The 45th and 180th day deadlines in a 1031 are considered to the time sensitive activities by the IRS and are thus eligible for a 120 day extention, IF you are deemed to be an eligible tax payer. 

SO - if you or a client currently has an ongoing 1031 Exchange in Honolulu County, California then you should check out the IRS website to determine eligibility or call your 1031 Exchange Coordinator.

For your ease, the URL for the IRS page about the Hawaii Disaster is:  http://www.irs.gov/newsroom/article/0,,id=202329,00.html

Housing Assistance Tax Act of 2008 Affects §1031 Exchange Strategies

Amy Gustin, CES® and Vice President of 1031 Exchange Coordinators can be reached at amy@1031eci.com

Investors or owners of second homes may have to change their strategic plans subsequent to President Bush signing the 2008 Housing and Economic Recovery Act (HERA), H.R. 3221 on July 30, 2008. 

Under the new amendments, periods of nonqualified use will not be eligible for the exclusion of gain.  Any property that had been acquired as a second home, investment property or in a 1031 exchange as replacement property and subsequently converted, and maintained as a primary residence for a minimum or two-years and then sold as a primary residence would only qualify for a pro rata share of the exclusion.

We've probably all heard some of the positive real estate benefits that have come from the new 2008 Housing and Economic Recovery Act (HERA), H.R. 3221 which included $16 billion in tax incentive to help with today's turbulent real estate and mortgage markets.  What many don't realize is that under the pay-go system, the $16 billion has to come from somewhere...

For the most part these tax-incentives were paid for by credit card companies and multi-nationals but a small portion of the bill altered §121 which pertains to the capital gains exclusions of $250,000 / $500,000.

 Example 1:  Fred and Ginger acquired a "really cool" rental home in Scottsdale in 2008 as part of a 1031 exchange.  They rent it out for 3 years and eventually, (in 2011) Fred and Ginger move to Arizona and convert rental home to their primary residence.  In 2013 Fred and Ginger decide that the heat is too much and decide to return to the Pacific Northwest.  Upon sale, Fred and Ginger are only eligible to exclude 3/6 of the gain up to the maximum amount of the exclusion ($250,000 / $500,000).

The new act becomes effective January 1, 2009 and applies not only to investment properties but to second homes as well. 

Example 2:  Barney and Betty, a married couple and joint filers purchased their rental home in 1990 as part of a 1031 exchange in which they deferred $385,000 of gain.  They planned to retire in 2012 and move into the rental home.  They want to live there for 2 years and then sell taking the exclusion of $500,000 and paying 15% on the remaining gain (if any).  Under the new regulations, Barney and Betty will only be eligible to exclude 2/6 of the gain because they only lived in the home for 2 of the 6 years they owned it post January 1, 2009.

The act does not affect homeowners who have gain in excess of the §121 limits and plan to convert their primary residence to a rental two years prior to sale in order to take the §121 exclusions as well as 1031 Exchange the remaining gain.  Periods of non-primary residence use "which is after the last date that such property is used as the principal residence" is not included in the definition of nonqualified use. 

Investors who need additional help applying the new regulations to their individual exchange strategies should contact their 1031 Exchange Coordinator or tax planner for assistance.

Capital Gains tax rates vary over time just as our income tax rates vary year-to-year.  At the whim of Congress, our tax rates can increase and are oft times scheduled to increase.  With the Bush tax cuts on Capital Gains scheduled to sunset in 2009, returning our capital gains tax rates in 2010 to the 2000 mark of 20%, investors are more aware than ever of the need to complete a 1031 Exchange as they reposition their real estate investments and are looking for options of how to reinvest in properties that meet their lifestyle goals while not sacrificing the equities they have build up as properties have appreciated over the last 5+ years.

With all of the options the world has to offer, shouldn't real estate investors also have options when trying to defer capital gains taxes?  I think so - and incidentally, so does the I.R.S..  § 1031 was written in 1921 to allow farmers to directly swap lands as the geography changed with season.  The code remains relatively unchanged and continues to provide that:

"no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of a like-kind which is to be held either for productive use in a trade or business or for investment."

SO, what does like-kind really mean? 

Like-kind, in the Real Estate world simply means investment or business real estate for other investment or business real estate. 

So, how many choices are there?

MANY - in addition to the standard single family home, multi-family, commercial, retail, industrial, hospitality, and raw land options, there are others gaining popularity despite the fact that few real estate agents sell them.   The below options include Tenants-in-Common (TIC) interests and both working and royalty interests in Oil and Gas.  While these options are not top-of-mind for most agents, they do often meet the demands of an ever changing investor profile.  Each may be a valid 1031 Exchange option for investors which REALTORS® should be aware of them.

Tenants in Common (TICs) - This Billion dollar + industry is essentially five years old.  Blossoming with the issuance of IRS Rev Proc 2002-22, which acknowledged and approved a Tenancy in Common investment as like-kind replacement property, the TIC industry has continued to grow and is thriving today.  Tenants- in- Common interests are sold by licensed Securities Brokers - not real estate agents (unless they are dually licensed).  Recently, the National Association of REALTORS®(NAR) petitioned the Securities and Exchange Commission(SEC) to allow experienced real estate agents to be compensated for their involvement in TIC transactions.  NAR defines an experienced REALTOR® as one who has received a CCIM, SIOR, ACL or has sufficient transactional experience to equal the above.  No solution has been announced as of this article but one is expected shortly.

Here's how a TIC works:  a Sponsor company buys institutional grade investment property and secures financing for Tenant in Common purchasers.  They then go through a legal process preparing a private placement memorandum in compliance with the S.E.C. and then offer the property, via certain Securities Brokers, for sale in undivided fractional interests to accredited investors.  Each investor has a minimum investment amount as the SEC allows a maximum of 35 investors per property.

At minimum, an accredited investor is an individual or married couple with a Net Worth exceeding $1M or an annual income for the previous two years of $200,000 if single or $300,000 annually if married.    The industry is made up of investments of varying property types across the entire nation and draws over a billion dollars of real estate equity each year - most often from property sold as part of a 1031 Exchange.

Investors purchase an undivided interest in a specific piece of real estate and typically receive a deeded property interest.  Owners of TICs receive their proportional share of the rental income and are able to depreciate their share of the asset.  Types of properties purchased as a TIC vary.  The majority of purchases in 2007 were in Office and Apartment however in past years, retail properties have taken a lead. 

Benefits of TIC properties to investors include:  1) Hands-off investment backed by a real estate asset 2) The ability to 1031 exchange into a passive investment 3) Returns from larger properties without the capital requirement. 

Nothing is perfect, and there are some negatives as well, which may include:  1) Mandatory financing which may make it difficult to buy non-TIC replacement properties after the property is sold.  2) The illiquidity of the investment makes it difficult for investors to sell their fractional interest prior to the entire property selling.  3) Securities Brokers are not real estate agents and the due diligence and returns quoted may not be what an experienced real estate investor is accustomed to seeing. 

All things considered, there are securities brokers who have made TIC sales their primary business and have experience with hundreds of properties and have seen them go full cycle.  Also, some real estate agents have found it lucrative to become dually licensed and have the experience analyzing investment properties required to assist investors to make informed and educated decisions about their investments.   

Oil and Gas - The rise of oil and gas as like-kind replacement properties really started to grow post 2002-22 as well;  Not because of any new guidelines for this industry (the I.R.S. has allowed real estate like-kind-exchanges into both working and royalty interests pre - 2002), but more so because of two factors.  1)  The very hot real estate market that made finding suitable replacement properties difficult if not impossible.  2) The securities brokers increased awareness of the need to help 1031 real estate investors find replacement properties.  Statistics about the quantity of equities flowing into this industry are difficult to confirm.   Estimates indicate that "oil and gas interests sold through the TIC distribution channel now appear to total several hundred million dollars annually" (Stephen I. Burr -Foley & Lardner LLP, Tenant-in-Common Legal News November 2006).  This somewhat less mentioned replacement property option is appealing to investors because of the simplicity of the transaction, low minimum investment requirements, full-cash purchase without leveraging, diversification, passive income and the ability to resale in an established secondary market.  In addition, the tax benefits, not only of completing a 1031 exchange into this like-kind replacement property, but also depletion and depreciation of intangible drilling costs (i.d.c's), may be enticing to investors.

Price Volatility is of great concern to the Oil and Gas Industry.  As the price per barrel of US oil increases, returns to investors increase.  The same applies to declining prices. Unlike with the real estate market that provides indicators of changing market conditions, the oil and gas industry can be affected by unpredictable events such as hurricanes, wars, insurrections, technology advances and pollution concerns.  In commercial real estate, properties often have an alternate use should demand for a specific tenant evaporate.  With oil and gas, there is no alternate use.  Depletion and decline of production from a well can significantly impact an investor's return, as can operational risks due to drilling activities with a working interest.  Sponsors of these interests do not always have a long history and securities brokers with little knowledge of how to evaluate such investments make it difficult to assess the risk associated.

Understanding more like-kind replacement options can make real estate brokers counsel more relevant and valuable to his/her clients.  Once an agreement between the SEC and NAR is reached, we will see some securities firms begin to offer referral fees or consulting fees to real estate agents who help direct their accredited sellers to the broker and help evaluate the TIC as replacement property for their 1031 exchange.    

The Baby-boomer generation is retiring, Gen X'ers are having families, and lives change with the passing of days.  A 1031 Exchange allows investors to transfer equity which does not fit their lifestyle and goals to an asset which meets their current and future needs.

 Amy Gustin, CES® is a Qualified Intermediary with 1031 Exchange Coordinators.  She facilitates hundreds of exchanges each year including reverse and improvement exchanges.  She serves on the Board of the Snohomish County Camano Association of REALTORS®, is a member of the WA State CCIM Chapter and is actively engaged teaching continuing education with Washington REALTORS®.   Amy may be reached at 800-320.1031 or amy@1031eci.com.

Benjamin Franklin insightfully stated, "In this world, nothing is certain but death and taxes."  Death is certainly an option we all must exercise someday; there is another alternative worth considering to get out of your capital gains tax. 

Exercise the Move-in Option.  While some may argue that moving is more painful than dying, this option is available for those not wishing to settle up with Uncle Sam on the taxes deferred (during a lifetime of exchanging) and enjoy their accumulated wealth prior to death.  The Move-in Option allows §1031 exchangers to move into a rental property and convert it into their personal residence.

In the past few years, the Internal Revenue Service (I.R.S.) has issued new counsel giving taxpayers a clear picture of what they expect from exchangers wishing to exercise the Move -in Option.  These revisions can further assist exchangers in achieving their financial and lifestyle goals. 

 The first came in the form of the American Jobs Creation Act of 2004.  This legislation amended §121, which addresses the exclusion of gain on the sale of a primary residence, to include a provision for property having been acquired in a 1031 exchange.  In a nutshell, if an exchanger purchases a dwelling unit in a 1031 exchange, uses it a rental home for a while and later moves in, making it their primary residence for at least two years;  then they may take the exclusion at sale if they own the home for more than 5 years. 

In February of this year, the I.R.S.  released Revenue Procedure 2008-16 clarifying how much rental time would be required and how much personal use would be tolerated in order for a property to safely be considered as an investment.  The Service concluded that properties must be held for 24 months pre-exchange with a minimum rental of 14 days per 12 month period AND have a maximum of 14 days of personal use per 12 month period.  Essentially, the lack of rental or the excessive use of a property could disqualify it as an investment property and therefore eliminate a §1031 Exchange as an option.

Perhaps the best way to illustrate benefits from these revisions is by a local example:  Jonathan and Paige Baker (fictional names) invest in real estate as a hobby.  They have always made wise investment decisions and anticipate their real estate investments will contribute heavily to their retirement.  Eventually, the Bakers would like to retire in the Phoenix area. 

Recently, they exchanged out of their 8-unit in Snohomish County and their 16-plex on Green Lake.  They acquired a home on a golf course in Scottsdale which they lease to a corporation for housing a foreign executive; a 3 bedroom beach house with an ocean views in Seabrook, Washington which they put into the vacation rental pool; plus a percentage interest in a Tenant-in-Common property which will generate a 7% cash-on-cash return.  The Bakers intend to spend a few weekends a year at the Seabrook home when it is not rented (but no more than the greater of 14 days or 10% of the time they rent it).  They hope to eventually retire to the Scottsdale home, and use the rental income from the TIC to supplement their pension.

The Move-in Option works very well for the Bakers and allows them to then use the cash from the sale of their primary residence in Seattle to purchase additional real estate investments to augment the rental incomes from the TIC.  Should they choose, Jonathan and Paige may also spend each summer at the Seabrook cottage after the first 24 months of ownership.  If the Bakers ever decide to sell the Scottsdale home (after having lived there two years, and owned it for five years) they could be eligible for up to a $500,000 exclusion on capital gain for that property, which includes the deferred gain from their prior §1031 exchanges.  The Move-in Options requires a strict adherence to the regulations, but can help Exchangers in making dreams come true.

Amy Gustin, CES® is the Vice President at 1031 Exchange Coordinators.  Amy facilitates hundreds of the most difficult exchanges each year, nationwide.  She is also teaches continuing education as an instructor with Washington REALTORS®