1031 Exchanges for Vacation Homes

From Maine down the Atlantic coast, across to the lakes and ski mountains of the Northeast, many people own some type of vacation or second home.  Large or small, used year-round or only seasonally, it’s their personal getaway.  They may even consider it an investment, building upon the original structure or simply letting the value and equity grow.  Unfortunately when it comes time to sell, owners do not benefit from the same tax exclusions as that of a primary residence sale.  

 

Many have no idea the federal and state capital gains tax will be due, and possibly even the 3.8% Affordable Healthcare Tax depending on their adjusted gross income.  The IRS maintains holding property solely for “personal use & enjoyment” does not qualify it for a 1031 Exchange. With no proven business use (i.e. rentals), the IRS reasons that “holding this property with the hope of future gain” is simply not enough to qualify property as “held for investment” under the §1031 Tax Code.

Investors inevitably ask: “How long do I have to rent out the property? How much can I use it?”  In 2008 the IRS answered: for a “dwelling unit” to qualify as property held for investment purposes and be eligible for the Section 1031 tax deferral, the Taxpayer must have:

  1. owned it for 24 months immediately before the sale/exchange, and
  2. rented it at fair market rental for 14 days or more within each of the past two 12-month periods the Exchanger, and
  3. restricted personal use to not exceed the greater of 14 days or 10% of the total days rented within each of those 12-month periods.

Going forward, purchasing a vacation/second home as replacement property must meet the same criteria as above for the following 2 years, and the Exchange itself must meet all other §1031 requirements.  

Many property owners hoping to keep their investment properties “safe from damage” during those first few years will rent to those found through a rental agency, or rent to friends and acquaintances for fair market value. This will help ensure it remain in good condition for future years when the taxpayer may eventually decide to sell, or convert the investment to a personal vacation home or even their primary residence.

 

Patricia A. Flowers is Vice President for Investment Property Exchange Services, Inc. (IPX1031®), Boston, MA. www.ipx1031.com

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§1031 EXCHANGES KEEP REAL ESTATE MOVING

Have you been feeling it?  We sure have!  Real estate transactions have been up considerably in the last few years and a large percentage of those have been 1031 Exchanges.  When speaking with our clients, the high volume of exchanges can be attributed to a number of reasons.  

Real estate remains strong and investors are starting to look for ways to change or build upon their portfolios.  Properties that held as stable investments through the downturn are now showing significant appreciation and equity.  Since multiple properties can be acquired through a single Tax Deferred Exchange, investors can diversify their real estate portfolio, thereby hedging the investment risk inherent in a single property.  These replacement properties can offer greater income and long-term appreciation potential.

For some, it’s all about the taxes: In 2013 the Affordable Healthcare Act began imposing a 3.8% tax on certain investment income, including capital gains, for those with an Adjusted Gross Income exceeding $200,000 for single filers and $250,000 for married couples filing jointly. Additionally, the American Taxpayer Relief Act raised the top long-term capital gains rate from 15% to 20% for those with a taxable income of $400,000 for single individuals and $450,000 for married couples filing jointly.  Both of these taxes, combined with the 25% Depreciation Recapture Tax and the state capital gains tax, cause a substantially greater amount of equity to be due to the Federal Government at tax time.  With upwards of 1/3 the gain due in taxes, Investors utilize 1031 Exchanges to preserve their equity and grow their portfolio!

For others, Exchanging is an estate planning tool:  Investors want the income and benefits of ownership while they are alive, but want the property and hard-earned equity to pass on to their heirs upon death.  When a taxpayer dies, the estate receives a stepped up basis in the inherited property.  As a result, all of the built in gain disappears upon the taxpayer’s death.  This taxpayer could have exchanged multiple times during their lifetime, leaving their heirs with a sizable benefit that would have otherwise been greatly reduced if the taxpayer had sold the property outright, paid the taxes and just given the remaining cash to the future heirs.   

These strategies are excellent tax saving opportunities for a 1031 Exchange, and for all those involved in the real estate transaction.  We pride ourselves on not only being the industry leader in service and security, but we also strive to help our clients and their advisors keep current on tax issues pertaining to §1031 exchanges and applications for them. IPX1031® is your complete information resource. For more information about us, IRC Section 1031, or our complimentary monthly webinars, visit our website at http://www.ipx1031.com.

Patricia A. Flowers is Vice President with Investment Property Exchange Services, Inc.(IPX1031), the largest and most secure Qualified Intermediary in the country.  In 2004, Patricia received one of the first industry-awarded Certified Exchange Specialist® (CES®) Designations. In her role she strategically guides investors and advisors through the process, structuring transactions to help investors preserve equity and save thousands in taxes.

Patricia’s involvement spans the legal, financial, brokerage, tax and real estate industries, where she has participated in thousands of Exchanges. She is a member of various associations, including CREW-Boston (Women in Commercial Real Estate) and the Federation of Exchange Accommodators (FEA). Patricia is a frequent lecturer on IRC §1031 Exchanges, an instructor for CLE, CPE and CE credit, and author of numerous articles including an ongoing column the New England Real Estate Journal.

She can be contacted at 617-423-1031 or patricia.flowers@ipx1031.com

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Cyber Fraud – an Emerging and Worsening Threat

Written by Patty Flowers. Patty Flowers is AVP for Investment Property Exchange Services (IPX1031®) and a Certified Exchange Specialist®. See her website.

Take Key Steps to Combat It

Patty Flowers

Patty Flowers

Simply put, cyber fraud is when credit and financial information is stolen online by a hacker and used in a criminal manner. What’s alarming is the rapid growth of detected cyber fraud incidents, as well as the financial costs associated with these events. This emerging threat has the potential to cause serious damage.

“Cybercrime is a clear, present, and permanent danger. While it’s a permanent condition, however, the actors, threats, and techniques are very dynamic.” — Tom Ridge, CEO of Ridge Global and first secretary of the US Department of Homeland Security.

The long known scams of phishing emails, claims of lottery winnings, an inheritance from a long lost relative, or forwarding funds to Nigeria are consistently elevating to new and more deviant levels. More and more criminals are exploiting the speed, convenience and anonymity of the Internet. The fraudsters are getting smarter and bolder and fraud attempts are approached with increased vigor. As an investor or someone directly or indirectly involved in 1031 Exchanges and real estate transactions, being aware and attentive is critically important to you and your clients’ funds and business interests.

For the many frauds that have succeeded, there have been many more near misses that have been caught before funds could be disbursed and potentially never retrieved. IPX1031® is aware of a number of such cyber fraud attempts. These attempts generally try to redirect (and ultimately steal) deposits, purchase funds, closing proceeds or commissions.

At IPX1031® we take these threats very seriously. Protection of investors’ hard earned funds, potentially their entire life savings – is of the utmost importance to us. As part of Fidelity National Financial, we have access to secure systems and industry professionals that may not be available to smaller entities. The security of your information is extremely important in protecting your assets. When you want the best, expect it from IPX1031®, a leader in what matters – safety, security and expertise.

Many individuals and businesses underestimate the threat online fraud poses to their profitability, cash flow and reputation. So don’t leave your data – and your profits – open to cyber criminals. Take some simple steps towards keeping your computers, your information and business secure. Reduce your vulnerability and you reduce your threat.

Here’s a few resources from the FBI and the United Kingdom’s National Crime Agency (NCA) on measures you can take to protect yourself and your technology moving forward.

  1. FBI’s how to protect your computer
  2. FBI’s getting educated on Internet fraud

NCA’s Online Safety Guidance for the Public top tips:

  1. No bank or card issuer will contact you by email and ask you to enter all your personal and financial details online. If you receive a message like this, report it to your bank, then delete it
  2. If you get an email from an unknown source, do not open it and do not click on any attachments
  3. Make sure that your anti-virus software is up to date
  4. Never follow the messages from anti-virus software you encounter whilst on the internet. Only follow the anti-virus instructions from the software you have installed on your computer
  5. Install an anti-spyware package
  6. Always use a firewall
  7. Ensure that your software is up to date

NCA’s Common Cyber Threats

  1. Phishing: bogus emails asking for security information and personal details
  2. Webcam manager: where criminals takeover your webcam
  3. File hijacker: where criminals hijack files and hold them to ransom
  4. Keylogging: where criminals record what you type on your keyboard
  5. Screenshot manager: allows criminals take screenshots of your computer screen
  6. Ad clicker: allows a criminal to direct a victim’s computer to click a specific link
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Shades of Gray in 1031 Flips

Written by Patty Flowers. Patty Flowers is AVP for Investment Property Exchange Services (IPX1031®) and a Certified Exchange Specialist®. See her website.

Patty Flowers

Patty Flowers

Forget cooking shows, America’s newest reality show obsession is watching real estate shows such as Flip This House, Flip or Flop, and Rehab Addict. Seeing how a house is bought at a bargain price, quickly transformed and sold for large profits can be scintillating. In fact, it can entice many to try their hand at flipping properties. A big question often encountered is whether profits earned from a flipped property can be used, tax deferred, to purchase the next fixer-upper by structuring the purchase as a 1031 Exchange?

To qualify for tax deferral under section 1031, the property must be “held for” investment or to own the property for the taxpayer’s trade or business (“a qualifying purpose”). This “held for” requirement is not purely black and white. Rather it contains shades of gray.

To help understand the “held for” requirement, the two words “principal intent” are crucial. If the property was acquired with the principal intent to sell, like most flipped properties are, then the property is considered to be inventory and will not be eligible for tax-deferral under section 1031. The goal for most people acquiring property to rehab and thus intent, is for a quick sale and profit, not for an investment or business purpose. Therefore, instead of being able to use all of their profits, tax-deferred to purchase the next property, profits will be taxed as ordinary income.

However if somebody buys a property to fix up to rent, then the principal intent is to own the property for trade or business – the business of renting. This qualifies as a proper use for section 1031 purposes. Likewise, if they acquire vacant land with the intent to hold the property for future appreciation, this qualifies as an investment use for 1031 purposes.

There are other important factors considered by the courts. These can include length of time before selling, why the property was purchased, how the property was used, what improvements were made to the property, the taxpayer’s ordinary business and number of prior sales (are their actions consistent with investing or selling inventory), and how the property was being used when sold. There is no one single factor that will prevail. Rather, courts tend to look at all of the facts to determine whether the taxpayer held the property for a qualifying purpose.

Flips can be lucrative and create a reward of a quick profit. However with most flips, you will be paying taxes at ordinary income tax rates. If your intent is for business or investment and you meet certain criteria, then your property may qualify for 1031 treatment. In areas of gray, consider the benefits of a 1031 compared to the potential costs of an IRS audit, interest and penalties compared to paying taxes due. Talk to your tax or legal advisor to review your individual circumstances.

Washington Update – 1031 Under Attack

Written by instructor Patty Flowers. Patty Flowers is AVP for Investment Property Exchange Services (IPX1031®) and a Certified Exchange Specialist®. See her website

 

Patty Flowers

Patty Flowers

1031 Exchanges have been an integral part of real estate’s recovery. Now the government is proposing to eliminate all 1031 Exchange activity.

For decades, real estate investors, business owners and Fortune 500 companies have used 1031 Exchanges to defer the payment of capital gains tax and depreciation recapture tax associated with the sale of their investment properties. 1031 Exchanges also allow taxpayers to maintain or diversify their portfolios and increase their purchasing power. Any investment property or property held for productive use in a trade or business, ranging from vacant land to shopping centers, can be exchanged. The taxpayer must simply purchase new qualifying real estate and follow some basic rules to complete a tax deferred 1031 Exchange.

Even though 1031 Exchanges have long been recognized as a major factor in encouraging real estate sales, as part of tax reform in separate Discussion Drafts, the House of Representatives, Senate and the President’s Budget Office have all proposed eliminating or sharply curtailing the benefits of Section 1031:

  1. House Ways & Means Committee Chairman Dave Camp released a Discussion Draft of his Comprehensive Tax Reform Proposal on February 25, 2014. The Camp Proposal would repeal Code Section 1031 for like-kind exchanges occurring after 2014.
  2. Senate Finance Committee Chairman Max Baucus’ tax reform Discussion Draft includes a proposal to repeal Section 1031 in its entirety. The proposed repeal would apply to exchanges made in taxable years beginning after December 31, 2014.
  3. President Obama’s 2015 Budget proposal also contains significant changes to IRS Code 1031. The President’s proposal does not eliminate 1031 Exchanges, but limits the amount that can be deferred to $1 million per taxpayer per year.

The elimination of 1031 Exchanges will result in a sharp decrease in real estate transactions. Due to its severe impact on all areas of the real estate community and how this could potentially affect you, IPX1031® will keep you up to date on these proposals. Simply send an email to info@ipx1031.com to be added to the “Washington Update” list.

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1031 Tax Straddling for 2014

Written by instructor Patty Flowers. Patty Flowers is AVP for Investment Property Exchange Services (IPX1031®) and a Certified Exchange Specialist®. See her website

Patty Flowers

Patty Flowers

With the end of 2013 approaching, there are investors selling real estate who are not sure whether to initiate a 1031 Exchange because they are concerned about securing replacement property. One thing to keep in mind is that the IRS does not penalize investors for attempting to complete a 1031 Exchange. However, if investors cannot successfully complete their 1031 Exchange, the taxes associated with the sale of their investment property will be due. The good news is at this time of the year, there may be a silver lining. “Tax straddling” may be an option where the taxpayer receives a one year tax deferral.

How does it work? Once a 1031 Exchange is initiated, if replacement property is not purchased to complete the exchange, the earliest the Qualified Intermediary can return the taxpayer’s funds is on the 46th day (the day after the identification time period has ended) or, in some cases, the 181st day (the day when the 1031 Exchange time period is complete). Taxpayers who enter into a 1031 Exchange during the fourth quarter of 2013 and receive their funds back from the Qualified Intermediary in 2014 have the option of deferring payment of taxes on the profits from their sale until 2015 – the due date of their 2014 tax return. Combining §1031 with §453 permits the cash received from the Qualified Intermediary at end of the exchange to be treated as a payment in the year of actual receipt, rather than in the year the property was sold.
Tax straddling provides added incentive to taxpayers selling investment property at the end of the year. Why not attempt to complete a 1031 Exchange when a one year deferral is available as the back-up plan?
Taxpayers should consult with their tax advisors since tax straddling does not apply to all sales, and any gain attributed to debt relief will still have to be recognized in the year of sale. It is also important that the taxpayer has the intent to complete the 1031 Exchange when the 1031 account is opened.
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Everything You Need to Know to Defer Taxes

Written by Patty Flowers. Patty Flowers is AVP for Investment Property Exchange Services (IPX1031®) and a Certified Exchange Specialist®. See her website

As we roll into the summer, it’s refreshing to see continuing economic improvement mirroring the growth of income property sales and 1031 Exchanges. However, the excitement of an increased property sale value can be quickly diminished with unexpected taxes. Many real estate investors are surprised to learn that taxes on their profits are substantially higher this year. When investment real estate is sold in 2013, some taxpayers could pay up to 20% capital gains tax, a 3.8% healthcare tax, depreciation recapture tax and varying state imposed taxes. Added together, these taxes can total anywhere between 30-40%, making 1031 Exchanges an invaluable wealth preservation tool.

Tax deferral is the hot topic in the real estate community and a 1031 Exchange still allows taxpayers to defer all of these taxes by simply rolling their profits into another property or properties. While the concept of a 1031 Exchange is straightforward, some investors and advisors may not have participated in a transaction for many years and may need to be updated on how to properly execute a 1031 Exchange.

Know your options and make informed decisions for your next 1031 Exchange transaction. Register today for IPX’s two complimentary webinars!

A 1031 Exchange Introduction and Refresher Webinar

This webinar will be held on June 12th and will provide a comprehensive foundation of 1031 Exchange information. Learn the basic rules and regulations and how to apply these to your transaction for maximum benefits.

Click here to register for the June 12th webinar

Advanced 1031 Exchange Issues Webinar

This webinar will be held on June 19th and will discuss the most recent changes in tax deferred exchanges and will cover topics such as reverse exchanges, build-to-suit exchanges, using seller financing in a 1031 transaction, and related party issues.

Click here to register for the June 19th webinar

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