Just a reminder to those who started a 1031 exchange in 2016 and have not purchased their replacement property yet. Do not file your 2016 tax return until after the acquisition of the replacement property.
The 1031 EXCHANGE process has many checks and balances created by the IRS to ensure taxpayer honesty, including the creation of the Qualified Intermediary industry. These checks and balances require the cooperation of the other party to the transaction. When Fannie Mae is the "other" party to a 1031 exchange, they always refuse to sign the IRS required documents, leaving the taxpayer vulnerable to IRS disallowance of the exchange.
True story....I received a call from a individual selling a storage facility and wanting to defer taxes on the sale using a 1031 exchange. The sale price of the property was $3.1 million. The contract indicated the sale is for the real estate with no value allocated to any other assets being conveyed. The Seller also had entered into a contract to purchase real estate of approximately the same value with a closing date within 30 days of the sale. This transaction appeared to be the perfect opportunity for a taxpayer to save thousands of dollars in taxes utilizing a 1031 exchange.
At time of closing and at the advice of the Seller's CPA, the settlement sheet indicated an allocation of the sales price of $800 thousand to real estate and $2.3 million to goodwill. The CPA's thought process was that if the exchange failed, the bulk of the taxes would be capital gains taxes and not depreciation recapture taxes as the real estate was being valued below the depreciated value. In addition, the CPA for the Buyer knew that the amortization of goodwill was over a 15 year period vs. a 39 year period for commercial real estate, thereby affording his client greater amortization deductions against income each year. Both CPAs also were trying to avoid higher transfer taxes for the Buyer and Seller by understating the real estate value.
Well, as their intentions and thought processes were logical, neither were aware that the gain on goodwill could not be deferred in a 1031 exchange. Since the real estate assigned value was less than the depreciated value, there was no tax savings to be had on the real estate sale. Hence, the full $2.3 million of goodwill was taxable, costing the Seller approximately $700 thousand in taxes as opposed to no taxes owed if the real estate was valued at the full $3.1 million sales price.
Given this revelation came at the settlement table upon review of the settlement sheet, the Buyer was not willing to adjust the allocation negotiated by the two CPAs, proving that Bad Advice Can Cost Thousands! Involving the Qualified Intermediary in the negotiations would have saved this Seller $700 thousand in taxes. Perhaps next time the advice of an expert will be sought!
If a good faith deposit is funded from a 1031 exchange escrow, it cannot be held by a “disqualified person” in the exchange, including the client’s attorney, Realtor, banker, CPA, or any other agent of the taxpayer. Upon audit or review of an IRC Section 1031 “Like-Kind” exchange, the IRS may deem the receipt of 1031 funds by the Taxpayer’s agent as constructive receipt by the taxpayer and, therefore deny tax deferment.
Rev. Proc. 2008-16 established a guideline for 1031 exchanges of vacation homes. The guideline suggested minimum rental and usage over a 24 month period. A lender's decision to treat a 1031 property as an "investment" vs. "vacation" property is dependent upon the lender's underwriting guidelines and not the IRS definition of a vacation home for 1031 purposes.
Improvements made to a property after title is acquired are not "like-kind" in a 1031 exchange, as they are considered personalty. An "improvement exchange" can be utilized to acquire property and construct improvements on behalf of the taxpayer, affording them the value of both land and improvements in the exchange.
Often, a buyer who needs time to settle on a property enters into a lease-purchase agreement with the seller. If the seller wishes to complete a 1031 exchange, the structure of the lease-purchase agreement can make a difference between a successful or unsuccessful exchange. We are happy to provide guidance through the process.
"No Man Is An Island" accurately describes the 1031 EXCHANGE process. The Qualified Intermediary's collaboration with the client, his or her attorney, accountant, Realtor, banker, title company and insurer is critical to completing a successful exchange. Some of the functions performed by us, as QI, are highlighted in the following link. Please take a look. https://lnkd.in/eEBrrCy
Understanding a client's objectives, albeit, larger or smaller property, better location, increased rental income, future value, reducing a mortgage, cashing-out, partnership split-ups, reduced maintenance, etc. is as much a part of what we do as Qualified Intermediary as is holding the funds and ensuring the regulations are adhered to.
The bulk of our 1031 business is the exchange of real property. Often the holders of real property also own collectibles, such as, art, rugs, antiques, metals, gems, stamps, coins and alcoholic beverages. These items are also exchangeable for "like-kind" property, potentially saving the client thousands of dollars in taxes.
At this time of the year I am often asked if there is a benefit to beginning a 1031 EXCHANGE in 2016 or 2017. Selecting the proper year is dependent on the anticipated success of the exchange, the amount of gain being deferred or taxed, the debt satisfied on the sale of the 1st property, the client's total income level, and the client's ability to delay filing their tax return if the need arises. We can help you make informed decisions.
2017 Standard Mileage Rates for Business, Medical and Moving Announced
WASHINGTON — The Internal Revenue Service today issued the 2017 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.
Beginning on Jan. 1, 2017, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
• 53.5 cents per mile for business miles driven, down from 54 cents for 2016
• 17 cents per mile driven for medical or moving purposes, down from 19 cents for 2016
• 14 cents per mile driven in service of charitable organizations
The business mileage rate decreased half a cent per mile and the medical and moving expense rates each dropped 2 cents per mile from 2016. The charitable rate is set by statute and remains unchanged. The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs.Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.
These and other requirements are described in Rev. Proc. 2010-51. Notice 2016-79, posted today on IRS.gov, contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.
Many individuals believe if they convert their vacation/investment home to primary usage for 2 years, they can exclude up to $250k/500k of gain upon sale. The Revenue Act of 2008 created "qualified" and "non-qualified" periods which allocate the gain based on usage, making the non-qualified period taxable and limiting the 250/500 exclusion for the qualified period. In addition, depreciation recapture, as always, is not allocated to the exclusion. Before converting a vacation/investment home to a primary home, individuals should evaluate if the sale as a primary home is beneficial or selling the property as an investment/vacation home utilizing a 1031 EXCHANGE is more beneficial.
A person selling a mobile home and the underlying ground or furniture in a vacation home...Is the transaction real property, personal property, or both for 1031 EXCHANGE purposes? The answer depends on the structure of the transaction and the values assigned to the individual pieces. Call us for the most favorable tax treatment.
A LLC owned solely by H/W is generally taxed as a partnership except in community property states or under a qualified joint venture whereby the LLC is disregarded for tax purposes and the tax filings are at the individual level.
Single Member Disregarded Entity LLCs in a 1031 (link to post)
I had 2 calls recently from individuals who sought IRS approval of their 1031 transaction before it began, only to receive a response from the IRS: "We cannot provide an opinion on your transaction. You should seek the advice of a Qualified Intermediary." Having an experienced QI, such as us, in your transaction is critical to its success.
Sales of new homes surge to biggest total since 2008 (link to article)
My response to a client question about holding periods in a 1031 exchange:
There is no minimum holding period in a 1031 exchange except for related party transactions. In 2008, the IRS issued Rev Proc 2008-16 relating to vacation homes. This Rev Proc was the only time the IRS quantified a holding period with minimum renting and maximum personal usage periods. The holding period in the Rev Proc was 24 months before and after the exchange. The IRS grants “free passes” when meeting the Rev Proc and reserves the right to review the facts and circumstances of the transaction if the taxpayer falls short of the Rev Proc. Falling short of the Rev Proc does not result in an automatic failure.
Intent and actual usage weigh heavily in 1031’s, especially when falling short of the safe harbors. The main concern of the IRS is to weed out “flippers” and “dealers” where ordinary income tax is at risk.
Homeowner Equity has more than doubled since 2009 (Link to article)
HOW SAFE ARE MY FUNDS?
As a Qualified Intermediary of 1031 exchanges and the recipient of, in some cases, individual’s life savings, I am occasionally asked “How safe are my funds?”. Generally, the question is not asked as the majority of our business is from referrals from trusted professionals, such as attorneys, accountants and title agencies. With the growing use of Google to find service providers, more and more of our business is coming from random internet searches. In anticipation of this growing market, we include numerous testimonials from trusted professionals on our website with their respective contact information and encouragement to contact these individuals for further information about us as Qualified Intermediaries.
Spending the first half of my career as a practicing CPA and auditor with companies such as Price Waterhouse and Hertz, the invaluable training in the area of safeguarding assets has remained with me throughout my life. The establishment of adequate internal controls and safeguards has been applied to every business and transaction I am involved in.
Having said that, what controls do we incorporate to prevent the loss of client funds? We strongly focus on the controls to “prevent” loss, as once the horse is out of the barn, so to speak, then lawsuits, police and insurances are the only remedy.
First, we only utilize a bank that is financially strong. The fear of bank failures was foremost in the public mind for many years. For that reason, we have chosen TD Bank for all of our client escrow accounts. This selection was not because of account earnings but on the soundness and strength of TD and the availability of a secure escrow system managed by TD’s E-Treasury Department outside of the local branch.
TD Bank offers a principally-preserved escrow system whereby, client funds are established in separate accounts “for the benefit of” the client and maintained by client federal identification. The client receives 1099-Interest statements directly from TD Bank and each account is FDIC insured. Many Qualified Intermediary companies comingle all client funds into one account to maximize interest earnings. Doing so limits the FDIC insurance availability. Other Qualified Intermediaries do not utilize principally-preserved accounts, once again, to maximize interest. By doing so, FDIC insurance is generally forfeited and the client risks losing all or a part of their principal. This later scenario occurred in the Land America case several years ago, whereby, client 1031 funds were invested in non-principally preserved accounts to maximize interest earnings. The result of doing so lost over 400 million dollars of client funds. The client 1031 exchanges failed and resulted in significant tax liabilities, Land America filed for bankruptcy protection, and the clients had to stand in line with other creditors to attempt to retrieve a portion of their lost funds. To protect the client funds from bankruptcy and other creditors, our Exchange Agreement clearly states: “1031 ESI is only holding exchange funds to accommodate the exchange, and does not have unfettered control or ownership of the funds. 1031 ESI shall not withdraw, invest, encumber, or pledge the exchange funds without the taxpayer's express written consent. All exchange funds are being set aside for the taxpayer's exchange and shall not be deemed a part of 1031 ESI's general assets or subject to claims of creditors.”
The TD Bank escrow system requires the authorization and approval of all activity by two authorized users. Each user has a separate user identification and password. The passwords are required to be changed every 30 days. Once in the escrow system, the approval and movement of funds requires a separate code that is displayed on an electronic fob held at all times by each authorized user. The fob code changes every 30 seconds. Once again, funds cannot be transferred without the input of electronic fob codes by two authorized users. In our company, the two owners, myself and William Steffens, are the only individuals who have access to the escrow system, are the only authorized users, and each carry the electronic fob with them at all times.
Many Qualified Intermediaries taut having multi-millions of dollars in Fidelity Bond insurance to protect client 1031 funds. What they are not disclosing is that, by definition, “A fidelity bond is a form of insurance protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees.” A fidelity bond does not insure losses caused by fraudulent acts by the owners of a business, nor does it protect against mismanaged or poor investments into non-principally preserved accounts or bankruptcy. Access to or control of client funds by employees is not permitted in our company and the controls we have implemented would prevent that from occurring. We do not have a parent company putting undo pressure on its employees to meet stockholder demands by taking investment risks with client funds. We are two business owners who enjoy helping people save taxes and collect a modest fee for doing so. We kept our doors open through the toughest of markets and through federal disasters, such as Super Storm Sandy, sometimes without drawing a salary, because our first commitment is to our clients and secondly, because we love what we do.
This year, 2016, marks 19 years as being a Qualified Intermediary, following 19 years as an accountant, auditor and practicing CPA. During my time as a Qualified Intermediary, I have facilitated over 7,200 exchanges totaling more than 3.5 billion dollars of property. I can proudly state that not a dollar of client funds has been misplaced, misdirected or lost while under my watch, nor have any of my client’s exchanges been audited, reviewed or reversed. Our reputation for honesty, integrity, experience and knowledge is why our phone continues to ring. We maintain offices in Florida and New Jersey, facilitating 1031 exchanges in all 50 states. We appreciate your business and work every day to earn your trust.
George M. Christofely
Founder & President