Q:
If I wanted to do a sec 1031 exchange with say 7 properties (residential rental apt
buildings), each of which are in their own S Corp, in exchange for 1 property of equal or higher value (also rental property), how is best way to structure transaction?
If you form a Partnership of the 7 S Corps & then do the Exchange, how is ownership of replacement property handled?
Can 1 of the former S Corps own the new property, or would a new S Corp have to be formed as 100% owner?
Thank you,
A:
Since the names on the titles of the original and replacement properties need to match, there are at least a few ways in which to accomplish this that I can readily think of.
The seven different properties can be transferred into one person or entity’s name and then they can be swapped for the new property.
The easier way, and one which I have often seen done is to have each of the seven property owners exchange their property for a certain percentage of the new property. You would use percentages sufficient to cover the equal or higher value of their old properties to cover the exchange replacement requirement.
Later, after the dust has settled from the acquisition, the seven different entities can possibly fine tune the ownership by contributing their portions of the new property to a new entity, if that is what you want to do. There are also several other ways you could go, including leaving the ownership divided among the seven corps, or even merging the seven corps into one.
I hope this helps. Good luck.
Kerry Kerstetter
Follow-up Q:
Kerry:
Thanx so much for the prompt reply. I have 2 more questions re the 1031 exchange, if you have the time to reply, I really do appreciate it.
If you are looking for property of equal or greater value as the replacement property,
what evidential matter is sufficient for IRS to establish proper mkt value of the replacement property? Is independent appraisal for both properties sufficient?
Finally, a real estate agent advised property owner that to affect a tax free exchange, he would only have to find replacement property equal to or more than what the profit would be on the property, had it been sold & not exchanged.
I thought you have to find new property at least with mkt value of the old property, unless there are mortgages involved on either or both properties. Who’s correct?
Thanx again,
A:
For the 45 day identification list, values don’t even have to be shown unless you are using the 200% Rule. For this purpose, you can use the listing prices or your best guesstimates of their values. IRS is mainly concerned that the property that is acquired as the replacement is on the ID list and rarely looks into the total values on that list.
For replacement purposes, it is a commonly held misconception that you only have to reinvest equal or higher than the profit. I am constantly asked if a person can recover their investment from the sale and roll over the profit. The answer has always been a big NO.
The target replacement price to have a completely tax free exchange is the net sales price of the old property. This is the gross price less the direct selling costs (commissions, escrow fees, etc.). Unlike another commonly held misconception, it is not reduced by mortgages on the old property.
Whatever the target price is missed by is considered as boot and is taxed. IRS does not allow people to designate the boot as recovery of cost. It is profit.
We don’t make the rules. We just try to help people understand them properly. Unfortunately, in spite of the hundreds of seminars I have presented to Realtors around the country on this very topic, there are still many who don’t properly understand the details of 1031 exchanges and pass along incorrect info that could very easily get them into serious trouble if someone were to actually act on it, such as your example. That Realtor is just itching for a lawsuit from a client who acquires a too inexpensive replacement property and ends up with taxable profit.
I hope this helps.
Kerry Kerstetter
Final Response:
Kerry:
Thanx again for all your info. I too am a CPA, for many years, with a 1 man practice here in Westchester County, NY.
This is my first exposure to actually planning for a 1031 exchange & I knew the real estate agent was incorrect, but just needed another professional’s confirmation, which is what you gave me.
If I have any other questions, I will try to keep them to a minimum, as I know we are both going thru the crazy tax season, this being my 34th!
Regards,
