Creating Assets From Liabilities

576 views
496 views

Published on

The Magic of 1031 Tax Exchanges

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
576
On SlideShare
0
From Embeds
0
Number of Embeds
7
Actions
Shares
0
Downloads
7
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Creating Assets From Liabilities

  1. 1. The Magic of 1031 Creating Assets From Liabilities
  2. 2. What is a 1031 Exchange? <ul><li>A 1031 Exchange makes it possible for investors to sell and buy of like kind while deferring Capital Gains Taxes. Section 1031 of the IRS code offers investors a reliable strategy for the protection of their real estate assets. A successful 1031 Exchange allows the investor to reinvest 100% of the equity from the sale of a property into the purchase of a chosen Replacement Property without recognizing any gain. This type of property sale and reinvestment can either be done through a simultaneous or delayed 1031 Exchange. In most cases a 1031 Exchange is done as a three-party delayed Exchange also known as a “Starker Exchange” in which an Intermediary ensures a reciprocal transfer of the properties and provides a “safe harbor” against the actual receipt of Exchange funds. </li></ul>
  3. 3. Non-Tax benefits of a 1031 Exchange <ul><li>1031 Exchanges provide real estate owners with a range of opportunities to meet personal investment objectives including increased leverage, improved cash flow, diversification, reduction of management obligations, geographic relocation and/or consolidation. The tax dollars saved by an Exchange may be maximized to increase an investor’s overall net worth. Ultimately, the Exchange process allows investors to recognize and improve their real estate portfolios to best suit their interests and needs. </li></ul>
  4. 4. Advantages of a 1031 Exchange <ul><li>Immediate Tax Savings </li></ul><ul><li>Capital Gain Tax Reductions </li></ul><ul><li>Increase Net Worth </li></ul><ul><li>Increased Earnings – Income </li></ul><ul><li>Preserve Equity </li></ul><ul><li>Eliminate Property Management Pitfalls </li></ul><ul><li>Upgrade and Improve Property Portfolio </li></ul><ul><li>Diversify – Relocate Holdings Nationally </li></ul><ul><li>Trade Up – Better Performing Investments </li></ul><ul><li>Consolidate Multiple Properties </li></ul><ul><li>Eliminate Taxation via Estate Planning Advantage </li></ul><ul><li>Exchange Multiple Times </li></ul>
  5. 5. What are the different types of exchanges? <ul><li>Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs at the same time. </li></ul><ul><li>Delayed Exchange: This is the most common type of exchange. A Delayed Exchange occurs when there is a time gap between the transfer of the Relinquished Property. A Delayed Exchange is subject to strict time limits, which are set forth in the Treasury Regulations. </li></ul><ul><li>Build-to-Suit (Improvement or Construction) Exchange: This technique allows the taxpayer to build on, or make improvements to, the replacement property, using the exchange proceeds. </li></ul>
  6. 6. What are the different types of exchanges? <ul><li>Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges, as outlined in Rev. Proc. 2000-37, effective September 15, 2000. These transactions are sometimes referred to as “parking arrangements” and may also be structured in ways which are outside the safe harbor. </li></ul><ul><li>Personal Property Exchange: Exchanges are not limited to real property. Personal property can also be exchanged for other personal property of like-kind or like-class. </li></ul>
  7. 7. Who should consider a 1031 Exchange? <ul><li>Anyone who is thinking about selling a business use or investment should consider a 1031 Exchange. An Exchange offers the investors an opportunity to reinvest the capital gains that would normally be handed over to the IRS and put that money to work for themselves. Essentially, 1031 Exchanges should be thought of as an interest free loan from the IRS; one in which the principal may be increased through subsequent Exchanges and may never require repayment, if you plan properly. </li></ul>
  8. 8. What are the requirements for a valid exchange? <ul><li>Qualifying Property – Certain types of property are specifically excluded from Section 1031 treatment: property held primarily for sale; inventories; stocks, bonds or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trusts or beneficial interests. In general, if property is not specifically excluded, it can qualify for tax-deferred treatment. </li></ul><ul><li>Proper Purpose – Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. The taxpayer’s personal residence will not qualify. </li></ul>
  9. 9. What are the requirements for a valid exchange? <ul><li>Like Kind – Replacement property acquired in an exchange must be “like-kind” to the property being relinquished. All qualifying real property located in the United States is like-kind. Personal property that is relinquished must be either like-kind or like-class to the personal property which is acquired. Property located outside the United States is not like-kind to property located in the United States. </li></ul><ul><li>Exchange Requirement – The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property. Most deferred exchanges are facilitated by Qualified Intermediaries, who assist the taxpayer in meeting the requirements of Section 1031. </li></ul>
  10. 10. Both Properties Must Be Held For Investment Or Business Use <ul><li>Your use of both the Relinquished Property and Replacement Property must be investment or business use; each for a minimum of one to two years. Properties must not be used for personal use for more than 14 days per year or 10% of the actual number of days the property has been rented in a given year. Replacement Property cannot be purchased with the intent to sell immediately. </li></ul>
  11. 11. What is a Qualified Intermediary (QI)? <ul><li>One of the safe harbors of the regulations is the use of a Qualified Intermediary, such as Greystone Real Estate Group, to facilitate the Exchange. A Qualified Intermediary is an independent party who facilitates tax-deferred exchanges pursuant to Section 1031 of the Internal Revenue Code. The QI cannot be the taxpayer or a disqualified person. </li></ul><ul><li>Acting under a written agreement with the taxpayer, the QI acquires the relinquished property and transfers it to the buyers. The QI holds the sales proceeds, to prevent the taxpayer from having actual or constructive receipt of the funds. </li></ul><ul><li>Finally, the QI acquires the replacement property and transfers it to the taxpayer to complete the exchange within the appropriate time limits. </li></ul>
  12. 12. The Exchanger Must Satisfy Time Restrictions <ul><li>The 45-day Identification Period begins on the day of the Relinquished Property closing. This requires the identification of like-kind Replacement Property in writing to the Intermediary before the 45-day deadline. Once the Replacement Property has been identified you have 180 days from the date Relinquished Property closed until you have to close on your Replacement Property. </li></ul>
  13. 13. What are the general guidelines to follow in order for a taxpayer to defer all the taxable gain? <ul><li>The value of the replacement property must be equal to or greater than the value of the relinquished property. </li></ul><ul><li>The equity in the replacement property must be equal to or greater than the equity in the relinquished property. </li></ul><ul><li>The debt on the replacement property must be equal to or greater than the debt on the relinquished property. </li></ul><ul><li>All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property. </li></ul>
  14. 14. What if the taxpayer cannot identify any replacement property within 45 days, or close on a replacement property before the end of the exchange period? <ul><li>Unfortunately, there are no extensions available. If the taxpayer does not meet the time limits, the exchange will fail and the taxpayer will have to pay any taxes arising from the sale of the relinquished property. </li></ul>
  15. 15. Is there any limit to the number of properties that can be indentified? <ul><li>There are three rules that limit the number of properties that can be identified. The taxpayer must meet the requirements of at least one of these rules. </li></ul><ul><li>3 – Property Rule: The taxpayer may identify up to 3 potential replacement properties, without regard to their value; or </li></ul><ul><li>200% Rule: Any number of properties may be identified, but their total value cannot exceed twice the value of the relinquished property, or </li></ul><ul><li>95% Rule: The taxpayer may identify as many properties as he wants, but before the end of the exchange period the taxpayer must acquire replacement properties with an aggregate fair market value equal to at least 95% of the aggregate fair market value of all the identified properties. </li></ul>
  16. 16. What is a “multi-asset” exchange? <ul><li>A multi-asset exchange involves both real and personal property. For example, the sale of a hotel will typically include the underlying land and buildings, as well as the furnishings and equipment. If the taxpayer wants to exchange the hotel for a similar property, he would exchange the land and buildings as one part of the exchange. The furnishings and equipment would be separated into groups of like-kind or like-class property, with the groups of relinquished property being exchanged for groups of replacement property. </li></ul><ul><li>Although the definition of like-kind is much narrower for personal property and business equipment, careful planning will allow the taxpayer to enjoy the benefits of an exchange for the entire relinquished property, not just for the real estate portion. </li></ul>
  17. 17. What is the difference between “realized” gain and “recognized” gain? <ul><li>Realized gain is the increase in the taxpayer’s economic position as a result of the exchange. In a sale, tax is paid on the realized gain. Recognized gain is the taxable gain. Recognized gain is the lesser of realized gain or the net boot received. </li></ul>
  18. 18. What is a Boot? <ul><li>Boot is any property received by the taxpayer in the exchange which is not like-kind to the relinquished property. Boot is characterized as either “cash” boot or “mortgage” boot. Realized Gain is recognized to the extent of net boot received. </li></ul>
  19. 19. What is a Tenant-in-Common Ownership? <ul><li>Tenant-in-Common Ownership, also known as TIC Ownership, is rapidly becoming the most popular choice among real estate Exchangers seeking ideal Replacement Properties. While it is often difficult to locate a property that has the right purchase price, debt ratio and closing schedule within the 45-day time limit, TIC Properties are flexible enough to meet almost all of the 1031 Exchanger’s needs. A TIC interest represents Co-Ownership between two or more investors and is especially suited to investors involved in the 1031 Exchange process because the Properties can be identified and closed in a timely manner thanks to prearranged financing. </li></ul>
  20. 20. 15 Items for a TIC Deal <ul><li>1. Tenancy in Common Ownership – Each of the co-owners must hold title to the Property (either directly or through a disregarded entity) as a tenant in common under local law. Thus, title to the Property as a whole may not be held by an entity recognized under local law. </li></ul>
  21. 21. 15 Items for a TIC Deal <ul><li>2. Number of Co-Owners – The number of co-owners must be limited to no more than 35 persons. For this purpose, a person is defined as in 7701(a)(1), except that a husband and wife are treated as a single person and all persons who acquire interests from a co-owner by inheritance are treated as a single person. </li></ul>
  22. 22. 15 Items for a TIC Deal <ul><li>3. No Treatment of Co-Ownership as an Entity. The co-ownership may not file a partnership or corporate tax return, conduct business under a common name, execute an agreement identifying any or all of the co-owners as partners, shareholders, or members of a business entity, or otherwise hold itself as a partnership or other form of business entity (nor may the co-owners hold themselves out as partners, shareholders, or members of a business entity). The Service generally will not issue a ruling under this revenue procedure if the co-owners held interests in the Property through a partnership or corporation immediately prior to the formation of the co-ownership. </li></ul>
  23. 23. 15 Items for a TIC Deal <ul><li>4. Co-Ownership Agreement. The co-owners may enter into a limited co-ownership agreement that may run with the land. For example, a co-ownership agreement may provide that a co-owner must offer the co-ownership interest for sale to the other co-owners, the sponsor, or the lessee at fair market value (determined as of the time the partition right is exercised) before exercising any right to partition (see section 6.05 of this revenue procedure for conditions relation to voting. </li></ul>
  24. 24. 15 Items for a TIC Deal <ul><li>5. Voting. The co-owners must retain the right to approve the hiring of any manager, the sale or other disposition of the Property, any leases of a portion or all of the Property, or the creation or modification of a blanket lien. Any sale, lease, or re-lease of a portion or all of the Property, any negotiation or renegotiation of indebtedness secured by a blanket lien, the hiring of any manager, or the negotiation of any management contract (or any extension or renewal of such contract) must be unanimous approval of the co-owners. For all other actions on behalf of the co-ownership, the co-owners may agree to be bound by the vote of those holding more than 50 percent of the undivided interests in the Property. A co-owner who has consented to an action in conformance with this section 6.05 may provide the manager or other person a power of attorney to execute a specific document with respect to that action, but may not provide the manager or other person with a global power of attorney. </li></ul>
  25. 25. 15 Items for a TIC Deal <ul><li>6. Restrictions on Alienation. In general, each co-owner must have the rights to transfer, partition, and encumber the co-owners undivided interest in the Property without the agreement or approval of any person. However, restrictions on the right to transfer, partition, or encumber interests in the Property that are required by a lender and that are consistent with customary commercial lending practices are not prohibited. See section 6.14 of this revenue procedure for restrictions on who may be a lender. Moreover, the co-owners, the sponsor, or the lessee may have a right of first offer (the right to have the first opportunity to offer to purchase the co-ownership interest) with respect to any co-owners exercise of the right to transfer the co-ownership interest in the Property. In addition, a co-owner may agree to offer the co-ownership interest for sale to the other co-owner, the sponsor, or the lessee at fair market value (determined as of the time the partition right is exercised) before exercising any right to partition. </li></ul>
  26. 26. 15 Items for a TIC Deal <ul><li>7. Sharing Proceeds and Liabilities upon Sale of Property. If the Property is sold, any debt secured by a blanket lien must be satisfied and the remaining sales proceeds must be distributed to the co-owners. </li></ul>
  27. 27. 15 Items for a TIC Deal <ul><li>8. Proportionate Sharing of Profits and Losses. Each co-owner must share in all revenues generated by the Property and all costs associated with the Property in proportion to the co-owners undivided interest in the Property. Neither the other co-owners, nor the sponsor, nor the manager may advance funds to a co-owner to meet expenses associated with the co-ownership interest, unless the advance is recourse to the co-owner (and, where the co-owner is a disregarded entity, the owner of the co-owner) and is not for a period exceeding 31 days. </li></ul>
  28. 28. 15 Items for a TIC Deal <ul><li>9. Proportionate Sharing of Debt. The co-owners must share in any indebtedness secured by a blanket lien in proportion to their undivided interests. </li></ul>
  29. 29. 15 Items for a TIC Deal <ul><li>10. Options. A co-owner may issue an option to purchase the co-owners undivided interest (call option), provided that the exercise price for the call option reflects the fair market value of the Property determined as of the time the option is exercised. For this purpose, the fair market value of an undivided interest in the Property is equal to the co-owners percentage interest in the Property multiplied by the fair market value of the Property as a whole. A co-owner may not acquire an option to sell the co-owners undivided interest (put option) to the sponsor, the lessee, another co-owner, or the lender, or any person related to the sponsor, the lessee, another co-owner, or the lender. </li></ul>
  30. 30. 15 Items for a TIC Deal <ul><li>11. No Business Activities. The co-owners activities must be limited to those customarily performed in connection with the maintenance and repair of rental real property (customary activities). See Rev. Rul. 75-374, 1975-2 C.B 261. Activities will be treated as customary activities for this purpose if the activities would not prevent an amount received by an organization described in ‘511(a)(2) from qualifying as rent under ‘512(b)(3)(A) and the regulations thereunder. In determining the co-owners activities, all activities of the co-owners, their agents, and any persons related to the co-owners with respect to the Property will be taken into account, whether or not those activities are performed by the co-owners in their capacities as co-owners. For example, if the sponsor or a lessee is a co-owners, then all of the activities of the sponsor or lessee (or any person related to the sponsor or lessee) with respect to the Property will be taken into account in determining whether the co-owners activities are customary activities. However, activities of a co-owner or a related person with related person with respect to the Property (other than in the co-owners capacity as a co-owner) will not be taken into account if the co-owner owns an undivided interest in the Property for less than 6 months. </li></ul>
  31. 31. 15 Items for a TIC Deal <ul><li>12. Management and Brokerage Agreements. The co-owners may enter into management or brokerage agreements, which must be renewable no less frequently than annually, with an agent, who may be the sponsor or a co-owner (or any person related to the sponsor or a co-owner), but who may not be a lessee. The management agreement may authorize the manager to maintain a common bank account for the collection and deposit of rents and to offset expenses associated with the Property against any revenues before disbursing each co-owners share of net revenues. In all events, however, the manager must disburse to the co-owners their shares of new revenues within 3 months from the date of receipt of those revenues. The management agreement may also authorize the manager to prepare statements for the co-owners showing their shares of revenue and costs from the Property. In addition, the management agreement may authorize the manager to obtain or modify insurance on the Property, and to negotiate modifications of the terms of any lease or any indebtedness encumbering the Property, subject to the approval of the co-owners. (See section 6.05 of this revenue procedure for conditions relating to the approval of lease and debt modifications.) The determination of any fees paid by the co-ownership to the manager must not depend in whole or in part on the income or profits derived by any person from the Property and may not exceed the fair market value of the managers services. Any fee paid by the co-ownership to a broker must be comparable to fees paid by unrelated parties to brokers for similar services. </li></ul>
  32. 32. 15 Items for a TIC Deal <ul><li>13. Leasing Agreements. All leasing arrangements must be bona fide leases for federal tax purposes. Rents paid by a lessee must reflect the fair market value for the use of the Property. The determination of the amount of the rent must not depend, in whole or in part, on the income or profits derived by any person from the Property leased (other than an amount based on a fixed percentage or percentages of receipts or sales). See section 856(d)(2)(A) and the regulations thereunder. Thus, for example, the amount of rent paid by a lessee may not be based on a percentage of net income from the Property, cash flow, increases in equity, or similar arrangements. </li></ul>
  33. 33. 15 Items for a TIC Deal <ul><li>14. Loan Agreements. The lender with respect to any debt that encumbers the Property or with respect to any debt incurred to acquire an undivided interest in the Property may not be a related person to any co-owner, the sponsor, the manager, or any lessee of the Property. </li></ul>
  34. 34. 15 Items for a TIC Deal <ul><li>15. Payments to Sponsor. Except as otherwise provided in this revenue procedure, the amount of any payment to the sponsor for the acquisition of the co-ownership interest (and the amount of any fees paid to the sponsor for services) must reflect the fair market value of the acquired co-ownership interest (or the services rendered) and may not depend, in whole or in part, on the income or profits derived by any person from the Property. </li></ul>
  35. 35. Greystone Real Estate Group <ul><li> Equity funds can be re-invested in institutional properties. </li></ul><ul><li> Returns are paid at competitive rates. </li></ul><ul><li> Should you need additional advice, we can direct you to our team of tax, legal and brokerage advisors through our partnerships. </li></ul>
  36. 36. Caromont Medical Center
  37. 37. Midtown Plaza
  38. 38. Abbey Place
  39. 39. 1100 South Tryon
  40. 40. Lincoln Center
  41. 41. Summit Medical
  42. 42. 201 West Moorehead
  43. 43. 624 Tyvola
  44. 44. Manor House
  45. 45. Greystone Real Estate Group <ul><li>Douglas M. Clayton </li></ul><ul><li>Principal </li></ul><ul><li>Kimberly A. Willis-Smith </li></ul><ul><li>Director of Acquisitions </li></ul><ul><li>Arnetta A. Cline </li></ul><ul><li>Director of Client Relations </li></ul>
  46. 46. Greystone Real Estate Group <ul><li>2423 Highway 17 South </li></ul><ul><li>North Myrtle Beach, SC 29582 </li></ul><ul><li>Office: 843.272.1030 </li></ul><ul><li>Toll Free: 866.396.1031 </li></ul><ul><li>Fax: 843.272.1347 </li></ul><ul><li>Email: [email_address] </li></ul><ul><li>Web Site: GreyStone1031Exchange.Com </li></ul>

×