1. real estate

Basic Structures & How to
Preserve Wealth Through a 1031
Exchange
Jennifer Keen
William K. Tanaka, Esq.
Executive Vice President
IPX1031®
General Counsel
Fidelity National Title
808‐387‐4140 866‐577‐1031
[email protected]
808‐536‐0404
[email protected]
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Disclaimer
Fidelity National Title & Escrow of Hawaii, Inc. and Investment Property Exchange Services, Inc. cannot provide advice regarding specific tax consequences. Investors considering an IRC section 1031 Exchange should seek the counsel of their accountant and attorney to obtain professional and legal advice.
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Agenda
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Review 1031 Terms & Definitions
Discuss Original Taxation Laws
Origins, Structure & Benefits of a 1031 Exchange
When & How to Set‐up a 1031 Tax Deferred Exchange
Updates
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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What is a 1031Exchange?
• Exchanges have been around since 1921
• What is a 1031 Exchange?
— Primary vs. Investment
— Tax Deferral Treatment
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Terms & Definitions
• Boot – Any cash or consideration remaining after the Exchange is complete
• Direct Deeding – The seller transfers title directly to the buyer (excluding the QI)
• Disqualified Party – Anyone who has acted as the taxpayer’s •
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employee, attorney, accountant, investment banker/broker or real estate agent/broker within the 2 year period ending on the date of the transfer of the relinquished property.
Exchange Agreement – Documentation that sets forth the intent to Exchange, as well as, the terms of the transaction and responsibilities of both the QI and Taxpayer
Related Party – Any person bearing a relationship to the taxpayer. (Further described in §267(b))
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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History of 1031Tax Deferred Exchanges
• 1921 – Revenue Act of 1921 allowed exchange of securities •
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and non like‐kind property under IRC Section 202(c)
1928 – Revenue Act of 1928 changed section number that applies to tax‐deferred exchanges to Section 112(b)(1)
1935 – Board of Tax Appeals approved first use of a QI
1954 – Tax code amended and Section 112(b)(1) re‐codified as Section 1031
1979 – Starker Case justified non‐simultaneous exchanges
1984 – Deficit Reduction Act of 1984 introduced 45 & 180 day deadlines
1986 – Tax Reform Act of 1986 took away special tax treatments to investors
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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History of 1031Tax Deferred Exchanges (cont)
• 1989 – Revenue Reconciliation Act of 1989 created related •
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party restrictions and disallowed exchanges of U.S. property for foreign property
1991 – Amendment to IRC §1031 – defined the role of a QI
2000 – Rev. Proc. 2000‐37 created safe harbors that would allow for a “Reverse Exchange” (buy first, sell second)
2002 – Rev. Proc. 2002‐22 addresses federal tax treatment for undivided Tenant‐In‐Common (TIC) ownership interests in property
2002 – Rev. Proc. 2002‐83 clarifies the IRS’s position that a taxpayer may not acquire replacement property from a related party
2005 – Rev. Proc. 2005‐14 recognizes that a single disposition of property could qualify under both IRC §121 and §1031
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Reasons Investors Exchange
Defer Tax – what taxes?
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Federal Capital Gains Tax
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State Capital Gains Tax
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State Withholding
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Depreciation Recapture
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Capital Gain Taxes Example
15% Federal Rate ‐ based on the gain $500,000 ‐ $100,000 = $400,000 x 15% = $60,000
20% Federal Rate – earning $400K/$450K
$500,000 ‐ $100,000 = $400,000 x 20% = $80,000
7.25% State of HI ‐ based on the gain (long term)
$400,000 x 7.25% = $29,000
= $89,000
= $109,000
25% ‐ based on depreciation taken
$3,700/yr x 10yr = $37,000 x 25% = $9,250
TOTAL = $98,250
TOTAL = $118,250
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Capital Gain Taxes Example (cont)
And if that isn’t enough, if you earn more than $200K/$250K
3.8% Health Care Bill
$500,000 ‐ $100,000 = $400,000 x 3.8% = $15,200
$98,250
$15,200
$113,450
$118,250
$ 15,200
$133,450
Doesn’t a 1031 Exchange sound exciting?
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Non-Tax Reasons to Exchange
• Diversify Your Real Estate Portfolio
— Interest Rates are at an All‐Time Low! Great Time to Buy!
• Consolidate Your Real Estate Portfolio
— Sell Smaller Assets and Buy One Larger Asset
• Exchange Into Property Closer to Home
— Easier to manage closer to home
• Exchange Into Property with Better Cash Flow
• Buy Into Property with a New Amortization Schedule
• Purchase Property to Obtain a New Depreciation Schedule
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Like-Kind Property
In general:
No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of Like‐Kind.
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Like-Kind Property Examples
Property held for Business, Trade or Investment
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Non Like-Kind Property
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Money, cash or cash equivalents
Personal property for real property
Stocks, bonds or notes
Stock in trade or other property held primarily for sale
Interests in Partnerships
Certificates of Trust or Beneficial Interest
Other securities or evidences of indebtedness or interest
Primary Residences & Second Homes
U.S. property for foreign property
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Important Concepts
Things the IRS is looking for:
• Intent – Reason behind doing the exchange
• Substance – Use of a QI
• Form – Proper documentation
— Exchange Agreement, 8824, Cooperation Language
• Constructive Receipt
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Constructive Receipt
The taxpayer must not have the right to receive, pledge, borrow or otherwise obtain the benefits of money or other property before the end of the exchange period
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Time Frames
45 days – to identify replacement property
180 days – to acquire replacement property
day 1
45 days
180 days
• Escrow closes, next day is considered day 1
• 45 days is part of 180 days
• There are no exceptions or extensions to these time frames, except for federally declared disasters
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Methods of Identification Replacement Property
Manner of identifying property – must have complete address, must be signed and dated
Alternate & Multiple properties rules:
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3 Property Rule – identify up to 3 properties without regard to value
200% Rule – identify 4 or more properties, the total value of all cannot exceed 200% of the value of the property sold
95% Rule – must purchase 95% of the value of all properties identified
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Broad Strokes of a Reverse 1031 Exchange
• More complex than a regular “Delayed” Exchange
• In a Reverse 1031 Exchange, the taxpayer
— Buys first and then sells later
— Must not be on title to the sale & purchase at same time
• Therefore the QI (IPX 1031®) must
— Create a single member LLC & hold title to one of the properties
— And triple net lease that property to the taxpayer until the exchange can be completed
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Additional Things to Remember
Estate Taxes
• Old Estate Tax Regs Back Into Play for 2011
• If client inherited property in 2010, have them call CPA
‐ No step up in basis
Short Sale Exchanges
• Carry Over Basis from Prior Exchanges
Federal Capital Gains Rate for 2013 • Remained Same for 400/450K or less. 20% for above
• Healthcare Bill (taxes on Investments) (3.8%)
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Short Sale Exchange Example
Property A Purchased in 1985 for $100,000
Property A Sold in 2004 for $800,000
Exchanges into Property B which is Purchased for $1,500,000
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$700k Equity & $800k Loan
Refi & Pull Out $200k for Improvements, Vacation & New Car
Economy Declines & Property Values Shrink
Client Sells Property B in 2012 for $900,000 even though they owe $1,000,000
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Lender Approves a Short Sale at $900,000
Even though Client has no Cash at the Close of Property B he/she still NEEDS to Exchange because of Carryover Basis
• Original Basis in the Exchange is $100,000
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Marketing Concepts for 1031 Exchanges
What is available to you as a resource for 1031 Exchanges?
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Free Monthly Online Webinars (Basic & Advanced) E‐Blasts on 1031 Topics (monthly)
Website (interactive) www.ipx1031.com
Sales Executives available nationally for meetings, seminars and individual consultations
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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Jennifer Keen
Executive Vice President
IPX 1031 Exchange Services, Inc.
808‐387‐4140 mobile
866‐577‐1031 toll free
[email protected]
www.ipx1031.com
William K. Tanaka, Esq.
General Counsel
Fidelity National Title
808‐536‐0404 [email protected]
www.fidelityhawaii.com
Basic Structures & How To Preserve Wealth Through a 1031 Exchange
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