Reverse 1031 Exchange Questions
Never having done one, I know little about 1031 exchanges, especially reverse exchanges. My understanding is that it is possible to purchase the replacement property BEFORE selling the relinquished property.
Questions:
Can I use a property I have already bought, or do I have to identify it as an exchange property before I buy it?
Is there a time limit on when the funds have to be received from the relinquished property after the replacement property is purchased, such as the 180 day limitation after the relinquised property is sold?
Can I combine a reverse and forward exchange- in other words, buy one property prior to the sale of the relinquished property, and another after the sale?
If I fail to use all of the funds received to purchase replacement properties, are all of the residual funds considered capital gains or only the percentage that represents your percentage of profit on the sale? (In other words, if I sell a property for twice what I bought it for but only spend 75% on replacement properties, is the remaining 25% all capital gains or is only half of it?)
Can I accept a down payment in cash this year, then 1031 the balance when I "receive" it next year?
Thanks for your help!
Chris
Can I use a property I have already bought, or do I have to identify it as an exchange property before I buy it?
No, the replacement property in a 1031 exchange is must be property that you will purchase. Property you already own can not be used as the replacement property.
Is there a time limit on when the funds have to be received from the relinquished property after the replacement property is purchased, such as the 180 day limitation after the relinquised property is sold?
Yes, there is a 180 day rule in place for the reverse exchange. The clock starts on the day your QI purchases the replacement property. From that date, you have 180 days to sell your relinquished property and have the net sale proceeds deposited into your exchange escrow account.
Remember that this is a reverse exchange. The triggering event that opens the exchange window is the purchase of the replacement property. The sale of your relinquished property closes the exchange.
Can I combine a reverse and forward exchange- in other words, buy one property prior to the sale of the relinquished property, and another after the sale?
Yes you can, but, it has to all be accomplished under a single exchange umbrella. In effect you have one relinquished property and two replacement properties. When the first replacement property is acquired in your reverse exchange, the 180 day exchange window opens. During the next 180 days you will have to sell your relinquished property AND acquire the second replacement property to complete the exchange.
If I fail to use all of the funds received to purchase replacement properties, are all of the residual funds considered capital gains or only the percentage that represents your percentage of profit on the sale? (In other words, if I sell a property for twice what I bought it for but only spend 75% on replacement properties, is the remaining 25% all capital gains or is only half of it?)
All of the residual funds in your exchange account will be cash boot and taxed as a capital gain in the same manner as it would have been without an exchange. This means that the residual funds will first be applied to unrecaptured depreciation and whatever is left will be taxed as capital gain from appreciation. The amount taxed as unrecaptured depreciation will become recaptured depreciation that is reflected in an adjusted basis in your replacement property.
Can I accept a down payment in cash this year, then 1031 the balance when I "receive" it next year?
Yes, you could but the amount of downpayment cash received will be taxable cash boot as in the example above.
I wanted to clarify the information here regarding combining a reverse and forward 1031 exchange transaction and the 180 day period.
The amount of time that you have will depend on which property is "parked" by the Qualified Intermediary.
Parking the replacement property will start the 180 day period for the reverse 1031 exchange, but not the forward 1031 exchange, because the actual 1031 exchange has not been completed yet. It is actually a parking arrangement upfront with a simultaneous 1031 exchange at the back end. The simultaneous 1031 exchange can be used to start a new forward 1031 exchange at the back end with another 180 days.
However, if the lender is not willing to participate in the reverse 1031 exchange and the relinquished property must be parked, then it is really a simultaneous 1031 exchange up front and you only have one 180 day period beginning with the close of the replacement property.
[addsig]
Bill,
Since Revenue Procedure No. 2008-16 specifies a 2 year qualifying use period for both the relinquished property and for the replacment property in an exchange, a sequential exchange scenario solution is not available here.
As I see it, the reverse exchange and the forward exchange have to be accomplished under a single exchange umbrella where one relinquished property is exchanged for two replacement properties (one to be constructed, the other to be purchased)
But, correct me if I am wrong, if I am considered a real estate professional, then I can take unlimited losses?
You are correct, the $25K net passive loss allowance does not apply to real estate professionals who actively manage their own rental properties.
If your income is so high that your net passive loss allowance is phased out, then I am guessing that you have a full time job with W-2 income. If this is the case, then I seriously doubt that you spend enough time managing your rental property during the year to qualify for real estate professional status.
You are not a real estate professional just because you own real estate, even if you own the LLC that owns real estate. To qualify as a real estate professional, you have to satisfy material participation rules in a real estate business, and the time spent in your real estate activity must be (1) at least 750 hours, and, (2) more than 50% of the time you spent in all activities combined.
Depending upon how your LLC is taxed, or if your property is held in trust with your LLC as the beneficiary, you could be ineligible to use the net passive loss allowance regardless of your income or real estate professional status.
Consult your tax advisor for specific details.
[ Edited by NewKidInTown3 on Date 04/08/2008 ]
Thanks everyone for the info!
Finniganps Posted: 23:49 on 04-09-2008
To minimize your tax hit in the future, you can keep the properties for 366 days as a RENTAL then sell them to get long term capital gains tax rates (max 15%) and NO self employment taxes
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My question Do you have to RENT the property or just have (OWN) it in your name. I see different ideas from different post in different forums
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FROM ANOTHER FORUM. “the long term capital gains apply to property HELD for more than one year....he has not held it (Owned it) if he sells it in less than one year
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My question to that other forum post
I purchased the property in Jan of 07, sold it in March of 08. (14 months). So I have held the property for the one year and one day time requirement. Sounds good so far but I have also heard that you must have been RENTING , leasing etc. the property, not just OWNING it in your name and it just be sitting there . Any guidance on this.
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OK TCI members what is it. Do I have to RENT the property or just OWN it in my name and possession?????? Thanks
Great news I was just on the phone with the IRS. You can call an 800 directory, and ask for the IRS. When you contact them ask them for there business department. Basically when you sell a contract you would pay under ordinary income. I found this out when I was transferred to there COMPLEX ISSUES Dept. By the way they do not have an ordinary number for this dept, you can only be transferred there.
Business IRS number 1-800-829-4943
Also the primary info concerning this and profits and losses in real estate are Publication 544. Chapter 1 goes in great detail, for current 2007 returns.
You will pay SE tax, but the reasons for an entity like an LLC, S-Corp, or Corp are the following:
-Veil of protection
-Deferring SE Tax
Since you do not own the property, and only assigning you interest in the property you do not pay capital gains. You would have to either had owned the property in your name.
On the bottom of Pub 544 there is a list of Tax Publications for Tax Payers, this includes info on Trusts as well.
THS44- yes, I agree that you will have to pay SE tax.
Haynesm, it is all about intent. If your intent is to flip the property, even if it takes you two years to sell it it is still a flip. If your intent is to hold it for investment, even if you are unable to rent it out and so choose to sell it your intent was to hold it, and so LTCG rates apply.
Advertising it for sale during your first year of ownership shows intent to flip. Advertising the property for rent/lease shows intent to hold, as does taking the depreciation deduction on your first tax return after the purchase. The key is to prove intent.
Chris
Thanks so much for the quick reply. I have the nolo book and found it to be a great reference. I just turned my residence into a rental when we bought the duplex, now I am feeling overwhelmed with options and tax implications.
1. So, if we agree to have 50/50 ownership of the duplex, because its in my husbands name we will file a Sched E and not C-EZ (MFJ), because he will be receiving the 1099’s? (…. we will be writing up a partnership/other agreement once I know what we should be doing).
I am an architect, and just remodeled the duplex and have increased the ‘value’, I was wondering if we should refi it and pull money out to make our taxable income less when we rent it, and to do some more work? Do I get any tax break for doing the work…or how can I compensate myself? If we earn above 150k, we are limited to our deductions right (AMT)?
2. Don’t we want a rental loss: because overtime the rents will increase and we’ll be paying more taxes?
Do you have any tips for other places I should be doing research?
A Clarification for Clara-
A refi in and of itself will not increase your expenses (beyond the loan cost, of course!). Although you will be paying more interest on the higher loan amount, only the portion of the interest paid for the money that went into the property is deductable from your rental income. The interest paid on the cash you pull out, if that cash is spent on something other than improving the property, is not deductable.
Chris