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  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • The Same Taxpayer Requirement in a 1031 Tax Deferred Exchange

    What is the Same Taxpayer Rule in a 1031 Like-Kind Exchange?
    In a 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.  Keep in mind that one of the justifications for tax deferral is that a taxpayer has reported all the incidences of ownership and that the taxpayer’s basis will carry over into the new replacement property.  The taxpayer is only getting deferral, not permanent tax avoidance, and the sheltered gain will be due ultimately upon a future sale of the property without an exchange. If the taxpayer were to change tax identities within an exchange, there would be no continuity of tax ownership and no reason to afford deferral.
    In addition, the exchange regulations provide that the taxpayer must transfer the relinquished property as well as receive the transfer of the replacement property.  If, for tax purposes, the taxpayer changes its tax identity between the sale and the purchase, then the same taxpayer will not have disposed of and received property.  So, while the same taxpayer requirement will not be found by those words in the regulations, it is very clearly implicit.
    When determining what constitutes “the same taxpayer” the tax identity may be different than the legal title.  It is the tax identity that must be maintained and follow from the relinquished property ownership to the replacement property ownership.  Another way to look at this is whether the selling and buying entities use the same social security number for both properties and does it change to a Federal Tax-Identification Number (FEIN or EIN) from one property to the other. The social security number would typically be used for a single individual’s ownership, including ownership under tax disregarded entities discussed below in more detail. The FEIN number would typically be used for a business or an entity ownership consisting of more than one person or more than one entity, such as a multi-member limited liability company or a partnership.
    Can a Taxpayer Change the Ownership but Maintain the Tax Identity?
    Remember that we are talking about the tax identity, not necessarily the specific name of the title of the property.  So let’s look at some various ways in which a taxpayer can hold title that would preserve the tax identity:

    Hold title in taxpayer’s own name
    Hold title under a single member limited liability company (LLC)
    Hold title as the trustee of a Revocable Living Trust
    Hold title as beneficiary of an Illinois type land trust
    Hold title as a Tenant in Common (TIC)
    Hold title under a Delaware Statutory Trust (DST)

    Holding Title in the Taxpayer’s Own Name
    Using the taxpayer’s own name is the most common form or ownership.  This ownership can be as an individual, LLC, partnership, etc.  There is always a tax identification number associated with this ownership. 
    Holding Title as a Single Member LLC, Trustee of a Revocable Living Trust, or TIC
    Single member LLCs and Self Declarations of Trust (Living Trust) are known as “tax disregarded entities.” These entities are taxed to the party that is the sole member of the LLC or the grantor/beneficiary of the trust.  A TIC is also deemed to be owned by the owner of that Tenant in Common share.  The fact that there are other co-owners of the property has no adverse consequences to the taxpayer being the same taxpayer who sold the property individually.
    Holding Title under a Delaware Statutory Trust
    DSTs themselves are regarded as a trust, however the owner of a DST share is regarded as owning a beneficial interest in the trust.  As such, a person selling as an individual but buying through a DST interest is still treated as the same taxpayer assuming the beneficial interest is held in the same individual taxpayer’s name.  In 2004,

  • 1031 Exchange Rules for Vacation Homes, Primary Residences, and Mixed Use Properties

    It is quite common for clients to call a 1031 exchange company with questions regarding exchanges of their former or future principal residences or vacation homes.  Under what circumstances can these dwellings be used as part of a 1031 exchange?  Do they satisfy the requirement that both the relinquished and replacement properties must be held for investment or for use in a business or trade?  Does some personal use trump the investment use of the property?  This blog is intended to answer these commonly asked questions:

    Under what circumstances can a second home or vacation home constitute relinquished or replacement property for the purposes of a 1031 exchange?
    Can a principal residence be converted into an investment property eligible for 1031 tax deferral upon sale?
    Can a property that has been held for investment be converted to a principal residence and what are the rules when it is sold?
    Can a mixed use property be sold with a personal residence exemption and 1031 exchange deferral?

    Rules for Including a Vacation Home in a 1031 Exchange
    Historically, determining whether a home that was both rented out and used by its owner could be eligible for 1031 tax deferral was difficult to ascertain.  There was some case law but that was a bit inconsistent.  The IRS attempted to provide some definitive guidance regarding some of these questions in the form of Revenue Procedure 2008-16.  As the IRS aptly put it:
    “The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes. In the interest of sound tax administration, this revenue procedure provides taxpayers with a safe harbor under which a dwelling unit will qualify as property held for productive use in a trade or business or for investment under §1031 even though a taxpayer occasionally uses the dwelling unit for personal purposes.”
    This revenue procedure made clear that for a relinquished vacation property to qualify for a 1031 exchange, the property has to be owned by the taxpayer and held as an investment for at least 24 months immediately prior to the exchange.  Additionally, within each of the two 12-month periods prior to the sale, the property must have been rented at fair market value to a person for at least 14 days or more, and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented. 
    The requirements for property to qualify as a 1031 replacement property are very similar.  The property has to be owned by the taxpayer for at least 24 months immediately after the exchange.  Also, within each of the two 12-month periods after the exchange, property must have been rented at fair market value to a person for at least 14 days or more and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented.  The taxpayer is allowed to use the relinquished or replacement property for additional days if the use is for property maintenance or repair.
    Rules for Converting a Personal Residence for a 1031 Exchange
    In many cases, conversion of a personal residence to a property held as an investment or for use in a business or trade “exchange eligible property,” as defined above, may still allow a taxpayer to receive a full exemption of gain pursuant to the rules of Internal Revenue Code Section 121 upon sale of the property.  That Code section provides for an exclusion of gain of up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly upon the sale of a principal residence.  There is a requirement that during the five-year period immediately preceding the sale, the taxpayer must have used the property as a principal residence for a cumulative period of at least two years. 
    Even if the property has had principal residence use followed by exchange eligible use, the taxpayer does not necessarily have to do an exchange on the investment/business use of the property if the total gain can be sheltered by the §121 allowed exclusions.  So even if during the immediate two years preceding the sale, the property was used as exchange eligible property, the taxpayer may still benefit from the personal residence exclusion.  In the event the gain exceeds the maximums allowed for per IRC Section 121 primary residence, the taxpayer may still be able to shelter the balance via a 1031 exchange, thus combining the benefits of these two code sections.
    Under Revenue Procedure 2008-16 the conversion of the principal residence to an exchange eligible investment property does not disqualify a family member as the tenant.  However, the revenue procedure requires that this should be done at a fair market rental and it must constitute the family member’s personal residence and not the family member’s vacation home.  There are additional rules for the rental of the property by a family member who co-owns the property with the taxpayer.
    Should a taxpayer wish to convert the personal residence to exchange eligible property, the taxpayer must have owned the property for the two years immediately prior to the sale and:

    For each of the years the property must be rented to a person for 14 days or more
    The taxpayer’s personal use has to be limited to no more than 14 days per year or less than 10% of the days per year that property is rented.

    Rules for Converting a 1031 Exchange Property to a Personal Residence
    If the taxpayer’s intent, based upon facts and circumstances at the time of the property acquisition was to hold the property as an investment or for use in a business, the subsequent conversion use of the property to use as a principal residence should not otherwise jeopardize the ability to exchange.  As an example, a taxpayer may wish to exchange into a rental condominium in Florida and upon retirement relocate from a northern state into the condominium as the principal residence.
    If the taxpayer subsequently sells the principal residence, there may be the ability to defer the gain under §121.  However there are some limitations to this deferral upon conversion, otherwise taxpayers might convert exchange property into a principal residence property, sell shortly thereafter, and seek IRC Section 121 primary residence deferral.  These rules require that the property has to be held for at least five years in total with the period of time the property was held as an exchange property included.  The period of time the property was used as an exchange property needs to be backed out of the calculation for the principal residence use deferral.  This calculation is made by using the period of time the property was held as an exchange property as the numerator and the period of time the property was held in total as the denominator.  The resulting fraction or percentage would be applied to the total gain and the resulting dollar amount would not be eligible for a §121 deferral. 
    Take the example of a property owned by a taxpayer for seven years prior to sale, three of which were used as an exchange property and four of which were used as the taxpayer’s principal residence.  Assume that the gain upon sale is $200,000.  Dividing the number of three years by seven years x $200,000 results in the amount of $85,714 which is taxable.
    1031 Exchanges and Mixed Use Properties
    At times, a taxpayer may own a home as the principal residence but part of the property may have been used as an investment or in connection with a business or trade, creating an exchange eligible component.  This is known as a mixed use property.  An example might be a psychologist who sees patients in a home office.  Another example might be a property with a separate coach house that is rented out.  It is quite common for a taxpayer to sell a three flat where the taxpayer uses one unit as the principal residence.  In these instances IRC Section 121 and IRC Section 1031 can both be used to achieve total deferral.    
    There is one caveat with exchanges of mixed use properties, which is that on closing statements there is a tendency to give credits for prorated rent and security deposits to the buyer.  This causes the net amount of proceeds attributable to each property use component to be reduced proportionately.  Technically, those credits only pertain to the exchange eligible portion of the property and should not appear as a credit on the personal residence portion of the sale.
    Summary
    A variety of circumstances surround property that has been or will be exchange eligible and may also have been used or will be used by the taxpayer as a principal residence or vacation home.  Revenue Procedure 2008-16 provides rules regarding vacation homes and exchange eligible property.  Likewise, there are rules under IRC Section 121 for converting exchange property into a personal residence and vice-versa.  Properties that have both a principal residence component as well as an exchange-eligible one can benefit by both the deferral sections, but care should be taken to do proper accounting so that buyer credits affect the exchange eligible portion of the sale only.
     
    Updated 4/18/2022.

  • 1031 Exchange Rules for Vacation Homes, Primary Residences, and Mixed Use Properties

    It is quite common for clients to call a 1031 exchange company with questions regarding exchanges of their former or future principal residences or vacation homes.  Under what circumstances can these dwellings be used as part of a 1031 exchange?  Do they satisfy the requirement that both the relinquished and replacement properties must be held for investment or for use in a business or trade?  Does some personal use trump the investment use of the property?  This blog is intended to answer these commonly asked questions:

    Under what circumstances can a second home or vacation home constitute relinquished or replacement property for the purposes of a 1031 exchange?
    Can a principal residence be converted into an investment property eligible for 1031 tax deferral upon sale?
    Can a property that has been held for investment be converted to a principal residence and what are the rules when it is sold?
    Can a mixed use property be sold with a personal residence exemption and 1031 exchange deferral?

    Rules for Including a Vacation Home in a 1031 Exchange
    Historically, determining whether a home that was both rented out and used by its owner could be eligible for 1031 tax deferral was difficult to ascertain.  There was some case law but that was a bit inconsistent.  The IRS attempted to provide some definitive guidance regarding some of these questions in the form of Revenue Procedure 2008-16.  As the IRS aptly put it:
    “The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes. In the interest of sound tax administration, this revenue procedure provides taxpayers with a safe harbor under which a dwelling unit will qualify as property held for productive use in a trade or business or for investment under §1031 even though a taxpayer occasionally uses the dwelling unit for personal purposes.”
    This revenue procedure made clear that for a relinquished vacation property to qualify for a 1031 exchange, the property has to be owned by the taxpayer and held as an investment for at least 24 months immediately prior to the exchange.  Additionally, within each of the two 12-month periods prior to the sale, the property must have been rented at fair market value to a person for at least 14 days or more, and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented. 
    The requirements for property to qualify as a 1031 replacement property are very similar.  The property has to be owned by the taxpayer for at least 24 months immediately after the exchange.  Also, within each of the two 12-month periods after the exchange, property must have been rented at fair market value to a person for at least 14 days or more and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented.  The taxpayer is allowed to use the relinquished or replacement property for additional days if the use is for property maintenance or repair.
    Rules for Converting a Personal Residence for a 1031 Exchange
    In many cases, conversion of a personal residence to a property held as an investment or for use in a business or trade “exchange eligible property,” as defined above, may still allow a taxpayer to receive a full exemption of gain pursuant to the rules of Internal Revenue Code Section 121 upon sale of the property.  That Code section provides for an exclusion of gain of up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly upon the sale of a principal residence.  There is a requirement that during the five-year period immediately preceding the sale, the taxpayer must have used the property as a principal residence for a cumulative period of at least two years. 
    Even if the property has had principal residence use followed by exchange eligible use, the taxpayer does not necessarily have to do an exchange on the investment/business use of the property if the total gain can be sheltered by the §121 allowed exclusions.  So even if during the immediate two years preceding the sale, the property was used as exchange eligible property, the taxpayer may still benefit from the personal residence exclusion.  In the event the gain exceeds the maximums allowed for per IRC Section 121 primary residence, the taxpayer may still be able to shelter the balance via a 1031 exchange, thus combining the benefits of these two code sections.
    Under Revenue Procedure 2008-16 the conversion of the principal residence to an exchange eligible investment property does not disqualify a family member as the tenant.  However, the revenue procedure requires that this should be done at a fair market rental and it must constitute the family member’s personal residence and not the family member’s vacation home.  There are additional rules for the rental of the property by a family member who co-owns the property with the taxpayer.
    Should a taxpayer wish to convert the personal residence to exchange eligible property, the taxpayer must have owned the property for the two years immediately prior to the sale and:

    For each of the years the property must be rented to a person for 14 days or more
    The taxpayer’s personal use has to be limited to no more than 14 days per year or less than 10% of the days per year that property is rented.

    Rules for Converting a 1031 Exchange Property to a Personal Residence
    If the taxpayer’s intent, based upon facts and circumstances at the time of the property acquisition was to hold the property as an investment or for use in a business, the subsequent conversion use of the property to use as a principal residence should not otherwise jeopardize the ability to exchange.  As an example, a taxpayer may wish to exchange into a rental condominium in Florida and upon retirement relocate from a northern state into the condominium as the principal residence.
    If the taxpayer subsequently sells the principal residence, there may be the ability to defer the gain under §121.  However there are some limitations to this deferral upon conversion, otherwise taxpayers might convert exchange property into a principal residence property, sell shortly thereafter, and seek IRC Section 121 primary residence deferral.  These rules require that the property has to be held for at least five years in total with the period of time the property was held as an exchange property included.  The period of time the property was used as an exchange property needs to be backed out of the calculation for the principal residence use deferral.  This calculation is made by using the period of time the property was held as an exchange property as the numerator and the period of time the property was held in total as the denominator.  The resulting fraction or percentage would be applied to the total gain and the resulting dollar amount would not be eligible for a §121 deferral. 
    Take the example of a property owned by a taxpayer for seven years prior to sale, three of which were used as an exchange property and four of which were used as the taxpayer’s principal residence.  Assume that the gain upon sale is $200,000.  Dividing the number of three years by seven years x $200,000 results in the amount of $85,714 which is taxable.
    1031 Exchanges and Mixed Use Properties
    At times, a taxpayer may own a home as the principal residence but part of the property may have been used as an investment or in connection with a business or trade, creating an exchange eligible component.  This is known as a mixed use property.  An example might be a psychologist who sees patients in a home office.  Another example might be a property with a separate coach house that is rented out.  It is quite common for a taxpayer to sell a three flat where the taxpayer uses one unit as the principal residence.  In these instances IRC Section 121 and IRC Section 1031 can both be used to achieve total deferral.    
    There is one caveat with exchanges of mixed use properties, which is that on closing statements there is a tendency to give credits for prorated rent and security deposits to the buyer.  This causes the net amount of proceeds attributable to each property use component to be reduced proportionately.  Technically, those credits only pertain to the exchange eligible portion of the property and should not appear as a credit on the personal residence portion of the sale.
    Summary
    A variety of circumstances surround property that has been or will be exchange eligible and may also have been used or will be used by the taxpayer as a principal residence or vacation home.  Revenue Procedure 2008-16 provides rules regarding vacation homes and exchange eligible property.  Likewise, there are rules under IRC Section 121 for converting exchange property into a personal residence and vice-versa.  Properties that have both a principal residence component as well as an exchange-eligible one can benefit by both the deferral sections, but care should be taken to do proper accounting so that buyer credits affect the exchange eligible portion of the sale only.
     
    Updated 4/18/2022.

  • 1031 Exchange Rules for Vacation Homes, Primary Residences, and Mixed Use Properties

    It is quite common for clients to call a 1031 exchange company with questions regarding exchanges of their former or future principal residences or vacation homes.  Under what circumstances can these dwellings be used as part of a 1031 exchange?  Do they satisfy the requirement that both the relinquished and replacement properties must be held for investment or for use in a business or trade?  Does some personal use trump the investment use of the property?  This blog is intended to answer these commonly asked questions:

    Under what circumstances can a second home or vacation home constitute relinquished or replacement property for the purposes of a 1031 exchange?
    Can a principal residence be converted into an investment property eligible for 1031 tax deferral upon sale?
    Can a property that has been held for investment be converted to a principal residence and what are the rules when it is sold?
    Can a mixed use property be sold with a personal residence exemption and 1031 exchange deferral?

    Rules for Including a Vacation Home in a 1031 Exchange
    Historically, determining whether a home that was both rented out and used by its owner could be eligible for 1031 tax deferral was difficult to ascertain.  There was some case law but that was a bit inconsistent.  The IRS attempted to provide some definitive guidance regarding some of these questions in the form of Revenue Procedure 2008-16.  As the IRS aptly put it:
    “The Service recognizes that many taxpayers hold dwelling units primarily for the production of current rental income, but also use the properties occasionally for personal purposes. In the interest of sound tax administration, this revenue procedure provides taxpayers with a safe harbor under which a dwelling unit will qualify as property held for productive use in a trade or business or for investment under §1031 even though a taxpayer occasionally uses the dwelling unit for personal purposes.”
    This revenue procedure made clear that for a relinquished vacation property to qualify for a 1031 exchange, the property has to be owned by the taxpayer and held as an investment for at least 24 months immediately prior to the exchange.  Additionally, within each of the two 12-month periods prior to the sale, the property must have been rented at fair market value to a person for at least 14 days or more, and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented. 
    The requirements for property to qualify as a 1031 replacement property are very similar.  The property has to be owned by the taxpayer for at least 24 months immediately after the exchange.  Also, within each of the two 12-month periods after the exchange, property must have been rented at fair market value to a person for at least 14 days or more and the taxpayer cannot have used the property personally for the greater of 14 days or 10% of the number of days in the 12-month period that it had been rented.  The taxpayer is allowed to use the relinquished or replacement property for additional days if the use is for property maintenance or repair.
    Rules for Converting a Personal Residence for a 1031 Exchange
    In many cases, conversion of a personal residence to a property held as an investment or for use in a business or trade “exchange eligible property,” as defined above, may still allow a taxpayer to receive a full exemption of gain pursuant to the rules of Internal Revenue Code Section 121 upon sale of the property.  That Code section provides for an exclusion of gain of up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly upon the sale of a principal residence.  There is a requirement that during the five-year period immediately preceding the sale, the taxpayer must have used the property as a principal residence for a cumulative period of at least two years. 
    Even if the property has had principal residence use followed by exchange eligible use, the taxpayer does not necessarily have to do an exchange on the investment/business use of the property if the total gain can be sheltered by the §121 allowed exclusions.  So even if during the immediate two years preceding the sale, the property was used as exchange eligible property, the taxpayer may still benefit from the personal residence exclusion.  In the event the gain exceeds the maximums allowed for per IRC Section 121 primary residence, the taxpayer may still be able to shelter the balance via a 1031 exchange, thus combining the benefits of these two code sections.
    Under Revenue Procedure 2008-16 the conversion of the principal residence to an exchange eligible investment property does not disqualify a family member as the tenant.  However, the revenue procedure requires that this should be done at a fair market rental and it must constitute the family member’s personal residence and not the family member’s vacation home.  There are additional rules for the rental of the property by a family member who co-owns the property with the taxpayer.
    Should a taxpayer wish to convert the personal residence to exchange eligible property, the taxpayer must have owned the property for the two years immediately prior to the sale and:

    For each of the years the property must be rented to a person for 14 days or more
    The taxpayer’s personal use has to be limited to no more than 14 days per year or less than 10% of the days per year that property is rented.

    Rules for Converting a 1031 Exchange Property to a Personal Residence
    If the taxpayer’s intent, based upon facts and circumstances at the time of the property acquisition was to hold the property as an investment or for use in a business, the subsequent conversion use of the property to use as a principal residence should not otherwise jeopardize the ability to exchange.  As an example, a taxpayer may wish to exchange into a rental condominium in Florida and upon retirement relocate from a northern state into the condominium as the principal residence.
    If the taxpayer subsequently sells the principal residence, there may be the ability to defer the gain under §121.  However there are some limitations to this deferral upon conversion, otherwise taxpayers might convert exchange property into a principal residence property, sell shortly thereafter, and seek IRC Section 121 primary residence deferral.  These rules require that the property has to be held for at least five years in total with the period of time the property was held as an exchange property included.  The period of time the property was used as an exchange property needs to be backed out of the calculation for the principal residence use deferral.  This calculation is made by using the period of time the property was held as an exchange property as the numerator and the period of time the property was held in total as the denominator.  The resulting fraction or percentage would be applied to the total gain and the resulting dollar amount would not be eligible for a §121 deferral. 
    Take the example of a property owned by a taxpayer for seven years prior to sale, three of which were used as an exchange property and four of which were used as the taxpayer’s principal residence.  Assume that the gain upon sale is $200,000.  Dividing the number of three years by seven years x $200,000 results in the amount of $85,714 which is taxable.
    1031 Exchanges and Mixed Use Properties
    At times, a taxpayer may own a home as the principal residence but part of the property may have been used as an investment or in connection with a business or trade, creating an exchange eligible component.  This is known as a mixed use property.  An example might be a psychologist who sees patients in a home office.  Another example might be a property with a separate coach house that is rented out.  It is quite common for a taxpayer to sell a three flat where the taxpayer uses one unit as the principal residence.  In these instances IRC Section 121 and IRC Section 1031 can both be used to achieve total deferral.    
    There is one caveat with exchanges of mixed use properties, which is that on closing statements there is a tendency to give credits for prorated rent and security deposits to the buyer.  This causes the net amount of proceeds attributable to each property use component to be reduced proportionately.  Technically, those credits only pertain to the exchange eligible portion of the property and should not appear as a credit on the personal residence portion of the sale.
    Summary
    A variety of circumstances surround property that has been or will be exchange eligible and may also have been used or will be used by the taxpayer as a principal residence or vacation home.  Revenue Procedure 2008-16 provides rules regarding vacation homes and exchange eligible property.  Likewise, there are rules under IRC Section 121 for converting exchange property into a personal residence and vice-versa.  Properties that have both a principal residence component as well as an exchange-eligible one can benefit by both the deferral sections, but care should be taken to do proper accounting so that buyer credits affect the exchange eligible portion of the sale only.
     
    Updated 4/18/2022.

  • Qualia FORES22 Debut of Exchange Manager Pro(SM)

    Exchange Manager ProSM by Accruit had the pleasure of not only attending, but co-sponsoring the recent Qualia Future of Real Estate Summit 2022 (FORES22). FORES22, Building a Connected Tomorrow, was designed to bring together title & escrow, mortgage, and property tech companies to explore technology, processes, and business models to unite all segments for an improved client experience. Exchange Manager ProSM was right at home, introducing its white label 1031 exchange solution, Managed Service, to companies in attendance from across the US.
    What is Managed Service?
    Managed Service through Exchange Manager ProSM provides a value add for title companies and others that are interested in offering 1031 exchange services. The white-labeled 1031 exchange technology solution allows the company, referred to as exchange facilitator, to maintain the relationship with their client while Exchange Manager ProSM provides all of the documentation and banking services of the Qualified Intermediary (QI) behind the scenes, providing a turnkey 1031 exchange experience for all parties.
    Managed Service not only provides an improved customer experience for the exchange facilitator’s client, but it also eliminates the need for companies to turn away clients or worse, recommend a competitor for the 1031 exchange. Lastly, it creates a new income source for exchange facilitators through a revenue share.
    How does Managed Service Work? 
    Implementing our white-labeled QI, Managed Service, is seamless for all involved. Once a Managed Service agreement is in place, there are a few simple steps for the exchange facilitator to follow in order to offer in-house 1031 exchange services to their existing clients:

    Qualify the client for a 1031 Exchange: Is the client interested in doing a 1031 exchange on their real estate transaction? Utilize a provided guide to confirm the client and their transaction qualify for a 1031 exchange.
     
    Collect client information and documents: Through our cloud-based intake form, submit client info and documentation pertinent to the 1031 exchange. All information required is likely already on-hand due to the work your company is already completing on behalf of the client.>
     
    Once all information is provided, the remaining 1031 exchange processes will be facilitated through Exchange Manager ProSM including document creation and execution, deadline reminders, wiring of funds, etc.

    Through Managed Service, companies can facilitate 1031 exchanges for their clients and ultimately retain future business by keeping everything under one roof.
    Benefits of Managed Service
    While there are numerous benefits of implementing Managed Service, some of the more notable benefits that will directly impact your company’s bottom line include:

    Retain 1031 Exchange Business: When your client requests a 1031 Exchange, instead of referring them to another company that services 1031 exchanges and potentially losing future business with that client, you will be able to facilitate the 1031 exchange in-house and preserve future business.
     
    Offer 1031 Exchanges as a Disqualified Party: Per IRC §1031 you may be a disqualified party and unable to facilitate the 1031 exchange; however, through Managed Service you could still offer 1031 exchange services.
     
    Drive Income Through NEW Revenue Share: With minimal effort and manpower on your end, you will drive income through a new, favorable revenue share while retaining your current clients – win, win!

    Learn more about Managed Service.