Burying Your 1031 Exchange Proceeds in Raw Land

Normally raw land is non-depreciable. You cannot depreciate it, so it’s kind of like a cost of doing business. You have to put money into the dirt and you can’t recoup your outlay for the dirt until you eventually sell the dirt. What some investors are doing is they’re taking an apartment building that they’ve fully depreciated and they have maybe a $2 million gain from the sale of this apartment and they’re taking that $2 million and using it to 1031 exchange into a $2 million+ piece of dirt. In other words, they’re burying their gain in the dirt.

The nice thing about buying dirt with your 1031 exchange money is you’re burying your gain in an asset that could not have otherwise been depreciated. Then later you construct your improvements on top of the ground estate and you’d have completely fresh basis in your newly constructed improvements.

Do you Have to Build Improvements on Top of That Dirt for the 1031 Exchange to Succeed?

If the value of the dirt exceeds the net sales price of the relinquished property so you’re continuing your investment into property of equal or greater value, then no improvements are necessary for a successful 1031 exchange because you’ve already got the value. The reason you may want to do a build-to-suit exchange is when the unimproved piece of dirt isn’t of sufficient value and you want to construct improvements with your remaining exchange funds.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

In a 1031 Exchange, Are Closing Costs Backed Out of the Seller’s Taxable Gain?

If one were to hypothetically sell a property for $1M with 6% commissions and closing costs (or $60k) and it has a current tax basis of $800k, would the seller’s taxable gain be $200k or $140k? In other words, are commissions and closing costs backed out of the seller’s post sale taxable gain?

This is an excellent question that comes up a lot in 1031 exchanges. Certain transactional expenses reduce the “amount realized” on the sale or exchange of real property.

3 General Rules of Thumb

There are three general rules of thumb to quickly see if you will defer ALL of the recognition of gain.

1. Typically you will acquire replacement property that is “up or equal” in Value* (price); {*net of sales commissions and customary transactional expenses}

2. You will roll over all of your Equity (net proceeds) from the relinquished property into your replacement property.

3. And to the extent that you were relieved of liabilities and Debt, such as mortgages on your old relinquished property, the debt relief is offset by (1) new liabilities or mortgages taken on in conjunction with your purchase of the replacement property; OR (2) by investing additional cash in the replacement property equal to the amount of liabilities and debts that were discharged.

You can have a partial tax deferral if you miss these general benchmarks. Be sure to check with your CPA about these general rules of thumb, to make sure they apply to your specific situation.

For more information on this topic, check out this article.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges Involving Seller-Backed Financing

This article discusses a specific 1031 exchange situation we recently dealt with involving seller-backed financing. Our client came to us with the following question:

• Can a 1031 exchangor complete their like-kind exchange by purchasing property with seller-backed financing on a land-contract, or contract for deed?

The short answer is yes. Generally speaking, in a 1031 exchange a taxpayer can purchase property on a land contract or contract for deed as the vendee.

Exchange Funds

Typically, all of the exchange funds are used to pay the down payment, and the remainder of the purchase price is financed by the seller.

For tax purposes, the vendee is deemed to be the equitable owner of the replacement property; and the seller is treated as a creditor holding bear legal title as an enforcement mechanism to ensure payment of the debt.

The Devil is in the Details

Contracts can be written in many different ways, and the devil is in the details…so before proceeding with a 1031 exchange in this situation, you will need to answer the following questions:

• Does the vendee have exclusive possession of the property?

• Is the vendee responsible for the property taxes and insurance?

• Does the vendee bear the risk of loss in the event the property is damaged or destroyed?

• Is the vendee effectively the owner of the property for all practical purposes except for financing?

These are all essential questions you’ll need to answer with the help of your qualified intermediary in order to ensure a successful 1031 exchange.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

How to Mix 1250 & 1245 Property in a 1031 Exchange

In a real estate transaction you may have 1250 property (the traditional real estate and buildings), and then you may have other components that are personal property that are characterized as 1245 property for depreciation.

1250 & 1245 Property

What’s the impact of having a mixed bag of 1250 and 1245 components in a like-kind exchange? The answer is that in order to maximize the benefit of your 1031 exchange you’re going to want to receive replacement property that has both 1245 and 1250 components so that we can match up the proceeds from the sale of your 1245 with new 1245 property, and the proceeds from the old 1250 property to new 1250 property.

Getting the Maximum Benefit

In order to get the maximum benefit you really need to know what your depreciation has been on the prior relinquished property and then target replacement properties that meet your needs to maximize the tax deferral.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved

The Importance of Maintaining Section 1031 of the IRC

In this article, we are going to talk a little bit about the history of the 1031 exchange and why it’s important to preserve this important part of the internal revenue code.

Section 1031 Has Been Around for Nearly 100 Years

Getting back to the idea that simplification requires the elimination of 1031, it’s important to note that section 1031 and its predecessors have been in the tax code since 1921. It’s almost a hundred years old. There’s a reason that it survived as long as it has in the code because it fulfills an important function.

It says that as long as you have a continuation of investment into another like-kind property, the government is not going to punish you by making you recognize gains because you’re continuing your investment into another like-kind property. We want investors to be able to move their cash to where it’s needed in the economy because it benefits them, but more importantly it benefits the whole economy by creating jobs and increasing property values.

Preserving The 1031 Exchange

If we eliminate 1031 exchanges, deals will stop happening. That will cause property values to decrease. When property values decrease, then you can’t even refinance out your equity and you’re locked into the property and unable to sell. Eliminating 1031 is not a good idea. We need to preserve 1031 even through the most comprehensive of tax reforms because it is a vital key to keeping property values up, stimulating the economy, and creating jobs.

• 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.

© 2023 Copyright Jeffrey R. Peterson All Rights Reserved