REAL PROPERTY FOR ANY OTHER TYPE OF REAL PROPERTY?

I have said it before, under Section 1031 the property exchanged must be "like kind".  When it comes to real property held for investment or used in a trade or business, any real estate qualifies as "like kind" for any other type of real estate. 

It's a beautiful world, especially when it comes to Section 1031 and the definition of "like kind" real estate. Here are some examples of "like kind" real estate exchanges:  a commercial building for unimproved land; property in a municipality for a ranch or a farm; full ownership in a piece of real estate for the rights to a 99 year lease; an apartment building for a condominium that is being rented out; an orange grove for a shopping center. 

The examples are endless.  The short version, any type of real estate for any other type of real estate.  FYI--the ownership of a lease that still has 30 or more years to run is defined as real estate.  1031-Real Estate-It's A Beautiful World--sounds pretty good, I should show this to our marketing department.

WAYNER'S SIX (6) STRATEGIES FOR SAVING

I love getting friend's newlsetters, as they give me ideas and topics for this blog that have nothing to do with Section 1031.  And so 1 out of every 8 or 9 of our blogs will have nothing to do with Section 1031 or Bayview Financial Exchange Services. 

Here are some ideas from my friend's newletter:  "Research continues to show that many people are unprepared, not just for retirement, but for the many phases in life that require substantial financial commitment. So, how can you prepare for your financial future?" 

Here are 6 simple "... savings strategies that might help put you on the right track.  (1) Don't splurge with your tax refund.  Use it to pay down debt or save;
(2) Save where you work--- Participate in your company's 401K plan, if available, and take advantage of offers to match your contribution;
(3) Turn your spending into savings--instead of buying that morning latter, save the money;
(4) Automatically deposit funds into a savings account before you even see your paycheck;
(5) Create separate savings accounts for your child's education, unexpected emergencies or a new home" (FYI--in my  own particular case, I took out my handy financial calculator and figured out how much extra I would have to pay on my mortgage payment each month in order to have my home free and clear at the time my daughter went to college.  I made those extra payments each month for 9 years.  Upon her entering college, I had two options for paying for college, either to make monthly payments like I had been making already  now to the college instead of  to my mortgage lender or go out and borrow again on my free and clear home); 
(6)  Work with knowledgeable financial and legal advisors--That is very, very important. 

CAN I EXCHANGE MY INTEREST IN AN REIT?

An interest in a REIT (Real Estate Investment Trust) will not qualify for Section 1031 treatment.   The reason is that an interest in a REIT is ownership of the entity and not an interest in the real estate that the REIT owns.   Generally, a REIT is formed as a corporation, a trust or an association.  Your ownership in the REIT is an ownership of the corporation, trust or association, again not an ownership in the real estate which the REIT owns.

SUPERMAN STEVE TO THE RESCUE! Saving Collectibles From Extinction

As anyone who knows me or is a regular reader of my Blog, I am an art lover.  As a long-time art collector and former Trustee of Art-in-Public Places in Miami, I am a big supporter of the Arts.  My ‘poor-mans art collection includes several Andy Warhol’s including his silkscreen of Superman, my childhood idol.  So perhaps a bit of that childhood desire to be Superman recently kicked in when collectibles came under legislative fire.

The crisis started when one U.S. Senator added a provision to the current Farm Bill no longer allowing collectables to be exchanged.  Currently, under Section 1031, investors of collectable items are allowed to exchange their collectables for other "like kind" collectables and defer (not have to pay) any and all of their Federal and State taxes on the profits.  Under the proposed Farm Bill, those investors selling a collectable would be taxed at a 28% tax rate (that's the federal tax rate for the sale of collectables--nationwide)-- plus the additional state income tax which can be as high as 8-9% in some states. 

My reaction.  Those who read our articles weekly know that Bayview1031 handles not only real estate exchanges but also personal property exchanges.  That, combined with my personal commitment and investment in the arts, propelled me to react with a vengeance.  I contacted nearly all of the Art Auction Houses and a number of prominent art galleries.  I also wrote to numerous Congresspersons. 

The result.  According to the lobbyist for the Federation of Exchange Accommodators, I am the person credited with saving the right to have investment collectables as an item in Section 1031 tax deferred exchanges.  My one-man campaign, along with help from the auction houses and galleries, did the trick!  That provision has been deleted from the proposed legislation.  No, I am not Superman, but, in minor measure maybe for a day, I did get a super result in getting Congress to relent.  You know, I definitely feel pretty "super" about that!

WHAT ARE THE IDENTIFICATION RULES FOR A SECTION 1031 EXCHANGE?

There are 3 different rules, any one of which may be used for identifying your replacement property in a Section 1031 exchange. 

They are: 

(1) The "Three Property Rule"--which allows the taxpayer to identify 3 properties regardless of value of the properties; OR

(2) The "200 Percent Rule"  which allows the taxpayer to identify any number of properties so long as their total fair market value at the end of the identification period does not exceed 200 percent of the fair market value of the relinquished property; OR

(3) the "95 Percent Rule" which allows the taxpayer to identify any number of properties, as long as the taxpayer purchases 95% of the aggregate fair market value of all identified replacement property. 

The  most important point I can make, is that the taxpayer can use any ONE of these rules (but only ONE) when identifying their replacement property(ies).  For a more thorough discussion, go to our resource site at:  Bayview1031.com

CAN I RESELL THE REPLACEMENT PROPERTY IMMEDIATELY AFTER I PURCHASED IT AND DO ANOTHER EXCHANGE?

Now that is a tough question to answer! 

For refreshment purposes, the taxpayer can sell(relinquish) an investment property, that it held for a "reasonable time" and purchase a "replacement" property that is also intended to be used as an investment property or used in a trade or business.  But what if the taxpayer wants to immediately resell that "replacement" property and do another exchange?  IRS will ask the important question:  Did the taxpayer intend to hold this original "replacement" property "indefinitely"?  IRS says that a "reasonable time" for holding an investment property is two years.   That is an awfully long time, considering that long term capital gains is one year and one day. 

Many IRS representatives still use that "two year rule".  It's known as the "old and cold" rule.  Transactions that occur more than 2 years are "old and cold" and therefore not suspect under Section 1031.  But that begs the question of what happens when the replacement property is "resold" in a short time period after the 1031 exchange has been concluded. 

The answer goes to a number of court decisions, all revolving around that big word INTENT.   What did the taxpayer intend when they purchased the replacement property?  Did they intend to hold it and out the blue an unbelievable offer came in on the property they just closed on?   If they had already contemplated on reselling in a  short time period, they probably have a problem, especially if they are audited.  This is not a black and white issue--its a grey one--proving INTENT will be the key to whether the taxpayer will be able to complete a Section 1031 exchange and proving INTENT may not be so easy. 

So be very careful when deciding to resell a "replacement" property a short time after purchasing it.   I have everyone of my clients explain the entire situation to me, requesting that they document as much as they can, so that they will not have a problem with Uncle Sam in the future.

TWO INTERESTING CASES ON THE SALE OF A BUSINESS

Recently we had two different files come into the office,  from different parts of the United States, both of which involved the sale of franchised restaurants.   Both of these transactions had contracts entered into before they contacted Bayview 1031 (Bayview Financial Exchange Services) to act as their Qualified Intermediary. 

Each transaction was drafted differently by their financial and legal advisors.   Let's review both of cases.  In Example "A" the contract called for the sale of the assets as follows:   real estate--90%,   personal property--7%, and good will--3%.  In the second transaction, Example "B", the contract called for the sale of assets as follows:  real estate--40%, personal property 10%, and good will--50%. 

Which selling taxpayer will benefit more under Section 1031?  Without a question, the taxpayer in Example "A" comes out way ahead and the reason for that is that "good will" is not an exchangeable item.  IRS states that the "good will" of a business is never "like kind" to the "good will" of another business--see Reg. Sec 1.1031(a)-2(c)(2).  So in Example "B", the taxpayer will have to pay tax on the property sold as "good will", which in that case was 50% of the entire sales price--obviously not very good tax planning on the part of his "advisors".

Just one more additional note--If either of the above examples had included a "Covenant Not to Compete", that Covenant would not be a capital asset, may not be exchanged and in fact would be taxed as ordinary income to the transferor/taxpayer.

Who Are Fannie And Freddie And How Do They Help Homeowners?

A friend of mine, mortgage broker Dennis Kleinman,  wrote a wonderful article explaining how Fannie Mae and Freddie Mac are involved in the mortgage lending business.  It was so well written that it was worth adding it to our blog.

"Fannie Mae and Freddie Mac are quasi-government agencies in that they are publicly-owned, but overseen by the government.  The purpose of Fannie and Freddie is to make sure that money is available to homeowners that want home loans.  Neither lends to consumers directly, though; you'll have to talk to your loan officer for that.  Instead, Fannie and Freddie's role is to buy loans from lending institutions that make loans to everyday people.   For example, all banks in America abide by laws limiting the amount of money they can lend as a percentage of their total asset base.  If your home loan is on the books of Bank ABC, Bank ABC is, therefore, restricted in issuing additional loans because your loan counts against that ratio.   But, if Bank ABC sells the loan to Fannie Mae or Freddie Mac, your mortgage converts back into cash and Bank ABC can then lend again to somebody else. 

Because of Fannie and Freddie, a bank can lend to multiple homeowners using the same asset base, thereby making sure that "the system" has plenty of money available for homeowners in need of loans.  In this sense, both Fannie and Freddie keep mortgage money flowing on the street level.  But it only works to a point.  Fannie and Freddie have very strict guidelines about what types of home loans they will purchase from banks and only accept loans that conform to their respective criteria.   Loans falling outside the criteria, by contrast, will not be purchased by the agencies. 

IS IT POSSIBLE TO EXCHANGE THE AUTOMOBILE I USE IN MY BUSINESS FOR A NEW AUTO TO BE USED IN MY BUSINESS?

The trading in of an old automobile used in your trade or business for a new updated model to be used in your trade or business, qualifies for non-recognition tax treatment under Section 1031.  In fact, IRS has even written an example in their Regulations;  See Reg. Sec. 1.1031 (a)-1(c). 

I don't want to get technical on you bloggers, but just want you to remember that if the fair market value of the auto you are trading in has a fair market value of less than it's adjusted basis, it would be more desirable for you the taxpayer, not to do a Section 1031 exchange, but rather-- just have a sale of that auto.  the result is that you the taxpayer would have a loss, which you could then deduct from your income tax return. 

At Bayview Financial Exchange Services, we are always looking for new business, but when it is to your advantage to sell the property rather than doing an exchange, we invariably will tell you so.  It's fair to say we want your business, but only for the right reasons.