What is a Master Lease?

Sometimes people buy a replacement property that’s subject to a master lease, which means there is a tenant in place that is obligated to pay the landowner a fixed amount of income every month. In this article, we are going to talk about the benefits of a master lease.

Benefits of a Master Lease

The master tenant typically has subtenants under them. The benefit to the owner is that the master tenant really bears the economic risk and responsibility for managing the property and paying a fixed amount of rent each month regardless of the economic ups and downs in the rental market.

Master Leases & 1031 Exchanges

A master lease is often used as a method to make the property less management intensive for the owner and to shift the risk of economic ups and downs onto the tenant.

From a 1031 point of view, many people that have been involved in management intensive properties (like farming or apartment complexes) are seeking replacement properties that are less management intensive and have a more predictable cash flow so that they can have a steady stream of income in their retirement years without all the hassle and responsibilities of day-today management. Instead, those management duties and economic uncertainties are shifted over to the master tenant and off of the owner.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

What Commercial Real Estate Investors Need to Know About Reverse 1031 Exchanges

Note: In this article, we hear from guest contributing blogger Kip Dunkelberger (kdunk@venturemortgage.com), the President and CEO of Venture Mortgage Corporation.  Kip leads this trusted, dynamic commercial real estate mortgage banking firm, and he himself is known as an experienced and resourceful problem solver in the realm of commercial real estate financing.  

1031 Exchange Deadlines

Today’s savvy investors, particularly those looking to defer tax consequences by taking advantage of 1031 exchanges, are wisely looking for ways to secure a replacement property before selling the soon-to-be-relinquished property.  These investors need to know that once they close on the sale of their old property, they have a new property investment to exchange into. 

They are rightly concerned, because the deadlines for a normal forward exchange require you to identify your replacement properties within 45 days and close on them within 180 days. 45 days to identify in a hot (seller’s) market  presents a potentially formidable challenge. Here in the Upper Midwest, where the competition for choice replacement multi-family properties is particularly fierce, the process of identifying and trying to close on a replacement property in a normal forward exchange is not always a realistic possibility. That’s where a reverse 1031 exchange, combined with a creative, problem solving commercial real estate mortgage banking firm with access to a wide variety of lenders, can make all the difference.

How can Investors Step into a Sure Thing via 1031 Exchange?

Many investors are turning to these reverse exchanges to increase their chances of completing a 1031 exchange. In a reverse exchange, an investor can have their replacement property purchased for them by a qualified intermediary before closing on the sale of their old relinquished property.  The qualified intermediary (“QI”) then creates a new LLC to be the purchaser of the replacement property and holds title (or “parks the ownership”) for up to 180 days while the investor sells the relinquished property.  The ability to finance the purchase of the replacement property before you have the proceeds from your sale is where the need for innovative financing comes in.

In Practice: Tip # 1 – Tax Statements

At the first closing of the replacement property, on the deed from the seller to the LLC, the lower right hand portion can be filled out to tell the county to mail the property tax statement directly to the investor’s address, rather than to the QI or its LLC.  That way the investor receives the bills and statements for the property taxes directly.

In Practice: Tip # 2 - Insurance

The insurance certificate for the liability insurance should list the lender, the LLC, and the investor all as insured parties.  That way, if there is a claim, all of the parties with an insurable interest in the property are protected.

If you have questions about obtaining a mortgage or financing for a reverse exchange or any other commercial real estate investment, you are invited to call Kip Dunkelberger at (952) 843-5125, or email him at kdunk@venturemortgage.com.

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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

1031 Real Estate Exchanges

One of the most popular uses for a 1031 exchange is in the sale of real estate. 1031 real estate exchanges are popular and easy because the like-kind requirements are very broad in the world of real estate.

Like-Kind Real Estate

Nearly all real property within the USA is considered to be like-kind. The types of real property that may be exchanged include property held in fee, ground leases (with remaining terms of 30 years or more), undivided interests in real property held as tenants in common (TICs) and interest in “DSTs” or Delaware Statutory Trusts. Here is a partial list of some of the kinds of properties that qualify for 1031:

• Apartment Buildings

• Farms

• Shopping Centers

• Airport Hangers

• Condos and Town Homes

• Raw Land

• Single Family-Rentals

• Industrial Property

Another reason people often structure the sale of real property as 1031 exchanges is because improvements (such as buildings) have been depreciated down over time, subjecting the sale to a maximum of 25% depreciation recapture rates (C corporations can be as high as 35%) on the portion of the gain that is attributed to the depreciation.

Depreciate your Investment Property

As a real estate investor, you can depreciate your real estate business and investment property. The maximum 20% capital gain rate is generally known as the long-term capital gains rate and is the maximum rate that applies to real estate that you have held for at least 366 days (more than one year).

There is also the Net Investment Income Tax (“NITI”) which is imposed by IRC Section 1411 and applies an extra rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts (2015 amounts: Married filing jointly = $250,000; Married filing separately = $125,000; Single = $200,000). 

The long-term capital gain tax is typically a lot less than what you pay on your regular income. If your holding period has been for less than one year, consider deferring the gain on the sale through a 1031 exchange so that you can meet the greater-than-one-year period before cashing out on a later sale.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Don’t Burn up Your Loss Carry-Overs on Real Estate

Sometimes taxpayers opt not to conduct a 1031 exchange because they have prior loss carry-overs that can be applied to reduce their tax liability. 

What is a Loss Carry-over?

If in the past a taxpayer has sold a capital asset for less than their adjusted basis, this results in a capital loss. If the taxpayer is unable to take advantage of the loss with a corresponding tax deduction for the entire amount for the current tax year…then that loss (lingering or pending tax deduction) can be carried over into future tax years.

Keep your Powder Dry

Loss carry-overs are valuable tax attributes because they can be used in the future to offset future income (this is especially so if tax rates increase). Generally, I tell people to save their loss carry-overs for gains that cannot be deferred, and indefinitely defer the real estate gains through a 1031 exchange, especially if they own other assets such as stocks.

Always Exhaust the 1031 Option First

If the taxpayer is inclined to buy more real estate anyway, it may be prudent to set up a 1031 to keep their options open for 45 days to see what they want to do, and if they want to identify any replacement properties.

You Gotta Know When to Hold'em

Sophisticated taxpayers and their tax advisors know that it is better to not burn up their loss carry-overs without considering an alternative that allows them to defer their gains and also keep these valuable tax attributes (to use against other future gains).

Defer, Defer, Defer…Die

Because of the step-up in basis, the ability to refinance replacement properties (to pull out equity tax-free) and the long duration that 1031 properties can be held (until after the death of the taxpayer), it is prudent to consider all of the alternatives before playing the loss carry-forward card on real estate.

• Start Your 1031 Exchange: If you have questions about real estate loss carry-overs, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved