Calculating Capital Gains
Original Purchase Price
Plus Capital Improvements
Minus Depreciation Taken (D)
|( ____________) [D]
|Equals Adjusted Basis
|Current Sales Price
Minus Adjusted Basis
Minus Transactions Costs (Commissions, fees, etc.)
|Equals Capital Gain (Amount of gain deferred if you exchange) - CG
= ____________ [CG]
|[CG-D] x Capital Gain Tax Rate (15%)
|[D] x Tax Rate (25 %) For Depreciation
|Add State Taxes
|Equals Capital Gains Tax (This is the amount you save if you exchange)
Vacation Homes: New IRS Tax Rules
"Until now, the issue of whether a vacation home qualifies for tax deferral treatment under IRC §1031 was the subject of much scrutiny and uncertainty. To the delight of many tax practitioners, on Feb. 15, the IRS eliminated that uncertainty by issuing Revenue Procedure ("Rev. Proc.") 2008-16, effective March 1 which provides a safe harbor for exchanges of vacation homes (defined as "dwelling unit" in the Rev. Proc.).
Now taxpayers can have a clear understanding of the circumstances under which the IRS will not challenge whether a vacation home will qualify as property "held for investment" under §1031.
Vacation home as relinquished property
For a vacation home to qualify as relinquished property, it must meet the following criteria:
• It is owned by the taxpayer for at least 24 months immediately before the exchange ("qualifying use period"); and
• Within the qualifying use period, in each of the two 12 month periods, (1) the taxpayer rents the dwelling unit at fair rental to another person for 14 days or more and (2) the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12 month period that the dwelling unit was rented at fair rental value.
The first 12 month period immediately preceding the exchange ends on the day before the exchange takes place (and begins 12 months prior to that day). The second 12 month period ends on the day before the first 12 month period begins (and begins 12 months prior to that day).
Vacation home as replacement property
For a vacation home to qualify as replacement property, it must meet the following criteria:
• It is owned by the taxpayer for at least 24 months immediately following the exchange ("qualifying use period"); and
• Within the qualifying use period, in each of the two 12 month periods, (1) the taxpayer rents the dwelling unit to another person at fair rental for 14 days or more and (2) the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12 month period that the dwelling unit was rented at fair rental.
The 12 month period immediately after the exchange begins on the day after the exchange takes place and the second 12 month period begins on the day after the first 12 month period ends.
Personal use is defined broadly.
Use by the taxpayer or other person having an interest in the dwelling unit and any family member will be considered "personal use" by the taxpayer. Family use includes brothers and sisters (by the whole or half blood), spouses, ancestors, and lineal descendants.
Also, any arrangement whereby fair market rent is not paid will be considered "personal use" by the taxpayer. Notwithstanding the foregoing, use by family members will not be considered "personal use" by the taxpayer only if the dwelling unit is rented at fair market rent and the family member uses it as his principal residence.
Fair rental is based upon all of the facts and circumstances that exist when the rental agreement is entered into. All rights and obligations of the rental agreement are taken into account.
Note special rule for replacement property. If the taxpayer files a return reporting a transaction under §1031 based on the expectation that the dwelling unit will meet the qualifying use standards and subsequently determines that the dwelling unit does not meet the qualifying use standards, the taxpayer, if necessary, should file an amended return.
Exchanges of vacation homes outside the Rev. Proc. 2008-16 safe harbor. An exchange of a vacation home may still qualify under §1031 even though it falls outside the parameters of Rev. Proc. 2008-16. Any such circumstance will be subject to greater scrutiny and therefore should be carefully planned and reviewed by the taxpayer’s tax advisor."
- Courier News Online 2/25/2008
1031 Exchanges Frequently Asked Questions
1. Who can qualify for an exchange?
Any entity (S-Corp., C-Corp., Pension fund, Partnerships, LLC’s) who owns property held for trade or investment.
2. What is “Like kind”?
It means investment property for investment property. You can exchange a duplex for vacant land, a apartment building for a mobile home park, a rental house for a condo in Florida.
3. How do I choose the replacement property?
You will have to submit by letter, fax or in person a list of the possible replacement property within 45 days of closing on the old property. You can identify up to three properties of any value or as many as you want as long as the combined value does not exceed 200% of the value of the old property.
4. Before I close how long do I have on the new property(ies)?
The IRS allows you 180 days to close on the replacement property(ies).
5. What happens if I can’t meet either time frame? Can I ask for an extension?
Both dates (the 45 day identification period and the 180 days are calendar days and run concurrently.) There are no extensions except in very rare instances like hurricane Katrina.
6. Is a 1031 exchange costly?
No! You will have the normal closing costs as with any real estate transaction. The fee for the exchange will cost about $750 depending on the type of exchange. You will receive any interest earned on the funds which sometimes is more than the exchange costs.
7. Can I purchase the replacement property before I sell my old property?
Yes! This called a reverse exchange. This is a more complex procedure. Contact us before you sign a contract.
8. What happens if I buy a property for less than the one I am selling?
You can defer the amount of tax for the amount you exchange for; you will have to pay tax on any difference.
9. Can I do an exchange for a vacation cabin?
Perhaps. The IRS has specific guidelines for this type of property. But it is possible.
10. Can a dissolving partnership complete a 1031 exchange?
The same entity (tax return) that owned the old property must own the replacement property. There is a procedure that has been used successfully. If the partnership would deed the various percentages to the individual partners before the sale takes place, some or all of the partners could do an exchange with their interest. Click on the 1031 button for more information.
11. Do I have to use a qualified Intermediary?
Yes. IRS regulations make this a requirement.
12. Can I have access to the funds between the time I sell my old property and purchase a replacement property?
No. This would disqualify the exchange.
13. Can I offer seller financing in an exchange?
Seller financing can be considered an installment sale and may be deferrable upon certain conditions. Contact us before signing a contract.
14. Are timber, water rights, and mineral rights eligible for a 1031 exchange?
It depends on which state the property is located. In some states timber is considered real property and in others it is considered personal property. Contact an attorney who specializes in this area.
15. What if my property is condemned or destroyed by acts of nature?
This is called a 1033 exchange. The rules for this are extensive and we recommend that you seek the advice of an attorney or tax professional.
16. What is boot?
Cash boot is where you sell a property for more than the replacement property. The difference is boot and is taxable. For example you sell your property for $500,000 and purchase a replacement property for $450,000 the $50,000 difference is considered boot.
Mortgage boot is when you sell your property for $500,000 and you have a $200,000 mortgage. You must have at least a $200,000 mortgage on the new property. If you have a lesser mortgage on the new property the difference is considered boot. The one exception is you can invest cash to bring the mortgage amount down on the new property.
1031 Exchange Information Links
Field Guide To 1031 Exchanges
1031 Exchange to avoid Capital Gains Tax
||The Basics on 1031 Exchanges
1031 Exchange FAQs, (Federation of Exchange Accomodators).
Section 1031 provides advantage for swapping over selling, (Practical Tax Strategies, Dec. 2005).
Show me the money: Using exchanges, (Realty Times, July 19, 2005).
Five misconceptions of 1031 exchanges, (National Real Estate Investor, May 2005).
1031 Exchange Manual, (1031 Corporation, 2004).
The basics of a deferred like-kind exchange, (Business Entities, Sept./Oct. 2003).
An overview of real estate like-kind exchanges, (The Appraisal Journal, July 2003).
20 questions about deferred realty exchanges under IRC Sec. 1031, (The CPA Journal, May 2003).
Review the fundamentals of Section 1031 like-kind exchanges, (Commercial Investment Real Estate, Jan./Feb. 2003).
Supplemental Information on 1031's
1031 exchanges -- qualification and planning, (Journal of Financial Service Professionals, Jan. 2006).
Title holding issues in 1031 exchanges, (Realty Times, Mar. 3, 2006).
Sale of a residence and like-kind exchanges, Part 1 and Part 2, (The Tax Adviser, Nov. 2005).
What type of properties qualify for a 1031 exchange?, (Realty Times, Sept. 5, 2005).
Unlocking new revenue streams in real estate: Three winning strategies to maximize your 1031 exchange, (Georgia REALTOR®, June 2005).
Like-kind exchanges -- common problems and solutions, (The Tax Adviser, Apr. 2005).
Make a clean exchange: Avoid common mistakes with 1031 exchanges, (Texas REALTOR® , Mar. 2005).
Use 1031 exchanges to close more deals; Practitioners capitalize on tax code to capture lifelong clients, (REALTOR® Magazine, Feb. 2005).
Multi-asset mastery: These tax-deferred exchanges require pre-planning and careful attention, (Commercial Investment Real Estate, Nov./Dec. 2004).
|| Exchange eligibility: Do your properties meet IRS requirements for 1031 transactions?, (Commercial Investment Real Estate, July/Aug. 2004).
1031 details: Manage transactions precisely to maximize tax benefits, (Commercial Investment Real Estate, Mar./Apr. 2004).
Leasehold interests offer alternative 1031 exchange options, (Commercial Investment Real Estate, Nov./Dec. 2003).
1031 exchanges do more than save taxes; These transactions can be used strategically to upgrade portfolios or even to liquidate partnerships, (National Real Estate Investor, Jan. 2003).
Smooth moves: Successful exchanges follow these 12 rules of the road, (Commercial Investment Real Estate, Mar./Apr. 2001).
Exchanges add value in up markets, too; Like-kind exchanges offer complicated, but important option to clients interested in disposing of property, (REALTOR® Magazine, Jan. 2001).
Rules, Forms, & Guidelines from the IRS
Publication 544: Sales and Other Dispostion of Assets
Form 8824: Like-Kind Exchanges
Like-Kind Exchanges: Frequently Asked Questions
Like-Kind Exchanges: Real Estate Tax Tips
Internal Revenue Code, Part 1: Income Taxes - Scroll down to access section 1.1031 et seq.
Rev. Proc. 2002-22: Undivided fractional interests in real estate - Scroll to page 733.
Reverse exchanges: An alternate route, (REALTOR® Magazine, Aug. 2005).
Some practical aspects of undertaking a reverse exchange, (Business Entities, July/Aug. 2005).
Using the reverse Starker, (Realty Times, Sept. 29, 2003).
Reverse exchanges offer investors tax-saving benefits, (Commercial Investment Real Estate, Mar./Apr. 2003).
New safe harbor for reverse exchanges, (The CPA Journal, Jan. 2003).
Tax trade-off; Section 1031 offers a safe harbor in like-kind exchanges, (Journal of Property Management, Sept./Oct. 2002).
Reverse exchanges come of age, (Journal of Accountancy, Aug. 2001).
Tenancy-In-Common (TIC) Exchanges
Legislative/Regulatory Issues: Tenants-in-Common, (National Association of REALTORS®, 2006).
Common interests: Tenancy-in-Common investments create opportunities for property owners and managers, (Journal of Property Management, Mar./Apr. 2006).
TIC reinvestment strategies: As the tenant-in-common industry prepares for a slew of property sales, real estate investors contemplate their next move, (Trusts & Estates, Mar. 2006).
Tenants-in-Common Interests (Hot Topics -- Answers to Current Business Issues), (REALTORS® Commercial Alliance, 4th Quarter 2005).
The pizza paradigm: Investors buying into the TIC pie to avoid capital gains taxes, (Real Estate Finance, Aug. 2005).
TIC fever, (Tierra Grande, July 2005).
TICs take off, (RCA Report, Summer 2005). - Scroll to page 6
Riding the TIC wave, (National Real Estate Investor, June 2005).
Splitting Heirs: Carefully manage tenancy-in-common investments to facilitate smooth wealth transfer, (Commercial Investment Real Estate, Jan./Feb. 2005).
The ABCs of TICs: Learn the fundamentals of this 1031 exchange strategy, (Commercial Investment Real Estate, Jan./Feb. 2005).
1031 exchange options: Tenancy-in-common, (Realty Times, July 28, 2004).
1031 exchangers test the waters, (National Real Estate Investor, June 2004).
Using Tenacy-in-Common interests, (RCA Report, Spring 2004). - Scroll to page 8
IRS revenue procedure provide guidance for Section 1031 exchanges for property held in tenancy-in-common form, (Real Estate Finance, Aug. 2003).
Federation of Exchange Accomodators (FEA) - Professional organization for exchange specialists. Includes directory of exchange companies & specialists around the U.S.
Glossary of Real Estate Exchange Terminology - Basic glossary of exchange-related terms, from Asset Preservation, Inc. and James A. Smith.
Links Retrieved From Realtor.com Resources