All Forum Posts by: Sean Ross

@Bill Exeter is correct, I misinterpreted your question @Nicholas Lovric.  The payments received by the seller over time are still taxable to the seller as long-term gain (though the seller may want to consider possible changes to how the feds treat gains taxes in coming years).  Spreading out the gains over multiple years can even lower the effective rate paid depending on circumstance, since all of the income is not reported in one tax year. In other words, the seller may drop from a 20% long-term gains bracket to a 15% long-term gains bracket or potentially even avoid the 3.8% NIIT tax on some income. 

I don't know how much gain and depreciation recapture was deferred with the seller's prior 1031. Those past deferred capital gains would not instantly become taxable in the year of sale (but depreciation IS recaptured in the year of sale).

@Nicholas Lovric, this is a complicated question. 

Seller financing in a 1031 exchange is difficult.  A few reasons why:

•  In any 1031 exchange you only get tax deferral to the extent that you replace Real Estate with Real Estate (the "like-kind" requirement). The IRS interprets the seller's owner-carry note as receiving a non-like-kind asset.
  
  
•  100% of the recapture depreciation allocable to the installment note will be subject to taxation in 2021. (Seller may find themselves cash-poor to pay this tax if they've used their proceeds to make a down payment in the 1031 exchange)
  
  
•  The tax basis in the note is equal to its face value. 
  
  
•  Income received through the installment portion is taxable as the seller receives payments and they will owe capital gains on those. Interest earned on the note is taxable as ordinary income.

Better options?

1. Seller brings cash to make up the difference. Substitute a new cash loan rather than owner-carry finance. That new cash (now a lump-sum and not coming as installments) goes into their 1031x escrow account. They can use all of the proceeds now to buy a replacement property. 

2. The seller-carry note can be drafted as payable to the 1031 intermediary. This way, the 1031 intermediary can sell the note (either to the seller, or a related party, or even on the secondary market) and then add the proceeds to the 1031x escrow account. 

3. Exclude the note from the exchange. Only 1031 exchange out of the portion of the real estate allocable to the available purchase funds at closing.  This might make it easier to trade into a replacement property of equal or greater value. 

@Travis Salley, I agree with @Corby Goade that we would need more information on what you consider a great deal.  What's the primary goal here?  Appreciation? Income? Tax efficiency? Flexibility?

As far as valid 1031 exchange properties, I can help you there. 

The IRS requires that any relinquished or replacement property in a 1031 exchange be "held for investment or use in trade or business", which is a very broad and liberal term. You can invest in residential, commercial, single-family, multi-family, TIC interests, raw land, oil and gas rights, water rights, conservation easements...and many other options too.

Hope this helps. 

@Sheri Lowrance we have a lot of realtor relationships in FL (some of our employees work remotely from FL) -- I'll share some contact info with you in a private message. 

@Lance Friesz

Dave has you covered for the basics and options.  The only option I want to add is...

- say your current rental is worth more than the ADU
- say the ADU has the bones to support some additions or there is land to build something else
- you could do an "improvement" 1031 into the ADU and thus make it more valuable as a replacement property to that you get full tax deferral in your 1031.  

Improvement exchanges are more complicated and must be structured very carefully. 

Let me know if you want more details on process/rules.  

@Cole Shope, let me elaborate a little on @Zach Westerfield's point about 1031 exchanging and tax benefits there. 

1. 1031 exchanges allow for tax deferral, which effectively acts like an interest-free loan from the government equal to the taxes you would normally owe upon sale. To do this, you reinvest your sale proceeds into a property of equal or greater value (and you must use a 1031 intermediary to perform this action). As Zach mentioned, you may do this indefinitely!

 2. You don't necessarily need to wait 12 months to be eligible for a 1031 exchange.  "Time held" is only one of many factors that the IRS considers.  What matters most is your intent for the property -- and it's possible to have the intent to hold for long-term business or investment use even if the property sells before 12 months. 

 3. When you do a 1031 exchange, you don't reset to a brand new cost basis in the new property.  Your old basis carries forward with some adjustments.  So you will likely lose out on a little bit of depreciation.  This is not always a huge factor, but important to know. 

No doubt @Mike Dymski!  Thanks for the clarification

@Mike Dymski, converting investment into primary (for the exclusion) can be a good thought and a common plan among long-time investors.  But make sure you understand the distinction that @Dave Foster points out when he says 

"Because it is a converted investment they will have to prorate the gain between the period they lived in it and the period it was a rental. But at least part of the gain will be tax free."

It used to be true that you could really take full advantage of Section 121 home exclusions every 2 years on former investment properties, but the benefit is rather diluted now.  Much of your gain will not be excludable and the depreciation recapture won't be excludable either.  For example, a 5-year investment property that is converted into a primary for 2 years and then sold will only have Section 121 apply for 2/7 of the gain allocable to those years that you treated it as a primary. 

Dave makes another good point on the DST/TIC front. Those are solutions that could very well fit your goals while maintaining some tax efficiency.

Happy Monday @Nick Gray, and hello Manchester (a really cool place!)

There is no specific statutory holding period for a property to qualify as "held for investment" in a 1031 exchange.  The IRS (and the regulations) care most about "intent" and pattern. 

You may hear some advisors suggest only 1031ing properties held for 12+ or even 24+ months. But this is the height of caution.  Time held is only one factor that determines your intent as an investor. 

If you make a habit of buying and selling too quickly, the IRS could deem you a "developer" and suggest that your property is "inventory" rather than real property held for investment.  But if your fact pattern is different (maybe you have several other properties held for long-term use), then you are in good shape to do an exchange. 

Be careful about how the sale and any future project are structured; partnership interests are not eligible for 1031 tax deferral. 

Hope this helps,

@Henri Chow, my partners and I run a very technology-focused (and tech-curious) QI and we tend to get a lot of clients that like good, simple, sleek, automated services.  And there are simple things any financial services business can automate or present that make investors' lives easier. 

But the crux of good 1031 work isn't understanding the mechanisms (which, after a little practice, are usually reflexive). It's about (A) security and (B) an eye-to long term objectives that are situational. 

As advanced as we like to be, our on-boarding is old school. We're always willing to listen to any  new or interesting ideas. But tried as we have, the client intake and strategic elements of 1031s don't fit automation. Especially if you leave the world of simple forward "delayed" 1031 exchanges. 

Hope this helps and good luck!