CAN TWO OR MORE FAMILY MEMBERS PARTITION PROPERTIES BETWEEN THEMSELVES?

The simple answer is YES they can. 

In fact, IRS stated in LTR 20073002 that family members can partition property without having to worry about the transaction becoming labeled as a "Tax Avoidance Transaction" (something a taxpayer does not want to be labeled because of the major tax penalties associated therein). 

Let me simplify through an example.  Tom and Jerry are the sons of Bill and Bertha.  Both Bill and Bertha  die in a tragic car accident and leave the family ranch and their vacation home in the mountains, to their two sons.   Each son gets a 50% interest in the ranch and a 50% interest in the vacation home.  A couple of months after their parent's death, the brothers, Tom and Jerry, decide that they would like to exchange each of their 50% interests in one of the properties to each other.   The result would be that Jerry would own 100% of the ranch and Tom would own 100% of the vacation home.  The properties are worth the same in value, but if they transferred their interests to each other, would there be any taxes due?  The good news, as I stated above, is that they can exchange between themselves without having to worry about the "related party rule" which has major time constraints, and just as importantly, they can in fact exchange their interests, under Section 1031, and not pay any taxes, if any were due, at the time of the exchange.   Whew, that was a long sentence. 

One of my Business Development Consultants said the other day he "loves" working for Bayview1031 because we can usually make people happy.  I agree, because when I was practicing law, even if my client was on the winning side, someone was not happy (the party on the losing side).  When handling a 1031 tax deferred exchange--almost all of the time--99% of the time--the client is happy.  I love running a Qualified Intermediary business !!

PARTNERSHIPS--CASHING OUT A PARTNER USING SECTION 704 (b) - Part 5 of 5

I realize the subjects we have been discussing in this five (5) part series of blogs are a little complicated, that is the reason you should always have a good tax advisor and of course you want to use Bayview1031 as your Qualified Intermediary on your Section 1031 exchanges.   

As promised we are now going to discuss the final segment of our 5 part blog on Partnership issues and Section 1031.   We have the same example as in  Part 4.    Adam, Bill and Colin equally own  interests in the ABC partnership.  The ABC partnership wishes to sell its property.   Adam wants to "cash out", while Bill and  Colin wish to transact a Section 1031 tax deferred exchange with their proceeds and want to keep the partnership in tact.   The ABC partnership can make a Section 704 (b) allocation of the amount of cash (boot)  to Colin, in the exact amount of proceeds he would have received if the property being sold had not been part of a Section 1031 exchange.  The partnership goes forward with the exchange using the remaining funds.  In other words--the partnership pays Adam the funds he should receive and the partnership continues using the remaining funds and transacts a Section 1031 exchange. 

There are certain other problematic issues that must be addressed if you wish to use this method.   Your tax advisor might want to make sure that this still qualifies for "substantial economic effect" under Section 704 (b) and your tax advisor will want to review the possibility of depreciation recapture, etc.  I usually don't write such complicated blogs, but I just came back from our National trade organization convention and they emphasized the importance of educating our clients and possible referral sources--even if the subjects to be discussed are complicated. 

I suggest you go back and review the previous 4 blogs for more on partnership allocations and methods of handling a Section 1031 exchange when one of the partners wants to "cash out".  For that matter, go back and look at the last 2 1/2 years worth of blogs--we cover a lot of issues and it is quite educational.  Enjoy.

PARTNERSHIPS--USING AN INSTALLMENT NOTE TO CASH OUT A PARTNER AND STILL ACCOMPLISH A SECTION 1031 EXCHANGE - Part 4 of 5

Previously (the last 3 blogs) we discussed some of the problem areas involved with partnerships and doing a Section 1031 tax deferred exchange.  We also discussed two methods (Single Member LLC's and "Drop and Swaps") that may work to solve some of the partnership issues.

For a good review go back to our last three (3) blogs or go to our on-line library at  www.bayview1031.com for more information. 

So lets discuss another wonderful method that can alleviate some of the headaches when one of the partners wants to "cash out" and the other partners want to transact a Section 1031 exchange----and that solution involves the use of an installment note. 

An installment note is one where the debtor pays to the owner of the note, periodic payments.   The owner of the note pays tax on any interest earned and any profit they receive, but not on the return of their original investment.   So for example,  if an investor were to receive payments over 300 months, part of each payment received would be interest (taxable), part of each payment would be profit made while they owned the property (taxable), and part of each payment would be return of their original investment (not taxable). 

Let's use an example.  Adam, Bill and Colin equally own  interests in the ABC partnership.  The ABC partnership wishes to sell its property.   Adam wants to "cash out", while Bill and  Colin wish to transact a Section 1031 tax deferred exchange and keep the partnership in tact.   At the time of closing, the Buyers of the property give to  the ABC partnership an installment note in an amount that is equal to what Adam would have received had the property just been sold and no Section 1031 transaction occurred.  The ABC partnership would therefore receive two-thirds (2/3) of their proceeds in cash, along with one third (1/3) of the proceeds represented by the installment note.   Adam's interest in the partnership is then liquidated and the installment note is transferred to him. 

The remaining partners (B & C) can then go forward with their Section 1031 exchange.  The installment note can be paid periodically or paid off any time after Adam's interest in the ABC partnership has been liquidated.   This method has been used numerous times and approved by IRS.  It's neat and everyone is happy.   

Our next blog will briefly discuss another method of dealing with partnerships and cashing out a partner with the remaining partners continuing to transact a Section 1031 exchange--the concept is called--"special allocation of boot to the cashing out partner".  Learn more at the next blog

Parnerships Part 3 of 5 - PARTNERSHIPS, SECTION 1031 AND "DROP AND SWAPS"

As has been previously discussed in parts 1 and 2, partnerships can do a Section 1031 exchange, but individual partners cannot exchange their own individual partnership interests. 

So how can we solve this dilemma? 

The best way to discuss the issue is by an example. 

The ABC partnership is owned equally by each of the partners, A, B, and C.  A & B wish to "cash out" and C would like to do a Section 1031 exchange with the proceeds he receives from the sale of the partnership property.  A, B, and C wish to dissolve the partnership when the relinquished partnership property is sold.  They agree to do a "drop and swap", which means the partners "drop" the partnership property, in other words, transfer it to each of the partners individually, as tenants in common.   New title to the former partnership property will now be held as follows:  A, B & C, as tenants in common.  They do this immediately before the sale of the relinquished property.   

At closing, A & B receive their funds for the sale of the relinquished property and are cashed out.  C, reinvests his proceeds by accomplishing a Section 1031 exchange into a suitable replacement property ("swapping" into a suitable replacement property).   

So there was a "drop" (disbursing the property from the ABC partnership to A, B, & C individually) and there was a "swap" (C, purchasing a replacement property under Section 1031). 

The issue that is in dispute is whether the "swap" violates the "held for productive use" rule under Section 1031 because it was done just before the sale of the relinquished property.  IRS takes the position that a "drop" immediately before the sale of the relinquished property does not meet the "held for productive use" requirement.  There are some cases rejecting the IRS's position.  Most of the experts now suggest that the "drop and swap" method is a thing of the past.   

More to come on this issue in the future.  Our next blog will cover the use of an Installment note to "cash out" a partner.

IRS WARNING: BEWARE OF SCHEMES

"Taxpayers should be wary of individuals promoting improper use of like-kind exchanges.  Typically they are not tax professionals.   Sales pitches may encourage taxpayers to exchange non-qualifying vacation or second homes.  Many promoters of like-kind exchanges refer to them as “tax-free” exchanges not “tax-deferred” exchanges. Taxpayers may also be advised to claim an exchange despite the fact that they have taken possession of cash proceeds from the sale. "   Source:  FS 2008-18.    From Bayview1031's standpoint, we always recommend that you discuss your factual pattern with your tax advisor and then relay that information to your exchange coordinator at Bayview1031

Partnerships Part 2 of 5 - SINGLE MEMBER LIMITED LIABILITY COMPANIES (LLC) AND THEIR USE WITH PARTNERSHIPS AND SECTION 1031

When partners are cooperating with each other and all of them want to do a Section 1031 exchange, but each partner would like to own their replacement property in their own name--what are they to do? 

One answer is to sell the relinquished property and purchase each of the replacement properties in a separate Limited Liability Company (LLC), owned by the partnership and then distribute the LLC's to each of the partners upon dissolution of the partnership. 

I know it sounds complicated, so lets make it simpler by giving you an example. 

Partnership LMN is owned by partners, L, M, and N.  They own property A.  They sell property A and form 3 distinct single member LLC's, known as LLC  L,  LLC  m and LLC  N.   Partnership LMN purchases 3 different properties, which we will call property B, property C and property D.  They place one (1) of these properties in each of the LLC's which are owned by the LMN partnership.   

After they have owned these LLC's and replacement properties for more than a year, they disburse the ownership of one of the  LLC's  to the each partner.  They then liquidate the partnership and each of the partners will own its own LLC which of course owns the property they wished to individually own. 

Because an LLC is taxed as a "disregarded entity", which means the taxpayer gets taxed directly -- rather than the LLC, a Section 1031 exchange is allowed.   Sounds complicated, but it works!!!!  That's why ever taxpayer needs to hire a Qualified Intermediary that is knowledgeable in the intricacies of Section 1031.  Our next blog will cover the infamous "drop and swap" method for solving the partnership issues and Section 1031

PARTNERSHIP ISSUES WITH 1031 EXCHANGES - Part 1 of 5

What happens when both partners agree to "get rid of" their partnership property, but one wants to "cash out" and pay its tax and the other (the smart partner) wants to do a Section 1031 tax deferred exchange? 

In some cases, all of the partners in a partnership might want to accomplish a Section 1031 exchange, but individually, they may want to own different replacement properties---can they accomplish this goal?   

Most of my bloggers are aware that a partner cannot sell its individual partnership interest to another and obtain the nonrecognition tax treatment under Section 1031--so the Tony Phillips statement is correct:  "...when partners want to end their relationship, they cannot exchange out of their partnership interest into another partnership interest or real property under Section 1031."   

Further, our experienced bloggers know that both the property that was transferred (the relinquished property) and the property received (the replacement property) must be held either "for productive use in a trade or business or for investment". 

So what is a partner to do?   

There are really 4 different methods that a partners can purportedly use to solve their dilemma and they are: 

(1) Use Single Member Limited Liability subsidiaries;

(2) Try to use the "Drop and Swap" method;

(3) Use an Installment Note to "cash" out the partner; or

(4)  Use Section 704 (b) which uses special allocation of boot to "cash out" a partner. 

Sounds complicated and in some cases any and all of the above resolutions may be  complicated.  Rather than writing a long 3 or 4 page explanation in 1 blog, I will be discussing each of these solutions in our next four (4) blogs.  I promise try to demystify the process--so read our blogs for the next two weeks and learn what sophisticated tax professionals should know about the subject of partnerships and Section 1031.

FANNIE MAE AND HOMEOWNERS WHO TRY TO WALK AWAY

As is my custom--around every 10th blog is usually one having nothing to do with Section 1031 but rather with some consumer oriented issue---this particular blog continues that tradition. 

Ken Harney recently reported that:  "The country's two largest sources of mortgage money have a blunt warning for anyone thinking about joining the growing "walkaway" trend, where homeowners stop making payments and months later send the house keys back to their lender:

You will feel the pain. 

On March 31, Fannie Mae sent out new guidelines to lenders intended for walkaways and other foreclosure situations. Fannie will now prohibit foreclosed borrowers from getting another mortgage through the giant investor for five years, unless there are "documented extenuating circumstances."

In those cases, the mortgage prohibition is for three years.  Even after five years, borrowers with foreclosures in their files will be required to make at least a 10 percent down payment, and will need minimum FICO credit scores of 680.

Freddie Mac, Fannie's rival, counts foreclosures as major credit blots for seven years, and a senior official said the company is now aggressively pursuing some walkaway borrowers "to preserve our deficiency rights" where permitted under state law. 

The walkaway trend is particularly noteworthy in former housing boom markets - including California, Florida and Nevada - where many homeowners find themselves upside down on their loans, owing tens of thousands more than the current market value of their houses. If they invested little or nothing in down payments, some owners reason, continuing to make payments - even if they can afford to - may be throwing good money after bad."

UNDERSTAND THE TERMS ON YOUR CREDIT CARD

Every once in a while I give a consumer oriented blog which has nothing to do with Section 1031 tax deferred exchanges.  Here is an excerpt from a newsletter I received.  It's short, concise and to the point.

"Credit cards are one of the most pervasive forms of your financial picture. On a daily basis, they provide the flexibility and freedom to reserve a hotel room, travel without carrying cash, and purchase just about anything at anytime." 

"As such, your credit cards can have a major impact on your financial wellbeing and even your credit score. But did you know that your credit score can also impact your credit cards...specifically your interest rates? Although some companies have abandoned the practice, many won't hesitate to raise your interest rate if your credit score declines - even if you are paying them on time! By following these tips, you can help avoid inflated interest rates on your credit cards...and perhaps even enjoy more trips to the ballpark:"

"Understand the terms. The best way to protect yourself from high interest rates and hikes is to read and understand your credit cards policy terms. Pay particular attention to the interest rate, how long that rate is in effect, and what actions can lead to a hike - such as a late payment on your card, a declining credit score, or even a late payment on a completely unrelated bill." 

"Don't be late. Making a late payment can lead to increased interest rates on all your cards. In addition, they can lower your credit score, causing you even more problems down the road. So make a schedule and always pay on time." 

"Watch the mail. We all get junk mail, but some of it may not be junk after all. Whenever you receive any information in the mail from your credit card, read it carefully in case any policies or interest rates are changing."

"Make a call. If your rate does change, call the company. If you've made your payments on time consistently, you may be able to get your original rate restored. If the company seems hesitant, you may want to threaten to transfer your balances to another card - customers in good standing may find they have more bargaining power than they realize. And don't just threaten to make a change...actually do it if it makes sense. You may find the grass actually is greener on the other side." 

"Be careful what you close. Closing a card that has a current balance will likely send your interest rate soaring. In addition, closing your oldest credit cards can have a negative impact on your overall credit score. So make sure you check and double check which cards are best to close."

If I am Selling an Investment Condominium Must my Replacement Property be an Investment Condominium?

I gave the answer to this question almost 2 years ago in our blog from May 2006, but here is the repeat answer: 

The above assumption,  an investment condominium for an investment condominium, or a piece of raw land only for a piece of raw land,  is a misconception in the 1031 industry.  How many times have you heard that the property purchased must be the same exact type as the property sold to meet the “like kind” requirements? 

Well that is just plain WRONG!!!! 

The good news is that any type of real property is “like kind” to any other type real property under Section 1031 guidelines.  This means that a shopping center can be “like kind” for raw land, and an office building can be “like kind” for an investment residence, etc.  Real Estate exchanged for any other type of Real Estate, makes handling Section 1031 exchanges a lot simpler.