Section 1031 For Clients

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  • Opening screen: The Power of Section 1031 Welcome to “The Power of Section 1031”. We appreciate the time you took out of your schedules to come and spend some time with us. Our purpose here today is to turn you on to some very powerful aspects of Section 1031, show you how to identify the strategic uses for your clients, and demonstrate some alternative strategies that you may or may not have been aware of. What an exciting topic, figuring out ways in which you can help your clients to take advantage of interest free loans from Uncle Sam.
  • Section 1031 For Clients

    1. 2. Shhhhh. Don’t tell anyone. You are eligible for interest free loans from the US Government… … for as long as they’d like. … for as many times as they’d like.
    2. 3. Of the approximately $200Billion in commercial real estate transactions last year, it is estimated that 20-25% could have benefited from Section 1031 treatment. Only 3% did.
    3. 4. What’s In It For You? <ul><li>Defer 100% of capital gains taxes including: </li></ul><ul><ul><li>Federal - 15% </li></ul></ul><ul><ul><li>State - 3% to 9% (Depending on State) </li></ul></ul><ul><ul><li>Depreciation Recapture - 25% </li></ul></ul><ul><li>Use the deferred gains to enhance your buying Power </li></ul><ul><li>Swap ‘til you Drop – You can exchange over and over again </li></ul>
    4. 5. What’s In It For You? <ul><li>Exchange into passive real estate investments </li></ul><ul><ul><li>Tenants - in - Common </li></ul></ul><ul><ul><li>Oil & Gas </li></ul></ul><ul><li>Exchange into a security </li></ul><ul><ul><li>UPREITs </li></ul></ul><ul><li>Exchange into a guaranteed income </li></ul><ul><ul><li>Structured Sale </li></ul></ul><ul><li>Exchange into your dream home </li></ul><ul><ul><li>Follow the rules! </li></ul></ul>
    5. 6. Today We Will Explore… <ul><li>What Is Section 1031? </li></ul><ul><li>Section 1031 Misconceptions </li></ul><ul><li>How To Recognize When to Use Section 1031? </li></ul><ul><li>Who Qualifies For an Exchange? </li></ul><ul><li>What Qualifies For an Exchange? </li></ul><ul><li>Real-life Examples of Our Exchanges </li></ul><ul><li>Alternative Exchange Strategies </li></ul>
    6. 7. What Is An Exchange? <ul><li>Method to sell investment real estate and replace it with new property that doesn’t trigger any tax. </li></ul><ul><li>Its essential elements are: </li></ul><ul><ul><li>Give a Deed </li></ul></ul><ul><ul><li>Get a Deed </li></ul></ul><ul><ul><li>Don’t handle Cash </li></ul></ul>
    7. 8. The Regulation - Section 1.1031(k)-1 <ul><li>“ A deferred exchange is defined as an exchange in which, pursuant to an agreement , the taxpayer transfers property held for productive use in a trade or business or for investment (the ‘relinquished property’) and subsequently receives property to be held either for productive use in a trade or business or for investment (the ‘replacement property’).” </li></ul>QI
    8. 9. Section 1031(a)(1) <ul><li>“ No gain or loss shall be recognized on the exchange of property held for productive use in trade or business or for investment if such property is exchanged solely for property of like kind which is held either for productive use in a trade or business or for investment.” </li></ul>Section 1031 Works ONLY with Investment property YOU MUST PROVE INTENT!
    9. 10. What is Investment Purpose? <ul><li>Investment is the passive holding of property for more than a temporary period with the expectation of appreciation </li></ul><ul><li>Real estate (even if unproductive) held by a non dealer for future use or increment in value is held for investment and not primarily for sale (Reg. Section 1.1031(a)-1(b)) </li></ul><ul><li>Thus property held for sale in the immediate future is not held for investment </li></ul>
    10. 11. What are the benefits of an Exchange? <ul><li>Full capital gains tax deferral </li></ul><ul><li>Relocation of investment </li></ul><ul><li>Change in investment type </li></ul><ul><li>Diversification of investment </li></ul><ul><li>Planning of investment </li></ul><ul><li>Solve problem of joint ownership </li></ul><ul><li>Increase cash flow </li></ul>
    11. 12. Three essential elements: <ul><li>The properties must be exchanged (not sold) </li></ul><ul><li>Both the “Relinquished” property and the “Replacement” property must be held by the same taxpayer for investment or productive use </li></ul><ul><li>The properties must be “Like-Kind” with one another </li></ul><ul><ul><li>Real property for real property </li></ul></ul><ul><ul><li>Personal property for personal property </li></ul></ul>
    12. 13. Like-kind requirement <ul><li>The term “like-kind” refers to the nature or character of the property and not to its grade or quality </li></ul><ul><li>Real property cannot be exchanged for personal property </li></ul><ul><li>Qualifying personal property can be exchanged for property of a similar character </li></ul>
    13. 14. Like - Kind Single Family Dwelling Land Apartments Condos Commercial Development
    14. 15. Personal Property <ul><li>Same General Asset Class or Product Code </li></ul><ul><li>North American Industry Classification System </li></ul><ul><li>Sector 31-33-Manufacturing </li></ul><ul><ul><li>Examples: Heavy Construction Equipment, Well Drilling Equipment, Logging Equipment, Commercial Vessels, Commercial Laundry Equipment </li></ul></ul><ul><ul><li>See www.census.gov/naics </li></ul></ul>
    15. 16. Timing is everything! <ul><li>The Exchange period begins on the transfer of the Relinquished Property </li></ul><ul><li>Exchangor must identify qualified Replacement Property within 45 days of closing </li></ul><ul><li>Exchangor must acquire within 180 days </li></ul><ul><li>There are no extensions unless mandated as a federal disaster </li></ul>
    16. 17. Can Anyone Handle An exchange? <ul><li>No! It must be a “Qualified Intermediary”(QI) as defined by regulation: </li></ul><ul><li>Cannot Be the Exchangor or a Relative </li></ul><ul><li>Cannot be an Agent of the Taxpayer </li></ul><ul><ul><li>One who has acted as employee, attorney, accountant, investment banker, broker or real estate agent with the past 2 years </li></ul></ul><ul><li>The QI Handles All Aspects of the Exchange and Should be Involved EARLY in the Process </li></ul>
    17. 18. What does the QI do? <ul><li>Creates Exchange Agreement </li></ul><ul><li>Has Standing in the Sale of Relinquished Property and Purchase of Replacement Property </li></ul><ul><li>Notice of Assignment </li></ul><ul><li>Closing Instructions to Settlement Agent </li></ul><ul><li>Banking and Safeguarding of Exchange Funds </li></ul><ul><li>Assurance of Critical Deadlines Including the 45 & 180 Day Deadlines </li></ul><ul><li>Final accounting for tax purposes </li></ul>
    18. 19. Who Qualifies for an Exchange? <ul><li>Owners of investment property and business property may qualify for a Section 1031 deferral. Individuals , C Corporations , S corporations , partnerships (general or limited), limited liability corporations , trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031. </li></ul><ul><li>  </li></ul><ul><li> </li></ul>
    19. 20. Does Your Situation Qualify?
    20. 21. The Five Most Common Section 1031 Misconceptions 1 All 1031 Exchanges must involve swapping or trading with other property owners......
    21. 22. The Five Most Common Section 1031 Misconceptions 2 It’s required that all types of 1031 exchanges must close simultaneously......
    22. 23. The Four Most Common Section 1031 Misconceptions 3 &quot;Like-kind&quot; means purchasing the same type of property which was sold.......
    23. 24. The Four Most Common Section 1031 Misconceptions 4 1031 Exchanges must be limited to 1 exchange and 1 replacement property.......
    24. 25. The Four Most Common Section 1031 Misconceptions 5 A Section 1031 is NOT a path to cash.
    25. 26. The Power of Section 1031 What happens when both participate in 3 typical real estate transactions… … with radically different approaches?
    26. 27. Hypothetical Example Assumptions Courtesy of Grubb & Ellis Commercial Real Estate Services
    27. 28. First Transaction - Today Courtesy of Grubb & Ellis Commercial Real Estate Services
    28. 29. Second Transaction – In 5 Years Courtesy of Grubb & Ellis Commercial Real Estate Services
    29. 30. Third Transaction – In 10 Years Courtesy of Grubb & Ellis Commercial Real Estate Services
    30. 31. Fourth Transaction – In 15 Years Courtesy of Grubb & Ellis Commercial Real Estate Services $361,336 $507,000 $108,400 $152,100 ($21,680) $ 0 $448,056 $659,100 $2,240 $3,296
    31. 32. Summary of Wealth Building Benefits Courtesy of Grubb & Ellis Commercial Real Estate Services 4 th Transaction $448,056 $659,100 Cumulative Increase 49.3% 119.7%
    32. 33. Summary of Increased Cash Flow Courtesy of Grubb & Ellis Commercial Real Estate Services At 15 th Year
    33. 34. The Most Common Exchange Types <ul><li>Delayed Exchange </li></ul><ul><ul><li>The client sells his property, identifies replacement property options within 45 days, then purchases the property(ies) within 180 days. </li></ul></ul><ul><li>Reverse Exchange </li></ul><ul><ul><li>The client purchases (with a Single Purpose Entity) the replacement property before his current property is sold. The client then has 180 days to close on his relinquished property. </li></ul></ul><ul><li>Build-to-Suit </li></ul><ul><ul><li>The client wishes to purchase and improve a property(ies) with the proceeds from the sale of his relinquished property. This is also accomplished with a Single Purpose Entity. </li></ul></ul>
    34. 35. ACQUIRE A RENTAL PROPERTY FOR A FAMILY MEMBER <ul><li>Exchange for a home for the kids… </li></ul><ul><li>… charge fair market rent. </li></ul><ul><li>Then gift the property. </li></ul>
    35. 36. Alternate Exchange Opportunities <ul><li>THERE ARE A MYRIAD OF OTHER INVESTMENT OPPORTUNITIES THAT CAN BE ACCOMPLISHED WITH AN EXCHANGE! </li></ul>
    36. 37. Tenants - In - Common <ul><li>TENANTS-IN-COMMON (TICs) OFFER A STRESS FREE OPTION TO OWN INVESTMENT GRADE REAL ESTATE </li></ul>Tenants-in-common Any Real Property
    37. 38. Who is a Typical TIC Investor? Courtesy of Grubb & Ellis Commercial Real Estate Services
    38. 39. Why Use TICS in an Exchange? Courtesy of Grubb & Ellis Commercial Real Estate Services
    39. 40. What is a TIC? Courtesy of Grubb & Ellis Commercial Real Estate Services
    40. 41. TIC Property Characteristics <ul><li>Undivided Fractional Ownership in Real Estate </li></ul><ul><li>Each Owner Receives a Proportional Share of Net Revenues </li></ul><ul><li>Under Sponsored Structure, TICs are: </li></ul><ul><ul><li>Grade “A” Real Estate Investments </li></ul></ul><ul><ul><li>Professionally Managed </li></ul></ul><ul><li>The Result Is A Passive Ownership </li></ul>Courtesy of Grubb & Ellis Commercial Real Estate Services
    41. 42. Umbrella Partnership Real Estate Investment Trust (UP-REIT) Any Real Property Exchange!
    42. 43. What Is An UPREIT? <ul><li>Similar to a Mutual Fund For Real Estate Investors. </li></ul><ul><li>Allows Exchanging Real Property Into Operating Partnership (OP) Shares of Existing REITs </li></ul><ul><li>REITS can convert existing properties into TICs allowing 35 ownership positions; then </li></ul><ul><ul><li>TICs are then converted back to REIT shares and investors then hold shares in the REIT’s entire portfolio. </li></ul></ul><ul><ul><li>Portfolio is professionally managed with 95% of the net income to investors. </li></ul></ul>
    43. 44. UPREIT Benefits <ul><li>Transaction completed on a tax-deferred basis. If shares go to an estate the ultimate recipients will receive a stepped up basis. </li></ul><ul><li>Transaction can be structured enabling property owner to convert an interest in a specific property into a larger, more balanced portfolio held by the UPREIT. </li></ul><ul><li>Allows an interest in illiquid individual properties to become more easily saleable. </li></ul>
    44. 45. Oil & Gas Leases <ul><li>INVESTORS CAN EXCHANGE REAL PROPERTY FOR INTERESTS IN PRODUCING OIL & GAS ENTERPRISES </li></ul>Any Real Property
    45. 46. Oil & Gas Lease AN EXTREMELY VIABLE ALTERNATIVE FOR AN EXCHANGE. A Viable Alternative Investment for &quot;like-kind&quot; 1031 Exchange. <ul><li>Working and Royalty Interest </li></ul><ul><li>Leasehold Interest Allows the Right to Search for and Produce Oil and Gas </li></ul><ul><li>Fractional Owners Have the Same Rights as a Single Owner and Can subdivide or Offer for Sale on the Open Market </li></ul>
    46. 47. Oil & Gas Lease Characteristics <ul><li>Liquidity </li></ul><ul><ul><li>Active Secondary Market </li></ul></ul><ul><li>Life of Production </li></ul><ul><ul><li>Supported by Qualified 3 rd Party Reports </li></ul></ul><ul><li>Annual Return </li></ul><ul><ul><li>Average 15% - 18% Over Term </li></ul></ul><ul><li>Tax Treatment </li></ul><ul><ul><li>15% Tax Free Depletion Allowance </li></ul></ul><ul><li>Valuation </li></ul><ul><ul><li>Valued on the Amount of Potential Production </li></ul></ul>
    47. 48. Oil & Gas Lease Benefits <ul><li>Immediate Economic Closing With Predictable Cash Flow </li></ul><ul><li>Ability to Participate in the Future Production </li></ul><ul><li>Highly Liquid Individual Fractional Ownership </li></ul><ul><li>Diversification By Investing In One or Several Qualified Working Interests in Different Markets </li></ul>
    48. 49. Structured Sales <ul><li>STRUCTURED SALES ALLOWS THE INVESTOR TO ARRANGE FOR A FUTURE PAYCHECK </li></ul>Any Real Property Exchange!
    49. 50. The Structured Sale <ul><li>The Structured Sale is a method for selling appreciated assets such as real estate and businesses that allows sellers to: </li></ul><ul><li>Defer capital gains taxes to future years </li></ul><ul><li>Collect a stream of guaranteed payments over a set number of years </li></ul><ul><li>In Addition: </li></ul><ul><li>Makes the transaction safer for the seller </li></ul><ul><li>Doesn't require the seller to acquire new property. </li></ul><ul><li>This method was developed in 2005 and is becoming a sought after method for tax deferral when selling a business or real estate. </li></ul>
    50. 51. The Structured Sale & Section 1031 <ul><li>Identified as an Alternative Strategy In Exchange Agreement </li></ul><ul><li>Gives Buyer Full Title </li></ul><ul><li>Can Be Used When Replacement Properties Cannot Be Identified and/or Purchased in the 45/180 Day Time Restraints </li></ul><ul><li>Can Be Used For Taxable “Boot” </li></ul>
    51. 52. The Structured Sale & Selling a Business <ul><li>There is Inherent Risk Associated With a Typical Installment Sale </li></ul><ul><li>The Structured Sale Provides a Safe Alternative </li></ul><ul><li>Can Be Used in an Exchange for non “like-kind” Items like goodwill and FF&E, or; </li></ul><ul><li>Can be used for the entire transaction amount if the client wants to exit the real estate class </li></ul>
    52. 53. The Structured Sale
    53. 54. If you are considering an Exchange…. <ul><li>Contact a professional BEFORE closing on your property: </li></ul><ul><ul><li>Your Accountant </li></ul></ul><ul><ul><li>Your Attorney </li></ul></ul><ul><ul><li>Your Financial Advisor </li></ul></ul><ul><ul><li>A Qualified Intermediary </li></ul></ul><ul><li>Do your homework on Section 1031 </li></ul>
    54. 55. Also… <ul><li>Must employ a Qualified Intermediary </li></ul><ul><li>Time limits of 45 and 180 days </li></ul><ul><li>Properties must be “Like-Kind” </li></ul><ul><li>Business or Investment Purpose </li></ul><ul><li>Relinquished and Replacement Properties held by same taxpayer </li></ul><ul><li>Exchanges can be done either forward or reverse </li></ul>

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