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Welcome. Tax Deferred 1031 Real Property Exchanges. As a courtesy to others. Please turn off phones and pagers. Course Goal. Recognize and evaluate when a 1031 tax-deferred exchange could be advantageous Explain the tax saving benefits

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  1. Welcome Tax Deferred 1031 Real Property Exchanges

  2. As a courtesy to others. . . Please turn off phones and pagers

  3. Course Goal • Recognize and evaluate when a 1031 tax-deferred exchange could be advantageous • Explain the tax saving benefits • Work with the client and a team of experts to structure the transaction

  4. Objectives • Gain an understanding of how the rules governing 1031 tax-deferred real property exchanges are applied and how transactions are put together • Explain the tax deferral benefits of a 1031 exchange

  5. Objectives • Recognize and evaluate situations in which a 1031 tax deferred exchange could be to the client’s advantage • Involve and work with intermediaries and other experts to structure the transaction

  6. DayOne • The Fundamentals • Safe Harbors and Intermediaries

  7. Day Two . . . • Practicum – Case Studies • Putting the Deal Together • Completion Exam

  8. Two Positive Economic Outcomes . . . • Deferral of capital gain taxes • Preservation of equity

  9. When…… • Business reasons should always be the driving factor • When the potential tax liability outweighs both taxes and costs

  10. Real Estate Professional’s Role . . • Help the client think through the pros and cons • Identify exchangeable properties • Interface with the team of professional advisors

  11. Basic Concept . . . • Continue an investment without adverse tax consequences • Solution to the “tax-locked property” dilemma

  12. Sale Purchase Value of Real Estate Holdings Exchange Purchase Exchange Time Basic Concept . . .

  13. Eligibility . . . • Property must be held for investment or productive use in trade or business - AND - • Exchanged for like-kind property

  14. Business Objectives . . .

  15. Advantages . . . • Capital gains tax deferred • Heirs receive a stepped-up basis and tax on accumulated capital gain is forgiven • Tax-locked property is freed up • Money available for reinvestment instead of taxes

  16. Disadvantages . . . • Future tax rates could be higher • Carryover of basis to replacement property • Complex and expensive transactions • Losses cannot be recognized • Proceeds must be reinvested in real estate • Time limits must be strictly adhered to

  17. Capital Gains & Income Tax Top Rates . . .

  18. Four Basic Rules . . . Property must be held for investment or productive use in trade or business Like kind property must be exchanged for like kind Replacement properties must be identified within 45 days Exchange must be completed within 180 days or tax due date

  19. Rule 1 . . . Held for investment or productive use in trade or business • Personal residences cannot be exchanged • Classification: • relinquished property when transferred • replacement property when received • If owner occupies a unit as a personal residence, the rental portion can be an exchange, personal use portion receives capital gain tax treatment

  20. Rule 1 . . . Held for investment or productive use in trade or business Vacation Properties. . . • Exchanges can be problematic if any personal use of it–hard to document occupancy • Considered personal residence if owner occupied more than (greater of) 14 days, or 10% of the total days rented

  21. Rule 1 . . . Held for investment or productive use in trade or business • Dealer property specifically excluded for 1031 exchange • Dealer property: primarily for sale in ordinary course of business • Real estate brokers/agents are not automatically dealers

  22. Qualified property determined by owner’s intent . . . Qualified Not Qualified Home Sweet Home Vacant Land (1221) & Investment Property Keep Out Personal Residence For Sale Dealer Property Used in Trade or Business (1231) ForRent

  23. Rule 1 . . . Held for investment or productive use in trade or business Unqualified Property . . . • Personal residence • Dealer property • Stock, bonds, notes • Choses in action • Certificates of trust or beneficial interests • Securities or evidences of indebtedness • Interests in a partnership

  24. Rule 2 . . . Like kind exchanged for like kind • All real estate held for investment or productive use in trade or business is like-kind • Property included in exchange that is not like-kind is taxable boot • Property located outside the U. S. (50 states & DC) not like kind • Exception, U.S. Virgin Islands

  25. Rule 2 . . . Like kind exchanged for like kind Like Kind Exchange Real Estate Trade or Business, Investment $ PersonalProperty

  26. Rule 3 . . . 45 Days to Identify Replacement Property • Identification period starts on the day that the title to the relinquished property is transferred • If multiple properties relinquished, date of first transfer starts 45-day period

  27. Rule 4 . . . 180 days or by tax due date to complete exchange • The replacement property must be transferred before the EARLIER of 180 days after the date of transfer of the relinquished property, OR the due date, including extensions, of the tax return for the tax year of the exchange

  28. Rule 4 . . . 180 days or by tax due date to complete exchange. • Count the days • 180 days does not equal 6 months * * May file for an extension, but exchange must be completed with 180 days.

  29. Foreign Taxpayers • Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) • Applies when the transferor (seller) is a non-U.S. taxpayer (individual or organization) and the property is a U.S. real property interest (USRPI). • Withholding agent (may be the real estate agent) must withhold 10% of the amount realized (not gain) and remit the it to the IRS within 20 days of transaction.

  30. Taxpayer Identification Number (TIN) • For an individual who cannot or does not qualify to receive a Social Security number. • Non-U.S. persons must provide a TIN when they buy or sell U.S. real property.

  31. Boot in 1031 Exchanges . . . • Cash or unlike property received in the exchange • Taxable gain • Fair market value is recognized

  32. Unqualified Property Personal residence Dealer Property Mortgage Relief Cash Unqualified Property in an Exchange = Taxable Boot Rule 2 . . . Like kind exchanged for like kind

  33. Boot in 1031 Exchanges . . . • Compare the fair market value of boot with the gain that would result from selling the property • Taxable gain is the lesser of these two amounts

  34. Total consideration received $135,000 Less - Adjusted basis $30,000 Total realized gain $105,000 GAIN Total boot received $35,000 Taxable gain is the smaller of the two $35,000 Boot in 1031 Exchanges . . . Example2.1. . .Real estate with an adjusted basis of $30,000 is exchanged for other real estate with a fair market value of $100,000, plus $35,000 boot.

  35. Boot in 1031 Exchanges . . . • If either party assumes any of debts or liabilities of the other as part of the exchange, the amount of liability is treated as cash boot

  36. Boot in 1031 Exchanges . . . Example 2.2. . . Allen exchanged real estate with an adjusted basis of $30,000 for other real estate with a fair market value of $100,000. In addition, he received $35,000 cash and the other party assumed a mortgage of $25,000.

  37. Boot in 1031 Exchanges . . . Step 1 - Total Gain Realized FMV of like-kind property Allen received $100,000 Cash boot received $35,000 Mortgage assumed by other party $25,000 Total consideration Allen received $160,000 Less basis of property given up $30,000 Total gain realized $130,000 Step 2 - Total Boot Received Mortgage assumed by other party $25,000 Cash received $35,000 Total boot received $60,000 Taxable gain is lesser amount . . . $60,000

  38. Boot in 1031 Exchanges . . . • Netting the Liabilities . . . • Mortgage on relinquished property is boot received • Mortgage assumed may be offset against this boot

  39. Boot in 1031 Exchanges . . . Example 2.3 . . .Christine exchanged land with a mortgage of $10,000 for land with a mortgage of $15,000. In addition, she received cash boot of $6,000. After offsetting the mortgages, she has paid $5,000 mortgage boot, but is not allowed to deduct this boot paid from the cash boot received. Her taxable boot received is $6,000.

  40. Boot in 1031 Exchanges . . . • Transaction costs reduce both recognized and realized gain on the sale side and increase basis on the purchase side • Includes: brokerage commissions and closing costs such as title policy, escrow, and recording fees

  41. Boot in 1031 Exchanges . . . Example 2.4 . . . Dave owned property with an adjusted basis of $30,000 and exchanged it for like-kind property with a fair market value of $100,000 plus $35,000 cash. He paid a $9,000 commission to his real estate broker. Dave’s taxable gain is limited to the net boot he received—$26,000. A "loss" is not deductible.

  42. Boot in 1031 Exchanges . . . • Cash boot paid offsets boot received • Mortgage boot paid offsets mortgage boot received • Mortgage paid, if more than mortgage assumed, may not offset cash or unlike property • Other boot paid may be treated as the purchase price for non-like kind property received • Selling expenses may offset boot received ornet mortgage relief if no cash or unlike property is received • Recognized gain may be offset by suspended losses

  43. Basis . . . • Cost of a property for tax purposes • If purchased outright, basis is the price paid for the property plus acquisition costs

  44. Basis . . . • Capital improvements increase basis • Items that provide a tax benefit decrease basis, e.g. cost recovery (depreciation)

  45. Property Sold Property Purchased Market Value Capital Gain 15% tax Original Basis 25% tax Cost Recovery Recapture Cost Recovery Time 39 Years Cost recovery decreases basis; recaptured at sale, taxed at 25%. No cost recovery on land. Basis . . .

  46. Basis . . . Very Important . . .Basis in the relinquished property is carried over to the replacement property, regardless of the cost of either of the properties

  47. Increases in Basis . . . • Cash paid in to balance equities • Liabilities/debts assumed on the replacement property • Improvements to the property • Acquisition costs

  48. Decreases in Basis . . . • Depreciation • Cash or nonqualified property received • Debt relief on the relinquished property • Reimbursement from an insurance policy for casualty or theft loss

  49. Equity . . . Replacement Property Relinquished Property $550,000 Equity $50,000 selling costs * Could finance $1.5 Million and take out $50,000 cash (taxable). Transfer of Equity $550,000 Equity $1,450,000 New Mortgage* $400,000 Mortgage Balance Property A$1 Million Property B$2 Million

  50. Basis . . . Replacement Property Relinquished Property $450,000 deferred gain $50,000 selling costs Transfer of Basis $450,000 deferred gain $1,550,000 substitute basis $500,000 adjusted basis Property A$1 Million Property B$2 Million

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