1031 exchange, convert to principal residence

Dear 1031x.com,  If a property was initially bought as an investment using a 1031  exchange method, and now will become an owner occupied residence due to a  divorce, how does this affect the deferred tax status, both now and if the  same property is sold for another owner occupied residence?

Dear Mr. A: You have 1031 exchanged into a property, and now, due to a divorce, have converted the use of the property from investment use to principal residence use.  Your tax treatment going forward is as follows:  After you have lived in the property for two years most of the gain realized upon sale will be tax exempt under IRC section 121.  Under this code section you must have owned and lived in the home for two out of the last five years in order to qualify for tax exemption.  Once you qualify for this exemption  only one piece of the realized gain will NOT be tax exempt.  During the time that this property (or the preceding property which was part of your 1031 exchange) was held for investment, you probably took a depreciation allowance.  Any depreciation taken between May 1995 and the date it was converted to principal residence (the date depreciation allowance stops) will be recognized (taxed) upon sale of the property even if the rest of the gain qualifies for tax exemption under IRC section 121.  Call with questions,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
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owner carry mortgage, boot, 1031 exchange

Dear 1031x.com: As an incentive to buyers of my exchange properties I would like to offer to take back a 2nd. My properties all have very low basis and I understand my 2nd trust would be treated as boot.

 

Say the property was initially acquired by me for $120,000 coming from another property that I sold. The acquired property has a basis of only $20,000 due to many years of depreciation and exchanges. Say I sell it for $300,000 and the mortgage to be paid off is $100,000. I take back a 2nd in the amount of $10,000. I would replace the property with an exchange property of equal or greater total price and debt.

 

Is there a way to not end up paying $10,000 in taxes out of the $10,000 boot?

 

Maybe I can add $10,000 of my own to increase what I invest in the replacement property. Maybe I can take on a larger mortgage and more expensive replacement. I have no idea how to calculate the tax on the boot or what are my options, if any, to minimize the tax on the boot. Can you tell me my options? Even more of a challenge: can you explain it so I can understand it?

 

Thanks, C

 

Dear C:  I am going to use your numbers when replying to you.  Because the size of the owner carry is small ($10K)  I am going to suggest a specific strategy.  Instead of carrying back the mortgage, raise $10K of cash from another source.  Bring it to closing and lend it to your buyer.  Now the $10K will come back to you at closing and will be part of your 1031 exchange.  In this strategy you will not have any boot.  If you carried back a mortgage your tax basis in the carry back would be ZERO.  With my strategy your tax basis in the $10K mortgage is $10K.  With my strategy when you are paid back the $10K you pay no tax on the principal.  You only pay tax on the interest.  Call with any questions.

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

infox@1031xcastle.com

1031 exchange child as tenant

Dear 1031x, My mother is 73 and selling her house that was 75% rental. She lived in 25%. She will be receiving 2.3 million. She'll be paying off a mortgage
> of $250,000. After closing costs she'll be left with around 1.9 million. She bought it in 1967 for $23,000. So there really is no cost basis. She is thinking
> about buying 3 properties, putting $200,000 down on each and having her 3 children pay rent to cover the remaining mortgages on the properties. Can these be 1031 exchanges? Are relatives allowed to be tenants in 1031? Also we were wondering, considering her age would it make sense tax wise for her to buy a condo for herself or just rent? Thank you,

 

Dear C:  I really like the plan that you propose.  The children, tenants, can each pick out a home that they want to live in and one day receive by inheritance.  Then they can pay rent to Mom providing her with income as she gets older.  This is a perfectly valid 1031x.  Children can, and often are, tenants in their parent's property.  However, I urge each of you to pay a fair rent to Mom.  If the rent is not close to what it ought to be then the 1031x could be challenged.  However, the tenants (children) could take on additional responsibilities, like paying property taxes, insurance and upkeep on the properties, thereby lowering their rent payments.   As far as Mom buying a condo or renting, at her age, I kind of like the idea of her renting.  She can thereby keep 25% of the sales price (the part she lived in) in the form of cash.  This might give her a comfort level that people her age often like.  I want you to use us for your 1031x.  How can we earn your business?  Sincerely,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

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1031 exchange calculate depreciation

Dear 1031x.com: I'm interested in the 1031 exchange on a property I'd like to  sell in Seattle.  How do I find out the depreciation on my house?

Dear C:  Depreciation is taken on improved property gradually and year by year.  Usually the annual depreciation allowance is the same every year.  However, there are accelerated depreciation schedules that are sometimes used.  The only way for you to determine your accumulated depreciation is to examine your past tax returns.  Look back at the last several years.  If the depreciation taken is the same for each year then it is a pretty safe assumption that the same depreciation was taken every year since you acquired the property.  Multiply the annual depreciation taken by the number of years owned and you will have you total accumulated depreciation.  Please note the when a property is acquired or sold during a year you usually get less than a full years depreciation allowance.  Please choose us for your 1031 exchange.  Sincerely,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

infox@1031xcastle.com

1031 exchange beneficial interest in trust

Dear Steve: The reason you would want to exchange the beneficiary interests is for
anonymity.  Bill puts out a lot of information on wealth preservation.  Of
course when you do this you would want to assign another successor trustee
to take care of the respective trusts.  The trust do not have a separate tax
ID number.  They file under the individual Social Security number.  In the
state of Washington there's a lot of nice things that can be accomplished if
you just exchange the beneficiary interests leaving the trusts in place.
For one thing it's a very simple transaction.  You don't have to have escrow
as long as the properties are free and clear.  Bill said that he exchanged a
property like this himself.  I'm just wondering if he's the only one in the
world that does anything like this.  Or is he creating a tax liability he
does not know about.  Or if he's full of hot air.    Thanks, Brad

Dear B: I  appreciate all of the additional information.  These trust appear to be disregarded entities.  You describe the other benefits of swapping beneficial interests.  As long as everyone is comfortable closing without escrow, then I see no reason not the exchange beneficial interest in the trust, trade trustees, and rewrite the trust documents to suit yourselves.  This would in fact be two 1031 exchanges from a tax reporting standpoint.  Is there a trust registration process in WA?  If so then the transaction might need to be reported somehow in WA.  That would be the case in CO.  Remember to review the existing trust documents and make that they can be freely amended.  You don't want to take over the beneficial interest in a trust that cannot be amended to suit you.  Sincerely,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

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1031 exchange beneficial interests in trust

Dear Steve,
you asked me to e-mail you the scenario
here it is:
Property A is owned by Mrs. A., an older woman.  (Actually she owns the
beneficiary interest in a trust)  Property B and Property C are owned by
me(Mr. B).  Property A is in a trust with Joe trustee as the trustee.
Properties B and C are in another trust with David as the trustee (my wife
and I being the sole beneficiaries).  The only thing in these trusts is the
subject property.  Property A's value is conservatively $400,000.
Properties B and C are worth conservatively $200,000 each.  Can we just
switch the beneficiary interests in these trusts and count that as a 1031
exchange?  Would the trust not be a disregarded entity for tax purposes
because it was owned by individuals?

Dear B:  I am not sure why you think that it is a better idea to swap beneficial interests in the trust rather than have the trust swap properties.  To me it makes much more sense for the trust to swap properties rather than swap beneficiaries.  Swapping beneficiaries does not make sense to me.  If you did that you would have "Joe" as you trustee and the elderly woman would have "Dave" as her trustee.  This makes no sense to me.  As far as disregarded entities is concerned I would like to know about each trust.  Does either trust have a separate tax ID number, and file a separate tax return.  I still think that the best thing would be for the trust to swap properties with each trust doing a 1031x.  I hope we can help with this.  Sincerely,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

infox@1031xcastle.com

1031 exchange combined with 121 exemption

>Dear 1031x Comments: I have what appears to be a somewhat complex situation.  My wife  and I bought our home in 2003 (first home).  It's technically a triplex,  we live in the front 2/1 dwelling, and across the driveway is a separate  dwelling that is split into two studio rental units.  I've gotten a job  offer in a different city, so we are considering selling.  We bought for  $765K, and the prop is worth somewhere in the neighborhood of $1.2mil now. 

 Here are my questions:
 1) What is the most appropriate method for calculating the portion of the 
gain attributable to the rental units?  Our house in approx 1000 sq ft, 
and each studio is approx 330 sq ft.  Remainder of the lot (approx 1200 sq 
ft of yard and parking) is used exclusively by us.  According to the tax 
records from when we bought, of the total $765K purchase price, land value 
was $710K and bldgs only $55K.  I think a good argument can be made that 
the investment portion is the sq ft % of the total land, i.e. about 23%. 
What do you think?
 2) In July, one of our tenants moved out and we took over occupying that 
unit (we'll call it Unit A).  We use Unit A as part of our principal 
residence, mainly as a guest room for my mother.  Unit B continues to be 
rented out.  If I hadn't received the new job offer, we planned on keeping 
this arrangement indefinitely.  What are the tax consequences of having 
done this?
 3) Is the gain attributable to Unit A subject to the 121 exclusion?  A 
partial exclusion for the time we've occupied it, since the move is 
"unexpected"?  What if we hold off on selling our house (and don't buy a 
new house in the new location and rent instead) and keep possession of 
Unit A (without renting it) until we reach the 2-year threshhold?
4) Does it make sense for us to do a 1031 exchange for the investment 
portion of our property by buying rental property elsewhere?  If you think 
our current occupation of Unit A doesn't meet the requirements for the 121 
exclusion for the gain attributable to Unit A, would it otherwise qualify 
for 1031?  Or do we need to rent it out again for any length of time 
before we can do the 1031x?
 Appreciate and guidance you can give me.  Thanks!

 

Dear S:  Yes because of your dual use, change in use and change in place of employment your tax question is a bit involved.   Yes you can perform both a 121 tax exemption on the larger part and a 1031x on the smaller investment part.  As far as the percentages assigned to each use any reasonable basis for the division between principal residence use and investment use is OK.  However, you must be consistent historically with currently.  What I mean is that you cannot claim a larger percentage use for investment during your ownership period and a smaller one at the time of sale.  EXCEPT in your case there has been a change of use on Unit A.  Because you are moving for a new job you will be able to claim the principal residence portion AND on unit A all as tax exempt under IRC section 121.  Then you will have a small gain attributed to unit B.  This gain you can 1031 exchange or pay tax on.  Also keep this in mind:  The depreciation on unit A will also be recaptured even if you claim 121 exemption on Unit A.  because of this recaptured depreciation issue on Unit A, you might be better off using 1031 to defer the taxes on both Units A and B, and claiming 121 exemption on the principal residence portion.  I hope this helps.   And that we can help if you decide 1031 exchange is the way to go.

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
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Fax 303.715.1012

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1031 exchange and principal residence

Dear 1031x: We bought a house for 485,000 and have refinanced the house for  both landscape upgrades and also to eliminate some debt.  We now owe  $700,000.  The market value of the home is 1,200,000. Would the husband  and wife $500,000 tax exclusion be based on the 500,000 purchase price or  the 700,000 balance that is now owed on the house?

Dear J:  Your gain will be calculated by subtracting your tax basis from your sales price (minus costs of selling).  In your case your basis is probably close to your purchase price (unless you made capital improvements to the property which would increase your tax basis)  The size of the mortgage bears no relationship to your gain.  Therefore, simplistically your gain will be the difference between $485K and $1.2M. After you add capital improvements and subtract costs of selling, then apply the $500K exemption (IRC section 121)  you will probably still have a small tax liability.  Not a bad place to be. 

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

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1031 exchange or not?

Dear 1031x.com: My 71 yr. old father has relocated to another state and  wants to gift me his house,  He has also signed over power of atty. for the sale  of this house if I intend to do so. I am thinking of selling the home I currently live in and moving into his  home for 2 yrs. to avoid capital gains, although I would rather go into an entirely different house. I think I understand the  concept behind a 1031x but, want to know is there any way we can do this  and not have the replacement property have his name on it? he does not  want to have the responsibility of taxes in his name etc, If we do a quit claim on the property (the house is still fully in his  name) is there any way to 1031x it in my name? or am I just better off  living out 2 yrs to fulfill the irs wish list?? Thankyou

Dear Sir:  As I understand it your father still owns his home and he did not change his principal residence that long ago.  As long as he sells that property within three years after he creates a new principal residence he can sell the house and qualify for tax exemption under IRC section 121.  The best strategy is for him to sell his house, and exempt as much as possible under IRC section 121.  Then he gift you the cash.  You sell your own home and it too qualifies for exemption under IRC section 121.  Of course since no 1031 exchange is occurring you do not need our service.  Please let me know if this works and keep us in mind for other business that you can refer to us.  Sincerely, 

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

infox@1031xcastle.com

tic structure

Dear 1031x.com: Can an investor (Mr. A) partner up with another investor (Mr.  1031) who has relinquished his property and wishes to acquire another  larger ppty. Mr 1031 has $500k with a 1031 facilitator and the ppty  identified requires a down pmt of $700k. Can Mr.1031 join forces with  another investor who will provide the additional $250k in equity to  satisfy the required down payment. Can they form a TIC in this scenario.  Eventually, Mr. A and Mr. 1031 plan to have an equal 50/50 share in the  ppty. If not, what vehicle/type of entity would best suit this type of  structure. The objective for Mr.1031 is to defer capital gains realized  from the sale of his ppty.

Dear Mr. H:  Yes you can sell 100% of a relinquished property and buy a fractional interest in a replacement property in a 1031 exchange.  And, yes the tenant in common arrangement is the right structure.  Remember the person doing the 1031 exchange must not only trade equal or up in equity ($500K in your example) but also equal or up in value.  For this reason the 50-50 split may or may not work.  To reiterate the 1031 exchanger's fractional interest must be of equal or greater value than 100% oft he relinquished property.  Next time please chose us for your 1031 exchange service.  Also, I could write a tenant in common agreement for you if needed.  Sincerely,

Steve Hickox
Attorney / President

1031x.com has grown to provide many services to our clients as Castle United!
Click here:  http://www.CastleUnited.com/

1031x.com, Inc.
2120 S. Birch St.
Denver, CO 80222
303.504.0144
Toll Free 888.899.1031
Fax 303.715.1012

infox@1031xcastle.com