The Flip Board® – Real Estate Blog

The U.S. is facing a foreclosure crisis. We are about to enter into a commercial property crisis as businesses can’t afford monthly rents. But, for the newbies out there, let’s just stick with residential property in this discussion.

Did you know homeowners do not always have to go through foreclosure when problems arise?

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(Listen Here 4:57 min)

Normally in a 1031 exchange, you defer all of your capital gains (both from appreciation in value and depreciation deductions taken over the years) by acquiring a like-kind replacement of equal of more value; and equal of more equity.

In Tax Law – Nobody Wants Surprises

There are some situations when the relinquished property will have some tax complications (snakes in the grass) that could cause you to unexpectedly  recognize gain.  To make matters worse, the surprise gains could be characterized as ordinary income and taxed at higher rates than mere capital gains rates.

What Do You Need to Check Out?

Here are some things to check out with your CPA, accountant or tax attorney:

Tax Credits

When Congress wants to encourage investors to do something…they provide tax incentives.  One of the most effective tax incentive is to offer tax credits.  Tax credits are more valuable than mere deductions because they off-set your tax liability dollar-for-dollar. The problem is that tax credits on your relinquished property for either  “rehabilitation expenditures” under Section 47; or from “low income housing” under Section 42 may be recaptured. Both of these Tax Code Sections allow for recapture of the amount of the tax credits.  It is always prudent to check with your accountant BEFORE you sell…just to make sure you do not have any problems with old tax credits.

Special Recapture for Rapid Deprecation

If you were able to take rapid deprecation under Section 179 or you qualified for bonus deprecation for investment in the Gulf Opportunity (GO) Zone areas impacted by hurricanes Katrina, Rita, and Wilma, then you need to check into the recapture provisions of those specific programs if your property ceases to be Qualified GO Zone Property.

Section 1245 Gain

Cost segregation engineering studies are often used by property owner to peel out those components of a piece of real estate that can be more rapidly deprecated.  A typical commercial building is deprecated over 39 years.  That is a long deprecation schedule.  A multi-family apartment building can be deprecated over 27.5 years.  Certain components of real-estate can be re-classified and more rapidly deprecated over a 5..10..15 year schedule. Those components can cause you to have recapture, unless you are mindful and when you buy your replacement property you buy qualifying property that matches up component for component with those Cost Segregation properties that were more rapidly deprecated.

Conclusion

Be on the look out for recapture that could spoil your 1031 exchange.  Talk to your CPA or tax advisor and have them run a projection to make sure that there are not any snakes lying in the grass…waiting to give you the tax bite.

(Listen Here 4:26 min)

Cars and trucks are getting more like-kind. The IRS recently issued a private letter ruling (LTR 200912004) specifically to a tax-payer that was a rental car company that conducted ongoing 1031 like-kind exchange programs. So, every time they disposed of their old rental cars, those were the disposition of “relinquished properties”. Every time they brought in new cars into their rental fleet, those were the “replacement properties”. This was an ongoing cycle, a program of exchanges that had been incorporated into their business model to have the most efficient (tax neutral sale) disposition of their properties. This particular taxpayer had a conundrum, because appreciable personal property such as rental cars are broken into different asset classes.

Cars and Trucks…Depreciable Tangible Personal Property are
 Normally Only Considered Like-Class to
Other Depreciable Tangible Personal Property in
the SAME *General Asset Class*

There are thirteen different “general asset classes” set out in Rev. Proc. 87-56. Two of those asset classes are applicable to this taxpayer’s property. Asset class 00.241 is for general purpose light duty trucks, while asset class 00.22 is for cars and taxis. Depreciable tangible personal property is of a like-class to other depreciable tangible personal property if the exchanged properties are either within the same General Asset Class or within the same (North American Industry Classification System – NAICS) Product Class. The conundrum that this taxpayer had is that since these general assets had been created, the car industry has morphed, and we now have ‘crossover vehicles’ and ‘sport utility vehicles’ and little ‘minivans’. There are cars that look like trucks, and trucks that look like cars, and it is hard to determine whether these automobiles and light duty trucks and crossovers (in the middle) are like-kind. Especially if they are in separate general asset classes.

Throw Out the Mumbo Gumbo “General Asset Classes”

Alright, this private letter ruling from the Internal Revenue Service is very taxpayer friendly because this acknowledges that the industry has changed, and that the regulation of automobiles has changed. The IRS basically said “Look, even though these items are not in the same general asset class, they can still be considered like-kind”. So, this private letter ruling is taxpayer friendly in that it acknowledges that the car industry has changed, and it gives the taxpayer the ability to exchange an SUV for a car… a light duty truck that is less than thirteen thousand pounds in weight for another automobile or SUV or minivan that is in that same general ‘genre of automobile’.

1031 Exchanges Just Got Easier

This private letter ruling is good for the U.S. automobile leasing industry. It is good for consumers, and it is good for America because Section 1031 stimulates economic growth by allowing business owners and investors to move their capital to the most advantageous replacement property. It also minimizes a drag that normally would occur from income tax and capital gains taxes. Section 1031 helps the automobile leasing industry, and it can help other investors and business owners also. Section 1031 is broader than just real estate. We can see in this private letter ruling that automobiles, light duty trucks and minivans all quality for 1031 treatment if they are exchanged for other like-kind property that will also be used in their trade or business of the taxpayer.

MGM Mirage hired bankruptcy counsel in a last-ditch effort to salvage an $8.6 billion resort and casino development in the heart of the Las Vegas strip.

Commercial real-estate loans are souring at an accelerating pace, threatening to exceed the commercial downturn of the early 1990s.

With foreigners returning home and banks reining in loans, the global crisis has shattered Singapore's goal of reinventing itself as a financial and entertainment hub like Dubai or Monte Carlo.

Dubai World is suing MGM Mirage, saying the casino operator is violating terms of their partnership in a Las Vegas project.

A number of shopping developments are slated to open this year, even though many will be less extravagant than initially envisioned.

(Listen Here 5:43 min)

Assembling the Full Team of Experts is Wise to Do

This podcast is entitled Pennywise… 1031 Foolish. What I mean by that is when you are doing a 1031 Exchange, you do not want to cut corners on the professional advisers that you need to complete your exchange. You want to have your team assembled, and you want to have the full complement of professional services available. So, if a problem comes up, you can get through it.

#1 Your 1031 Exchange Qualified Intermediary Acts as an Insulator

First and foremost, when you are doing a 1031 Exchange in a delayed fashion, where you have 45 days to identify and 180 days to complete, you need to have a Qualified Intermediary. The Qualified Intermediary will act as an insulator – someone who is going to hold the proceeds so that you don’t have actual or constructive receipt of the monies. In addition, the Qualified Intermediary also can prepare the exchange agreement, the assignment agreement, and the required written notices to the parties. They can interact and make sure that the paperwork which documents the exchange is properly set up.

#2 Your Title Company or Law Firm Acts as Settlement Agent

In addition to a Qualified Intermediary, you need to have a settlement agent. Typically, in the real estate realm, closings are conducted by either a title company or a law firm. Whichever one you have, you want to use a sophisticated operation that is familiar with commercial real estate transactions - more precisely, 1031 Exchanges. Because the learning curve can be rather steep, you don’t want to have an outfit that doesn’t do what you need. You want someone who is experienced with 1031 Exchanges, so they will set up your transaction and disburse the monies correctly.

# 3 Your Real Estate Agent is Doing More
than Collecting a Big Commission

Also, if you are doing real estate, you want to have the best and the most experienced commercial real estate agent – broker involved. People in the process need to be familiar and comfortable with 1031 Exchanges. Many of the things that they do behind the scenes can make the process much easier for you. For example, a real estate agent should put a cooperation clause in the listing agreement and in the purchase agreement that says that the parties understand that the taxpayer is doing an exchange and everyone agrees to cooperate with that. If you don’t have an experienced real estate agent, you are not going to finish all of those things that need to be done behind the scenes. 

#5 Your CPA Reports the Exchange on IRS Form 8824

Also, having a CPA involved in the transaction can be very helpful. Many people don’t think to call their CPA until the exchange is over. However, that is tough on the CPA because then they have to forensically figure out what was done, and they have to dissect the transaction in the rearview mirror. Rather than do that, you will want to involve the CPA early in a consultation, and then keep them posted as you progress through the process. That way, when it comes time to report the exchange, they are familiar with the transaction. They will know the date on which you identified your replacement property because you communicated with them throughout the process. Therefore, your CPA will be able to report the transaction correctly.

#6 Your Tax Attorney Is On Call To Give You Advice And Legal Opinions

Another critical person to have on your team, or at least on your bench, is a tax attorney. A tax attorney can do the research, and more importantly, give you an opinion on questions that you might have during the 1031 process. Some of the questions might be as follows: “Can we do this exchange? Is this appropriate? What are the parameters? Where is the gray line turning into black?” The tax attorney is a critical player, and many people overlook this because they think that this is so cut and dried. However, as in most things in life, and especially in the area of tax law, not everything is cut and dried. Therefore, you need a tax attorney on your team from the outset.

#7 Your Financial Planner Makes Sure Your Assets Match Your Goals

The last person that you want to have on your team, and the person that you don’t often think about, is a financial planner. This person will be an adviser who can make certain that the properties that you are purchasing as a replacement are appropriate for your overall portfolio of investments. If you are ninety-nine per cent in real estate and don’t have any exposures to stocks, bonds, gold or other investments, perhaps you need to rethink this and do a partial 1031 Exchange. Or, you might find a way to finance your real estate holdings to expand and diversify into other areas. So, a financial planner can be a critical part of making certain that the replacement properties that you buy are appropriate with your overall goals, your adversity to risk, and the length of time that you think you will hold these properties.

The World Trade Center rebuilding, already hobbled by delays, is facing fresh problems with developer Larry Silverstein asking the government for crucial financial assistance.