1031 News

Section 1031 allows you to roll the gain -- and pay no capital gains tax -- from the sale of your Old Property into the purchase of your New Property. To do this, you have to jump through some hoops.

Our second Ñ1031 requirement is that you must formally identify the property that you might want to purchase. Simply stated, from the day you close the sale of your Old Property you have 45 days to file a list of properties you want to buy with your QI (the person or company you designate to handle your exchange).
You can identify up to three properties on your list without limitation. For example, if you sold your Old Property for $100,000, you could list three potential replacement properties for $10 Million each (a total of $30 Million). So long as you identify three or less, there are simply no limitations.

It’s tax time again, which means we'll be getting lots of good questions about 1031 Exchanges and tax returns. Easily one of the most common questions we get is how to handle depreciation on the New Property in an exchange.

"Depreciation" is a term for the tax benefit that allows you to recover the cost of a property over a predetermined life. Land is not depreciable, but improvements to it, like buildings, are. If you are not already depreciating your property, you can find great information about it at the IRS website at irs.ustreas.gov/prod/forms_pubs. Publication 946 is particularly good. This article, then, is for taxpayers who are depreciating their Old Property which they've sold, and have acquired a New Property through a 1031 Exchange.

Section 1031 is an IRS code section that allows you to roll the gain from the sale of your Old Property over to your New Property.

To accomplish this, there are hoops you have to jump through, and the first of these is that both the Old Property you are selling and the New Property you are buying have to be held for investment or for business use. 1031 Exchanges allow the investor to defer paying any capital gains tax on the sale of their real estate. But it's NOT for your personal, primary residence -- it's only for investment or business use properties.

Two years ago the IRS issued guidelines for taxpayers who wish to buy a small slice of a large property. Their ruling covers groups that are put together by promoters, or "sponsors" and is intended to cover groups comprised of people who don't know each other. These groups are known as "Tenants-In-Common", or "T.I.C.s" and most often called "TICs" (rhymes with "sticks") in the real estate industry.

The ruling sets out the minimum requirements that must be met before the IRS will accept an application for a group's exemption from the partnership rules. Being subject to the IRS's partnership rules would be fatal for a TIC.

Since this ruling was released, the TIC industry has exploded and is easily the fastest growing segment of the real estate industry.

We get this question all the time, "What will the IRS look for if they audit my exchange?" A 1031 Exchange is reported on form 8824, "Like Kind Exchanges," and attached to the taxpayer's tax return. Section 1031 of the IRC actually has two parts, real estate and personal property exchanges. Regarding real estate, a 1031 exchange joins together the sale of Old Property with the purchase of New for the purpose of deferring taxes. In today's appreciating real estate market, the deferred tax savings can be significant, so rest assured the IRS will examine the whole transaction in an audit, not just numbers and dates.

The IRS Recently Issued a ruling that is bound to impact Arizona real estate and 1031 exchanges. Revenue Procedure 2002-69 says that a husband and wife, who own all of the shares of a limited liability company (usually called an "LLC") in a community property state (ie: Arizona), will be able to disregard the separate nature of the LLC and report all of the income and expenses in their personal return.

Until now, the IRS has refused to rule on whether a husband and wife who own all of the shares of an LLC constitute a "single member" for purposes of the "disregarded entity" rules for filing a return. If an LLC has only one member, the disregarded entity rules state that the LLC does not have to file a tax return, but may instead report all of its income and expenses in the tax return of the sole member.

A common question we get is how a client's Revocable Living Trust impacts their exchange. One of the major rules of a 1031 exchange is that you have to take title to your New Property in the same manner that you held title to your Old Property.

The question about Revocable Living Trusts generally arises where the client's Old Property was owned by their Living Trust, but the lender for their New Property will not make the loan to the trust. And occasionally we get a client who has sold their Old Property in their name, but for estate planning reasons would rather purchase their New Property in the name of a newly formed Living Trust.

The answer to their questions is that their Revocable Living Trust will have no impact on their exchange. To be clear, there are many different kinds of trusts, and each of them impacts a 1031 exchange differently, but a "Revocable Living Trust" will not affect what the client is trying to do.

This article remains posted for it's historic context only -- some info herein is outdated.

Recently I wrote an article analyzing a private letter ruling (PLR 200251008), released at the end of last year (Using 1031 Funds to Build on Property You Already Own, Colorado Real Estate Journal, July 16, 2003). This decision allowed a taxpayer to use exchange proceeds from the sale of one property to build improvements on a piece of land that they already owned.

This ruling came as a shock to the exchange industry because it completely departed from a major 1951 tax court case (Bloomington Coca-Cola v. Commissioner) that disallowed such a scheme. Now, within a few months of the first ruling, the IRS has released a second ruling (PLR 200329021) that again allows a taxpayer to use exchange proceeds to build on their own land.

The 1031 Exchange area is so broad that you could spend days teaching the details of the topic. Most of you, however, want to simply introduce the topic to your students, and you should be able to do that adequately in about an hour. This article gives you an outline and the basic concepts that will let you do just that.

Most investors sell one property and simply replace it with another one. Occasionally, however, an investor wants to buy a number of new properties to complete their exchange. This can make the exchange complicated.

The identification rules of a 1031 exchange provide that you can identify three properties without any limitations. In other words, you could sell your Old Property for $100,000 and identify three new properties for $10,000,000 each, for a total of $30,000,000. This is OK.

If you identify more than three properties, however, the IRS rules change. In this case, the rules require that the total combined purchase price of everything on your list can not exceed twice the selling price of your Old Property. So now, continuing our example, if you identify four or more properties, the total combined purchase price of all of the properties on your list can not exceed $200,000 (i.e., $100,000 times 2).