Tax 1031 Exchange

  What type of properties QUALIFY for a 1031 Exchange?

Eli Magen is an experienced Mortgage Broker specialized with Investors in Orlando & the state of Florida. The Following will clarify some of IRS-Tax questions frequently asked by investors.

Section 1031 of the Internal Revenue Code allows you to roll the gain from the sale of your old property over to your new property without paying taxes. To qualify for this great benefit, both the old property and the new property have to be property held for investment or used in a trade or business. If you meet this requirement, you could sell your purple duplex and buy an office building, or an apartment building, a warehouse or even a bare land -- you do not need to buy another purple duplex.

What does the term "held for investment, or used in a trade or business" mean?  Well, first of all, it does not mean your personal residence - the one in which you are living. and it does not mean property held for resale. A prime example would be a property you are renting (such as your purple duplex).

One rental property can always be exchanged for another rental property. This is why you can sell a rental duplex and buy an office building. Bare land is pretty much always investment property and can be exchanged for a rental property or vise-versa. Renting property is not the only example of a transaction that will classify a property as one held for investment - trying to rent the property also counts.

Just make sure you hang on to proof of your rental attempts in case the IRS audits you and question your motives for purchasing the property.

Property used in a trade or business is real estate that is part of your business. For example, if you personally own the land and building that houses your real estate business, that property is now part of your real estate buisness and qualifies for a 1031 exchange. Similary if you are an agent for a real estate company, but operate out of an office in your home, that home office is now property used in a trade or business and could be part of an exchange when you sell your house.

Your personal residence, with the exception of the home-office situation referenced above, does not qualify for a 1031 exchange. Nor does "property held for resale".

What is property held for resale ?

Prime examples are "fix and flips" those ugly properties you buy, fix up, and put back on the market a few months later. These properties are bought with the intention of immediately reselling them so they do not qualify.

Does that mean you can't buy ugly properties, fix them up, and do an exchange?  It does not.  You can do a 1031 exchange on "fix and flips", but you have to hold them long enough to qualify them as investment property. Typically this means that you have to hold them for at least a year and a day. The principal reason for this is that the IRS does not want you to turn short-term capital gains (which typically are taxed at much lower rates) by doing a 1031 exchange.

Their fear is that you would do a series of short-term "fix and flips" 1031 exchanges, decide several years later that you are tired of the "fix and flips" game, sell your last property and then claim long-term capital gain treatment because the whole scheme, from first property to last, had taken longer then a year.

Note these final points : Both the old property and the new property  have to be located within the U.S. And it is possible to sell one old property and buy several new properties. Or you can sell several old properties and buy one new property. Keep in mind, however, multiple property transactions must still meet the 45-day and the 180-day time frame requirements.

In a 1031 Tax Exchange, proceeds from the sale of the borrower's previously sold property is transfered to an intermediary until the borrower finds a replacement property (i.e., the subject property).   The agreements to purchase the subject property are executed by or assigned to the intermediary and, generally, title to the subject property is recorded in the intermediary's name. The intermediary then immediately conveys the subject property to the borrower (AKA, exchangor).

At the discretion of the intermediary, title to subject property may be conveyed by direct deed from the seller.

In all cases, when using a 1031 tax exchange, the subject property must be an investment property. Primary Residences and Second Homes are not eligible.

For further assistance with real estate tax and IRS guidelines, you should contact a CPA/Tax Experts. I may have some referral sources for Tax 1031 exchange, per your request.

You may find some useful links on www.AbsoluteFloridaMortgage.com/FinancialSitesLinks .

1031 EXCHANGE TIP

SECOND HOME

Q: How can a second home be converted to an investment property?

A: Most tax advisors refer to I.R.C §280A for guidance. That section governs the allowance of deductions from a “dwelling unit” a taxpayer uses as a residence (including a vacation or second home). It provides that no deduction is permitted if the “dwelling unit” is used for personal purposes for a number of days which exceed the greater of, 14 days or 10% of the time it is rented for fair market value. Accordingly, many tax advisors will suggest a person do two things: first, reduce the personal use to no more than the §280A threshold; and second, begin renting the property reporting the income and deductions on their tax returns. It is important for a person to consult with his or her tax advisor with respect to the conversion of a property.

1031 EXCHANGE TIP
September 2007

Q: My seller is doing a 1031 exchange. Do I need to submit a Form 1099-S?

A: Yes. Form 1099-S is an informational document which sets forth the gross proceeds of a real estate transaction. Your client’s tax advisor will file Form 8824 with your seller’s tax return advising the IRS of the 1031 exchange. The only time a 1099-S does not have to be filed is when all six seller assurances are answered “true” in the “Certification for No Information Reporting on the Sale or Exchange of a Principal Residence”.

Email: Eli@AbsoluteFloridaMortgage.com