NNN 1031 Exchange Blog

Florida NNN Properties for 1031 Exchanges

Real Estate Exit Strategies

Written By: First American Exchange Company - Jan• 07•11

When interest rates rise and the real estate market starts turning “softer,” you may ask yourself the question “Do I want to continue owning real estate, or should I sell and consider other investment alternatives?” There are many wise investment alternatives, but the problem with selling real estate to get into them is that the capital gain tax will be triggered, and you will have less equity to reinvest.

There are, however, a few options that offer the ability to exit the real estate market while reducing or avoiding the capital gain tax.  Many of these strategies are complex and their suitability is totally reliant on your particular facts and circumstances, so be sure to talk with your tax or legal advisor before pursuing any one of these alternatives.

Option 1:  The 1031 Exchange

 

Internal Revenue Code Section 1031 applies to “property held for productive use in a trade or business or for investment,” and it allows for the deferral of capital gain tax if such property is exchanged solely for property of “like-kind.”  The broad definition of like kind can help investors in many ways.  For example, owners tired of the property management headaches of several properties can leverage their equity into one larger one.  IRC Section 1031 also has broad geographic application, applying to real estate throughout the United States.  For example, if properly structured a couple owning rental houses in California who have kids attending college out of state can exchange their California rentals for investment properties that their children can rent from them while attending college.  Many investors exchange real estate all of their lives and leverage their unused tax dollars to purchase real estate that generates greater and greater returns.  Once investors retire, they can then sell real estate and take.

the cash, paying the lowest capital gain tax possible due to their income tax retirement bracket. Even better yet, investors can leave their real estate holdings to their children, who will inherit the property at a stepped up basis, thereby eliminating any gain that had accumulated throughout the years!   

Option 2:  An Installment Sale

An installment sale, aka seller carryback note or seller financing, works best for real estate investors who want to sell their real estate but don’t need a lump sum payment.  Instead of receiving a lump sum of money at the time of sale, buyers pay the seller monthly income at a rate and term to be decided by the seller.  Taxes are not actually avoided nor totally deferred with a note; they are due yearly based upon the amount of payments the seller receives.  The Charitable Remainder Trust is also based upon this “money over time” concept.  The tax benefit of installment reporting is that because taxes are not due in one lump sum at the time of sale, interest is earned on the deferred dollars over the years. Always discuss the transaction with your tax advisor, however, as installment sale reporting may be disallowed or restricted if not structured properly. 

Option 3:  The Charitable Remainder Trust (CRT)

A CRT allows an investor to receive lifetime monthly payments after transferring the asset to a trust.  With this option, the asset is transferred to a trust, the trust can sell the property without paying tax and makes periodic distributions to the investor, and the charity inherits any remaining funds once the investor dies.  The main advantage of a CRT is that in addition to monthly cash flow and the satisfaction of one’s philanthropic objectives, the donor qualifies for a charitable income tax deduction, which is usually the present market value of the remaining interest to the charity.  Additionally, if the deduction is not all used during the first year of contribution, it may be carried forward and utilized over five years.   

Option 4:  Joint Use of IRC Sections 121/1031

When a personal residence is sold, IRC section 121 allows for capital gain tax exclusion of up to $250,000 if a taxpayer is single, and $500,000 if a taxpayer is married, as long as the residence has been owned and personally used by the taxpayer for an aggregate of two of the preceding five years before the sale.  With the enactment of Rev. Proc. 2005-14, there is now a way to exclude gain in excess of the $250,000/$500,000 limits.  For example, if a house was bought for $100,000 20 years ago, and it is now being sold for $1 million, the taxable gain is $900,000.  Under the old law, taxes would be owed on $400,000 of gain. Under the new law, if a married couple first converts the house to a rental, they can exclude $500,000 tax free at closing under IRC.

Section 121, and then perform a 1031 exchange and buy another rental house for $500,000, to exclude the remaining $400,000 of gain! 

Option 5:  Gifting Real Estate Interests

If you wish for your children to own a portion of your real estate while you are still alive, you can gift portions of the real estate to them each year in the amount of the annual gift tax exclusion ($13,000), or if a Family Limited Partnership (FLP) is set up, you can gift limited partnership interests to the children using the annual gift tax exclusions (plus the FLP can be discounted).  One caveat: Unlike inheriting real estate in which the heir’s basis is the fair market value of the property as of the date of inheritance (“stepped-up” basis), a donee’s basis from a gift is the same as the basis of the donor, so your children may wish to consider a 1031 exchange or other options in this newsletter when they sell their real estate to avoid a big capital gain consequence.

There are many other strategies that can be used in lieu of these options, and often the best results come from a combination of techniques.  There are also many risks and disadvantages associated with all of the options; for example, Charitable Remainder Trusts can be costly to structure. In addition to consulting with a tax advisor, investors should seek the advice of a real estate attorney with experience in tax and business, and also consider the advice of a financial planner who can offer even more options for one’s investment portfolio. 

First American Exchange Company
800.556.2520

First American Exchange is a Qualified Intermediary and is precluded from giving tax or legal advice. You must consult with your tax or legal advisor about your specific circumstances. First American Exchange is a wholly owned entity of First American Title Insurance Company.

www.firstexchange.com

About the 1031 Exchange

Written By: First American Exchange Company - Jan• 06•11

Frequently Asked Questions

 
[Q] Why do I need a Qualified Intermediary?

[A] A Qualified Intermediary is necessary to create the exchange of properties required under Section 1031. First American Exchange simplifies the exchange process by accepting a transfer of your property, conveying it to a buyer, taking custody of the proceeds, buying the replacement property, and transferring title to you. It is a sensitive role requiring experience, special knowledge, and extreme care to preserve the tax-deferred character of the transaction.
[Q] Can anyone serve as a Qualified Intermediary?
[A] No, there are certain persons who may not act as your Qualified Intermediary. Generally, these include certain relatives, or someone who, within a two-year period prior to your exchange, has acted as your attorney, accountant, real estate broker, or agent.
[Q] What characteristics should my advisors and I look for in selecting a Qualified Intermediary?
[A] Experience, financial stability, and customer satisfaction are factors that you should consider. First American Exchange possesses all of these characteristics.
[Q] If I select a Qualified Intermediary, do I still need a legal or tax advisor?
[A] Qualified Intermediaries are appointed to carry out the exchange and prepare the necessary documentation for tax deferral, but we are precluded from counseling you on the desirability or tax implications of an exchange.
[Q] How do I identify replacement property?
[A] The identification of replacement property must be submitted in writing, unambiguously described, signed by you, and delivered or sent before midnight of the 45th day. First American Exchange will provide you with forms to assist you with this requirement.
[Q] What happens if I change my mind about buying a replacement property and want to cancel my exchange?
[A] If you transfer the relinquished property and do not replace it with another, the sale will create a taxable event and any capital gain will be subject to federal and state capital gains taxes. Additionally, if you decide to cancel your exchange after First American Exchange receives the exchange proceeds, certain restrictions apply to all Qualified Intermediaries that limit access to those proceeds until certain time periods have elapsed. Our exchange professionals are available to discuss those restrictions.
[Q] What happens if I sell a property and then decide I want to make it a part of a tax-deferred Exchange?
[A] If you actually or constructively received proceeds from the sale, it might not be possible to include that property in a tax-deferred exchange. That’s why it’s important to note your intention to make this transaction part of a tax-deferred exchange in the contract to sell the relinquished property. If you have entered into a contract to sell, but have not closed, it may be possible to carry out a deferred exchange, provided you execute the proper exchange documents, identify the replacement property within 45 days of the closing, and actually receive it within 180 days or before your tax return is due. Your attorney or tax advisor can help you to make that determination.
[Q] What is boot?
[A] “Boot” can be cash received from the sale of the relinquished property or other non-cash consideration, including any property that is not “like-kind,” promissory notes, or debt relief (mortgage boot). If you receive boot in an exchange, it is likely that all or some portion of the boot will be taxed.
[Q] Do I need to do a tax-deferred exchange for my personal residence?
[A] No, your principal residence is not considered property held “for productive use in a trade or business” or “for investment,” and therefore, does not meet the requirements of Section 1031. However, Internal Revenue Code Section 121 allows an individual to exclude from taxation up to $250,000 of the capital gain realized on the sale of the individual’s principal residence. A married couple filing jointly can exclude up to $500,000. Section 121 has certain requirements that must be met.
[Q] Can I just sell my relinquished property and put the money in a separate account and use that to purchase my replacement property?
[A] No. You cannot receive the proceeds or take constructive receipt of the funds without disqualifying the exchange.

[Q] Does vacant land qualify as like-kind property?
[A] Yes; assuming it has been held for productive use in a trade or business, it is considered like-kind with all other types of real property.
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First American Exchange Company
800.556.2520

First American Exchange is a Qualified Intermediary and is precluded from giving tax or legal advice. You must consult with your tax or legal advisor about your specific circumstances. First American Exchange is a wholly owned entity of First American Title Insurance Company.

www.firstexchange.com

Just the Basics: Tax-Deferred Exchanges Under I.R.C. § 1031

Written By: First American Exchange Company - Jan• 05•11

Tax Reductions
Knowing some basic rules behind Internal Revenue Code 1031 can help investors defer paying capital gain tax on property dispositions, resulting in more money to invest in a property acquisition. Generally, any real or personal property can be exchanged, provided it is held “for productive use in a trade or business” or for “investment” and is exchanged for property of “like-kind” that will also be held for one of these same purposes.

Exchange of Property
The first requirement of a 1031 exchange is that the transaction must be structured as an exchange, rather than as a sale and purchase. In order to accomplish this, a Qualified Intermediary (QI) must be involved with the sale of the relinquished property (property sold) and acquisition of the replacement property (property acquired). To ensure that the transaction is considered an exchange, rather than a sale followed by a purchase, the investor must sign an exchange agreement, assignment of the purchase contract, as well as other documentation before the relinquished property sells, and the QI must hold the proceeds until they are used to buy the replacement property. As long as the appropriate documentation is signed, the QI does not need to take title to the property.

Like Kind Requirement
The replacement property must be considered “like-kind” to the relinquished property. The like-kind requirement is fairly broad for real property exchanges. For example, an office building can be exchanged for vacant land, an apartment building can be exchanged for a single family rental home, or a duplex can be exchanged for a retail strip center; basically any real property held for investment qualifies as like-kind.

Same Taxpayer Rule
In order to qualify for tax-deferral treatment, the same Taxpayer selling the relinquished property must purchase the replacement property. For example, if Company B sells the relinquished property, Company B must also acquire the replacement property. An exception to this requirement is entities that are considered disregarded for tax purposes, such as single member limited liability companies and revocable trusts. For example, Sue Smith may own a commercial building in her own name. She can sell that property and acquire replacement property in her own name, or she may take title in the name of a limited liability company in which she is the sole member, or she may create a revocable trust and take title in the name of the trust. In each case Sue Smith is still considered the same Taxpayer thus allowing her to complete an exchange.

Holding for Investment Purposes
Both the relinquished and replacement properties must be held for investment purposes or for use in the Taxpayer’s business. Property that is held for the purpose of appreciation or for rental income should satisfy the investment requirement. Typical exchange transactions involve an office or commercial building, a rental home or an apartment building. Personal residences, vacation homes frequently used by the owner, and property held for sale (i.e., new homes constructed by a homebuilder) would not qualify. Mixed use properties such as home offices or duplexes in which the investor lives in one unit and rents the other unit can qualify for a tax-deferred exchange for the portion of the property used for business or investment purposes.

The tax code does not clearly specify a minimum time frame that an investor must continue to hold the investment property to qualify for tax-deferral treatment. However, when the IRS examines exchange transactions, the Taxpayer must be able to show that the Taxpayer intended to hold the property for investment purposes at the time it was acquired. If a Taxpayer only holds his replacement property for a few months prior to selling it, the IRS may question whether the investor actually intended to hold the property for investment purposes.
Deferring All Tax
In order to defer all tax completely, the property that the investor is purchasing must be equal or greater in value, equity, and debt (but the debt can be replaced with cash) than the relinquished property. If any of these criteria are not met, the exchange may still be valid; however the transaction will likely be at least partially taxable.
Timing and Identification
The Taxpayer has 45 days from the closing of the relinquished property to identify replacement property. Proper identification of replacement property is a requirement for a valid exchange, and the investor can only acquire property which has been properly identified during the 45-day identification period. Replacement property that is acquired (i.e., closes) within the 45-day time period is considered properly identified. For property not purchased within the 45-day time frame, the identification must unambiguously describe the property (with an address or legal description), and must be made in writing, signed by the Taxpayer and sent before midnight of the 45th day. If multiple relinquished properties are grouped together in one exchange, the 45-day time period starts to run as of the closing of the first property. At First American Exchange, we provide you with forms to help you meet the required guidelines.

If a Taxpayer wants to identify more than one replacement property, there are several options. The two most common methods to identify multiple properties are:
1. The “Three Property” rule: the investor may identify up to three properties without regard to their fair market value; or
2. The “200%” rule: the Taxpayer may identify any number of properties so long as the total fair market value of all of the listed properties does not exceed 200% of the value of the relinquished property.
Once escrow closes on the relinquished property, the Taxpayer has the lesser of 180 days from the date of closing, or the date on which the Taxpayer’s tax return for the year the relinquished property was sold is due, to close the purchase transaction and complete the exchange. For exchanges closing in the final quarter of the year, the Taxpayer will need to get an extension to file his tax return to get the full 180 days.

Trust the Experts
Tax-deferred exchanges are an incredible investment tool. When considering a tax-deferred exchange, consult with your tax advisor and contact First American Exchange Company before the sale of the relinquished property. First American Exchange’s Certified Exchange Specialists® can assist you through every step of the process.
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First American Exchange Company
800.556.2520
First American Exchange is a Qualified Intermediary and is precluded from giving tax or legal advice. You must consult with your tax or legal advisor about your specific circumstances. First American Exchange is a wholly owned entity of First American Title Insurance Company.
www.firstexchange.com

Absolute NNN Ground Lease Naples,Florida

Written By: Patrick Moorton - Dec• 03•10

Chili’s Bar and Grill NNN Ground Lease. The property is a 1.5 Acre ouparcel in a Super Target Anchored Shopping Center in Naples, Florida. The ground lease is guaranteed by Brinker International doing business as Chili’s Bar & Grill. It is a rare opportunity to purchase an  investment grade ground lease in Naples, Florida.

Absolute NNN Ground Lease Naples, Florida

Chili's NNN Ground Lease Naples,Florida

Patrick Moorton is President of Realty Advisors of Southwest Florida Inc. Owner and operator of NNN1031Exchange.com, an online resource for investors buying and selling Single Tenant Net Leased Properties with Credit Tenants in Florida. For more information please visit http://www.NNN1031Exchange.com