I’m new here and not nearly as knowledgeable as the rest of you. I do have some real estate investment issues, however. I bought my first property years ago in my mid-twenties and I still own it. I then bought additional properties about twenty years ago and currently own six properties (one is land). Although I get around to buying, I never seem to be able to part with a property.
Currently, two condos are rented but two townhomes are not. We are using one of the townhomes as a second home intentionally. The other should be rented within a month. We also own a resort property jointly with two other parties. I am tired of being a landlord and would like to sell the two condos (lowest priced props) and buyout the two parties on the vacation property. I would like to do a 1031 exchange if there is any way possible since we will get killed on the capital gains taxes.
Is there any way to swap two smaller props to buy out two partners in the larger resort prop? They want to sell, but don’t want the condos. Then, the resort prop will need to be rented for several years which I am dreading because weekly summer rentals are a huge pain. However, this may end up as a retirement home down the road since it is a one level building.
If anyone has some suggestions, I would love to hear them. Also, I have managed the real estate investing for years while my partner has a demanding full time job. Shouldn’t I be able to deduct my office in home since I do all my work from here pretty much? I have never had any tax benefit that way and our abode here is a large older house (commonly referred to as a “money pit”). We own six properties and this house. I do most of the tax work myself and have a CPA review it. I’ve asked him about this and he’s been hesitant, but I don’t understand why other than he is ultra conservative. A friend in the neighborhood owns properties and does property management as his business out of his home.
I just discovered these boards. I was intending to be more active in real estate investing, but then three children came along and there never seemed to be time. Now we would like to retire (somewhat) and get some rest.
Your accountant may be hesitant because home office deductions are a “red flag” for an IRS audit. The IRS has specific rules on home office deductions and taxpayers invariably break one or more of the rules and their entire home office deduction is disallowed.
As a general rule, the amount of tax savings gained by the home office deduction is not significant enough to risk the tax audit it would invite.
Thanks Dave - I think you are right and he did mention the “audit” factor once when I asked about this a few years back. I wouldn’t want to be audited, but it seems as if this would be a legitimate expense in my situation. Any advice on the 1031 exchange?
Don’t be afraid of taking a home office deduction if you have a legitimate home office. For many, such as myself, a home office is really a personal and business use space, This is where the majority of home office deductions fail. My home office deduction would be denied because I don’t use the space exclusively for business. I also have a schedule C business that I operate out of my home – I don’t take a home office deduction for that either for the same reason.
You may be able to use a 1031 exchange to buy out your partner’s interests in the resort properties. You really need a qualified intermediary to thoroughly evaluate the situation and give an informed opinion.
I don’t take a home office deduction either for the same “red flag” issue DaveT mentioned. However, I did organize an LLC specifically for my real estate business when I started and the LLC has an Accountable Plan, a business function where the business reimburses employees for expenses. These expenses include a pro-rated portion of heat, electric, and mortgage used by the LLCs office in my home. Additionally, I reimburse for mileage, which usually is a significant figure each year. It can be a PITA to start,keep the records, and follow the IRS rules for the plan but it has turned out to be worth it, at least in my case. The Accountable Plan allows you to receive tax free money, in the form of legitimate expenses, and legitimately claim the business deduction.
Would an attorney who specializes in Real Estate be an intermediary? It seems as if there should be some way to do this, so I think I will need to find someone to advise me as you have recommended. I am like you Dave, the office does get some personal use although not a lot. jmd - would a Real Estate attorney set up an LLC? I only have one prop that is local so there is a bit of travel involved, especially when seasonal rentals are involved. It would be good to defer some of my costs if I keep with this in the future.
“Would an attorney who specializes in Real Estate be an intermediary?”
http://www.iowaequityexchange.com/ is one Equity Exchange expert that is a Qualified Intermediary. Not an attorney but a 30+ year investor that understands the ropes probably better than many attorney’s who do not specialize in this area. Most attorney’s understand the forward exchange but many do not understand the reverse exchange. This is really the preferable way to initiate an exchange, IMO.
So, a conversation with Ken would probably be a good idea for you, or anyone looking to do and exchange. He serves investors nationwide.
An attorney, but not your attorney, could be a qualfiied intermediary. 1031 exchange is a specialized area of tax law, and most real estate attornies are not current with the tax law.
If you need the services of a qualfied intermediary, suggest you Google “qualfied intermediary, 1031 exchange” and locate a professional exchange firm in your area. You can comparison shop for fees and compare services.
I don’t see that your situation calls for a reverse exchange. A delayed exchange will be much less expensive than a reverse exchange, and even cheaper still if you are direct deeding.
Thanks for your help, everyone. This is obviously a great place to come to for some direction. I wish this forum had been available twenty years ago :banghead. I’m reading a book on the 1031 (just started). I want to understand it better before I seek the intermediary. I just can’t trust people like I used to.
Any legitimate costs of rental ownership and operation can be taken on Schedule E. You don’t get any additional business expense deductions just because you have an LLC.
As a general rule, an LLC is tax neutral. That is, your tax liability will be the same with or without the LLC.
For property you own and manage yourself, the LLC provides little added value. Adequate liability insurance would be a better investment.
To determine whether a business entity (and which one) is appropriate for you, you need to have a conversation with your tax advisor, your CPA, your estate planner, and your financial advisor. Best if all these folks are in the same room at the same time.
I trust no one as well, and always like to get references for professional services. A 1031 intermediary is no exception. You might want to join a local real estate club, or at least talk to their organizer. He or she might have some contacts or direct you to someone in the club with recent 1031 experience. Joining a club would not be the worst thing you could do anyway considering your other questions. Just make sure it’s a club with experienced members. With 20 years or real estate experience under your belt, I bet you end up answering more questions than you ask.
If none of this works for you, I know that many big banks facilitate 1031 exchanges. Washington Mutual (or whatever they call themselves now) is one of them.
By the way, don’t feel guilty; not selling real estate is one of the easiest ways to riches.
In googling around, I found that Wachovia Bank handles 1031 exchanges. I happen to do some of my banking with them so maybe they would be a good choice? The funds are FDIC insured until the exchange is completed. I am a bit worried about how soon I will be able to sell the two condos. They are in good locations as those things go and not terribly expensive, but 180 days doesn’t seem like a lot of time nowadays. I have tenants and have not listed the properties yet. One tenant is leaving in June so I am wondering if I should try to rent and then sell or just sell. I haven’t had much trouble in the past renting, but it would be easier to show the property without the tenant in there. I will have to use a realtor for this since the prop is in another state. These condos are popular with first time buyers so it isn’t necessarily an investor’s market. Wish I had done this four years ago! :help
The 1031 exchange 180 day clock does not start until you sell the relinquished property. Starting from the settlement date on the relinquished property, you have 45 days to identify your replacement property and 135 more days to complete the replacement property acquisition.
If you have two properties, you can choose to run two separate exchanges, or include both properties under a single exchange umbrella.
I believe Wachovia is now owned by Wells Fargo, so you want to confirm that your local bank can still serve as your qualified intermediary, and if they offer any service other than just acting as your exchange escrow agent.
You may need to have your own attorney draft an Exchange Escrow Agreement for you to present the bank when you are ready to open your exchange escrow.
Thanks Dave - I only have a CPA and he’s not great on advice. Basically, I do the taxes and he checks things over. Don’t have a real estate attorney either and I’m beginning to think I’m not properly insured. I can probably get a recommendation on the attorney. Good advice on Wachovia, they haven’t changed any signs around here but I was aware of the Wells Fargo take over. Does anyone else feel a little threatened by all these changes? I can’t keep up. I am petrified and my husband will retire soon. I want to feel safe and not lose any more money if I can help it.
This is Ken . I was very pleasantly surprised to read obiwan1250’s unsolicited endorsement of my company. If obiwan1250 would like to identify himself or herself to me privately, I’d love to pass along my thanks.
You have raised a number of issues with regard to your properties and exchanging. The first one is whether you can sell your condos and buy out your “partners” in the resort property. The answer is yes, maybe. Some of the relevant questions are:
How title is presently held to the resort property?
Is the resort property itself is actually real estate or something else (like a timeshare) that wouldn’t qualify as replacement property.
As obiwan1250 pointed out, I am not an attorney, nor am I a CPA, I’m just an investor who knows a whole lot about exchanging and decided to open an exchange service a while back. My comment on your home office question is that it sounds likely that your situation would qualify for a deduction. I agree with Dave T’s comments: your CPA may be hesitant to recommend taking the deduction because home office deductions can serve as a red flag for an audit. If it would make a big difference to you tax-wise (and it often doesn’t), it may be worth pursuing even to the extent of finding another CPA if necessary.
You have gotten good advice in this thread. I agree with Dave T also on his comments about reverse exchanges. Your situation doesn’t appear to require the additional expense of a reverse. If you have two condos and two partners in the resort property, one potential solution would be to structure one exchange when one condo sells, using the proceeds to buy out resort partner #1, then set up a second exchange when the second one sells and buyout partner #2. You could avoid some of the timing burdens of an exchange in that way. (For instance, if you put both condos into the same exchange and had a problem with one of them selling, it could jeopardize your entire exchange.) Again, this all depends upon the properties themselves qualifying for an exchange.
While you could use a large intermediary firm or even one of the bank-owned QIs such as Wachovia, I feel very strongly that you will get better personal service from a smaller firm. The larger firms tend to work on a quantity basis. Smaller QI firms such as mine provide better “handholding” services through the exchange, in my opinion. We offer the same FDIC protection of any of the larger firms. If you would like to discuss your situation directly with me, I would be happy to do so. I have a long list of references from satisfied clients. . Best wishes to you regardless of what you decide.
In the FAQ section of your website you say that an exchangor must trade equal or up in both debt and equity to have a fully deferred exchange.
This is the case for a direct exchange, where two parties swap property and debt. This form of exchange is quite rare these days, since most exchanges are the “Starker” or delayed exchanges.
In a delayed exchange, sometimes called a forward exchange, there is no requirement to trade equal or up in debt. Instead, the IRS simply requires the value of the replacement property to be equal to or greater than the value of the relinquished property AND that all of the equity in the relinquished property be reinvested in the replacement property.
If all the equity is reinvested in the replacement property, then by default, the exchangor is trading equal or up in equity. Also, by default, all the exchange proceeds are reinvested in the replacment property since the exchange proceeds is the cash value of the equity in the relinquished property
home office deductions are NOT a “red flag” or any other flag. I won’t bore you with the details; suffice to say that’s not how the audit selection process works.
It is a legitimate deduction that you are allowed to take to legally avoid paying any more tax than you are required to pay. Period.
I have NEVER in 25 years had a client audited because of a home office deduction.
You may be able to use a 1031 exchange to buy out your partner’s interests in the resort properties. You really need a qualified intermediary to thoroughly evaluate the situation and give an informed opinion.
I don’t have a chance to spend much time on these boards. I notice, though, that you are here a lot, and you offer advice in many threads, the vast majority of it sound, I’m sure. As a relative newbie here, the last thing I want to do is upset an old hand; that is sincerely not my intent.
There is a saying in the exchange business, “Trade up and mortgage up.” It has been sound advice for many years and it continues to be sound advice. Is it oversimplified? Yes. Technically speaking, there are times when a taxpayer can buy property that is slightly lower in value than the property that was relinquished and still defer all capital gain recognition. This exception can exist because exchange expenses can be deducted from the value of the relinquished property and added to the cost of the replacement property, bringing them closer together in value. That being said, there is no example that I know of where a taxpayer can take on less debt on the replacement property than the amount of debt he or she had on the relinquished property without triggering the receipt of mortgage boot and the resulting tax implications. If you have an example showing otherwise, I would be very interested to know about it.
I work hard to help people understand 1031 exchanges in plain English without the mumbo-jumbo. The information on this subject in my web site’s FAQs section (http://iowaequityexchange.com/Page.aspx/8) may be somewhat simplified, but it is accurate. I don’t see a reason to make any changes. Thanks for your input. All the best to you.
My source is the tax codes. Mortgage boot occurs when the exchangor receives DEBT RELIEF as a result of the exchange.
In a delayed exchange, title to the relinquished property is transferred to the buyer free and clear of all liens. The sale proceeds are used to pay off any debt and cover the seller’s closing costs. Whatever is left over is the seller’s equity which becomes the exchange proceeds.
Because the existing loan on the relinquished property is paid off during the exchange, there is no debt relief. Consequently, there is no mortgage boot regardless of the amount of debt (if any) used to finance the replacement property.
It is that simple.
“Trade up and mortgage up” was the operating maxim for exchanges when the only exchanges accomplished were direct or simultaneous (two party) exchanges where the parties traded deeds and each party assumed the other’s mortgage debt. Debt relief is possible in a direct exchange.
Since 1991, when the IRS codified the rules for a Starker (delayed) exchange, the three party transaction facilitated by a qualified intermediary has become the most common exchange used today.