1031 Tax Exchanges
Material courtesy of Realty Exchangers at http://www.irs1031exchanges.com/ProcedureManual.shtml
A tax deferred exchange allows us to sell a
piece of investment (i.e. rental), trade or business
property, buy a new property with the gain or
profit from the sale, and not owe taxes on the
sale immediately. If you eventually sell the
new piece of property, you would owe taxes at
that time. Generally, all gains and losses on
sales of real estate are taxable, but an exception
lies where the property sold is traded or exchanged
for "like-kind" property. The new property
is seen as a continuation of the original investment,
so taxes are not due at the time of the sale.
Many people view tax deferred exchanges as being
for huge corporations, or only for professional
investors. I believe that everyone should take
advantage of these where they can. Strategy --
purchase a rental home below market value, rent
it for a year, sell it, and buy two rental properties
with your gain. Note that if you do this too
many times, the IRS may take the view that you
are not a long term investor, and disallow such
exchanges. When you get ready to do a tax-deferred
exchange, you will need the services of a qualified
CPA or Attorney. This is a basic introduction
only, and you should always get professional
advice from someone who has all the details on
your deal, since so much liability is at stake.
In my course I list the company that I use for
these real estate exchanges. They are a national
company and can help you out wherever you are
in the country. I have used them for several
deferred exchanges, and they have been an excellent
resource and extremely competent.
Let's look at how one of these deals would work.
Assume that you own a rental property that has
gone up in value. You'd like to sell this property
and then reinvest the proceeds into some other
rental real estate. You can avoid the tax bill
if you can find suitable property to exchange
for. The difficulty of the tax deferred exchange
is that the property you are going to purchase
must be identified within a certain amount of
time, and it must be closed within a certain
amount of time after it is identified. Unfortunately,
no extensions are possible.
Identifying Property
You must identify property in a written document
signed by you, and delivered to the party assisting
you with the exchange (cannot be related to you!)
on or before 45 days from the date you sold the
original rental property. There is a growing
body of support for identification of properties,
and closing of new properties before the original
property is sold. This is somewhat controversial
and outside the scope of this discussion.
Technical Note: You can identify more than one
property as the replacement property. However,
the maximum number of replacement properties
that you may identify without regard to fair
market value is three properties. You may identify
any number of properties provided that the total
value of these properties is not more than 200%
of the value of the original property you are
selling. Note that you don't have to close on
all the properties you identify. You can name
several if you're not sure what will close, or
not close, but you have to observe the rules
in this technical note in terms of the value
of properties you identify. If at the end of
the identification period you have identified
more properties than you are allowed, you are
generally treated as if no property was identified.
This means that you pay taxes!
Time Limits For Completing the Exchange
If you have correctly complied with the identification
phase of the exchange, you have up to 180 days
to complete an exchange, but the period may be
shorter. Specifically, property will not be treated
as like kind property if it is received more
than 180 days after the date you transferred
the property you are relinquishing, or after
the due date of your return (including extensions)
for the year in which you made the transfer.
For multiple property transfers, the 45 day
identification period and the 180 day exchange
period are determined by the earliest date a
property is transferred.
Avoid Boot!
Boot is defined as any money or any type of
property of unlike kind (example, a car received
as part of down-payment). You will be taxed on
this boot regardless of whether or not you carry
out the exchange correctly. You will want your
exchange company, or attorney to examine your
transaction closely to make sure you don't receive
anything that could count as boot. Special rules
apply for exchanging property with assumed mortgages.
Summary
The tax-deferred exchange is a great way to
maximize your wealth. By keeping your investments
growing without immediately paying taxes, you
can do wonders for your net-worth. You will need
to search out a good intermediary. I am happy
to provide the name of mine for our members.
This may seem like a dry subject, but it is important
to understand when you begin to accumulate some
rental properties.
Remember that this article is to provide basic
information only. If you are planning on doing
a tax deferred exchange, you really need to speak
with a professional that handles these transactions
on a regular basis. Information here is subject
to change by IRS regulations or statute, so be
sure to use current information provided by your
accountant or other professional when planning
a strategy involving tax deferred exchanges.
Buying a fixer upper
Ask many a home buyer about the type of house
they are looking for and many will reply "We
are looking for something we can fix up and live
in (or resell). We like the idea of gaining some
quick sweat equity." The classic "fixer-upper" home.
Unfortunately, there is a bit of fantasy in the
notion, though. First of all, there are many
more fixer-upper buyers than there are fixer-upper
properties. Second, the current thinking in many
minds is that anyone can make a killing in the
Real Estate market, which is not always the case.
Third,
many buyers totally mis-estimate both the cost
and the time involved in fixer-uppers, severely
impacting (and in some cases destroying) the
profit potential. Unless you are fully prepared
to deal with the realities of fixer-uppers rather
than the fantasies, it probably is a good idea
to look elsewhere for a home.
This does not mean that there isn't equity to
be gained (or profit to be made) by purchasing
the RIGHT property at the RIGHT price. The important
notion is to understand that there are several
factors that will make the difference between
winning and losing in such a transaction.
The Mindset
The first factor that must be understood is
that it isn't going to be easy. The only people
who think that finding, buying, fixing and selling
a home is an easy task are those who have never
done it. Those with any experience (even if only
once) will tell you that it rarely is as simple
as it appears. In general, it is best to assume
that repairs will cost twice what you estimated,
take double the amount of time and,when finished,
the house will be worth less than expected. If
you keep that in the forefront of your thinking,
the chances of being burned are much less.
Foreclosure sales are often good sources for
fixer-upper properties. A couple of resources
that specialize in listings of those types of
homes are and . All three of the resources above
offer free trial periods to evaluate their services
and search for foreclosure listings in the area
in which you are interested.
Start Out Small
Some of the worst examples of mistakes made
by buyers of fixer-uppers are first-time buyers
who bite off way more than they can chew. Examples
of this are houses that have structural problems
or will take an exceptionally long time to repair,
or are located somewhere other than a desirable
neighborhood. These can be a horrible drain on
finances, time and peace of mind.
A much better strategy for the inexperienced
is to purchase a home in a desirable neighborhood
that is in need of cosmetic attention--new paint,
carpeting, appliances, landscaping and the like.
These repairs can either be handled by the homeowner
or are easily contracted out, saving time, effort
and money. Yes, money can be made on homes needing
major renovations, even if they
are in less popular neighborhoods, but these
are jobs for professionals, not homeowners (and
definitely not for first-time homeowners!)
Avoid Surprises
The most expensive situations are often those
that are the least expected--those nasty little
(and often big) surprises that jump out at you.
You can avoid many of these surprises, though,
with a couple of easy steps taken BEFORE final
commitment to a property.
1) Have the property thoroughly inspected. Have
the inspector detail all obvious (as well as
potential) defects in the property. NOTE: The
seller may say "we are selling the house
as-is, so NO inspections." Avoid this property
like the plague.
2) Run the numbers. You must know the market
values for houses in the neighborhood in which
you are interested that need no repairs. Running
the numbers means working them backwards to see
how much equity or profit may be available (or
even IF there will be any) in the deal. You will
need to begin by computing the realistic value
of the home when all repairs are made. From that
point, you will need to subtract any selling
expenses you will incur (commissions and the
like) as well as the full cost of repairs and,
most importantly, the amount of desired profit
or equity.
Example:
$600,000: Expected Sale Price, Repaired
-40,000: Selling Expenses
-25,500: Repair Expenses
-50,000: Desired Profit/Equity
$485,000: Maximum Property Purchase Price
Don't be deluded into thinking that you'll be
able to sell for more than the market value or
do the repairs for less than the estimates. If
the numbers don't fit--with a good amount of "wiggle
room" for more expense or handling costs
or if the property does not sell quickly--don't
waste your time or your money!
Summing Up
When considering a fixer-upper, whether for
resale or to live in with increased equity, go
into the process fully prepared so you will avoid
many surprises. For your first project, only
consider structurally sound homes in good neighborhoods
requiring cosmetic repairs only. Have any property
you are considering fully inspected and then
get firm estimates for all needed repairs. Most
importantly, "run the numbers" to be
certain that the potential for gain is truly
there. If you are satisfied on all counts, you
may very well be able to be successful with your
fixer-upper project “Remember not making
a decision is still a decision!
Using your home as a rental
Renting your home out as a seasonal(vacation
rental)or long term.
Long term renters are easy to find as there is
a shortage of homes for rent. So, if you want
to buy something for retirement or a vacation
home and rent it out to help your payments-this
is typically the easiest way. (Long term rentals
are considered to be anything over 6 months,
as the tenants don't pay the 11.5% Florida tax)
• Generally long term rentals should be
unfurnished.
• Initially we do a credit check before
submitting a lease to you, then with your approval
of the lease, we collect the first and last months
rent plus a security deposit which is typically
a months rental amount. We are very proactive
in this area and I assure you the home is handled
professionally.
• As to utilities- The tenants take the
lease to the water, electric, phone and cable
people and have the utilities put in their name
and of course they pay their own deposits. Garbage
down here is included in your tax bill-so there
is no garbage bill.
• Seasonal rentals. Currently we can only
rent monthly or 28 days, meaning the owner can
only rent the home out 12 times per year. This
means about 5 months of income-Jan-Feb-Mar and
July-August. There are some April and June monthlies.
• As to finding people to rent for the rest
of the time! I deal a lot with navy transfers÷they
generally need something for 2-3 months while
they sell their home and buy another. So if it
is the off season, I try to fill your home up
this way. Another way to fill in the gaps is
to Companies that come down here. Most of the
major government and private building projects
are done by outside firms. Their management people
will generally want a nicer situation so they
will generally rent homes at better than average
rates.
• As to what is the best rental situation
, that is size, which areas, views, pools, how
water and boating accessibility affects rental
amounts and the typical rental amounts for both
long and short term, plus the fees involved,
please contact me. As to extra costs and what
is necessary to have a Home as a Rental.
• When you rent your home out you need to
license it through the County. This costs $25.00
and we handle the paperwork for you. The County
and the Tax people want the home licensed so
they know where there may be tax dollars coming
in. When your home is used as a rental, in effect
you are operating the same as a hotel or motel
and so come under their safety guidelines.
• Every bedroom and the main living area
must have a hardwired smoke detector and there
must also be an escape light. This light comes
on in case of a power outage-this also must be
hardwired. (About $550.00 installed smoke detectors
and escape light for a 2/2)
• There also needs to be a professional
quality refillable fire extinguisher that is
approved by the fire department (about $55.00).
This would be the same as you'd find in a restaurant
or hotel room. There needs to be a dead bolt
on the door that works from the inside and is
a different key than the main door. All of these
issues help protect your liability in cases of
fire/break in.
• When the home complies with all of the
above and we have the signed contract, then it
can go into the rental pool.
What makes a good Vacation Rental
• A clean, well-maintained home on a canal
or open water.
• Typically one of the bedrooms should have
a set of twin beds if the renters are bringing
children.
• Good linens and towels and a backup set.
This is especially important for monthly renters.
• The washer, dryer and refrigerator should
be newer if possible.
• A good Television hooked up to cable (about
$35.00 per month) and a CD or tape stereo system.
• The kitchen must be completely outfitted.
A microwave is also very important for renters.
• Patio and/or Lawn-Deck furniture. If there
is an upper deck, a table and chairs plus loungers.
• On the water side, below a set of loungers
and chairs.We get a lot of repeat renters÷if
the renters have a good experience, they will
come back. We see this especially with people
that book two to three months a year.
5 reasons to invest now
1. Prices in the Upper Keys have stabilized
and are in fact even better than other destination
resort areas in the United States. This includes
both residential and commercial Real Estate.
2. Real Estate sales and closings have seen
a steady increase in the Upper Keys since January
2006. This clearly indicates the buyers are responding
to increased inventory choices and competitive
pricing.
3. The explosive growth of South Dade County,
(just 30 miles away) will definitely benefit
Real Estate sales as people look for weekend
getaways. (Predictions for the Homestead area
and just north are for one million residents
by 2010) Think New York and the Jersey Shore.
4. Weekenders and potential home buyers from
Miami, Ft Lauderdale and Naples will find it
even easier and safer to come down weekends for
a Keys experience, due to the widening of the
18 mile stretch.
5. The Cost of Living Index (stats from Accra)
show the Keys now at a better rate then 24 major
American markets from the East Coast into California.
This means Baby Boomers looking for lifestyle
changes and/or 1031 and straight investments
are finding the Keys competitive and affordable.
The combination of all this is obvious. The
Keys only have so many homes and so much land,
and only a small amount of new homes can be built.
This is due to the fact there is only one road
in or out of here, US 1. If a hurricane is heading
our way, people have to get out—we have
a very organized method of evacuating on this
single road. That is why the Keys will never
be like California or the Jersey Shore.
As more people move into Southern Florida they
definitely use the Keys as a weekend getaway.
The majority of our summertime renters are from
Florida, looking for a Keys experience.
How about going on vacation and never coming
back? You know you've had this feeling before.
Why don't you consider giving yourself and your
family this option? The truth is, if you're going
to work, why not do it in the Keys! Having beautiful
weather and water and recreational opportunities
are not only good for your health but good for
you, period. Think on it and contact me.
