side by side in a subdivision in ID all in one transaction for $60,000 total a year ago.  We have an offer from an individual who wishes to buy two of the lots this week for $80,000.  We are also buying another 10 acre lot for $80,000 in the same general area that we plan to use to build a Summer home.

I want to do a 1031 exchange,  trading the two lots for the one lot, so we don’t have to pay tax on the gain.  The same buyer is buying the two lots so we can do one transaction with him.  Both closings for the two lot sale and the 10 acre  lot purchase will be within the next month.  

  One other twist that I am not sure about is this.  The buyer of the two lots is a builder who is building a pre-sold custom home on the first of the two lots.  He wants to pay 40,000 now and then the other 40,000 when he has closing on the finished property on the first lot.  Can I do the 80,000 sale within next 30 days with 40,000 down and the rest to be financed by us and then the remaining 40,000 to be paid down the road 6 months or whenever house on first lot is completed?

A:

What you are proposing may be possible; but there are some particular issues that you need to keep in mind.

First is the definition and descriptions of the properties to be involved.  Personal use property is not eligible for Section 1031 treatment.  Rental and investment properties are.  The property you are disposing of needs to be considered investment property to qualify for Section 1031.  Likewise, the new property needs to acquired for investment, business or rental usage to be considered like kind to the investment property you are disposing.  I would avoid using the term “Summer Home” and consider it as an investment or rental property.

Next is the issue of the cash from the carryback note you will be receiving from your buyer.  This must be turned into cash and reinvested into the new property within 180 days after you transfer title from your old property.  As with any 1031 exchange, you need to use the services of a neutral third party facilitator, as well as be sure not to touch or have constructive receipt of any of the proceeds.

If the note won’t be paid off until after the 180 days, a common technique that is used is for you to sell that note and convert it into cash before your 180 deadline.  We have seen a number of 1031 exchanges where that strategy was used, often with a family member as the buyer of the note.

These are just a few ideas that came to me.  As always, you should go into more detail with your own personal tax advisor.

Good luck.

Kerry Kerstetter

 

Real-Estate Flip Deals Have a Catch – Anyone investing in real estate without consulting with a qualified tax advisor is asking for big time trouble; especially when it comes to the proper use of 1031 exchanges and avoiding being labeled as a “dealer” who is ineligible for any special tax breaks.

Q:

Subject: Primary residence question

 

Dear Kerry,

This article was very interesting regarding taxes and the 2 year rule.

My question is this: What actually constitutes a property being the primary residence? I have lived with my Mother for 1 1/2 years taking care of her till her death in March 2005.

In May 2005 the house was quite-claim deeded to me.

Does the 2 years start as of the day I moved in with her or the day the house was deeded to me?

I want to sell it and go back to the city I was living in prior  to the move and your answer will help me decide when the sale will occur.

Thanks so much,

A:

 I think you are missing the big picture here.

For the Section 121 tax free residence sale, the time starts when you both own the home and live in it as your primary residence.  This would be May 2005, when the title was put into your name.

However, this is only an issue of concern if you are looking at a profit on the sale.  If you are planning to sell now, you shouldn’t be looking at very much profit, if any.  When a person passes away and leaves assets to others, the cost basis of each item is stepped up to its fair market value (FMV) at the time of her passing.  In your case here, your cost basis in the home would be its FMV as of the March 2005 date your mother passed away plus the cost of any improvements you have put into it since that date.  When you factor in selling costs, odds are that you may even have a net loss.

If you do have a net profit, you should be able to use the pro-rated exclusion of $342.47 of profit per day that you owned and lived in the home if the sale is due to an unusual circumstance, such as the death of your mother or a need to relocate for employment purposes.

As always, you should be working with a tax professional.  This is a very elementary issue that any competent tax pro should be able to help you with.  S/he will be able to help you calculate your cost basis and possible gain or loss.

I hope this helps.  Good luck.

Kerry Kerstetter

 Follow-Up Q:

 Thank you Kerry for your answer.

 I have 1 more question. Since we will probably see a profit over  the step up date for the FMV when we sell. Is there any way I can  utilize 1031 and use the profit to pay for an existing Manufactured  house I own in another city?

 Thanks

A:

 If you have been living in the home prior to its sale, Section 1031 is not an option for you here.

If you have not been living in it and have been using it as a rental or investment property, it could be disposed of under Section 1031.  However, the proceeds will all have to be invested into replacement property that is new to you.  Paying off debts on property you already own is not a valid like kind reinvestment.  You can see all of the rules for 1031 exchanges at www.TFEC.com  This is why you really need to be working with a tax pro who can take your particular circumstances into account.

Good luck.

Kerry Kerstetter