Exchange on a lease with 30+ years...

Can I do an exchange on a lease with more than 30 years remaining...?

Most real estate professionals are familiar with 1031 exchanges involving real estate. Common examples would include selling land and buying a rental condo, selling a commercial property and buying a vacation home, etc.

But, did you know that a lease with more than 30 years left on it can qualify, too? Leases of 30+ years are considered "real property" for tax purposes. This would include the lease term, plus any optional renewal periods. So for example, you could exchange a lease of just 10 years with four renewals of five years each, if you held that lease for business or investment.

Let's say you own a 50-year lease on a property. Someone wants to buy the lease from you. This might happen because the lease payment is so low, the lease is now worth more than the rent being paid. Well, you can sell this lease and exchange the proceeds into a piece of land, a rental, a vacation home, another 30+ year lease -- anything that would otherwise qualify for a 1031 exchange!

We see these situations arise on cell phone towers and billboard leases. There are also other situations where someone's building is located on leased property. For instance, there is a resort town in New Jersey where most of the homes are built on land encumbered by a 100 year lease -- these homes will qualify for a 1031 exchange.
If you'd like to learn more about this, give any one of our Experts a call.

--The Experts

Vacation Home Update

On May 30, 2007, the U.S. Tax Court issued another ruling concerning 1031 Exchanges and Vacation Homes (MOORE V COMMISSIONER, T.C. Memo 2007-134, May 30, 2007). While unfavorable, the Moore decision does not mean that you cannot do exchanges of vacation homes. However, you must be more careful than ever.

Moore was a classic case of a 1031 Exchange involving second homes. The taxpayers used the property for over four months per year, it sat vacant most of the year, they never rented (or tried to rent) it, and they deducted the mortgage interest on their tax returns as “home mortgage interest.” The court in MOORE disallowed the 1031 Exchange of these properties as being held for personal use and not held for investment.

So, now what?
Our advice is even more important now than it’s ever been. If you intend to do an exchange of a vacation home, you MUST be prepared to present a strong case that your primary motive for owning the real estate was for investment. Your personal use was secondary or incidental. Many tax advisors will tell you that in an exchange (i) do not personally use your old property more than 14 days during the 12 month period prior to selling, or (ii) personally use the property more than 14 days during the 12 month period after purchase. This is not bad advice.

Therefore, we strongly urge you to rent or try to rent your property. DO NOT deduct your vacation home’s interest as “home mortgage interest” on Schedule A of your tax return. Report all income, expenses and depreciation properly on your tax return. Go ahead and write that letter to your CPA or attorney detailing the wonderful investment potential of your property. Keep records of the comparable properties you examined and investment analyses you prepared. Lastly, this list is not exhaustive. If you or your tax advisor can think of anything else, go ahead and do it.

As always, if you have doubts, consult with your tax advisor..