Vacation Homes

Vacation homes, primary residences, and secondary residences (hereinafter referred to collectively as “Personal Use Realty”) generally have not qualified for Section 1031 tax deferral.

In order to qualify for a Section 1031 tax deferral, the property must be held for investment or business purposes.

A Section 1031 tax deferral is not appropriate if; (1) the relinquished property was previously used as Personal Use Realty; or (2) the replacement property is intended to ultimately be used as Personal Use Realty.

To conduct a valid Section 1031 exchange, it is often necessary to have such property rented to unrelated parties for a period of time both before and after the exchange.

For a more thorough discussion on this subject go to our website:  bayview1031.com and look up recent articles written on this subject.

CRIMINALS DISCOVER HOW TO FORGE DEEDS

I will never forget the time I stopped a criminal from selling a home they didn't own.  What the criminal did was find a homeowner who was not living in their home.  He then went to the public records to get the legal description and learned how title was being held. Then he had a new deed written up in his name (not his real name). 

He signed a contract to sell the home at a very good price to my client, with the proviso that the closing occur within 10 days.  I noticed that the deed had been recorded less than 4 weeks prior to the signing of the contract and felt uneasy, so I requested a copy of the closing statement in which the "criminal" had supposedly purchased the property.  I never received that documentation, so at the closing where my client was to be the purchaser, I required two forms of identification from the "seller."  He, of course, had no identification and we did not close. 

I forewarned my title insurance company of this suspicious transaction. Ironically, they had recently been hit with a number of fraudulent deeds, so they had an undercover police officer attend the closing where the "perp" was arrested and convicted. 

Why do I bring up this issue?  Because 5 years after that incident occurred, the headline of our local newspaper,  The  Miami Herald read as follows:  "DIRTY DEEDS--Criminals have discovered how easy it is to get real estate in Florida with no money down:  just forge a signature on a deed and file it."   

“In Florida, with no mechanism in place to ensure the authenticity of deeds filed at county offices, criminals have discovered that stealing a house can be easier than burglarizing one.  With little more than a forged signature and a stolen notary's seal, thieves have scooped up homes and vacant lots, taking out a mortgage or selling the property to unsuspecting buyers before the original owners knows what hit them.”

I believe one of the reasons why this criminal activity is still on the rise in South Florida is because thousands of vacant properties are owned by absentee property owners or, in many cases, investors.  OK, so how does the smart Blogger protect himself or herself? 

The Miami Herald suggests, and I agree, that the homeowner should do the following: 
1. When you are away from home for an extended time, have someone check on your property, or "...ask you local police department to send someone by while they are on patrol." 
2.  You can check with the municipal recorder's office to see if any illegitimate deeds have been filed on your property. 
3.  Check your real estate bill. If you didn't receive it when you should have received it, there is probably something wrong. 
4.  ALWAYS purchase an owner's title insurance policy, because, in most cases, it will protect you against deed forgeries.

HOLDING PERIOD---HOW LONG IS LONG ENOUGH?

I gave 2 eight hour seminars last week, one in Birmingham, Alabama, and the other in Memphis, Tennessee.  At both seminars I was asked, "How long do I have to own the relinquished property (the original property) before I can do an exchange?"  I was also asked “How long do I have to hold the replacement property (the new property) before I can re-sell it?" 

There is no hard and fast rule as to how long the relinquished property must be held as an investment property before a subsequent sale. Nor is there a test as to the length of time that a replacement property must be used for investment purposes following an exchange before it can be converted from investment use to personal use.   

The actual measuring stick is a "reasonable time.”  In determining what constitutes a "reasonable time,” the courts look at the "intent" of the taxpayer at the time of the original purchase and apply a "facts and circumstances" analysis to determine whether such investment "intent" is met.  Many tax advisors frequently recommend that taxpayers hold the replacement property for at least one year after acquisition, and the relinquished property for at least two years prior to sale, but these time periods are not always going to be the guaranteed positions of IRS.

EXTRA EXTRA READ ALL ABOUT IT------CO-OPS (COOPERATIVES ARE LIKE-KIND TO REAL ESTATE)

There are a couple of states that have ownership in real estate held in the form of a "Cooperative" (also known as a Co-op).  Instead of the taxpayer having title in their own name, title to the unit is held by a "Cooperative."  The taxpayer owns shares of stock in the "Cooperative" and is given a lease to the unit they occupy. 

I have stated for a number of years that the State of New York, which probably has the most number of "Co-ops" in existence, has taken the position that the ownership of a "Co-op" is the equivalent of owning the real estate.  Now the Internal Revenue Service, in PLR (Private Letter Ruling) 200631012 has once again ruled that stock in a New York State cooperative is like-kind to a warranty deed interest in improved and unimproved real property under Section 1031 of the Internal Revenue Code. 

What does all this legal jargon mean?  It means that a taxpayer can sell their interest in a Co-op and purchase, under Section 1031, any other type of real estate and defer paying any taxes owed.  Gosh, I love being the Qualified Intermediary on 1031 exchanges--it's a great job--I can help taxpayers increase their net worth and defer paying taxes at the same time.

UNCLE SAM IS YOUR PARTNER

Recently, one of Bayview Financial Exchange Services' (BFES) Business Development Consultants (BDC) described to me how he explains a Section 1031 tax deferred exchange to an investor who has no knowledge on the subject matter.  He starts out by saying, "Let me tell you about a real estate investment partner that I know of...he offers no monthly payments and he charges no interest, so you get an interest free loan. There is no balloon date or call date on this interest free loan.  In fact, he might not even require that you pay him back.....His name is UNCLE SAM!!!”

And Sal, our BDC, is correct because in a Section 1031 tax deferred exchange, UNCLE SAM (our Federal Government) allows you to defer the capital gains tax on the sale of your investment property. The Qualified Intermediary receives the funds from the sale of the relinquished property and uses the proceeds to purchase the replacement property selected by the taxpayer. The Qualified Intermediary charges no interest (as an interesting note, BFES pays interest to the taxpayer while acting as the Qualified Intermediary).  In many cases, the taxpayer will own his or her exchanged investment property at the time of his or her demise and may not owe any estate taxes, thereby having deferred and finally escaped the payment of any tax on the profits.  UNCLE SAM can be a great partner if you play by his rules (Section 1031).

USA TODAY SAYS THAT CONDOMINIUM SALES ARE SLOWING

I have held up writing about this subject, even though I predicted a real estate slowdown on this blog almost a year ago.  I didn't want to be and still don't want to be a naysayer.  But a couple of weeks ago, USA TODAY and the Associated Press in an article entitled Builders Nix Condo Plans as Sales Slow  stated that "more and more developers are canceling or delaying condominium projects as home sales slow, construction costs soar and lenders balk at financing units that might not sell."  For example, projects in Las Vegas that have been nixed include: Ivana Las Vegas, a 945 unit building named after Donald Trump's ex-wife Ivana; Aqua Blue, a $600 Million dollar project which had Michael Jordan as an investor; and the $3 billion, 4,400 unit development called Las Ramblas, which was backed by actor George Clooney and was to be co- developed by the Related Companies.  I am personally familiar with Related Companies, run by Jorge Perez, because they are based in Miami, and have literally improved the South Florida sky line over the past 10 years.

Even the conversion of apartments to condominiums has slowed down.  "With housing sales looking increasing anemic, it’s not surprising that developers are bailing out...In May, the volume of apartment-to-condo conversions plunged to $334 Million...The all time high was $4 Billion last September.  Builder confidence, measured by the National Association of Home Builders/Wells Fargo Housing Market Index, fell in June to its lowest level since April 1995." 

The article quoted Jack McCabe, the chief executive of McCabe Research and Consulting, who said, "...desperate developers with finished condos are offering incentives in South Florida. Freebies range from one year's free mortgage to the use of a yacht or upgraded kitchen packages.”  He thinks “some developers might even sell condo units at cost if sales continue to weaken."  Only time will tell.  If, in fact, we have entered or are approaching a real estate downturn, there certainly will be some bargains to buy.  Of course, a smart investor will have to make sure they have the additional necessary funds to hold out until the market turns around.

PERSONAL PROPERTY EXCHANGES?

Yes, a taxpayer can have a personal property exchange, but there is a problem--and that is that for a personal property exchange to be found valid under Section 1031of the Internal Revenue Code, the personal property must be "like kind" and is narrowly interpreted.  The personal property exchanged must be either like kind or like class. 

The North American Industry Classification System (NAICS) was put into place recently.  It specifically describes which personal property items can be exchanged for other personal property items.  Examples of valid personal property exchanges are:  (a) Australian gold coins for Mexican gold coins; (b) exchanges of major league sports contracts; (c) a computer for a typewriter; (d) fishing permits for fishing permits in another state; (e) carnival traveling shows for ice skating shows; (f) lamps for chandeliers. 

Examples of non-permitted personal property exchanges are: (a) gold bullion for silver bullion; (b) automobile for a bus; (c) livestock of different sexes.  Now you can understand why I say it so much easier to do a real estate exchange, because all real estate is like kind to all other real estate.

CAN I EXCHANGE AN EASEMENT FOR REAL PROPERTY?

I seem to be getting the question of whether or not a taxpayer can exchange an easement for an entire piece of real estate a lot lately.   The simple answer to the question is yes, because an easement is a right in real property and is considered "like kind" to a fee interest ( the entire ownership of a piece of property) in real estate.   For example:  Someone grants a "right of way" easement to an electric company and in a section 1031 exchange, purchases a strip shopping center.  It works and is valid because most state laws say that this type of easement is an interest in land and therefore would qualify for a section 1031 tax deferred exchange.   

As I have said in the past, the like kind requirement for real estate exchanges are very liberal as the like kind definition is, any type of real estate can be exchanged for any other type of real estate.

My next missive will cover personal property exchanges, which are a lot more restrictive.