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1031 Tax Exchange - Part IV
It has truly been my pleasure to have had
the opportunity to share with the real estate community information
regarding the tax deferring tool of 1031 Exchanges and Tenant In Common
investment opportunities. This is the final part of this series.
The information here will be a combination of review and some brief
additional information. In the gathering of information, I was able
to interview the owner and senior service provider of Cornerstone Exchange
Services/OMNI Brokerage, Mr. John Harvey, no relation.
John was able to confirm information that I
have previously submitted with some additional insight. John is a CPA
and holds a Masters in Business Taxation
(MBT) and a Bachelors of Science degree in Accounting from the
University of Southern California. When speaking to John, I wondered if
Realtors could form relationships with his firm on a commission/referral
basis. He gave me some very interesting information. As it now stands,
in order for any brokerage to pay out a real estate commission to an
agent on the TIC and 1031 Exchange transactions, the agent would have to
also hold a securities license that would include NASD series 24, 7, 66,
and 63. However, the good news is that perhaps in the very near future
there will be a relationship formed between the National Association of
Realtors and the SEC that would no longer require a licensed real estate
sales agent/broker to also hold securities licenses. This indeed would be a huge
advantage to agents and brokers in their ability to further serve the real
estate investment community by having this as an additional tool.
One of the potential
downfalls to any investment opportunity is the requirement to pay capital
gains tax. Below are the steps to calculate the estimated capital gains tax
on the sale of investment property. This can be helpful to investors,
accountants, and the legal counsel that represent them.
Step 1: Calculate Net
Adjusted Basis
Original Sales Price +
Improvements - Depreciation
Step 2: Calculate Capital
Gain Sales Price of Property
Sales Price - Net Adjusted
Basis
Step 3: Calculate Capital
Gains Tax Due
Recaptured Depreciation
(25%) + Federal Capital Gains Tax (15%) + Your State Specific Capital Gains
Tax
(This calculation gives the
total taxes due)
Step 4: Calculate Equity
Sales Price - Cost of Sale
- Loan Balances - Capital Gains Taxes Due
(This calculation gives the
After-Tax Equity)
A taxpayer is generally
required to report gains and losses in general on capital assets on their
tax return. However, there is no statutory authority that requires the
reporting of a full tax deferred exchange. The different forms and schedules
that may be applicable include the Schedule D and Form 4797. In addition,
for Like-Kind Exchanges, Form 8824 must also be filed.
There are closing costs
associated with doing 1031 Exchanges. These costs may vary between
Qualified Intermediaries. The purpose for addressing it here is to
specifically point out the closing costs as they relate to brokerage
commissions on the sale or purchase of individual transactions, which are
treated as boot given (see definition below). They may be offset against
mortgage or property boot received. The ruling that addresses this matter is
in Revenue Ruling 72-456. It may also be used for other non-deductible
transaction costs. However, these costs may not be costs that are
considered normally prorated items such as taxes, interest, commitment fees,
or prepayment penalties.
For the purpose of a brief
review, there are some general “Dos & Don'ts” to 1031 Exchange
transactions. Some are as follows:
- DO plan in advance.
- DO retain a quality
Qualified Intermediary.
- DON'T miss your
identification dates.
- DON'T change how title
is held to the property.
- DO make every effort to
sell the property to be relinquished before you purchase the replacement
property.
- DO be mindful in
planning a balanced exchange.
Within this series, I have
supplied the basics for a 1031 Exchange and for Tenant In Common (TIC)
investment opportunities. In this section I want to review some of the
general terms that are used within such transactions:
- Boot: Cash received and
handled by the investor outside of the Like-Kind Exchange that will be
subject to capital gains tax.
- Exchange Period: 180
days, which includes the 45- day identification.
- Like-Kind Property:
Refers to the nature and characteristics of the property and that it be
held for investment purposes versus resale.
- Qualified Intermediary:
The third-party entity that serves to facilitate the exchange on behalf of
the Exchanger.
- Relinquished Property:
Property to be sold.
- Replacement Property:
Newly acquired property.
There is one additional
term that I would like to add and that is the “napkin test.” This term
refers to the planning of a balanced exchange and it has two components:
- In the event the
exchanger is trading down in total value, there is a risk of being taxed
on the extent of the difference.
- The same thing could be
true if the exchanger is trading down in equity.
There are many, many more
aspects of better understanding both 1031 Exchange transactions and Tenant
In Common opportunities. Below are additional resources that provide more
in-depth information:
The book,
Exchanging Up by Gary Gorman
Cornerstone
Exchange Services/OMNI Brokerage
www.cornerstoneexchange.com
Investment
Property Exchange Services, Inc.
www.IPX1031.com
Starker
Services, Inc.
www.starker.com
TIMCOR Exchange
Corporation
www.wamu1031x.com
Vandema
Commercial Real Estate Resources
www.vandema.com
It is my hope that if this
information does not prove to be useful presently, that it may become a
viable tool in which to use in the near future to assist in directly
building wealth through real estate. Happy investing!
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Crystal Harvey is a
licensed real estate broker and pre-license instructor. She can be reached
at crystaldharvey@gmail.com.
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