How can an Owner of Rental Property Benefit from a 1031 Exchange?

Right now, the real estate market is hot and many owners of rental property may be looking for ways of selling their property without having to pay their capital gains taxes on the property. In this article, we are going to discuss how an owner of rental property can benefit from a 1031 exchange.

Why Exchange Your Rental Property?

With the current state of the real estate market, it is a great time to be a seller. Prices are high, inventory is tight, and that leads to a lot of competition among buyers.

As a rental property owner, there are many reasons why you might want to sell your property. Perhaps it’s in a location you no longer want to be in. Maybe there’s a lot of deferred maintenance you’d rather not deal with. Whatever the reason, this is a great time to reposition your portfolio and set the stage for future increases in value. Interest rates are also still at historic lows so it may be a perfect time to sell the assets you have and lever up into bigger and better property. That way, when the tides of appreciation come in, instead of having a small portfolio perhaps you have a much bigger portfolio all going up in value.  

Twin Cities 1031 Exchange Services

If you are searching for 1031 exchange services in the Twin Cities area, you’ve come to the right place! At CPEC1031, LLC we have been facilitating like-kind exchanges of investment real estate for over twenty years. Our qualified intermediaries can walk you through the entire exchange process and ensure you defer 100% of your capital gains taxes when selling investment property. Contact us at our Minneapolis office today to learn more about how we can help!

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

Defer the tax. Maximize your gain.

© 2022 Copyright Jeffrey R. Peterson All Rights Reserved

How to Convert Rental Property into Personal Use Property in a 1031 Exchange

When you do a 1031 exchange you need to acquire a replacement property that's like-kind. The definition of like kind in the realm of real estate is very broad. A lot of people that have been holding single-family rental property (a small duplex or fourplex) may be inclined to buy a property as a replacement that eventually could be converted into a personal use property such as a second home. Here are some things to keep in mind when converting rental property into personal use property.

Qualifying Purpose

You need to be very careful that when you receive the replacement property you have the requisite intent to hold it for a qualifying purpose of investment or business use.

Sometimes people will buy a property that is a vacation type property and put it into a rental pool and predominantly they're using the property as a rental property with incremental tenants. Now the taxpayers that have acquired this vacation property may be inclined to use it for personal use. Under a safe harbor that the IRS has you can use it up to 14 days a year or up to 10% of the time the property is actually rented.

IRS Guidelines

The IRS can test each of the two years after you acquire that replacement property to see if your personal use was within those guidelines. By the way if you go and use the property but you're there predominantly to maintain the property (to repair it, paint it, or fix it) then those periods that you're there for business would not count against your 14 days or 10% that you use it for personal use.

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

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges of Rental Properties and Vacation Homes

In a 1031 exchange, no gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment. But do vacation homes and rental properties satisfy those requirements?

Consider the Intent of the Owner

The relinquished property must be held for a qualifying purpose, e.g., investment / business. It has been said that one must have had the "intention" to hold the property for investment purposes at the time of the sale; and that it is the taxpayer's responsibility to demonstrate the requisite intent (to hold the property for productive use in a trade or business or for investment) at the time of the exchange. 

In Rev Rul 57-244, 1957-1 CB 247, the IRS held that a residential property could be changed to qualified exchange property if the taxpayer actually altered or transformed the use of the property. However, simply renting out a personal residence will not automatically qualify it for tax-deferred exchange treatment.

Here is an excerpt from a tax treaties that is somewhat on point but deals more with the holding of the new replacement property:

• The property received in the exchange must also be held for investment or in the taxpayer's trade or business. It is not clear how long such property must be held. The phrase "to be held for" in I.R.C. § 1031(a) implies a continuity of ownership. A subsequent disposition of the property received may be evidence that the property was not acquired for investment or use in the taxpayer's business.

What if the Property has Been Held a Very Short Time Before it is Exchanged? 

For example, if X received a distribution of a building from a partnership and immediately exchanges it, has X met the "held for" requirement?  See Bolker v. Commissioner, 760 F.2d 1039 (9th Cir. 1985), aff'g, 81 T.C. 782 (1983) (the court allowed a I.R.C. § 1031 exchange where the real estate transferred had just been received in connection with a liquidating distribution from a corporation); the court held that the requirement that the realty be held for investment was satisfied as it was not acquired in the liquidation with the intention of liquidating the realty or using it personally. 

What if the Taxpayer Wishes to Conduct an Exchange Involving a Vacation House? 

In Rev. Proc. 2008-1, C.B. 585, the IRS provides a safe harbor for whether a dwelling unit, including a vacation property, will be considered property held for productive use in a trade or business or for investment.

Please check with your CPA about the matter and if they would require additional rental history and tax reporting consistent with use as a rental property (rather than personal use).

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

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

Short-Term Intermittent Rentals will be Subject to More Tax in Minnesota

The Minnesota Department of Revenue recently announced that VRBO, AirBnB & other short-term intermittent rentals will be subject to more tax in Minnesota as they will be classified as commercial property. The department of revenue passed this earlier this year and sent a notice to all county assessors to identify these properties. Any required classification change identified by our appraisers will be effective for the 2020 assessment year and impact taxes payable in 2021.

Can short-term Rental Property be Classified as Residential?

In short, no. Short-term rental property cannot be classified as residential or apartment property because its primary function is income generation through short-term lodging (less than 30 consecutive days) - similar to a hotel property. Residential non-homestead and apartment classifications require rentals by tenants for 30 consecutive days or more.

CPEC1031

If you have any questions about how these new rules apply to your short-term rental property or whether or not you can subsequently do a 1031 exchange on such a property, contact us. For the past two decades, CPEC1031 has been helping taxpayers large and small exchange their investment property under section 1031 of the Internal Revenue Code. Our qualified intermediaries can advise you on replacement property, prepare your 1031 documents, and answer any questions you have along the way. Contact us today to learn more about the process and if your property qualifies. You can find us at our downtown Minneapolis office or at one of our satellite offices around the United States.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

Tips for 1031 Exchanging Rental Property

In a 1031 exchange, both the relinquished property that's sold, as well as the replacement property have to be held for a qualifying purpose of investment or business use.

Renting to Related Persons

Many people that are acquiring replacement properties in a 1031 exchange may be inclined to rent them out to related persons such as a son or a daughter. The concern with this situation is that this rental arrangement with your related-party may be perceived by the IRS as just a sham. That you're really intending to put a roof over your kid’s head instead of using the property for investment or business purposes.

Tips for Upholding your Qualifying Purpose

If you are actually acquiring the property with business intent to rent it out and you're renting it out to a son or daughter, you want to make sure that you are legitimately using the property for business purposes and you're able to substantiate that. Make sure you have all of the following:

• A real written lease between the taxpayer and the tenant at market rate.

• Rent checks coming in incrementally and regularly according to the terms of the lease.

• Finally, you want to report your rental activity on your tax return just like you would with any other investment or business property that's not rented out to a related party.

If you intend to move into the replacement property after some years of renting it out you need to be cautious that it doesn't appear that this whole rental arrangement was just a sham to make the replacement property fit into an investment or business paradigm when in fact you never really intended to rent it out. Getting too cute with the IRS and jumping through a charade of renting it out may backfire for taxpayers.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved