In order to qualify for the 1031 Exchange, the replacement property needs to be held as “investment.” The IRS has argued that a property rented to son by his father below market rent was considered a “family home,” rather than an “investment”
Revenue Procedure 2008-16 (attached) provides a safe harbor for vacation homes held for investment and defines whether or not a dwelling unit qualifies as property held for productive use in a trade or business or for investment under §1031 of the Internal Revenue Code. In Revenue Procedure 2008-16, it is noted that the dwelling unit must be rented “at a fair rental.” Later in Section 4 of this Revenue Procedure, “fair rental” is specifically defined as, “For the purposes of this revenue procedure, whether a dwelling unit is rented at a fair rental is determined based on all the facts and circumstances that exist when the rental agreement is entered into. All rights and obligations of the parties to the rental agreement are taken into account.”
The definition of this Revenue Procedure indicates that the IRS will look at all facts and circumstances of a particular 1031 exchange to ascertain whether or not fair market rent was received.
1. Rent at a rate that is comparable to other similar rental properties in the
market.
2. Enter into a rental or lease agreement in the same manner as with any
investment property tenant. If a longer term rental, make sure the
relationship is solely that of a landlord and tenant; the rent received is
appropriate to the local market; and, the terms of the rental agreement
strictly construe the rights and responsibilities of the parties as a landlord
and tenant. The documents need to prepare the exchange documents.
THE §1031 TAX DEFERRED EXCHANGE is one of the last tax shelters allowed by the IRS. It is a transaction in which a taxpayer exchanges investment
property for like-kind investment property to defer the payment of capital gain taxes, health care taxes, state taxes, and the recapture of deprecation taxes. The IRS defines like-kind property as all real property held for investment purposes, or the productive use in a trade or business. Essentially this includes any real estate held for investment and precludes your primary residence and second family home.
EXCHANGE RESOURCES, INC. (ERI) acts as one of the largest national independent accommodators in the United States. Staffed with in-house legal counsel who direct exchange business, ERI facilitates §1031 Tax Deferred Exchanges both nationally and globally. Exchange laws require explicit adherence to the rules and regulations which have been promulgated by the IRS and the various state taxing agencies though out the country. ERI offers an array of educational workshops, including CA BRE, Escrow Association, CPA & EA Associations, CA Bar Association, and Financial Planners. ERI prides themselves in helping all parties understand exchanges generally and assisting to provide a more knowledgeable working relationship with real estate investors and the §1031 Tax Deferred Exchange process.
At ERI, the security of client’s funds during the course of the exchange is of the utmost importance. ERI goes to great measures to protect and secure our client’s funds during the exchange process by providing fidelity bonding, errors and omissions insurance, and a segregated client trust account for each exchange. The segregated client trust account is held at Opus Bank and does NOT commingle exchange funds. Under this account structure funds will be not transferred out of a client’s account without the client’s written authorization. This provides additional security for exchange funds and peace of mind for our clients.
ERI’s in-house legal department oversees the exchange process and stand readily available to discuss exchange transactions. As part of the exchange fee ERI is happy to provide assistance to investors and their appointed tax and legal counsel in their exchange, however, ERI cannot provide tax or legal advice. Each client that engages in a §1031Tax Deferred Exchange should always seek advice from their own tax professional.
The following explains the mechanics of how to utilize a DELAYED Tax Deferred Exchange:
- The exchange must be opened before the close of escrow. ERI needs to be provided with the escrow contact information to request the documents necessary to open the exchange. The exchange documentation will assign ERI into the contract as the Qualified Intermediary to meet the IRS requirements.
- The replacement property to be acquired must be identified within 45 days after the close of the relinquished property which is sold. ERI provides an identification form with the exchange documentation. The 3-Property Rule permits the identification of up to 3 replacement properties without regard to their value, or under the 200% Rule – 4 or more properties may be identified only if the fair market value of all the replacement properties identified does not exceed 200% of the relinquished property.
- Any or all of the replacement properties must be acquired within 180 days from the close of the relinquished property that is sold.
- All net proceeds must be reinvested into the replacement property and any proceeds not reinvested are taxable.
- If a loan is paid off when the relinquished property is sold that debt must be replaced in the replacement property. This debt can be replaced with new debt or cash of equal or greater value.
ERI charges a flat fee of $750 for a delayed exchange, this includes one sale and one purchase. The following are included in our exchange fee:
- Fidelity bond
- Errors & omissions policy
- The security of a segregated (non-commingled) depository client trust account
- Written authorization required by the client before transfer of funds
- In-house legal counsel
- Wiring fees
- Any additional check cutting service
- All faxing
- All service calls with administrators
- Exchange documents for one relinquished property and one replacement property
If more than 2 properties are required in the exchange, an additional fee of $250 for each additional property applies.