There has been a large increase in the number of tax-free exchanges. At our recent annual meeting of the Federation of Exchange Accommodators in Denver all the members reported a large increase in exchanges, especially compared to the years after the real estate bust. Many states have created laws for monitoring Qualified Intermediaries. Several states have also enacted clawback laws. These require that replacement properties purchased out-of-state, that avoid state tax are required to report, so that an eventual sale will be required to pay the state tax.
There’ve also been some recent rulings of interest to real estate investors. A California investor sold a rental property in San Francisco for $572,000. He acquired a house in Eureka for $340,000. He traded down and therefore had taxable boot. Contrary to long-standing traditions he moved his son into the house. The son had rehab experience and began to work on the house. The owner accepted services in lieu of rent. After considerable rehab the son started paying $1200 per month in rent. They moved out in 2008.
The IRS ruled that the exchange was invalid because the house was acquired for personal purposes. The taxpayer argued that it was held for productive use in a trade or business or for investment. He claimed that the son paid fair market rent. The court ruled that the house was bought for investment and the exchange was valid. “William P Adams v Commissioner, T. C. Memo “
In another case the taxpayer sold a home and a restaurant to one person. They valued the home at $$750,000 and took the code section 121 exclusion of $500,000. The restaurant was valued at $895,000. They moved into the home four days after the purchase. The buyer of the residence sold it for $310,000 a few months later. The IRS argued that the allocation for the residence was overstated and that there replacement home did not qualify as replacement property. The taxpayers argued that their plan for the home was to start a B&B.
The court ruled that use of the property as a personal residence a mere four days after the closing created a clear presumption of nonbusiness intent. The court allowed the allocation of value to the restaurant and the home to stand because it was part of the contract and it afforded a presumption of business reality.
The 1031 exchange is an important tool for investors to expand their investments, change the type of properties, change the location, change the debt structure, defer federal and state taxes and enjoy other benefits. Our website https://www.1031taxfreesale.com/ has basic rules and information for investors to
To your success,
Jack Shea
Author, Mentor