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When Time Is of the Essence, 1031 Safe Harbor is the Answer" |
© 2002 1031SafeHarbor.net
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What is the 1031 Safe Harbor clearinghouse? What is the 1031 Safe Harbor clearinghouse? The Safe Harbor clearinghouse is the Internet equivalent of a shopping mall where you can locate all the providers you need to exchange 1031 properties. These providers include providers of 1031 properties, qualified intermediaries, title companies, mortgage bankers, and lenders. Nothing. Safe Harbor is paid by the providers who participate in the clearinghouse and never charges taxpayers anything. How do I sign up to exchange 1031 properties through the clearinghouse? Simply complete a short two-part registration process, which you can begin by clicking here. Why should I exchange 1031 properties rather than just buying and selling? Only a few investments afford investors the advantage of tax deferral. 401(K) plans are one such investment. The 1031 exchange is another. In short, the 1031 exchange is a way to dispose of an appreciated investment in real property and invest the entire proceeds—including the appreciation without deduction for taxes—in other real property. You may, under current 1031 exchange rules, use all of your equity to continually exchange 1031 properties upward, accelerating your investments’ net worth much faster than if you were to buy, sell, pay tax, and then use the net after-tax proceeds to buy, sell, and pay tax once again. In a nutshell, the investment power of your equity is not diluted by taxes in 1031 exchanges. Many investors who own a property with low or no debt use debt to trade up to a more valuable property with better cash flow and potential depreciation benefits. A taxpayer owning a single whole property (say, an apartment building in Florida) may exchange into a fractional tenant-in-common interest in a number of different types of property (say, an office building with investment-grade tenants or a health care facility leased to an investment-grade tenant, which almost always are NNN 1031 properties) in different geographic regions, thereby diversifying the taxpayer’s portfolio and reducing a number of investment risks. Taxpayers exchanging from multiple properties (such as single-family rentals) to a single property (such as an apartment building) or a whole property to a TIC can enjoy considerable reduction in the burdens of management. Can you show me in dollars and sense the benefit I enjoy if I exchange 1031 properties? If possible, you should avoid taking a note as a part of the purchase price of the relinquished property. The note will become boot and subject to tax, without some tricky maneuvering: · You might use the note as part of the payment for the replacement 1031 properties, but the seller to you may want all cash and, in any event, is likely to be reluctant to accept a note from a stranger. · You might structure the note as a short-term note to be paid in full to the qualified intermediary during the 180-day exchange period, but you still will be bearing credit risk. · You might sell the note in the secondary market, but typically it will be at a steep discount. Leasehold interests are like-kind to fee interests if the leasehold has an unexpired term of no less than 30 years, including renewal periods exercisable at the option of the taxpayer. Among those things to look for in evaluating leasehold interests are these:
Can I acquire replacement 1031 properties before selling my relinquished property? Yes. This is known as a reverse exchange. In 2000, the IRS issued Revenue Procedure 2000-37 (October 2, 2000) containing a safe harbor for reverse exchanges. Reverse 1031 exchanges may be structured in one of two ways to serve different purposes. In the “exchange first” structure, taxpayers may expedite the closing of exchanges by parking title to the relinquished property with an intermediary known in the Revenue Procedure as an exchange accommodation titleholder (“EAT”). In the “exchange last” structure, taxpayers may park replacement 1031 properties with the EAT at the outset of the transaction. This can be useful in a seller's market, where listed properties are sold quickly. In the “exchange last” structure, the taxpayer generally loans the EAT the funds to purchase the replacement 1031 properties, then the EAT purchases replacement 1031 properties and provides the taxpayer with the power to manage and maintain the replacement 1031 properties. Once the taxpayer finds a buyer for the taxpayer’s relinquished property, the EAT sells the relinquished property to the buyer, transfers ownership of the “parked” replacement 1031 properties to the taxpayer, and repays the “loan” from the taxpayer. While reverse 1031 exchanges offer certain benefits, they are not without drawbacks. Financing is generally more difficult to locate. Closing costs will increase. Most importantly, the taxpayer must have sufficient cash to fund the loan for purchase of the replacement 1031 properties. Can I make improvements to my replacement 1031 properties in order to reinvest all sale proceeds and avoid the taxing of boot? Yes. This is known as a “construction exchange.” Usually done through the reverse “exchange last” structure, in which the EAT makes the improvements within the 180 day exchange period, the construction exchange affords taxpayers the opportunity to use tax-free dollars while building or improving new property. A construction exchange qualifies for 1031 deferral to the extent that the entire equity from the relinquished property is spent by the last day of the exchange period, the replacement 1031 property is substantially as identified in the identification period, and the combined purchase price of the replacement 1031 property plus the cost of all capital improvements is equal or greater than the sales price of the relinquished property. When considering a construction exchange, here are some things to bear in mind: · the improvements do not have to be fully complete within the 180 day exchange period. · adding capital improvements to replacement 1031 property that is not of equal value to relinquished property can reduce or eliminate current tax liability. · replacement 1031 property may start as raw land, to which you had improvements to suit your business plan. · if the replacement 1031 property needs refurbishing, it may be done with tax-deferred dollars. What can you tell me about disregarded entities? Under the “check the box” regulations, an entity with a single owner, such as a single member limited liability company, is a disregarded entity (assuming no election is made to be a corporation for tax purposes. Such a disregarded entity reports in the same manner as a sole proprietorship, while the owner of the LLC enjoys protection from the liabilities of the LLC. In fact, the owner of a single-member LLC may dispose of relinquished property, but have the LLC take title to the replacement 1031 properties. How long do I have to hold a property to have it be considered investment property? 1031 properties must be “held for investment.” To determine whether a property was “held for investment,” the relevant authorities look at, among other things, the length of time you have held the property. Here is a summary: · proposed (but not adopted) Internal Revenue Code changes—1 year. · IRS private letter ruling (PLR 8429039) —2 years. · Tax Court—five months and twenty days. A conservative course would be to hold any 1031 properties at least twelve months so that you will at least report the 1031 properties in two different filing periods. N.B., neither the proposed code changes or private letter ruling constitute binding legal precedents for all investors, and, in all events, time is only one factor in determining whether property is held for investment. Top of Page
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