Tax-saving Section 1031 exchanges, or ‘like-kind’ exchanges, may be more valuable than ever, but it might pay to act sooner rather than later.

original article on marketwatch.com: https://www.marketwatch.com/story/this-tax-maneuver-is-one-big-reason-that-some-real-estate-investors-have-struck-it-rich-over-the-years-11638397583?mod=home-page

As a real estate investor, you may want to unload one property and replace it with another. Real estate prices have surged in many areas. You may hold a property that you think has topped out and want to move on to what you think are greener pastures. Fair enough. But selling an appreciated property will result in a current tax hit — maybe a big one. That’s a suboptimal outcome if you intend to use the sales proceeds to buy replacement property.

What to do? Section 1031 exchange to the rescue. Here’s what you need to know.

What are Section 1031 exchanges, also known as ‘like-kind’ exchanges?
For now, Section 1031 of our beloved Internal Revenue Code allows you to postpone the federal income tax bill from unloading appreciated real property by arranging for a Section exchange — AKA a like-kind exchange. This time-honored maneuver is one big reason that some real estate investors have struck it rich over the years.

An earlier version of the Biden tax plan would have severely limited your ability to postpone taxes with a Section 1031 exchange. While that tax-raising proposal is now apparently off the table, it could come back sooner rather than later if lawmakers get serious about trying to tame federal budget deficits. So, it could be a really good idea to get Section 1031 exchanges done sooner rather than later while the current taxpayer-friendly rules are still in place.

Section 1031 exchange tax basics
You can arrange for real property swaps as long as the relinquished property (the property you unload in the swap) and the replacement property (the property you receive in the swap) are of like-kind. While that sounds like it could be a potential problem, it’s not, because anything that’s defined as real property can be swapped for anything else that’s defined as real property.

What constitutes real property?
Good question. Thankfully, IRS regulations use a very broad brush to define real property for Section 1031 exchange purposes. The starting point is that real property includes land, improvements to land, unsevered natural products of land, and water and air space superjacent to land.

If interconnected assets work together to serve a permanent structure (for example, systems that provide a building with electricity, heat, or water), the assets, may qualify as a structural component of real property. For example, a gas line that fuels a building’s heating system counts as real property.

The regulations also list examples of intangible assets that can count as real property — such as options, leaseholds, easements, and land development rights.

The regulations also stipulate that any property that’s considered real property under applicable state or local law counts as real property for Section 1031 exchange purposes.

Finally, the regulations allow you to receive an “incidental” amount of personal property in a Section 1031 exchange. Incidental personal property can comprise up to 15% of the aggregate fair market value of the property. For example, say you’re acquiring a small hotel worth $30 million in a Section 1031 swap. The swap can include personal property worth up to $4.5 million (15% of $30 million), and the whole package will qualify for favorable Section 1031 treatment.

Key point: Contact your tax adviser for full details about what constitutes real property before pulling the trigger on what you hope will be a 100% tax-deferred Section 1031 exchange.

The impact of ‘boot’
To avoid any current taxable gain on a real property swap, you must avoid receiving any “boot.” Boot means cash and property that’s not defined as real property. When mortgaged properties are involved, boot also includes the excess of the mortgage on the relinquished property (the debt you get rid of) over the mortgage on the replacement property (the debt you assume).

If you receive boot, you’re taxed currently on gain equal to the lesser of: (1) the value of the boot or (2) your overall gain on the transaction based on fair market values. So, if you receive only a small amount of boot, your swap will still be mostly tax-deferred (as opposed to completely tax-deferred). On the other hand, if you receive lots of boot, you could have a big taxable gain.

The easiest way to avoid receiving any boot is to swap a less-valuable property for a more-valuable property. That way, you’ll be paying boot rather than receiving it. Paying boot won’t trigger a taxable gain on your side of the deal.

In any case, the untaxed gain in a Section 1031 swap gets rolled over into the replacement property where it remains untaxed until you sell the replacement property in a taxable transaction.

Deferred Section 1031 exchanges
As you might imagine, it’s usually difficult, if not impossible, for someone who wants to make a Section 1031 swap to locate another party who owns suitable replacement property and who also wants to make a Section 1031 swap rather than a cash sale. The saving grace is that deferred exchanges can also qualify for tax-deferred Section 1031 exchange treatment.

Under the deferred exchange rules, you need not make a direct and immediate swap of one property for another. Instead, you can in effect sell the relinquished property for cash, park the sales proceeds with a qualified intermediary who effectively functions as your agent, locate a suitable replacement property later, and then arrange for a tax-free like-kind exchange by having the intermediary buy the property on your behalf. Here’s how a typical deferred swap works.

* You transfer the relinquished property (the property you want to swap) to a qualified exchange intermediary. The intermediary’s role is simply to facilitate a Section 1031 exchange for a fee which is usually based on a sliding scale according to the value of the deal. In percentage terms, intermediary fees are generally quite reasonable.

* Next the intermediary arranges for a cash sale of your relinquished property. The intermediary then holds the resulting cash sales proceeds on your behalf.

* The intermediary then uses the cash to buy suitable replacement property which you’ve identified and approved in advance.

* Finally, the intermediary transfers the replacement property to you to complete the Section 1031 exchange.

Voila! From your perspective, this series of transactions counts as a tax-deferred Section 1031 swap. Why? Because you wind up with the replacement property without ever having actually seen the cash that greased the skids for the underlying transactions.

Key point: See the side bar for the basic requirements for making a deferred Section 1031 exchange.

Tax-saving bonus
What if you still own the replacement property when you die? Under our current federal income tax rules, any taxable gain would be completely washed away thanks to another favorable provision that steps up the tax basis of a deceased person’s property to its date-of-death fair market value. So, under the current rules, taxable gains can be postponed indefinitely with like-kind swaps and then erased if you die while still owning the property. Wow.

Your heirs can then sell the property and owe zero federal income tax or just a little tax based on post-death appreciation, if any. What a deal. Real estate fortunes have been made in this fashion without having to share with Uncle Sam.

Warning: An earlier version of the Biden tax plan would have greatly reduced the date-of-death basis step-up break. While that tax-raising proposal is now apparently off the table, it could come back sooner rather than later. If it does come back, we can hope that it will only affect those who are truly rich. Fingers crossed.

The bottom line
While Section 1031 exchanges can get pretty complicated, the tax advantages can be huge, which makes all the complications well worth the trouble. As stated earlier, doing Section 1031 exchanges sooner rather than later may be highly advisable. Finally, get your tax adviser involved to avoid missteps. Arranging a Section 1031 exchange is not a good DIY project IMHO.

Side Bar: Requirements for deferred Section 1031 swaps
In order for your deferred real property exchange to qualify for tax-free Section 1031 swap treatment, you must meet two important requirements.

1. You must unambiguously identify the replacement property before the end of a 45-day identification period. The period commences when you transfer the relinquished property. You can satisfy the identification requirement by specifying the replacement property in a written and signed document given to the intermediary. In fact, that document can list up to three different properties that you would accept as suitable replacement property.

2. You must receive the replacement property before the end of the exchange period, which can be no more than 180 days. Like the identification period, the exchange period also commences when you transfer the relinquished property. The exchange period ends on the earlier of: (1) 180 days after the transfer or (2) the due date (including extensions) of your federal income tax return for the year that includes the transfer date. When your tax return due date would cut the exchange period to less than 180 days, you can simply extend your return. That restores the full 180-day period.

Looking for a Way to Test a Property’s Condition

Although putting a professional inspection contingency in the contract will help protect you from surprises, doing your own inspection before making an offer could save you considerable time and money.

How can you tell if a property is worth buying? Here’s how to look at the big picture—for structural concerns, major repairs that are needed, appliances that have to be replaced.

Crawl the Walls

Start out by going to the right when you enter the house, and keep following the wall. You will check each wall that way. Do the same on every floor. Look for settlement cracks, separating joints, defective plaster or other signs of stress or damage. Check wallpapered areas for crinkling or gathering, which may mean walls are settling or shifting.

Look for Leaks

Loose or wrinkled wallpaper could indicate a water leak somewhere. Look for water stains on the ceiling and walls. You may have to look closely—bring a flashlight—in case they have been painted over or repaired.

Spend time in the bathrooms and in every area with pipes, checking for leaks and drips. Also, run the shower and basin, then flush the toilet to check water pressure. Look for cracked or loose tiles and missing grout or mildew stains on the walls or floor, which could indicate a behind-the-wall leak.

Plug Into the Electrical System

Check every electric socket or outlet. Use a plug-in night light and turn every switch on and off. Look for extension cords and multiple plugs in sockets, which could mean insufficient or poorly placed sockets. Also, check every appliance to be sure it works well.

Focus on Condition

Open and close every door and window. Look and listen for squeaking, sticking, or a tendency to close on their own. Check for evidence of shifting or settling around the front stoop, chimney and walks, and places where the driveway and the fence meet the house. Also, check the deck for sturdiness and look for rotted wood. Go into the garage and check the walls, floors and doors—inside and out.

Pay Attention to Pests

Look for termites and ants. Especially look along the foundation, around doors and entry points of wiring and pipes. Check the grading of the yard to be sure water runs away from the house.

You can and should insist on a written report detailing what the problems are with the house, how important each one is. You may have to consult a contractor to estimate repair costs on any problems found.

If everything looks good and you decide to purchase the house, be sure to require a home inspection by a professional inspector before settlement. You will want a professional who will get into the crawl space, climb onto the roof and poke around with a flashlight in the attic. Your professional should also carefully inspect the major systems—electrical, gas, plumbing and heating/air conditioning.

To make sure a home is in tip-top shape before making an offer, give us a call today for more information about how you can spot red flags.

 

source:  Houlihan Lawrence newsletter

4 Ways to Save on Utility Bills in the Hot Summer Months

Although the summer months are a favorite for so many of us, homeowners can get stressed by the skyrocketing energy bills as your struggle to keep things cool inside the house. If you want to cut back on how much you’re spending on utility bills, a few behavioral strategies can make a huge difference.

Consider the following popular strategies to keep utility bills manageable during the hottest months of the year.

Use Your Ceiling Fans

Instead of switching on your air conditioner, consider turning on the ceiling fans instead. When we feel hot in the summer, most of the time it’s because of a lack of air circulation around the house.

There’s no better way to increase the cool airflow around your home than by using the ceiling fans. When the fans are on, you can even switch off the air-conditioning unit so it’s not running your electricity while inactive.

Keep the Drapes Closed

Sunlight is a major contributor to a hot household. If you have sunlight streaming in through the glass surfaces in your home, you’ll definitely be feeling the heat. Fix this problem by blocking out the heat and the light.

When it hits high noon and the sun is at its most intense point of the day, make sure that you close the curtains. This will prevent your rooms from climbing to temperature extremes that take a lot of energy power to cool down again so your air conditioning doesn’t have to work as hard.

Ventilate the House

Nothing beats that summer breeze — and letting it in will help regulate the temperature in and around your home. Opening the doors and windows periodically will help move the hot stagnant air that’s built up during the day out while letting in the fresh air.

Install a mesh screen over doors and windows to prevent any unwanted pests and insects from sneaking in while you’re airing out the home.

Clean Your Air-Conditioning Unit

A dirty air conditioning unit isn’t able to work it’s best. If your air conditioning isn’t regulating the temperature as efficiently as it should be, it may just need to be cleaned out. Air conditioners that are working through built-up dirt and grime require much more energy to cool down your home than does a clean unit.

You’ll want to clean the vents, too. Keeping a clean air-conditioning unit and air pathways will purify your interior environment — resulting in a healthier and cleaner home.

Now you can enjoy the summer season without a spike in utility costs. If you want more ideas to help you invest in memorable moments rather than household expenses, call us today.

 

source:  Houlihan Lawrence newsletter

Capital Gains and Home Sales

There’s a good chance that the profit from your home sale will not be taxable. Unmarried individuals can exclude up to $250,000 in profits from capital gains tax when they sell their primary personal residences, thanks to a home sales exclusion provided for by the Internal Revenue Code. Married taxpayers can exclude up to $500,000 in gains.

The tax break is the Section 121 Exclusion, which is commonly referred to as the home sale exclusion. This rule makes your capital gain or loss the difference between the sales price and your basis in property — what you paid — plus certain qualifying costs.

To calculate your gain, subtract your cost basis from your sales price. Find your cost basis by starting with what you paid for the home, then add the costs you incurred in the purchase, such as title fees, escrow fees and real estate agent commissions. Add the costs of any major improvements you made, such as replacing the roof or the furnace. Minor renovations such as painting a room don’t count. Subtract any accumulated depreciation you may have taken over the years — if you’ve ever taken a home office deduction, that would factor into the depreciation. The resulting number is your cost basis.

Your capital gain is the sales price of your home minus your cost basis. You’ve got a loss if the number is negative. You can’t claim a deduction for a loss from the sale of your main home or for any other personal property.

You’ve made a profit if the capital gain is positive. If the property is your primary residence, you can subtract the home sales exclusion to find your taxable gain. To be eligible for that break, you must have lived in the home for a minimum of two of the five years immediately preceding the date of sale. The two years don’t have to be consecutive, and you don’t have to live there on the date of the sale.

You can use this two-out-of-five-years rule to exclude your profits each time you sell your main home. However, you can claim the exclusion only once every two years because you must spend at least that much time in residence. You can’t have excluded the gain on another home in the last two-year period.

You also want to document any unforeseen circumstances that might force you to sell your home before you’ve lived there the required period of time. The IRS defines an unforeseen circumstance as an event that you couldn’t reasonably have anticipated before buying and occupying your main home. Natural disasters, a change in employment that left you unable to meet basic living expenses, death, divorce and multiple births from the same pregnancy qualify as unforeseen circumstances under IRS rules. Any unforeseen circumstances may get you a partial exclusion.

Active-duty service members aren’t subject to the residency rule. They can waive the rule for up to 10 years if they’re on qualified official extended duty.

Any profit from the sale of your home is reported on Schedule D as a capital gain if you realize a profit in excess of the exclusion amounts or if you don’t qualify for the exclusion.

This is just a summary — there may be other provisions and exceptions applicable to you. Be sure to consult a tax professional before filing.

 

source:  Houlihan Lawrence newsletter

Why buying and selling a house could soon be as simple as trading stocks – MarketWatch

On a recent weeknight, Dahlia and Adam Brown came home to their spacious Colonial on a quiet cul-de-sac in Marietta, Ga. The Browns both work demanding jobs and have two young sons. They bought the house in June using Knock, a company that’s trying to revolutionize the real-estate industry with a “home trade-in platform” making it easier to buy and sell at once. That solution was ideal for the Browns, who are just as busy as most couples but more introverted, making the idea of prospective buyers tramping through their private space seem excruciating.  more…

read full article here: Why buying and selling a house could soon be as simple as trading stocks – MarketWatch

Understanding the home appraisal process (LoanDepot article)

Whether you’re selling your home or refinancing, one of the next essential steps will be to get a home appraisal. Initiated by the lender and usually paid for by the buyer, a home appraisal is essentially an expert’s opinion of what your home is worth. The appraisal assures the lender that the buyer, or borrower, is not overpaying for the home.

Source: Understanding the home appraisal process

What to Expect as an Executor or Trustee (Wells Fargo)

Being asked to serve as an executor or a trustee for a family member’s estate is certainly an honor, but it’s also a considerable responsibility.

Knowing and understanding your responsibilities — and asking the right questions — can help you be prepared. Here are five things you need to know now if you’ve been asked to serve as a family member’s executor or trustee.

Source: What to Expect as an Executor or Trustee

Pre-Paid Funeral Plans: Buyer Beware | Chambliss, Bahner & Stophel, P.C. – JDSupra

Funerals rank among the most expensive purchases many consumers will ever make. A traditional funeral costs about $7,000, although “extras” like flowers, obituary notices, acknowledgment cards and limousines can bring the total to well over $10,000. Moreover, people often “overspend” on a funeral or burial because they think of it as a reflection of their feelings for the deceased.

Source: Pre-Paid Funeral Plans: Buyer Beware | Chambliss, Bahner & Stophel, P.C. – JDSupra

Tax Treatment of Canceled Mortgage Debt (thebalance.com)

Mortgage debt may qualify to be excluded from income under the Mortgage Forgiveness Debt Relief Act. This law provides that certain types of canceled mortgage debt can be excluded from taxes. This exclusion is important for people whose homes have been foreclosed, or who sold their house short, or who restructured their mortgage.

Read the rest of the article here: Tax Treatment of Canceled Mortgage Debt

NYC The dreaded tenant blacklist: What you need to know (BrickUnderground)

To see if your name appears in a database, you can request a report from a company that provides tenant-screening data, such as CoreLogic, TransUnion or On-Site. Just give them a call. It generally costs $15-$20, but can run up to $50, a fee that many landlords pass on as part of the lease application fee.

Source: The dreaded tenant blacklist: What you need to know