All Forum Posts by: Dylan Johnson

Hi @Mary Chen, 

If we are utilizing a 1031 exchange on the sale of this property the expenses you incur for repairs wouldn't necessarily fully translate to cash in hand at closing without potential tax burdens. With this being said I am not a licensed tax professional and your question is probably best suited for an accountant. 

To facilitate a 1031 exchange where you are deferring 100% of the gain, you would need to purchase a replacement property that is equal or greater in value to the total sale price, less closing expenses. The maintenance and variable costs you referenced above would not fall under closing expenses in the above sentence. That would be fees such as real estate commission, title costs, qualified intermediary fees, etc...

@Rich Solano, 

I wanted to provide one additional route you could look into adding on to what @Jon Taylor mentioned. 

There is a 1031 exchange called a "swap & drop" exchange that operates similarly to Jon's second example just flipping the timeline. This exchange would function in the name of the Partnership and said partnership would acquire separate replacement property that would be allocated after purchase to each of the owners individually. This would allow us to retain the tax identity of the partnership but also split the purchases between each of the partners. 

Let me know if I can answer any further questions about this! 

Hi @Rachel Payton, 

The house you are looking at purchasing, does it have a separate space set aside solely for the business or is it a "single family" type home that will just serve as a home office? 

@Kevin Sobilo, is generally correct in what he mentioned, however, there are a few revenue procedures that could allow for a split allocation of investment & primary portions of each where we could still discuss an exchange. 

Feel free to shoot me a direct message and we can discuss further. 

@Lesley Stoll I would be more than happy to answer any questions you might have surrounding the 1031 exchange process. No strings attached of course. We are a nation qualified intermediary and I would be happy to help! 

@James Bakun

Form 8828-B would need to be filed by the clients CPA preferably and the CPA would be able to advise on all the relevant information to include with the form. My understanding is the form itself is alerting the IRS to the plans of a 1031 exchange. 

The IRS is only looking for a copy of the relinquished property sale contract, they don't necessarily need the contract for replacement property right away as the FIRPTA exemption needs to be approved prior to the closing on the sale of relinquished property. 

Once the exchange is completed the CPA will report all necessary information relevant to the exchange at tax year end. 

As @Dave Foster said FIRPTA is a tough nut to crack. Everything aforementioned is great information, I just wanted to provide a little extra color in the hopes it assists your client's decision. The below is information put together by David Gorenberg, J.D., one of our subject matter experts. 

US Real Estate Ownership Among Foreign Citizens

According to the Congressional Research Service, foreign citizens own 3% of all US real estate, with investors from Canada, Netherlands, and Italy accounting for about half of that. As of 2019, the states with the highest number of foreign-owned acres were Texas (4.4 million acres), Maine (3.3 million acres), Alabama (1.8 million acres), and Washington and Colorado (1.5 million acres each). Arkansas, California, Florida, Georgia, Louisiana, Michigan, New Mexico, Oklahoma, and Oregon each report approximately 1 million acres owned by foreign citizens. What happens when these foreign owners want to sell their US real estate?

What is FIRPTA?

The disposition of any interest in US real property by a foreign taxpayer is subject to the Foreign Investment in Real Property Tax Act of 1980, commonly known as FIRPTA, income tax withholding. In short, what this means for the foreign seller of a US Real Property Interest is that the buyer of that interest must withhold 15% of the purchase price at the time of the sale. This applies to all transfers by foreign taxpayers – whether by sale, exchange, liquidation, redemption, gift, or otherwise. The recipient of the property – the buyer, transferee, purchasers’ agents, and settlement officers are tasked with holding back 15% of the purchase price, rather than paying it directly to the foreigner investor. If the transferor were a foreign taxpayer, and  the Buyer or settlement officer, fail to withhold those funds, they could be held liable for the tax.

FIRPTA withholding does include exceptions to the withholding rules. As applied to 1031 exchanges, the most relevant exceptions that allow you to disregard FIRPTA include:

• You (the Buyer) are going to be using the property as your principal residence, and the fair market value is less than $300,000
• The Seller provides you with a Certificate of Non-Foreign Status (meaning that FIRPTA does not apply)
• If the foreign Seller obtains a FIRPTA Withholding Certificate by filing Form 8288-B.

It is important to note that the foreign Seller cannot submit the Form 8288-B until there is a valid real estate contract. The completed form should be submitted to the IRS promptly, and before the actual closing date on the sale. Any form submitted after the closing date will be deemed by the IRS to be untimely and require that the mandatory withholding amount be sent to the IRS within 20 days of the closing date.

As a practical matter, all of this has two key impacts:

• 1031 exchange Buyer of a foreign person’s real estate – As the 1031 exchange Buyer of a foreign person’s real estate, you would be required to withhold 15% of the fair market value of the real estate, typically the purchase price, at the time of closing. More often than not, this task is completed by the settlement agent or escrow agent, but a prudent buyer would ensure compliance.
• Foreign investor selling as part of a 1031 exchange – When the foreign investor is selling as part of a 1031 exchange, that investor is advised to submit Form 8288-B as soon as they have a contract for the sale of that property. If the 8288-B is not submitted before closing, the Buyer will be required to withhold, and to then remit, the 15% to the IRS by the 20th day after closing. It typically takes the IRS up to 90 days to process requests for refunds or exemptions using Form 8288-B.

Buyers, closing agents, and Qualified Intermediaries such as Accruit are required to comply with FIRPTA withholdings. Whether you are a 1031 exchange buyer of a replacement property from a foreign taxpayer, or you are a foreign investor selling as part of a 1031 exchange, you should consult with your tax or legal advisors well in advance of the closing.

@Jack Little The note itself, shouldn't really need any specific language for the 1031 exchange. Generally if the note is being held by the QI it is preferred that said note is written in the name of the QI from the beginning. If not, could risk constructive receipt issues. 

The note itself can be documented close to the same as any other holdback, I would venture in saying legal council would be better resources to help draft this than a QI. 

I assume if the QI is holding the note, this belongs to the taxpayer engaging in a 1031 exchange? 

Hey Steven, 

Generally homes such as yours that may fall into the "fix and flip" category do not meet the qualified use regulations for 1031 exchanges. On either side of a 1031 exchange, the property must have intended to be held for a productive use in a trade or business. Property that is purchased and fixed then sold generally falls under intended primarily for sale. 

The IRS does not view these properties favorably and lumps them in with Stocks/Bonds/Membership in an entity etc... Another regulation we look for is that the property was rented out for a minimum of 14 days out of the year each year. 

There are some cases in our industry where the improvement portion of a purchase does not even count towards a taxpayer's 2 tax reporting year holding period. Meaning, after the home was fixed you could be looking at an additional 2 years of rental before it would qualify under section 1031. This is an area of many varying views. 

Feel free to DM me and we can speak on this further, it is one of the most common situations we deal with. 

Hi Ian, 

Because 1031 exchanges are a method of tax deferral, not tax avoidance, you will need to go back and look at the original property's "basis" when estimating your capital gains tax. Generally QI's cannot act as licensed tax professionals so this will need to be a conversation had with your CPA or licensed tax professional to get granular on the numbers. 

There will be recapture from the first 1031 exchange property, the full amount and calculation would be where your CPA steps in. 

Hope that helps! 

Hi Arielle, you definitely still have enough time to get a 1031 exchange setup! We normally ask for 48 hour notice minimum before a rush fee is charged. Even in that case we can get one turned around in 24 hours depending on the complexities. 

If you are only doing a partial exchange, I wouldn't mind going over the numbers together to make sure it does make sense for you. With that being said, more than likely will still hold some deferral benefit.