s1031 re 5.6.13 vt realtors 2013
TRANSCRIPT
Shhhhh.
Don‟t tell anyone.
Your clients are eligible for
interest free loans from the US
Government…
…for as long as they‟d like.
…for as many times as they‟d
like.
Of the approximately
$200Billion in commercial &
investement real estate transactions
last year, it is estimated that 20-30%
could have benefited from Section
1031 treatment.
Only 3% did.
What‟s In It For You?
• Absolutely Part of Your Fiduciary Responsibility• Tax Ramifications on the Sale of Investment Property are Key
• Clients Will Appreciate Your Resourcefulness
• Potentially More Sides & Multiple Commissions!• Help Your Client Sell and then Buy Replacement Property(ies)
• You Never Know Until You Ask “Whatcha‟ Want” & “Whatcha‟ Got”
• Become Involved With Client‟s Overall Real Estate
Strategy
• Strengthen & Expand Your Referral Base
About Our Firm
• Practice began in 1981; incorporated in 1987
• Exchanges are our exclusive line of business
• Background of accommodators
– John: 6 yrs training 1031, 5 yrs full time accommodator
– Christine: 30 yrs residential & commercial lending; 4 yrs as bank
president, 10 years as accommodator
• Member of Federation of Exchange Accommodators
• Specialize in facilitating exchanges and replacement
property options
• Nationwide practice; 48 states and counting…
Today We Will Explore…
• What Is Section 1031?
• Section 1031 Misconceptions
• How To Recognize When to Use Section 1031?
• Who Qualifies For an Exchange?
• What Qualifies For an Exchange?
• Real-life Examples of Our Exchanges
• Alternative Exchange Strategies
Primary Objectives of This Course
• Provide a Basic Section 1031 Education
• Provide Tools & Information Enabling You to
Better Serve Your Clients
• Assist You In Recognizing the Strategic
Applications of Section 1031 and Explore
Alternative Replacement Strategies
Primary Objectives of This Course
• Help You to Understand How
Section 1031 Integrates Into
Your Client‟s Overall Financial
Goals & Objectives
• Demonstrate our Ability to
Become Your Section 1031
Resource in the Future
What Is An Exchange?
• Method to sell investment real estate and replace it with new
property that doesn‟t trigger any tax.
• Its essential elements are:
– Give a Deed
– Get a Deed
– Don‟t handle Cash
What Is An Exchange?
• Method to convert non-income producing property or LOW
income producing property to passive investments:
– Managed Real Estate
– NNN Leased Properties
– Fractional Opportunities
– Oil & Gas
– Easements
– Annuities
• Method to purchase a property for eventual
personal use!
The Five Critical Elements
1. Intent
2. Form and Documentation
3. Control of Funds
4. Like-Kind Properties
5. Time Limits
The Regulation - Section 1.1031(k)-1
“A deferred exchange is
defined as an exchange in
which, pursuant to an
agreement, the taxpayer
transfers property held for
productive use in a trade or
business or for investment
(the „relinquished property‟)
and subsequently receives
property to be held either for
productive use in a trade or
business or for investment
(the „replacement
property‟).”
QI
An Exchange at a Glance
Exchange Documents
Relinquished Property
• Agreement With QI
• Assignment of Contract
• Notification of Assignment
• Settlement Instructions
Replacement Property
• Assignment
• Notification
• Settlement Instructions
QI
Section 1031(a)(1)
“No gain or loss shall be recognized on the
exchange of property held for productive use in trade or
business or for investment if such property is exchanged
solely for property of like kind which is held either for
productive use in a trade or business or for investment.”
Section 1031 Works ONLY with
Investment property
YOU MUST PROVE INTENT!
What is Investment Purpose?
• Investment is the passive holding of property for more than
a temporary period with the expectation of appreciation
• Real estate (even if unproductive) held by a non dealer for
future use or increment in value is held for investment and
not primarily for sale (Reg. Section 1.1031(a)-1(b))
• Thus property held for sale in the
immediate future is not held for
investment
What are the benefits of an Exchange?
• Full capital gains tax deferral
• Relocation of investment
• Change in investment type
• Diversification of investment
• Planning of investment
• Solve problem of joint ownership
• Increase cash flow
Three essential elements:
• The properties must be exchanged (not sold)
• Both the “Relinquished” property and the “Replacement”
property must be held by the same taxpayer for investment
or productive use
• The properties must be “Like-Kind” with one another
– Real property for real property
– Personal property for personal property
Replacement Property Rules
• The Three Property Rule The Exchangor may identify up to
three properties, without regard to their value; or
• The 200% Rule The Exchangor may identify more than three
properties, provided their combined fair market value does not
exceed 200% of the value of the Relinquished Property; or
• The 95% Rule The Exchangor may identify any number of
properties, without regard to their value, provided the
Exchangor acquires 95% of those properties.
Like-kind requirement
• The term “like-kind” refers to the nature or character of the
property and not to its grade or quality
• Real property cannot be exchanged for personal property
• Qualifying personal property can be exchanged for
property of a similar character
Examples of Like-kind
• Improved real property for Unimproved real property
• Lease for >30 year
• Partial interest for a whole interest
• One property for more than one
property and vice versa
What is Like Kind?
ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL
PROPERTY….
Apartment Building
Single Family Dwelling
What is Like Kind?
ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL
PROPERTY….
Multi-family Dwelling
Single Family Dwelling
What is Like Kind?
ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL
PROPERTY….
Land Development
Single Family Dwelling
What is Like Kind?
ANY REAL PROPERTY IS LIKE KIND WITH ANY OTHER REAL
PROPERTY….
Commercial Property
Single Family Dwelling
Personal Property
• Same General Asset Class or Product Code
• North American Industry Classification System
• Sector 31-33-Manufacturing
– Examples: Heavy Construction Equipment, Well Drilling Equipment,
Logging Equipment, Commercial Vessels, Commercial Laundry
Equipment
– See www.census.gov/naics
Timing is everything!
• The Exchange period begins on the transfer of the
Relinquished Property
• Exchangor must identify qualified Replacement Property
within 45 days of closing
• Exchangor must acquire within 180 days
• There are no extensions unless mandated as a federal
disaster
Can Anyone Handle An exchange?• No! It must be a “Qualified Intermediary”(QI) as defined by
regulation:
• Cannot Be the Exchangor or a Relative
• Cannot be an Agent of the Taxpayer
One who has acted as employee, attorney, accountant, investment
banker, broker or real estate agent with the past 2 years
The QI Handles All Aspects of the Exchange and Should be
Involved EARLY in the Process
What does the QI do?• Creates Exchange Agreement
• Has Standing in the Sale of Relinquished Property and Purchase of Replacement Property
• Notice of Assignment
• Closing Instructions to Settlement Agent
• Banking and Safeguarding of Exchange Funds
• Assurance of Critical Deadlines Including the 45 & 180 Day Deadlines
• Final accounting for tax purposes
Who Qualifies for an Exchange?
Owners of investment property and business property may
qualify for a Section 1031 deferral. Individuals, C Corporations,
S corporations, partnerships (general or limited), limited liability
corporations, trusts and any other taxpaying entity may set up
an exchange of business or investment properties for business
or investment properties under Section 1031.
The Five Most Common Section 1031
Misconceptions
1All 1031 Exchanges must involve
swapping or trading with other
property owners......
The Five Most Common Section 1031
Misconceptions
2It‟s required that all types of 1031
exchanges must close
simultaneously......
The Five Most Common Section 1031
Misconceptions
3"Like-kind" means purchasing the
same type of property which was
sold.......
The Five Most Common Section 1031
Misconceptions
41031 Exchanges must be limited to 1
exchange and 1 replacement
property.......
The Power of Section 1031
What happens when both participate in 3 typical real
investment estate transactions…
…with radically different approaches?
The Power of Section 1031
Joe‟s Boss is going to use Section 1031
to build his wealth while leveraging
Uncle Sam‟s money.
Fourth Transaction – In 15 Years
$361,336 $507,000
$108,400 $152,100
($21,680) $ 0
$448,056 $659,100
$2,240 $3,296
Summary of Wealth Building Benefits
4th Transaction $448,056 $659,100
Cumulative Increase 49.3% 119.7%
The After-Tax Analysis (a sale in Year 15)
• Joe The Plumber (in Year 15)
– Has Property worth $448,056; all taxes have been paid
• His Boss (in Year 15)
– Has property worth $659,100, with $136,810 tax due
• Net Result (after tax):
– His Boss has $74,234 more wealth than Joe, and has
received $92,779 more income.
– But why would his Boss ever pay the tax when he can
exchange over & over?
The Most Common Exchange Types
• Delayed Exchange
– The client sells his property, identifies replacement property options
within 45 days, then purchases the property(ies) within 180 days.
• Reverse Exchange
– The client purchases (with a Single Purpose Entity) the replacement
property before his current property is sold. The client then has 180
days to close on his relinquished property.
• Build-to-Suit
– The client wishes to purchase and improve a property(ies) with the
proceeds from the sale of his relinquished property. This is also
accomplished with a Single Purpose Entity.
Case StudiesThe case studies outlined
are presented as a
representation of the 5 most
common types of Section
1031 exchanges.
Please note that the case
studies have been simplified
and several essential steps
have been omitted for clarity.
Click on the case study you
would like to review.
www.section1031.com
CAMPGROUND FOR SEVERAL SINGLE FAMILY
RESIDENCES
One campground
exchanged for 16 new
properties…
…including 2 new
campgrounds.
6 PROPERTIES FOR A DOZEN CONDOMINIUMS
Sold six properties to
aggregate funds to buy…
…over a dozen brand new
condo units.
CONVERTING INVESTMENT PROPERTY TO PERSONAL
RESIDENCE
Exchange for your dream
home, rent it for two
years…
…convert it to your primary
residence.
BUYING A NEW PROPERTY BEFORE THE OLD PROPERTY SELLS
Negotiated the Purchase of
a Significant New
Property…
…but unable to sell a piece
of existing property in time
to do the the deal.
ACQUIRE A RENTAL PROPERTY FOR A FAMILY MEMBER
Exchange for a home for
the kids…
…charge fair market rent.
Then gift the property.
COMMERCIAL PROPERTY FOR RAW LAND WITH
IMPROVEMENTS
Sell a commercial
property…
…buy a vacant lot and
build a new building.
INDUSTRY SPECIFIC BUILDING ON IDENTIFIED PROPERTY
Build a new building…
…then sell existing
property.
ACQUIRING ABUTTING PROPERTY TO PRIMARY RESIDENCE
Purchasing shore front
land with bank funds…
…selling rental property to
pay down the debt.
1. What‟cha Got?– How has the property been used in the
client‟s hands?
– Has there been personal use of the
property?
– Does the property include personal
property or other intangibles?
2. Howd‟ya Get It?– As the result of a previous Exchange?
– Is the property from an estate or family?
– How long has the property been owned?
3. What else „ya Got?– Is there other property being sold?
– Are there other property rights or
easements?
– Any excess land associated with their
primary residence?
– Does the transaction need to be bigger,
smaller or done in stages?
4. What‟cha Want?– What is the short term/long term strategy
for the property?
– Ideally the value should be even or up.
– An important element of building wealth
using untaxed funds.
– Diversification i.e. type, location, quantity.
Alternate Exchange Opportunities
THERE ARE A MYRIAD OF OTHER
INVESTMENT OPPORTUNITIES THAT
CAN BE ACCOMPLISHED WITH AN
EXCHANGE!
Tenants - In - CommonTENANTS-IN-COMMON (TICs) OFFER A STRESS FREE
OPTION TO OWN INVESTMENT GRADE REAL ESTATE
Tenants-in-commonAny Real Property
TIC Property Characteristics
• Undivided Fractional Ownership in Real Estate
• Each Owner Receives a Proportional Share of Net
Revenues
• Under Sponsored Structure, TICs are:
• Grade “A” Real Estate Investments
• Professionally Managed
• The Result Is A Passive Ownership
Courtesy of Grubb & Ellis
Commercial Real Estate Services
Direct Ownership vs. TICConventional Direct Ownership
Property Exchange
1031 Tenant-in-Common
Property Exchange
Lower returns on less desirable properties Higher returns on institutional-quality properties
Difficult to comply with Section 1031 45 day
ID rules; Exchangor must find properties
Easy to comply with Section 1031 45 day ID
rules
when properties are pre-identified
Difficult to match Section 1031 exchange
debt and equity
Easy to match Section 1031 exchange debt
and equity
Investor must negotiate and arrange loan Prearranged financing
Expensive and time-consuming property
management
Professional proven property management in
place. You receive a monthly or quarterly
income check.
Cash flow, depreciation, and appreciation
potential
Cash flow, depreciation, and appreciation
potential
Ability to use the Section 1031 exchange
again
Ability to use the Section 1031 exchange again
Ability to refinance and distribute proceeds
“tax free”
Ability to refinance and distribute proceeds “tax
free”
How Does it Work?
Courtesy of Grubb & Ellis
Commercial Real Estate Services
1. Client sells investment property.
2. Proceeds transferred to QI (Edmund & Wheeler)
3. Client and advisor identify potential properties through a myriad of
sources within their 45-day ID period.
4. Client is granted a reservation.
5. Client and advisor fill out necessary paperwork to close.
6. Client is on title and receives a deed to the property.
7. Client assumes % interest of non-recourse financing (1)
8. Client receives % interest of the income generated from the property.
9. At the sale, the client receives % share of any and all potential profits.
What Is An UPREIT?
• Similar to a Mutual Fund For Real Estate Investors.
• Allows Exchanging Real Property Into Operating
Partnership (OP) Shares of Existing REITs
• REITS can convert existing properties into TICs allowing 35
ownership positions; then
• TICs are then converted back to REIT shares and
investors then hold shares in the REIT‟s entire portfolio.
• Portfolio is professionally managed with 95% of the net
income to investors.
Section 721 Exchange Overview
• Instead of Selling
and Exchanging,
The Investor
Contributes
Property to a
Partnership
• Receives Operating
Partnership (OP)
units.
UPREIT Benefits
• Transaction completed on a tax-deferred basis. If shares go
to an estate the ultimate recipients will receive a stepped up
basis.
• Transaction can be structured enabling property owner to
convert an interest in a specific property into a larger, more
balanced portfolio held by the UPREIT.
• Allows an interest in illiquid individual properties to become
more easily saleable.
Oil & Gas LeasesINVESTORS CAN EXCHANGE REAL PROPERTY FOR
INTERESTS IN PRODUCING OIL & GAS ENTERPRISES
Any Real Property
Oil & Gas LeaseAN EXTREMELY VIABLE ALTERNATIVE FOR AN EXCHANGE.
A Viable Alternative Investment for "like-kind" 1031 Exchange.
• Working and Royalty Interest
• Leasehold Interest Allows the Right to
Search for and Produce Oil and Gas
• Fractional Owners Have the Same
Rights as a Single Owner and Can
subdivide or Offer for Sale on the Open
Market
Oil & Gas Lease Characteristics
• Liquidity
• Active Secondary Market
• Life of Production
• Supported by Qualified 3rd Party Reports
• Annual Return
• Average 15% - 18% Over Term
• Tax Treatment
• 15% Tax Free Depletion Allowance
• Valuation
• Valued on the Amount of Potential
Production
Oil & Gas Lease Benefits
• Immediate Economic Closing With Predictable Cash Flow
• Ability to Participate in the Future Production
• Highly Liquid Individual Fractional Ownership
• Diversification By Investing In One or Several Qualified
Working Interests in Different Markets
Structured SalesSTRUCTURED SALES ALLOWS THE INVESTOR TO
ARRANGE FOR A FUTURE PAYCHECK
Any Real Property
Exchange!
The Structured SaleThe Structured Sale is a method for selling appreciated assets such as
real estate and businesses that allows sellers to:
• Defer capital gains taxes to future years
• Collect a stream of guaranteed payments over a set number of years
In Addition:
• Makes the transaction safer for the seller
• Doesn't require the seller to acquire new property.
This method was developed in 2005 and is becoming a sought after
method for tax deferral when selling a business or real estate.
The Structured Sale & Section 1031
• Identified as an Alternative Strategy In Exchange
Agreement
• Gives Buyer Full Title
• Can Be Used When Replacement Properties Cannot Be
Identified and/or Purchased in the 45/180 Day Time
Restraints
• Can Be Used For Taxable “Boot”
The Structured Sale & Selling a Business
• There is Inherent Risk Associated With a Typical
Installment Sale
• The Structured Sale Provides a Safe Alternative
• Can Be Used in an Exchange for non “like-kind” Items like
goodwill and FF&E, or;
• Can be used for the entire transaction amount if the client
wants to exit the real estate class
Section 1031 can be
used to dramatically
increase the value of
holdings by leveraging
Uncle Sam‟s money.
Also…
• Must employ a Qualified Intermediary
• Time limits of 45 and 180 days
• Properties must be “Like-Kind”
• Business or Investment Purpose
• Relinquished and Replacement Properties held
by same taxpayer
• Exchanges can be done either forward or reverse
Congratulations!
You are now a member of the elite, the
proud, the educated….
Edmund & Wheeler, Inc.
Alumni Association
Membership has it‟s benefits!
www.section1031.com/alumni