All Forum Posts by: Daniel Osman

@Christina Galdieri  

A 1031 exchange is specifically designed for real property held for productive use in a trade or business or for investment. This often leads to confusion because the term "trade or business" is mentioned, leading some to mistakenly believe that the entire business can be exchanged. However, the 1031 exchange only applies to the real estate component or real property, of the business, not the business itself or its non-real estate assets.

In other words, while you can exchange real estate used in your business for other like-kind real estate, the business itself, including goodwill, equipment, and other non-real estate assets, does not qualify for a 1031 exchange.

To maximize your tax deferral, focus on the real estate portion of the sale. You will need to allocate the total purchase price between the real estate and the business assets. This allocation should be based on the fair market value of each component, typically determined through an appraisal or the values agreed upon in the purchase agreement. It's crucial that this allocation is reasonable and well-documented to withstand IRS scrutiny. By doing so, you can defer taxes on the gain from the real estate portion through a 1031 exchange.

Hey Dylan,

The property that you live in and is your primary residence does not qualify for a 1031 exchange. The rental property could though if you structure it correctly. 

One thing to consider is that since you inherited the property, your basis is likely the value at the time of inheritance. Even if you take the $250,000 the realtor mentioned it would sell for as your basis that would mean you're looking at an $80k gain: 380,000 - (250,000 + 50,000 improvements) = 80,000

Since you want to buy a nicer home for your mom, a 1031 exchange may not be applicable if the new property is intended for personal use, as 1031 exchanges are for investment or business properties only. However, If the new property for your mom is intended as an investment (e.g., rental property), you could potentially use a 1031 exchange. You'll need to ensure the property is rented to your mother at a fair market rental rate. Charging below-market rent could indicate personal use rather than investment intent. 

The IRS safe harbor guidelines suggest holding the property for at least 24 months as a rental to establish it as an investment property. After the 24-month period, you have more flexibility. You could choose to let your mother stay in the property rent-free. However, this could limit your ability to complete a future 1031 exchange with that property. 

There's been a lot of great advice here! As everyone has mentioned being proactive before your property sells will be important. 

As you're looking at properties it's best to identify multiple potential replacement properties to give you more opportunities and alternatives. 

They're not typically the highest ROI, but if you are facing a large tax bill or are having trouble finding a replacement property within the 45 day timeline, a lot of our clients will identify a DST as a backup. It gives them a reinvestment option to complete the exchange and doesn't require active management. The typical holding period is 5-7 years, I know some DST's that have a 2-3 year holding period. After the holding period you can sell out of the DST and 1031 again.

A 1031 exchange allows you to defer taxes by exchanging real property held for productive use in a trade or business or for investment for other real property of like kind, which is also to be held for similar purposes. It's important to note that you cannot include your primary residence in a 1031 exchange, as it must be held for personal use rather than investment or business purposes.

However, your primary residence may qualify for the Section 121 tax exclusion if you've lived there for at least 2 of the last 5 years. This exclusion allows you to avoid recognizing up to 250,000 of gain (500,000 for married couples) on the sale of your primary residence.

Regarding your investment property in LA, it does qualify for a 1031 exchange. Keep in mind that the same entity (in this case, your LLC) that holds title to the relinquished property must also acquire the replacement property to maintain the tax-deferred status of the exchange.

Additionally, don't forget about depreciation recapture. When you sell a property that has been depreciated, the IRS requires you to "recapture" the depreciation deductions, taxing that portion of the gain at ordinary income tax rates. A 1031 exchange allows you to defer not only the capital gains tax but also the depreciation recapture tax, which can be at a higher rate.

If you have any further questions or need assistance with your 1031 exchange, feel free to reach out!

@Bruce D. Kowal

Great post! I couldn’t agree more with your emphasis on security of funds and the importance of due diligence when selecting a QI. The risks of choosing the wrong intermediary can’t be overstated, and your advice on verifying bonding, financial controls, and watching for red flags is spot on.

That said, I wanted to offer a slightly different perspective on the cost vs. security trade-off point. While it's true that some low-cost QIs may cut corners on security or service, that’s not always the case. At Deferred.com, we don’t charge fees for our 1031 exchange services on forward exchanges, not because we compromise on quality, but because of our approach. 

Here’s how we do it:

• Technology-Driven Operations: We've invested in advanced systems that streamline the exchange process, reducing overhead and allowing us to operate more efficiently without sacrificing service or security. This allows us to offer our No Fee Exchange even on smaller deals, (just did a deal last week for a $30,000 parcel of land for free). 
• Float Revenue Model: Like most QIs, we earn some revenue from the interest (float) on exchange funds held during the process. This allows us to eliminate fees for our clients while still maintaining top-tier protections. We will even share interest earnings and pay clients if they have a large transaction. 

Our goal is to make it easy and risk free for anyone to do a 1031 exchange because we think it's the greatest way to legally generate wealth.  

Even without charging fees for forward exchanges (we do charge for reverses and improvements), we prioritize fund security above all else. Our clients’ funds are held in FDIC insured segregated accounts at commercial banking partners with dual controls in place, and we maintain robust fidelity bonding and insurance coverage to provide peace of mind.

I completely agree with your point that cost shouldn’t be the sole deciding factor when choosing a QI because of the risk of a failed exchange. But it’s also important to understand why some companies, like ours, are able to offer no-fee services without compromising on security or service.

Thanks again for starting this important conversation. It’s crucial for investors to be fully informed when making these decisions.

I agree with @Ashish Acharya if you're interested in reinvesting the proceeds into another investment property and your goal is to minimize your tax liability a 1031 would work out well for you. It would allow you to sell your STR and defer all the taxes to reinvest all the proceeds into another property or multiple properties.

If you have any questions on 1031's feel free to ask! 

@John Gillick this is an interesting one. Based on IRS Private Letter Rulings (PLR 200805012 and PLR 200901020), development rights can qualify as like-kind property for a 1031 exchange if they are considered interests in real estate under state law. It's worth checking with an attorney for your state. 

If the original mortgage on your building remains in place and is not part of the exchange, you do not need to replace that specific debt. However, if you were to exchange the entire property, you would need to replace the debt to avoid mortgage boot. Since you are only selling the development rights and not the entire property, the existing mortgage on the building does not directly impact the 1031 exchange of the development rights. You do not need to take on new debt for the $450,000 reinvestment unless you choose to do so for other financial reasons.

If you have further questions or need clarification, feel free to ask!

@Matthew Becker Thanks! 

The rules are designed to prevent related parties from engaging in exchanges that shift high basis property for low basis property, followed by a sale of the low basis property, effectively "cashing out" without recognizing gain.

If you sell a property to a related party as part of a 1031 exchange, both you and the related party must hold the exchanged properties for at least two years following the exchange. If either party disposes of the property within this period, the exchange may be disqualified, and the deferred gain may be recognized.

If you are renting to a related party everything just has to be done at fair market value. 

@Tyler Speelman Hey! This actually seems like a great scenario for a 1031 exchange based on what you've said. If I understand correctly your siblings goals are to sell their rental properties, use the funds to purchase a primary residence they'll eventually move into, and limit their tax liability correct?

Your sibling can use a 1031 exchange to defer capital gains taxes on the sale of the rental properties by reinvesting the proceeds into like-kind investment properties. They can rent the property they purchase to you (or anyone).

The property must be held for investment purposes for at least 24 months immediately following the exchange. During this 24-month period, the property must be rented to another person at a fair market rental value.

After the 24 month period your sibling could convert it into a primary residence. This not only defers the taxes on the two rental properties but then once they live in the primary residence for at least 2 years that home now qualifies for the Section 121 exclusion on the gain. This strategy allows them to eventually exclude up to 250,000 (500,000 if married filing jointly) of gain from taxes when they sell the property as a primary residence.

Hope this helps! If you have any questions let me know.

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While this tool is a valuable resource, it's always recommended to consult with a CPA or tax professional for personalized advice regarding your specific situation.