Section 1031 Case Studies #1 - #3
| Read comments | Add comment / Rate this Article | Article by: Christine Latulip |
We travel all over the country training professionals, working with clients, and engineering complex Section 1031 Exchanges. Over and over, we hear that Section 1031 for a lot of folks seems overly complex and difficult to understand. Certainly, the use of Section 1031 can be daunting, but for the most part this powerful tool is very straight forward, especially if you work with an experienced Qualified Intermediary.
So, instead of presenting the mechanics of the Exchange, we have found that Section 1031 is much easier to digest when we present actual case studies relating to the strategies of the Exchange.
CASE STUDY #1 - BUYING A NEW PROPERTY BEFORE THE OLD PROPERTY SELLS
One of our favorite Exchanges was an "acquire first, reverse exchange". Sounds complicated, but it's not. Our client had negotiated the purchase of a significant new property but had been unable to sell a piece of existing property in time to do the deal. Rather than jeopardize the purchase, we created a single purpose entity (SPE), in this case, a Massachusetts trust, to acquire the new (parked) property.
We were engaged to create the new entity, hold the property until the old property was sold and the proceeds are available to acquire the "parked" property. The Exchangor funded the purchase with his own funds and bank resources. Once the old property was sold, the new property was deeded to the Exchangor. Since it is not permissible to own the old and new property at the same time, this strategy accomplished the Exchangor's desired outcomes, without capital gains tax.
CASE STUDY #2 - SIX PROPERTIES FOR A DOZEN CONDOMINIUMS
This particular client wanted to acquire a significant piece of commercial real estate in New England. The client sold six separate pieces of property in order to aggregate sufficient funds to make the new Replacement Property purchase. The client was extremely careful to time his sales and the new purchase all within a 45 day time frame. This was key to the success of the Exchange due to the fact that he acquires not just one piece of property, but rather a dozen condominiums.
There are two basic rules when it comes to identifying your Replacement property choices, the Three-Property Rule and the 200% Rule. This Exchange is an example of yet a third method of identifying Replacement property. It allows the client to acquire an unlimited number of properties and without regard to value as long as the properties are acquired with the 45 day identification period. This can be a little nerve-racking for the investor and it pays to have a back-up plan.
CASE STUDY #3 - CONVERTING INVESTMENT PROPERTY TO PERSONAL USE
It is possible to convert your investment property to personal use without paying capital gains tax, but remember, it takes planning and adherence to the rules. Our client, in this case, after many years of ownership, sold a two family rental property and acquired a replacement property in Florida. The new property was a single family, that they immediately rented to a third party. They rented it for two years and notified the tenant that they would not renew the lease. As soon as the property was ready, they moved into it and made it their primary residence. No tax triggering event occurred.
If the client later decides to sell the property and they have resided in it for at least two years and have owned it for five years, they will qualify for Section 121, personal residence exclusion. That exclusion is $250,000 for an individual or $500,000 for a married couple filing jointly. Revenue Procedure 2005-14 aligns Section 1031 and Section 121 for this treatment. Some recapture of depreciation may apply for deductions taken during the rental usage.
Be careful, recent changes to Section 121 as it relates to converting investment property to personal use dictates that depending on how long the property was rented, a percentage of the gain is still taxable when selling the property. There are several articles in this forum relating to this topic. Contact your financial advisor and/or your Qualified Intermediary for more information if you are planning this strategy. This new law takes effect January 1, 2009!
This information is not intended to replace qualified legal and/or tax advisors. Every taxpayer should review their specific transaction with their own legal and/or tax counsel.
