CAN I REVOKE AN IDENTIFICATION OF PROPERTY?

In order to do a Section 1031 exchange, the taxpayer must sell an investment property or property used in a trade or business for a like kind property.   When the taxpayer sells its relinquished property, they then have 45 days from the closing date to "identify" what they might like to buy.   

What happens if they taxpayer identifies a property they no longer are interested in, that is the question.  The answer is:  the taxpayer may revoke the property identified at any time prior to the end of the identification period (the 45 days mentioned above).  This revocation must be in writing and signed by the taxpayer and finally should be sent to the party to whom the taxpayer originally identified the property they wish to revoke. 

The delivery of the revocation can be by hand delivery, mail, or telecopy--but again must be sent before the expiration of the 45 days. 

For more information on identification and related subjects go to www.bayview1031.com and look up the resources section.  By the way, any of our Exchange Coordinators at Bayview Financial Exchange Services can also get your the answers to these types of issues.

CAN I ADD ANOTHER PARTY TO MY PURCHASE OF THE REPLACEMENT PROPERTY?

The head of our E-Marketing Dept. sent me a copy of an e-mail requesting information on the following issue:  Can an individual  taxpayer use the proceeds from the sale of its investment property(relinquished property), to purchase along with others, a replacement property?   

The answer is a firm YES THEY CAN.  For Example:  a taxpayer could sell a piece of investment RE(the relinquished property) for $1 million and purchase a $2 million replacement property, owning a 50% interest in the $2 million property, as a tenant in common with another party(ies).  In this example both the taxpayer and their other co-owner (legally described as tenant in common) each would put up the same sum of money, $1 million each. 

This leads to another question:  Could the other co-owner put a mortgage on the property in order to fund its $1 million contribution toward the purchase?  They could, but that would create another problem for the taxpayer, as that loan would become a lien on the entire property, which would allow IRS to take the position that the taxpayer who did an exchange really only put up $500,000 ,  not the full million.  I know this is a little complicated, that is why you bloggers need to make sure you are using a competent Qualified Intermediary.  You know where to find Bayview 1031.  Enough advertising--but I think you can agree that it is an interesting issue.

EASEMENTS AND THE ICE CREAM STORE

One of our clients owns an ice cream store.  They were approached by a sign company to sell to the sign company a perpetual easement on the ice cream store property, for a billboard sign.   Can the proceeds received by the property owner from the sale of perpetual easement be deferred by using IRS Code Section 1031?   

The answer in my humble opinion is YES it can qualify.  Remember, in a Section 1031 exchange the properties exchanged must be "like kind".    It has been determined that an easement is a right in real property. 

In one of the leading cases in the "1031 industry", the court talked about a "bundle of rights".  The giving of a perpetual easement is the giving up of a part of that "bundle of rights".  So in the case of the ice cream store, the owner of the property can sell a perpetual easement, giving up a right in that real estate, and use those funds to do an exchange for another type of real estate.  For that matter, they could exchange, using those funds, for a shopping center or an office building if they wanted to. 

Remember, any type of real estate can be exchanged for any other type of real estate.  Gosh I love that part of the IRS Code.

HOW TO PROVE YOUR VACATION HOME IS AN INVESTMENT--7 COMMON SENSE SUGGESTIONS

This is a follow-up to our previous blog on the changes in the law on vacation homes, so if you haven't read that blog--it might be a good idea to go back and look at that blog and then come on back to read this blog. 

The newest tax case, Moore v. Commissioner, that came out in May of this year,  holds that vacation homes must be primarily  held for investment and not personal use to qualify under Section 1031.   

So how does a taxpayer prove that their vacation home was held primarily as an investment?  Here are 7 common sense suggestions to follow:   

(1)  Rent out or put the property in a rental pool;
(2) If possible,  don't use the property personally in the year of the exchange or the year before the exchange and certainly don't immediately place the property for sale as that makes you look like a "dealer";
(3)  Don't make personal improvements to the property;
(4)  Purchase the humble cabin--not the most expensive property in the development;
(5)  Please remember to deduct interest as an investment not as home mortgage interest and remember to deduct expenses as maintenance;
(6) Always charge Fair Market Value (FMV) rent to relatives and friends that use the property and pay taxes on that rent; and finally
(7) If you are going to use the property, stay there less than 14 days in any calendar year.

VACATION HOMES---MORE PROBLEMS AHEAD

In order for a property to qualify for a Section 1031 tax deferred exchange, the property must be" held for" productive use in a trade or business or held as an investment.  Personal residences do NOT qualify for a Section 1031 exchange.   

A very important point I want to establish at the outset of this particular blog is that "the incidental use of the vacation home" will not necessarily taint the property otherwise held for investment.  This "held for" rule is determined at the time of the exchange and whether a particular property is held for a proper purpose is a question of fact.   

The reason why I am briefly educating you bloggers on this subject, is that I just returned from the FEA (Federation of Exchange Accommodators--the national trade organization for Qualified Intermediators) Convention.  It was pointed out in our Board of Directors meeting (I am on the Board) as well as at one of the general convention sessions, that IRS is getting stricter on its interpretation of whether a second/vacation home qualifies as an investment.  IRS's stricter interpretation is due to the recent, Moore v. Commissioner, T.C. Memo 2007-134 (2007) case. 

In that case the taxpayer owned a vacation home on the lake and used it around 2 to 3 weekends a month during the summer.  They had made numerous improvements to the property and never advertised or attempted to rent the property.  On their tax return, they did not claim deductions for investment interest, maintenance or repair costs.   The Tax Court found that the investment must be primary, not one of the motives for holding the property.   

In short, IRS is going to have you prove that it was an investment.  Did you rent it out?  Did you list it for rent with a Realtor or advertise the property for rent.  How much rent did you receive and did you pay taxes on that rent?  How many days a year did you use it personally?  What type of loan did you get on the property?--That's a real good question--because if you got a loan that was a second home loan(usually at a lower interest rate than an investment property loan) and you are saying this is an investment property, IRS could ask:  who did you lie to?--the Lender who gave you a second home loan not an investment loan or are you lying to IRS and this really is a second home and not an investment.  In either case they got ya. 

Finally, on another issue dealing with vacation homes, the Chicago Sun-Times reported last week that "The House Ways and Means Committee, seeking revenue to help homeowners in foreclosure, unanimously approved higher taxes on the sale of vacation homes."  They are trying to attack the use of Section 121 which allows taxpayers to exclude as much as $500,000 in profit from capital gains taxes.   This is not law yet--I as usual will try to keep you up to date.  We also have current news on Section 1031 on our website at:  Bayview1031.com.

CAN MY BANK HOLD THE EXCHANGE FUNDS?

The answer is :   It's not a real good idea to have your bank as the depository of the relinquished funds.  One of the major rules in Section 1031 Exchanges is the requirement that the taxpayer not control the funds received from the sale of the relinquished property.   

That is why I continuously point out to questioners that your Qualified Intermediary should be someone completely independent.   There are numerous cases pointing out where taxpayers had in the eyes of IRS, control over the proceeds and therefore were denied the use of Section 1031.   Your bank is just one example of someone you could have control over.   The safest way not to be in violation of this rule is to make sure that you DO NOT have the proceeds held by your Attorney, CPA, Realtor, Bank, Relative, Friend or Acquaintance.  That is another reason why QI's(Qualified Intermediary's) are used.   Qualified Intermediaries are independent and  help ensure that the taxpayer has met all of the safe harbor requirements.

INSIDE THE COUNTRYWIDE LENDING SPREE

As most of you bloggers are aware, every once in awhile, I spend a session on a subject that has nothing to do with Section 1031, but rather has to do with the Real Estate Industry. 

I just finished reading a well written article on the sub-prime mortgage debacle, written by Gretchen Morgenson that appeared in the New York Times.  I think it's well worth reading, so here is an excerpt: 

"On its way to becoming the nation's largest mortgage lender, the Countrywide Financial Corporation encouraged its sales force to court customers over the telephone with a seductive pitch that seldom varied. "I want to be sure you are getting the best loan possible," the sales representative would say.  But providing "the best loan possible" to customers wasn't always the bank's main goal, say some former employees.  Instead, potential borrowers were often led to high-cost and sometimes unfavorable loans that resulted in richer commissions for Countrywide's smooth-talking sales force, outsize fees to company affiliates providing services on the loans, and a roaring stock price that made Countrywide executives among the highest paid in  America.  Countrywide's entire operation, from its computer system to its incentive pay structure and financing arrangements, is intended to wring maximum profits out of the mortgage lending boom no matter what it costs borrowers, according to interviews with former employees and brokers who worked in different units of the company and internal documents they provided.  One document, for instance, shows that until last September the computer system in the company's subprime unit excluded borrowers' cash reserves, which had the effect of steering them away from lower-cost loans to those that were more expensive to homeowners and more profitable to Countrywide.  Now, with the entire mortgage business on tenterhooks and industry practices under scrutiny by securities regulators and banking industry overseers, Countrywide's money machine is sputtering...last week, Bank of America invested $2 billion for a 16 percent stake in Countrywide, a move that came amid speculation that Countrywide's survival was in question..."

MUST YOU TELL YOUR BUYER OR SELLER THAT YOU ARE DOING AN EXCHANGE?

There  is no requirement in the IRS Code or Regulations that the contract for sale of either the relinquished or replacement properties specify that the properties are going to be exchanged.  In fact, the taxpayer in many cases has not even decided when they sign their contract of sale that they are in fact going to do an exchange. 

My office, Bayview Financial Exchange Services (BFES) encounters numerous taxpayers that decide just before the closing, sometimes they decide right at the closing table, that they want to do a Section 1031 exchange.  In our case (BFES), we have the ability to prepare documents on a standard deferred exchange and have them delivered within minutes--that's of course a part of our great service.   Hopefully the taxpayer (exchanger) and the party on the other side will agree to sign our necessary paperwork--that of course makes the transaction a lot simpler. 

It always suggested that you have a cooperation clause inserted in your contract, when you are selling and when you are purchasing.  For a well written cooperation clause, go to www.cooperationclause.com.

A LOT OF INFORMATION IS IN OUR PAST BLOGS

I want to quote from a note that was sent to me from one of your fellow bloggers.  He went back to a number of our past blogs and said:  "I obtained more information from your old blogs than I had been able to gleam from all of the other sites I have visited."  My comment is thank you for the compliment and would add that you too should look up our old blogs.  We have them listed by the month on our blog site.  You might also want to go to Bayview Financial Exchange Services (BFES) website (www.bayview1031.com) and look up information at the resource center.  We answer a lot of your questions on that site also.  If there is still something you need to know, just give our office a call, at 866.903.1031 (toll free) and speak to any of our Exchange Coordinators.  FYI, for truly technical questions that cannot be answered by our Exchange Coordinators, please ask for one of our 6 CES's (Certified Exchange Specialists), who certainly will be able to get you the answer you need.