Can I 1031 Exchange a Property that was Originally Intended to be a Rental?

A client of ours recently came to us with the following situation. The client had an investment property that was originally intended to be a rental, but after going through renovations they felt like it might make more sense to sell. Could this qualify for a 1031 exchange?

Maintaining the Right Mindset

The simple answer is yes. If you have maintained a mind-set to hold the property for a qualifying purpose of “investment or business purposes,” then you could continue with a 1031 tax deferred exchange.

There is no minimum required period of time that the relinquished property must be owned. For the IRC 1031 to qualify, you must have had the intention (before closing) of holding property for investment or for use in a trade or business.

Tax Treatment of Repairs and Improvements

The client was also concerned about how all the money they put into the property in repairs and improvements would be treated from a tax perspective.

These amounts may be tax-deductible in the year incurred if they are deemed repairs. Conversely, they may be deemed as capital improvements which would increase the client’s basis in the property and are recouped more slowly through depreciation.

It is always a good idea to talk to your accountant about the proper tax treatment for these expenses. Generally, you are not allowed to reimburse yourself for these repair costs with 1031 funds at closing (without adverse tax consequences).

• Start Your Exchange : If you have questions about 1031 exchanges of rental property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Construction / Improvement 1031 Exchanges

In this 1031 FAQ video, Jeff Peterson discusses construction improvement 1031 exchanges. Watch more 1031 educational videos here.

• Start Your 1031 Exchange: If you have questions about construction / improvement exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Farmland Capital Gains & 1031 Exchanges

Recently, a client came to me with a question about farmland capital gains and their 1031 exchange. The lender they spoke with was concerned that they wouldn’t be able to transfer farmland capital gains into a NNN lease retail store with a 1031 exchange.  Specifically he was worried about the like-kind definition. So is there anything taxpayers need to be aware of in this type of situation? Great question.

Farmland Improved Property

Generally “unimproved” farm land may be exchange for other “improved” real property with buildings. 

Section 1.1031(a)-1(b) of the Income Tax Regulations defines like-kind as referring to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under  hat section, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only or the grade or quality of the property and not to its kind or class. See https://www.irs.gov/pub/irs-wd/0404044.pdf

Most real property that is exchanged is 1250 property, with slow depreciation schedules.

Sometimes farmers have some 1245 property (that has faster deprecation) mixed in with the Relinquished Property that is sold such as cribs, grain storage bins, and silos.  If a high amount of the purchase price is allocated to the 1245 property, then that could trigger some gain unless this 1245 property can be matched-up with a sufficient amount of new 1245 in the Replacement Property in order to defer 100% of the gain.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges of farm property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

What is a 1031 Improvement Exchange?

A 1031 improvement exchange is an exchange where you’re selling a piece of relinquished property at a large value (say a million dollars), and you want to acquire new replacement property but the initial land cost of your replacement property is less than the relinquished property value (say $500K). That’s not enough replacement property to defer all of your gains in a 1031 exchange. But you’re planning on constructing $500K worth of like-kind improvements on top of that new acquisition. How do we construct an exchange with these factors?

Bloomington Coca-Cola

There’s a case called Bloomington Coca-Cola that stands for the proposition that once the taxpayer acquires their new land, the exchange is over and any improvements that you construct won’t count towards your 1031 exchange.

Thankfully, there is a way around this issue. You need to have the improvements constructed and exist as like-kind property before you receive them. Often people will engage in a build-to-suit exchange, wherein their Qualified Intermediary forms an LLC to acquire the raw land and the LLC owns that land while the $500K of improvements are constructed. Then once the like-kind property exists and is valued at least as much as the relinquished property, the replacement property can be transferred to the taxpayer.

But guess what? You don’t have a lot of time for construction (only 180 days) so you’re not going to be able to construct the Taj Mahal. You’re only going to have time to make modest improvements and repairs during the exchange period. A partially completed Replacement Property can still count for your 1031 exchange, so long as there is enough existing like-kind real property improvements existing and completed by the 180th day of your exchange period.

• Start Your 1031 Exchange: If you have questions about 1031 improvement exchanges and build-to-suit exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved