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Exchanging Real Estate
March 15 , 2005 by Joe PhillipsThere used to be one answer; A 1031 exchange vs a Real Estate IRA/Retirement Plan
Sure real estate is hot, but how should someone buy, sell or trade the property is even hotter for new methods of doing so.
So, let’s start out with the basics, and the terminology.
What is a 1031 Exchange?
A 1031 Exchange (IRS Code 1031) allows property owners to defer capital gains taxes by reinvesting the proceeds from the sale of their properties into like kind replacement property. For purposes of an exchange of real estate, for real estate, is a like-kind exchange as by nature and character of the property.
“No gain or loss shall be recognized on said exchange of property held for productive use in a trade or business or for investment purposes if such property is exchanged solely for property of like-kind, which is to be held for productive use in trade or business or for investment.”
What are the qualifications in doing a 1031 exchange?
A) The IRS timeline for 1031 exchanges.
1) Identifying the new purchase period = 45 days
2) Replacement Property Purchase Period = 135 days
Total of 180 days
Must identify replacement properties within 45 days after said relinquished property closing date.
Must purchase replacement property by the earlier of the following:
• the 180th day from the relinquished property closing date
• the due date, including extensions, for the property owner’s tax return for the tax year in which the relinquished property closing date occurs
1031 EXCHANGE PROCESS
B) Must be held for trade or business, or for investment purposes. Not for, personal use.
C) Transaction must be provided by a Qualified Intermediary Services.
What are the types of properties can you exchange into:
Your property must match by way of character and nature, per the IRS
** Must be a Qualified Exchangeable item
Raw Land
Retail Shopping Centers
Office Buildings
Rental Houses
Personal Residences
REIT Shares – 1031 Program
LP Interests
Bonds
Partnership Interests Apartment Buildings
Notes
IRS RULES FOR A 1031 EXCHANGES so that it may defer 100% of the capital gains tax is as follows
• The value of the replacement property must be equal or greater than the value of the relinquished property.
• The debt on the replacement property must be equal or greater than the debt on the relinquished property.
• The net equity proceeds from the sale of the relinquished property must be reinvested in replacement property.
• Because actual or constructive receipt of the sales proceeds by the property owner will be considered taxable by the IRS, a third-party agent, such as a Qualified Intermediary (QI), is to be retained by the property owner to receive the sales proceeds and facilitate the 1031 transaction. The QI will hold these proceeds in a separate exchange account until the funds are used to purchase the replacement property. The IRS does specify that the QI must be an independent, unrelated person to the relinquished party.
What is a Real Estate IRA or Real Estate Pension Plan ™
Purchasing or investing in any type of real estate can be done in any type of account as long as there is sufficient money to make the transaction happen. Generic enough?
No matter if the money comes from your savings, checking or retirement account as long as you have the money to buy the real estate.
You’ve heard of large pension plans buying and selling real estate for years. A pension is a retirement account just like an IRA, a SEP, a ROTH, a Defined Benefit, and a 401K. Now after a few changes in tax laws, and since the big pension plans have been doing these transactions, this opens a door to tax options the “lay-person” has never had before.
How does it work?
1. The “Plan” (IRA, Pension, SEP…etc.) is drafted with the ERISA qualified language to allow real estate purchases.
2. An LLC is drafted up appointing you as the Managing Member (giving you control and decision authority over the “Plan”) and the “Plan is then set inside this LLC.
3. The LLC is held by a qualified custodian with you controlling its moves.
4. The “Plan” is held at a non-affiliated party (i.e, Bank) to report to the IRS that the “Plan” has done what it needs to do so to remain a “qualified plan”
5. You and your agent then go shopping for land, malls, apartments, houses…etc.
All the above moves are done for a reason. To show the IRS that you do control the LLC, and that the “Plan” is doing the buying and selling of real estate, and custodians are there as well to make it happen, therefore you “personally” don’t benefit from the real estate transactions, but the LLC and “Plan” do.
Time period: 30-45 days to set up your first RE-IRA™ . There is no additional period to wait or hold before buying or selling. Once you’ve sold your property in the real estate Pension Plan you are free to use the money for just about any type of investments.
Real estate IRAs, or Pension Plans can be a great way to fund and invest in your retirement using tax deferred tools, there still are some rules that you “must” follow to avoid creating a taxable situation.
Do’s and Don’ts of entering into any real estate exchange
Do - Seek professional help. Ask your accountant or financial advisor for “pre-help” in planning either transaction. You mess this up and it will cost you. The IRS looks hard and heavy at these transactions.
Do - Always retained the services of a Qualified Intermediary (QI)?
Don’t - Ever let the QI commingle your funds.
Do - Watch the clock on your 1031 and don’t let the 180 days run out
Do - Make sure it’s “like kind” property
Do - set up a qualified “plan” that can be used to hold real estate.
Don’t – try this alone. The IRS loves that.
The real estate Pension Plan has been used for years, but many are just hearing about ti. Judy Craven of Valleywide Realtors, “as a CPA and Realtor it’s opened my eyes to additional and better ways to serve my investor clients.”
Summary
There are two ways to defer taxes in the sale of real estate, the old classic 1031 exchange and the new robust real estate Pension Plan (aka, real estate IRA).
However, it’s a no “brainer” to me if you plan on doing more than one transaction per life time and here is why.
Pay once, a fee of between $2,500 - $4,500 for a real estate pension or use a 1031 exchange and pay every single time you sell a property a fee between $1,500 to $3,000.
In a real estate IRA or Pension you control the investments, you defer the gains and taxes. The RE Pension has no time criteria/limit as a 1031 does (180 day max).
A RE Pension can be used as an estate planning tool as your wealth increases and the need for estate planning arises. The 1031 exchange is much more complicated to use as an estate planning tool, but is tried.
A 1031 exchange “MUST” be transferred into “like kind” instrument; i.e., land for land, duplex for duplex/triplex or quad, condo rental for condo rental. Get the picture.
What if I’m tired of being a landlord, owning land, having a vacation home in new hurricane path? Too bad, Mr. 1031 says trade only “like kind” please.
The real estate IRA or Pension gives flexibility, control, access, and defers taxes with a low cost scenario.
Due to the limited word amount and article structure, there is still much to cover regarding the real estate IRAs and Pension Plans, so feel free to goto: www.re-ira.com for more information or call the 24/7 info line about real estate IRAs: 888-222-9287
Joe Phillips, CEA, is Founder and Managing Principal of Second Look Financial. His team of professionals comprise an excess of 125 years of financial expertise, offering a full-range of products and services including accounting, legal, real estate consulting mortgage and financial advice. For more answers to your questions, you’re invited to contact Mr. Phillips and his team. 480.998-0884 or by e-mail at jphillips@secondlookfinancial.com
Judy Craven, CPA is a Certified Public Accountant and Realtor for Valleywide Realty. She can be reached at 602-300-4838 or e-mail: jacraven@cox.net
Second Look Financial, llc is a Registered Investment Advisory firm.
Real estate ira is a general term, however the complexity of a real estate Pension Plan ™ is a registered service mark of Second Look Financial.
Joe Phillips is a regularly featured contributor whose articles are found under Features/Financial Planning.
