1031 Exchanges – Yesterday, Today and Tomorrow

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1031 Exchanges:
Yesterday, Today and Tomorrow
PRESENTED BY
Margo McDonnell, CES®
Certified Exchange Specialist®
1031 CORP., President
ABOUT ME
Margo McDonnell
Certified Exchange Specialist®
 Certified Exchange Specialist®
 Over 19 years in 1031 industry
 Involved in thousands of exchanges of
various size and complexity
 Serve on Board of Directors of FEA
 Spearheaded industry’s effort to launch
a 1031 certification and CE program
 Frequent presenter of 1031 courses
TODAY’S OBJECTIVES
 Current 1031 trends
 Anticipated 1031 activity over next decade
 Misconceptions about capital gains and their
unexpected tax bills
 Quick overview of 1031 exchanges
 Using your 1031 knowledge to your advantage
 Selecting a Qualified Intermediary (QI)
 Q&A
1031 EXCHANGE
WHAT IS A 1031 EXCHANGE?
Section 1031 of Internal Revenue Code provides no
gain or loss will be recognized on the exchange of
property held for productive use in a trade or
business or for investment.
Not for primary residences, flips or most vacation homes.
1031 BENEFITS
 Immediate Tax Avoidance
 Time Value of Deferral
 Avoid higher income tax
bracket and new 3.8%
Medicare Tax
 Preserve personal
exemptions and stay out of
Pease Tax
 Greater Buying Power
 Increased ROI
 Less Management
 Consolidation
 Fresh depreciation
schedule
 Create new cash flow
 Diversification of assets
 Relocation or expansion
of business
 Future conversion to
primary residence or
vacation home
 Possible elimination of gain
 Estate preservation with
stepped up basis
Tax Facts and Rates
The Power of a 1031 Exchange
TAX FACTS AND RATES
FACTS
 Taxes are due on capital gain
 Due on appreciation
 Short-term capital gains are taxed as ordinary income
 Maximum long-term capital gain tax rate for individuals
who held property more than 12 months
TAX FACTS AND RATES
CAPITAL GAINS*
 20% for taxpayers with ordinary incomes exceeding
$400,000 ($450,000 for married taxpayers)
 15% for incomes more than approx. $36,000 ($71,000
for married taxpayers) and less than $400,000
($450,000 for married taxpayers)
 0% for incomes less than approx. $36,000 ($71,000 for
married taxpayers)
*Consult tax advisor to determine actual tax rates.
TAX FACTS AND RATES
NEW 3.8% UNEARNED INCOME MEDICARE
CONTRIBUTION
 New tax goes went into effect 1/1/2013; part of
Affordable Care Act (Obama Care)
 Applies to unearned income (rental income, capital
gains, dividends, annuities)
 Affects individuals with a gross annual income
exceeding $200,000 and married couples exceeding
$250,000
TAX FACTS AND RATES
DEPRECIATION MUST BE RECAPTURED
 Generally taxed at 25% regardless of tax bracket.
STATE INCOME TAX
 Each state has different rules regarding exchanges.
 The Commonwealth of Pennsylvania generally does
NOT recognize a 1031 exchange.
 PA Gov. Corbett called for a PA version of section 1031 in
2013 budget address.
 Many states simply follow the Federal Code or have
adopted similar regulations
 Some states have special requirements such as the
replacement property must be located within the state
 Some states have no income tax
1031 vs. SALE
ASSUMPTIONS
 Individual owned property for many years
 Annual Salary of $125,000 and $50,000 of add’l income
(interest, dividends, rental income)
 Paid $250,000
 Made no capital improvements
 Depreciated down to $100,000
 Selling for $500,000
1031 vs. SALE
ASSUMPTIONS
 Capital gains of $250,000
 With $175,000 of income, falls into 20% capital gains tax
rate
 Subject to 3.8% Medicare Tax
 Subject to highest income tax bracket of 39.6%
 Deprecation recapture of $150,000 @ 25%
 Would likely face a phase out of Personal Exemptions and
be subject to the Pease Tax
1031 vs. SALE
Taxable Sale
Sale Price
Capital Gains
3.8% Medicare Tax
Depreciation Recapture
Federal Tax Liability
Net Proceeds
Buying Power (30% down)
$500,000
$37,500*
$9,500
$37,500
$84,500
$415,500
$1,385,000
*Calculated at 15%. Actual amount could be higher.
1031 Exchange
$500,000
0
0
0
$500,000
$1,666,667
1031 vs. SALE
Immediately avoids $84,500 federal tax liability
Able to invest all proceeds
Leverage extra $84,500
Acquire new property worth $281,667 MORE than
you could if you paid the tax
 Collect higher rents from Day 1
 More depreciation available
 Enjoy greater appreciation long-term
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

1031 Trends and Projections
CURRENT TRENDS
MULTIPLE REPLACEMENT PROPERTIES
 Investors are taking advantage of current CRE
market opportunities and historically low interest
rates to leverage into several replacement
properties
CURRENT TRENDS
COMMERCIAL PROPERTIES
 Commercial properties selling for over $2.5M are
being exchanged as a much faster rate than in
many years
CURRENT TRENDS
SHORT EXCHANGE PERIODS
 Exchangers are lining up their replacement property
and are ready to acquire it immediately after
conveying the old property to a buyer
 Average exchange is now completed within 43 days
(down from average of 93 days just two years ago)
CURRENT TRENDS
REVERSE EXCHANGES
 More and more investors are finding the ideal
replacement property before lining up a buyer
 Must be structured several weeks in advance
 Preserves clients ability to defer gain when property
eventually sells
 QI thru an EAT acquires either the old or the new
property and “parks” title for up to 180 days
CURRENT TRENDS
OIL & GAS ROYALTIES
 Investors are acquiring oil and gas royalties as
replacement property
 Current oil prices make this investment more attractive
 Provides good returns with no hands on
CURRENT TRENDS
NO MORTGAGES ON REPLACEMENT PROPERTY
 Higher than usual number of Exchangers choosing
to put in additional equity or trade down in property
value rather than put a mortgage on the new
property
 Trade downs are taxed on the amount of the trade down
CURRENT TRENDS
INCREASE IN PERSONAL PROPERTY 1031s
 Without the 100% bonus depreciation we had for 18
months, we are seeing a big increase in exchanges
of other assets held for investment
 Companies are purchasing capital assets using 1031
 New purchases to increase efficiency
 Examples: airplanes, equipment (cranes, lifts), printing
presses, railroad cars
CURRENT TRENDS
EXCHANGING PROPERTY WITH NO GAIN
 Investors are exchanging properties with little or no
gain, maybe even selling at a loss, to avoid costly
depreciation recapture
1031 ACTIVITY:
YESTERDAY , TODAY & TOMORROW
 FEA member surveys estimated exchange activity
dropped approximately 80% from 2005 to 2010
 Activity is definitely picking up nationwide
 Using data from FEA member surveys, the Joint
Committee on Taxation (JCT) estimates 1031 deferrals
of $2.5B in next 5 years and $18.2B in next 10 years
 Significant increase is expected as the real estate
market continues its rebound
1031 ACTIVITY:
YESTERDAY , TODAY & TOMORROW
 Beginning in September 2012, there has been quite a
bit of noise regarding section 1031
 1031 has been identified as one of the top tax
expenditures and a potential target in the tax reform
battle
 JTC has rescores section 1031. Now $42 – 47B!
 Entire real estate industry, including FEA, working
together to preserve top real estate expenditures
Unlocking the Power of Exchanges
Overview of 1031 Exchanges
LIKE-KIND DEFINED
REAL PROPERTY (REAL ESTATE) EXCHANGES
 Refers to the nature or character of property
 Specific type of property not essential




Very broad and liberal definition
Must be used for business use or investment
Located within 50 states, D.C. or selected territories
Can buy or sell multiple properties
LIKE-KIND EXAMPLES
 Examples of like-kind real estate








Duplex, apartment building, rental house
Office building, warehouse, shopping center
Land
Tenant-in-Common (TIC) interest
Conservation easements, utility easements
Leasehold interest of 30 years (including options)
Cell tower easements
Oil and Gas Royalties; Mineral Interests
LIKE-KIND EXAMPLES
 Examples of non like-kind real estate


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Personal residence and most vacation homes
Partnership interests
Mortgages and notes
Cash
Non real estate assets
Dealer property and inventory
Stocks
LIKE-KIND DEFINED
PERSONAL PROPERTY EXCHANGES
 Any asset held for business use or investment can
be exchanged.
 Definition of like-kind is much more restrictive for
personal property
 Assets must be within the same asset classification
code or the same kind of asset
 Examples of personal property assets: Equipment, aircraft,
franchise agreements, livestock, collectibles, antiques,
distribution routes, furniture and fixtures, etc.
QUALIFIED USE
 Holding period not defined in regulations
 One year is good rule of thumb
 Taxpayer Relief Act of 1997 defined “long-term” investments as
held longer than one year
 Two year safe harbor in Rev. Proc. 2008-16
 Intent of taxpayer is key
 Look at the picture you have painted
 Personal use must be minimal (§280A)
Consult tax and/or legal advisor to determine best strategy.
ADDITIONAL REQUIREMENTS
 QI acts as “middleman” to facilitate an exchange
 Exchanger cannot have access to exchange
proceeds
 Time Periods:
 Replacement Property* must be identified within 45-Day
Identification Period
 Replacement Property must be acquired within 180-Day
Exchange Period
*Title must be held in the same name as relinquished property
ADDITIONAL REQUIREMENTS
 Exchange must be set up (and 1031 docs signed)
before title passed to buyer
 To maximize deferral, replacement property must
have equal or greater VALUE and EQUITY.
 Value takes closing costs into account.
 A trade down in property value or equity is taxed just on
the trade down.
CHOOSING YOUR QI
 Your QI is your partner throughout the exchange
 Choose company who is responsive, experienced and has
good knowledge of local real estate and title practices
 Make sure funds are held in segregated FDIC insured
exchange account
 Look for fidelity bond coverage
 Seek Certified Exchange Specialist® (CES®)
 Look for member of Federation of Exchange
Accommodators (FEA)
SUMMARY
 1031 exchanges are a great wealth accumulation
vehicle.




Build real estate portfolio with pre-tax dollars
Great way to accomplish long-term objectives
Excellent estate planning tool
Creates many opportunities to grow your business
 The more you know, the more you will benefit.
 1031 CORP. can help!
QUESTIONS & ANSWERS
Margo McDonnell, CES®
Certified Exchange Specialist®
1.800.828.1031
[email protected]
Mobile: 610.680.6896
www.1031CORP.com
www.facebook.com/1031CORP
www.twitter.com/1031CORP
www.linkedin.com/in/MargoMcDonnell
www.facebook.com/MargoMcDonnell
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