Mid year1031 exchangers are once again looking at disposition resources and finding that net lease properties can be the right solution, especially with seller financing, effectively straddling two tax years.
The re-emergence of tax deferral driven investors seeking all three legs of the transaction- lease economics, credit and real estate – coupled with the lack of supply in the marketplace has created a very competitive environment. Statutory time constraints for locating and conveying ownership, few financing alternatives and limited supply have forced some investors to disregard one or more of these legs and select properties to which they would otherwise not consider. What if these same taxpayers had more time to shop? What if they could “hedge their exchange risk?”
Unknown to many is a provision within the 1031 Treasury Regulations which allows some* exchangers whose 1031 transactions have failed either entirely or partially, to postpone the recognition of gain if their exchange fails in a different taxable year than when it commenced. This straddling into a subsequent tax year enables the taxpayer to treat the original sale as if it were conducted via an installment sale process. Typically a seller enters into this type of arrangement to assist his/her purchaser with seller-financing. The installment process rewards the seller by allowing him/her to recognize the gain that is generated by the sale in installments rather than all at once because the seller does not receive 100% of their consideration in the form of cash all at once. As the taxpayer receives installment payments, the taxpayer recognizes the corresponding gain for that taxable year. This process is often spread over several years.
Similarly, a 1031 exchanger who finds him/herself in a “straddled position” recognizes their gain in the year in which their 1031 equity is released back to them by their qualified intermediary. For instance, if a taxpayer disposed of property on August 1, 2011 and assuming that the taxpayer had successfully fulfilled the requirements of the identification process but could not (or decided not to) acquire their “identified” property prior to their exchange period’s expiration date (January 28th), then the taxpayer’s exchange failure will have straddled itself into 2012. Since they recognize their gain on their 2012 tax return, which is filed in 2013, the tax that is ultimately due does not have to be paid until 2013! Knowing that a mini-tax deferral exists for exchanges commenced during the last 179 days of their taxable year provides a hedge against the risk of failure and a more meaningful analysis when selecting their golden goose.
The smart exchanger knows that they have to put their equity to work. We can all agree that in general, money is worth more now than in the future. Should their exchange attempt prove unsuccessful then putting their released proceeds to work while postponing their payment of taxes until 2013 inherently increases their investment power. In this economy, the net lease investment is more attractive than their alternatives (stocks, bonds, treasuries etc.). Their predictability of income, surety of cash flow and the elimination of most (if not all) of the landlord burdens is the perfect conduit for putting deferred dollars to work no matter how the deferral was originated!
*Certain situations or legal entities may not be able to benefit from the coordination of IRC Section 1031 (Exchanges) and 453 (Installments). We recommend that you contact your outside counsel for guidance to determine the applicability of this article’s content to your transactional variables.
This article is not intended to be construed as legal, accounting, tax services or advice and therefore should not be relied upon as such.
Lyle Preest is a real estate broker at Realty Advisors of Southwest Florida ,Inc., a firm specializing in Single Tenant Net Leased Properties, Site Selection, Bank REOs ,Troubled Asset Workouts, and Income Property Sales. Lyle holds the CCIM designation and is a recognized expert in the commercial and investment real estate industry.
Contact Lyle toll free at 888-788-4141 or by E-Mail at lylepreest@gmail.com
