Home Foreclosures and 1031 Exchanges

If you're about to be foreclosed on a property and you’re going to lose it involuntarily, one opportunity that you may not have even thought of is to do a 1031 exchange (or debt exchange).

Gain on the Sale

Your gain on the sale is computed by the difference between your adjusted basis in the property and the amount of debt relief that you're going to experience when you give back that property to the lender; NOT the amount of cash that you may or may not receive.

So if your basis is far below the debt, you may have MOB “mortgage over basis,” and that will result in taxable gain to you if you just give back the property to the lender. So even though you don't have any net sales proceeds of cash coming to you, you may still want to structure it as a 1031 exchange so you can defer the gain on the difference between your basis and a debt relief.

How do you do that? You get your qualified intermediary to prepare all the documents that would normally be executed in a 1031 exchange. You give notice to the lender (the buyer), and then you go forward and acquire a new replacement property within the deadlines.  

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges & Escrow

It's really sad when we get a call from somebody and they say “I sold my relinquished property two weeks ago and I've just decided to do a 1031 exchange. Can you set me up to do a 1031?”

This call comes in quite frequently, partly because people are ignorant about the requirements of Safe Harbor 1031. They think that they can just keep their money in an escrow account or leave the money with the title company and if they choose to do at 1031 they can set it up after the fact.

Be Prepared

The problem is that in order to do a valid Safe Harbor 1031 you have to have an exchange agreement with a qualified intermediary (or facilitator/accommodator) in place before you dispose of the relinquished property. Furthermore, you have to assign your rights in the purchase agreement with the buyer so that the relinquish property purchase agreement is assigned to the intermediary. The intermediary then directs you to deed that property straight to the buyer.

Notice of Assignment

On top of that you have to give written notice of your assignment to the intermediary to all of the other parties to the purchase agreement (e.g., the buyer of the Relinquished Property). If you don't have all of that in place before the closing occurs on the sale of your relinquished property then you don't have a defensible Safe Harbor 1031. The net result is that closing, when the benefits and burdens of ownership shift to the buyer who has actual or constructive receipt of the money.

Even if you leave your money in an escrow account at the title company, it's still your money. You still have the right to go in and take it out at any time (you have control over the proceeds). The only way to do it under the Safe Harbor regulations is to make sure that you have it set up with a facilitator or intermediary before you go to closing and dispose of that property so that you’re insulated so you don't have actual or constructive receipt of the funds.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can a Principal Residence be 1031 Exchanged?

Can a principal residence be exchanged in order to qualify for Section 1031? We answer that question and more in this article.

Investment or Business Purposes

In a 1031 exchange, the property must have been held for investment or business purposes. Most principal residences are not held for investment or business purposes. They’re held for the antithetical or completely opposite purpose of being your residence. It’s your home and generally speaking you can't do a 1031 on your home. That's usually not a big deal because under IRC section 121 the principal residence exclusion you get to take up to $500,000 of that profit tax return married filing a joint tax return, or $250,000 for single filing.

A Farm Example

But what do you do with a property such as a farm where you got the little farm house situated on 900 acres of tillable ground?

You’ve got one closing for the principal residence on which you take the exclusion under section 121 for the home and then for the rest of the farm (the tillable acreage) it's used for investment or business purposes on that portion of the sale you do a 1031 exchange to get the best result for both situations.

This situation also arises with part-owner occupied duplexes where you can use both section 121 for principal residence exclusion on the home portion and section 1031 on the rental portion.  We once had a 1031 exchange involving a funeral parlor business with the owner’s personal residence on the second floor of the building.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

House Flips & 1031 Exchanges

If you are a real estate flipper or rehabber, you are buying and selling properties primarily with the intent of reselling them. And if you're a buyer or a rehabber and you're doing a short term hold, you’re probably doing it in a fashion that is most tax inefficient, which means that you're going to get hammered with the most amount of tax. You're not holding these properties typically for long-term capital gains so you're in the short-term capital gains arena.

Changing your Business Model

Here’s a tax-saving tip -

• Change your business model from flip, flip, flip, to:

• Buy the property, fix it up, and rent it out for a period of time.

That way, instead of being a flipper you're an investor and you’re renting out these properties for a year or more. Now you can say to the IRS that you’re NOT holding these primarily for resale. You’re an investor in these properties and you want to do 1031 exchanges when you ultimately decide to sell that property.

Who can you sell the property to? Well if you have a tenant in the property leasing it, why not give them the springing option at the end of their 12 month lease that says if the tenant complies with all the terms and conditions of the lease they will have the exclusive right to purchase the property for x price.

1031 Exchange Advantages

The advantage for you is that you might have a potential buyer locked in from the outset. Also from a landlord management perspective, if the tenant thinks they have the prospect of buying the property from you, they are more likely to care for and treat the property as if it were their own. They won't be chopping vegetables on the countertop without a cutting board they’ll be careful to take care of those counters. So for many reasons flippers need to think about changing their business model and becoming investors so that they can avail themselves of the tax deferral under 1031 and go from being in the most tax inefficient to perhaps the most tax efficient, deferring those gain indefinitely, perhaps forever.

• Start Your 1031 Exchange: If you have questions about flipping property, tax efficiency and 1031 exchanges, 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 Delaware Statutory Trust?

A Delaware Statutory Trust (DST) is a new-fangled creature. Years ago, LLCs were the new kids on the block and not every state had an LLC statute. DSTs are kind of like the newest kids on the block. Here is a primer on Delaware Statutory Trusts as they relate to 1031 exchanges.

The Basics of a Delaware Statutory Trust

A Delaware Statutory Trust is a method of owning property where at the top of the ownership pyramid there is a trustee that is the figurehead owner of the property. That trustee can enter into institutional financing with creditors, and can enter into leases with occupants of the property. But for tax purposes the beneficial owners of the trust, the investors that put their money into the purchase of the DST, are not deemed to be owners of a trust, but instead are deemed to be owners of the assets (typically real property) of the trust.

DSTs and 1031 Exchanges

For 1031 exchange purposes you can sell a traditional fee interest in title and acquire a beneficial interest in a Delaware Statutory Trust and that interest will be treated as interest in the underlying real estate and as like-kind to the fee simple title sold in the relinquished property.

Some of the benefits of a Delaware Statutory Trust are that they may be designed to provide a steady income stream for the investors, typically the debt on a DST is institutional and non-recourse financing. So if a taxpayer has to acquire a property with debt on it, to satisfy any requirements under the napkin test for debt relief, at least they are taking-on non-recourse debt instead of debt for which they are personally liable for.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved