Section 1031 for Professionals

Transcription

1 Section 1031 for Professionals Real Estate Law Day November 14, 2014

2 John D. Hamrick, VP Edmund & Wheeler, Inc

3 Shhhhhhhh.. Don t Tell anyone. Your clients are eligible for interest free loans from the US and State Governments for as long as they d like. for as many times as they d like.

4 Of the approximately $300 Billion in investment real estate transactions during 2014, it is estimated that 25-40% could have benefited from Section 1031 treatment. Only 3% did.

5 What s In It For You? Absolutely Part of Your Fiduciary Responsibility Tax Ramifications on the Sale of Investment/Trade or Business Property are Key!! Clients Will Appreciate Your Resourcefulness & Knowledge 1031 Savvy Professionals are HEROS! Section 1031 has Wide Applicability in Your Practice Help your clients strategize the sale and repurchase of their holdings. Property portfolios may be realigned tax free. An EXCELLENT Wealth Building Strategy Using Uncle Sam s Money Extraordinary estate planning Tool Stay in the RE Class!

6 What s In it For Your Clients?

7 What s In it For Your Clients? Section 1031 Is NOT Just for Commercial Investors and the Wealthy: Many individuals have Exchangeable Assets Raw Land Excess Land (What is customary?) Second Homes (If planned correctly) Any Real Estate that is NOT Personal use or Dealer! Mixed Use Properties (B&B s, Home Offices & Mixed Use) Personal Property Horses/Livestock Coin Collections Airplanes & Coin Collections Heavy Equipment Used For Business

8 About Our Firm Practice began in 1981; incorporated in 1987 by George Foss Acquired by CenterPoint in 2012 Exchanges are our exclusive line of business Thousands of Exchanges almost $1Billion in transaction value Over $400 Million in DEFERRED TAXES Vermont Resource Chris Brown Dedicated & Knowledgeable Staff Experts in Replacement Options Many Industry Leading Partners Member of Federation of Exchange Accommodators Nationwide practice; 49 states and counting

9 Today We Will Explore What is Section 1031? Section 1031 s misconceptions How to recognize when to use Section 1031? Who qualifies for an Exchange? What Qualifies For an Exchange? How to report an Exchange How states handle Exchanges

10 Today We Will Explore Exchanges Partnerships Trusts Corporations Swap & Drop - Drop & Swap Real-life Examples of Our Exchanges Alternative Exchange Strategies Conversion to Personal Use Passive Real Estate Path s to Cash Relieving Mortgage Boot

11 Primary Objectives of This Course Provide a Basic Section 1031 Education Provide Tools & Information Enabling You to Better Serve Your Clients - How can it be used to benefit their overall financial objectives and estate planning. Assist You In Recognizing the Strategic Applications of Section 1031 Explore Alternative Replacement Strategies Create HEROS

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13 What Is An Exchange? Method to sell Investment and/or Trade or Business Property and replace it with New Property that doesn t trigger tax. The Client must: Give a Deed (or a Bill of Sale) Get a Deed (or a Bill of Sale) Not Handle Cash

14 The Five Critical Elements 1. Intent 2. Form and Documentation 3. Control of Funds 4. Like-Kind Properties (Real or Personal) 5. Time Limits

15 Section 1031(a)(1) No gain or loss shall be recognized on the exchange of property held for productive use in trade or business or for investment if such property is exchanged solely for property of like kind which is held either for productive use in a trade or business or for investment. Section 1031 Works ONLY with Investment/ Trade or Business Property YOU MUST PROVE INTENT!

16 DEALER REAL ESTATE House Flippers Land Developers Property held for resell PERSONAL USE ESTATE Primary Residence Second Homes Vacation Rentals Renal Property Commercial Property Farms - Businesses Raw Land INVESTMENT REAL ESTATE

17 An Exchange at a Glance Exchange Documents QI Relinquished Property Exchange Agreement Assignment of Contract Notification of Assignment Settlement Instructions Wiring Instructions Replacement Property Assignment of Contract Notification of Assignment Settlement Instructions Wire Funds

18 Exceptions to Section 1031 (Sec.1031(a)-(2)) Stock in trade or other property held primarily for sale Stocks, bonds or notes Other securities or evidences of indebtedness or interest Interests in a partnership Certificates of trust or beneficial interest Choses in action (litigation rights) Real Estate Investment Trusts Basically all Paper Assets

19 What is Investment Purpose? Investment is the passive holding of property for more than a temporary period with the expectation of appreciation Real estate (even if unproductive) held by a non dealer for future use or increment in value is held for investment and not primarily for sale (Reg (a)-1(b)) Thus property held for sale in the immediate future is not held for investment (Dealer Property)

20 What Are the Benefits of an Exchange? 1. Full capital gains tax deferral (Exchange goes Even or Up in Value) 2. The ability to use Uncle Sam s money to enhance holdings 3. Compounding Effect 4. Estate Planning (Step-up) 5. Exchange into passive holdings 7. Increase cash flow reduce effort 8. As long as taxpayers remain in the Real Estate Class Capital Gains will NEVER be due! SWAP UNTIL YOU DROP

21 Three Essential Elements

22 Like-Kind Requirement: The term like-kind refers to the nature or character of the property and not to its grade or quality (Reg (a)-1(2)(b)) Real property cannot be exchanged for personal property (Reg (a)-1(2)(b)) Qualifying personal property can be exchanged for property of a similar character (NAICS (formerly SIC) Codes must match; the Code must fall within Sector 31, 32 or 33 of NAICS; last digit cannot be a 9.) (Regs (a)-2, et seq.) Anything that is classified Real Estate in the 50 US States

23 Exchange Types Forward Exchange Reverse Exchange Improvement Exchange Personal Property Exchange Mixed Asset Exchange Simultaneous Exchange (A-B)

24 Exchange Types Delayed Exchange Regs (k)-1, et seq. Close Relinquished in an Exchange with Exchange Agreement in place. Net Funds (less cash taken) to Qualified Escrow Account. ID Replacement in 45 Days Close in 180 Days Funds Delivered for Replacement Property

25 Exchange Types Reverse Exchange Rev. Proc & Close Property (old or new) in Special Purpose Entity. ID in 45 Days (what are you selling / buying). Close in 180 Days. Reconvey Property to Exchanger from SPE.

26 Exchange Types Close Property in Special Purpose Entity. ID in 45 Days (what are you selling). Close Relinquished in an Exchange. Improve Replacement Property (180 Days). Reconvey Replacement Property as Improved. Improvement Exchange Reg (k)-1(e), et seq.

27 Exchange Types Convey Property with Bill of Sale with an Exchange Agreement in Place. Personal Property Exchange Net Funds to Qualified Escrow Account. ID in 45 Days (what are you buying). Close in 180 Days Funds Delivered for Replacement Property

28 Exchange Types A Combination of Real Property and Personal Property Mixed Asset Exchange Accomplished in Single Exchange Agreement Detailed Asset Class Analysis & Valuation

29 Exchange Types Deed for a Deed. Values Must Match, or Boot. No Qualified Intermediary Required Unless Money Changes Hands. Exchange Language in Contract. Simultaneous Exchange (A-B) Consulting with Qualified Intermediary Recommended.

30 EWI REAL ESTATE EXCHNAGES SINGLE FAMILY RESIDNCE RAW LAND APARTMENT BUILDING BOAT DOCK IN NEW HAMPSHIRE CELL TOWER LEASE > 30YRS CONSERVATION EASEMENT SUBSURFACE WATER RIGHTS EXCESS LAND OF PRIMARY RESIDENCE PARTIAL INTERST (TIC) GROUND LEASE >30YRS SUBSURFACE MINRAL RIGHTS MOBILE HOME IN NEW HAMPSHIRE CO-0P IN MANHATTEN DELEWARE STATUTORY TRUST CALIFORNIA LAND TRUST HORSE FARM CATTLE FARM WITH HOMESTEDAD BED & BREAKFAST MONOCO APARTMENTS DND FRANCHISE

31 More Examples of Like-kind Improved real property for Unimproved real property (Reg (a)-1(2)(b)) Lease for >30 years (Reg (a)-1(2)(c) Partial interest for a whole interest One property for more than one property and vice versa

32 Like Kind Like Kind Also Includes: NNN Leased Property Fractional Ownership DSTs Oil & Gas (Subsurface) Water Rights Leasehold > 30 Years Cell Towers Billboard Easements Conservation UP-REIT

33 What is Like Kind? ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL PROPERTY IN THE 50 US STATES

34 What is Like Kind? ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL PROPERTY IN THE 50 US STATES

35 What is Like Kind? ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL PROPERTY IN THE 50 US STATES

36 What is Like Kind? ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL PROPERTY IN THE 50 US STATES

37 What is Like Kind? ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL PROPERTY IN THE 50 US STATES

38 EWI PERSONAL PROPERTY (Regs (a)-2, et seq.) MOLITAR STRADIVARIOUS HELICOPTER FISHING BOAT LOADERS & EXCAVATORS AUTO COLLECTION HERD OF DAIRY COWS IN VT PAINTINGS IN NYC FCC BROADCAST LICENCE BEACHCRAFT BONANZA BEDROOM FURNITURE & FLAT SCREEN TVs INTANGIBLES & GOODWILL CELLO FOR A PSA MUSICIAN Same General Asset Class or Product Code North American Industry Classification System

39 Timing is everything! The Exchange Period begins on the transfer of the Relinquished Property This is Day #0 Exchangor must identify qualified Replacement Property within 45 days of closing (the Identification Period ) Exchangor must acquire within 180 days, or due date of the tax return (counting extensions) for the tax year of the sale (the Exchange Period ) (Reg (k)-1(b), et seq.) There are no extensions unless a federal disaster is declared in the vicinity of the taxpayer or the property.

40 Replacement Property Rules Reg (k)-1-(c)(4) The Three Property Rule The Exchangor may identify up to three (3) properties, without regard to value; or The 200% Rule The Exchangor may identify more than three properties, provided their combined fair market values does not exceed 200% of the value of the Relinquished Property; or The 95% Rule The Exchangor may identify any number of properties, provided the Exchangor acquires 95% of those properties (by value). Properties received before the 45th day do not have to be identified, but must appear on one of the ID s after Day 45.

41 Can Anyone Handle An Exchange? No! It must be a Qualified Intermediary (QI) as defined by regulation: see Regs (k)-1(k), et seq. Cannot Be the Exchangor or a Relative (Sec. 267(b) or Sec. 707(b)(1)) Cannot be an Agent of the Taxpayer One who has acted as employee, attorney, accountant, investment banker, broker or real estate agent within the past 2 years The QI Handles All Aspects of the Exchange and Should be Involved EARLY in the Process

42 What does a QI do? Regs (k)-1(g)(4), et seq. Creates Exchange Agreement; signed by Taxpayer. Has Legal Standing in the transaction Notice of the Assignment required to be given to Buyer and Seller, with Closing Instructions to both Settlement Agents. Banking, Safeguarding & Delivery of Exchange Funds Assurance of Critical Deadlines Including the 45 & 180 Day Deadlines Final wind-up package for tax purposes

43 What does EWI do? Early involvement with client strategies Consulting and Team Participation Accountant Attorney Financial Planner Real Estate Broker Passive Replacement Sponsor 1031 Transactions QI Replacement Property Consulting Referral Partners Today s Sponsor Rockwell

44 Straight Talk About Section 1031 & the QI Industry Several failures during costing taxpayers MILLIONS in Exchange funds. QI s are unregulated therefore EXTREME due diligence is required. BIGGER IS NOT BETTER A few bad apples.

45 Are They Kidding? From a recent Webinar given by a national, well known Qualified Intermediary.

46 Client's funds in segregated accounts using their own taxpayer ID. Client has online access to their own account. Client MUST log in and approve funds transfers, EWI can NOT move money without this approval. Surety bond and E&O insurance.

47 Who Qualifies for an Exchange? Owners of investment property and business property may qualify for a Section 1031 deferral. Individuals, C Corporations, S corporations, partnerships (general or limited), limited liability corporations, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section

48 The Five Most Common Section 1031 Misconceptions 1All 1031 Exchanges must involve swapping or trading with other property owners...

49 The Five Most Common Section 1031 Misconceptions 2It s required that all types of 1031 exchanges must close simultaneously...

50 The Five Most Common Section 1031 Misconceptions 3"Like-kind" means purchasing the same type of property which was sold...

51 The Five Most Common Section 1031 Misconceptions Exchanges must be limited to 1 exchange and 1 replacement property...

52 The Five Most Common Section 1031 Misconceptions 5A Section 1031 is NOT a path to cash.

53 What about the States? All states but PA allow a Section 1031 within or outside the state Most states follow the Federal rules closely. Some states require a Waiver of withholding Other states w/ income taxes don t bother Some states have a formal Waiver; others permit a Seller Affidavit California enacted clawback in 2014

54 What about Vermont? Follows the FEDS rules and regs Out of state owners must file waiver Takes 4 business days QI must remit if failed Land Gains Tax in VT Old & New properties must be in-state; New Property takes Old Holding Period

55 What is New Money (Basis Additions): The Taxpayer picks up new basis for all New Money that is added to the transaction. New money = Net new cash + Net increase in debt Strike Price = Sales price - Allowable Expenses Taxpayer gets increased basis if the New property + acquisition costs = or exceeds the Strike Price You can offset a mortgage with cash but you CAN t get cash from a new mortgage.

56 What is Boot? If the Price + costs of the New Property is less than the Price costs of the Old, Boot results. Boot can be avoided by exchanging even or up Boot is property of an Unlike Kind; Cash Boot is net cash; Mortgage Boot is less net debt. Boot Triggers TAX The Exchange Could Still Work!

57 IRS Form 8824 Reporting an Exchange

58 Main Street, City, State; 4 Family Rental 456 Main Street, City, State; Single Family Rental Property Information & Exchange Dates Related Party? YES Line 8, NO Line 12 Part II Related Party - Sec. 267(b) or Sec. 707(b)(1) Part III

59 Joe Related Taxpayer Brother XXX-XX-XXXX 789 Main Street, City, State, Zip Related Party Information Must remain NO for two tax years Related Party - Sec. 267(b) or Sec. 707(b)(1) If 9 or 10 is YES, 11 C is most probable answer (attach statement)

60 Multi-asset Exchanges Boot FMV Old basis + New money

61 Exchanges That Cross 2 Tax Years: Reported for the year of the sale of the Old Property July days (or Nov days) = Jan. 1st Election under Reg (k)-1(j) (Coordination of Sec & 453): Provided the Client had a bona-fide intention to exchange at the start of the Exchange Period

62 Can a Failed Exchange Be Fixed? IRS Regulations allow a sale to be rescinded within the same tax year if the parties are restored to their original positions (Rev Rule 80-58) Un-close with the Buyer. Re-close with the Buyer properly, using a Q.I. Can make buyer nervous, will want compensation. Very difficult with banks involved.

63 HIDEND DANGERS OF PARTNERSHIPS AND A 1031 EXCHANGE We own the property in a partnership NO

64 HIDEND DANGERS OF PARTNERSHIPS AND A 1031 EXCHANGE We own the property in a partnership Evaluate

65 Section 1031 Exchanges for Partnerships Exchange Must be at the Entity Level Drop & Swap Technique Does Not Work IRS Is Now Asking on Form 1065: At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property? Question #14

66 Section 1031 Exchanges for Partnerships (2) Swap & Drop Technique Does Not Work Either IRS Is Also Asking on Form 1065 Check this box if, during the current or prior tax year, the partnership distributed any property received in a like-kind exchange or contributed such property to another entity (including a disregarded entity) Question #13

67 Section 1031 Exchanges for Partnerships What to Do? Identify Partners Who Want To Depart Close on the Asset, Reserve Boot Departing Partners -> Cash Remaining Partners -> Like-Kind Replacement Property This Preserves the Partnership EIN# and Holding Period MOVE FORWARD WITH ENTITY IN TACT

68 Section 1031 Exchanges for Partnerships What to Do? What are the Members Goals & Objectives? How well are Members Communicating? Can Members Agree to Strategize with 1031? MOVE FORWARD WITH ENTITY IN TACT

69 Section 1031 or Section 1033? Section 1031 Can Be Used in concert or as a Substitution for Section 1033 Section 1033 Has Strict Guidelines for Replacement Section 1031 Has Shorter time Frames for Performance, and; Is More Flexible in Choices of Replacement Property Before Cash is Accepted, Call a QI!!

70 The Power of Section 1031 What happens when both participate in 3 typical real estate transactions with radically different approaches?

71 Hypothetical Example Assumptions Courtesy of Grubb & Ellis Commercial Real Estate Services