Gasoline Prices Are Helping To Keep Many Home Values Decreasing

As has been my custom, every once in awhile I write a blog that affects all consumers, not just those interested in Section 1031--today's blog and the next blog are for all consumers.  America's Mortgage Banker Bi-Weekly Bulletin recently reported that:  "... any connection between home values and gas prices may not immediately come to mind, but it’s a fact, especially for homes in the suburbs. As the daily cost of commuting is soaring, the values of those homes outside the urban cores are taking a hit.

An example cited in Bloomberg drives (no pun intended) the point home. In Virginia, a home which sold five years ago for $360,000 (before the real estate boom had surged into a river of unrealistic prices), is now selling for $239,000. Granted, the number of foreclosures and short-sales has lowered property values, but now a prospective homeowner has to seriously consider how much it will cost just to get to work and back. Those who already own homes in these areas are, as a result, watching their equity drop even more. "

TIC's and Real Estate Professionals--I told you so

When you write an article, sometimes what you said in that article comes back to haunt you.  Fortunately for me, this is not one of those incidents.  In the May 2005 issue of Southeast Real Estate Business, I wrote an article on TIC's and proffered that involving real estate agents in a TIC transaction only made sense.  I also wrote that I believed that the SEC would define a TIC as a security, which in fact they recently did, but I'll leave that additionally correct interpretation for another blog.   

First let me describe what a TIC is:   a tenancy-in-common (TIC) is the ownership of real estate between two or more parties. IRS, in Internal Revenue Procedure (Rev. Proc) 2002-22 set out guidelines for a new definition of a Tenenacy-In-Common.  I described, in the article mentioned above, these guidelines as follows:  "Each co-owner in a TIC must hold title to the property as a tenant-in-common under state law.  The number of co-owners is limited to 35 and the co-ownership many not file a partnership return.

The co-owners must collectively retain the right to unanimously approve the hiring or retaining of a manager as well as the sale or lease of all or a portion of the property.  Additionally, the co-owners share in the proceeds and liabilities upon the sale of the property as well as all profits and losses."   There have been some additional requirements added since 2002, but you now have the basics. 

The TIC industry has grown significantly since 2002 and in general is represented by some extremely conscientious and bright individuals and companies.  But it was missing a link in the chain of a real estate transaction--the real estate agent.  NAR, the National Association of Realtors, the national trade organization for most real estate agents has been putting pressure on the SEC and the TIC  industry to get a real estate agent involved in both sides of the transaction, thereby enabling the real estate agent to earn a "commission" or "referral fee".   

That might sound onerous, but that's not the case.  Let me quote from a recent newsletter I received written by John Krol, who sells TCI's as a Securities Broker/Dealer summarizing the NAR/TIC proposal as it exists today:  "...Broker/Dealers will be in control of determining the suitability of a client...An Acknowledgement Letter must be signed by investors acknowledging the fee being paid to the Real Estate Professional. 

This exemption is good news because Real Estate Professionals potentially may:  1.  Help clients potentially defer capital gains taxes ,  2.  Obtain listings from reluctant clients who are concerned about identifying suitable replacement properties,  3.  Have the ability to offer clients alternative solutions in markets with fewer replacement property options,  4.  Work with a leading TIC Broker/Dealer with professional due diligence & product inventory." 

The above proposals have not been finalized, but in my opinion they are a great beginning and will benefit both the TIC industry and the real estate industry.  One final point, the reason for this brief discussion on TIC's is that some investors are looking for less responsibility in managing their investments and therefore they look into TIC's as a possible replacement property when transacting a Section 1031 exchange.

IS REAL ESTATE THE ONLY TYPE OF SECTION 1031 EXCHANGE?

NO--in capital letters.    Yes it is true that the majority of taxpayers doing exchanges are exchanging real property--BUT--it is also true the any property that is held for productive use in a trade or business, or for investment purposes, can qualify for a Section 1031 tax deferred exchange.  For those of you faithful blog 1031 readers, you will recall one of our blogs from yesteryear,  where we discussed the case we had in the office involving a thoroughbred horse that was exchanged for another thoroughbred horse.   

Personal property exchanges are concluded all the time. We have be involved in exchanges of advertising signage for other advertising signage.  We have been involved in the sale of a motel, and the beds in the motel were exchanged for new beds in a different motel.  In fact, it is reported that  the Hertz auto rental firm exchanges their used vehicles for new ones every year.  The only difference between a personal property exchange and a real property exchange, is that in a personal property exchange, you must exchange for the exact same item that you sold (example:  exchanging a computer for a computer, not exchanging a computer for a copy machine); while in a real property exchange, you can exchange a piece of raw land for an office building---any type of real estate for any other type of real estate.   Go back and look at some of our previous articles for more examples

IS IT TOO LATE TO DO AN EXCHANGE IF A CONTRACT HAS BEEN SIGNED, BUT NO CLOSING HAS OCCURRED?

The simple answer is:  "It's not too late".  As long as a closing has not occurred, you the taxpayer can still do an exchange.  We have had numerous situations, where the taxpayer is selling their relinquished property, they are sitting at the closing table, but have not concluded the transaction and at that very moment, decide they want to do a Section 1031 exchange.  We have been able to deliver the Section 1031 documentation by PDF to the closing agent, in less than 20 minutes.  After the 1031 documents are executed, the closing continues and title is transferred.  I have to thank Adam Mishcon, for being able to have our computer systems accomplish the impossible--full 1031 documentation within minutes--It is truly wonderful to be able to have the best tools in the industry--so thanks again to Adam Mischon for making me look good.

WHAT PROPERTY WILL NOT QUALIFY FOR A TAX DEFERRED EXCHANGE?

The property must be an investment property or property used in a trade or business.  Certain property is specifically excluded from qualifying under Section 1031.   The following properties do not qualify for Section 1031 exchanges:  Property primarily for sale; stocks, bonds or promissory notes; securities or other types of evidences of indebtedness; inventories, certificates of trusts or beneficial interests in trusts; and sale of partnerships interests.   

Remember, the qualifying property, both relinquished and replacement properties must be held for investment purposes and/or used in the taxpayer's trade or business.  Two more notes:  (1) The taxpayer's personal residence will not qualify, because of course that is not an investment and is not used in a trade or business; and (2) the Property being acquired (replacement property) cannot be acquired with the intent of immediately reselling same.

WHAT IS THE THEORY BEHIND ALLOWING A SECTION 1031 EXCHANGE?

For history purposed, the original tax deferred exchange law was passed way back in 1921.  The reason (theory) behind this wonderful section of the Internal Revenue Code is to allow the taxpayer to reinvest the proceeds from the sale of their "investment property" or property used in their "trade or business" into another investment property or property used in their trade or business.   

By doing an exchange, the taxpayer does not realize any gain at the present time, since they are purchasing another property and therefore it would be unfair to tax the taxpayer on a "paper gain".  By allowing the taxpayer to do a tax deferred exchange, the economy grows and at the final point of sale, the tax will be paid.  This of course allows the taxpayer to have more funds available to invest in another property, which usually results in the taxpayer purchasing a more expensive property and continues to help the economy grow.

WHAT IS THE EQUAL OR GREATER VALUE RULE?

A part of the Section 1031 rules require that the property you purchase, which we call the "Replacement Property" be of equal or greater value than the relinquished property (which is the property you sold).  It is part of the "Napkin Rule".  Go to our website and look up the "Napkin Rule" for the other portions of this very important rule.

DO I HAVE TO DO A SECTION 1031 DEFERRED EXCHANGE WHEN I SELL MY PERSONAL RESIDENCE?

The simple answer is NO.  A different section (Section 121) of the IRS Code applies to personal residences.  Section 121 allows an individual to exclude up to $250,000 or $500,000 per married couple of profit if they have lived and owned the personal residence for 2 of the last 5 years. 

That is a wonderful income tax exclusion.  Section 1031 applies to property that is held for investment or held for productive use in a trade or business--your personal residence obviously is not an investment or used in a trade or business.  For those of you bloggers that want to check out a more thorough discussion on how to use both Section 121 and 1031 together, go to our reference site on our website:  www.bayview1031.com.   You can review excerpts of  an article I wrote  that appeared in the January 2006 issue of  THE CPA JOURNAL.