Real Estate


What Property Qualifies for 1031 Treatment?

To qualify for a tax deferred exchange under IRC §1031 both the relinquished and the replacement properties must be held by the Exchanger for investment purposes or for “productive use in their trade or business”. The Exchanger’s purpose and intent in holding the property, rather than the type of property, is the critical issue. The use of the property by the other parties to the exchange (buyer and/or seller) is irrelevant. The following are examples of qualifying properties:

Bare land Farmer’s farm

Commercial rental Residential rental

Industrial property Doctor’s own office

30-year leasehold interest Percentage interest in investment property

Under IRC §1031 the following properties do not qualify for exchange purposes:

1)     Stock in trade or other property held primarily for sale (Note: this includes property held by a developer or other dealers in property);

2) Securities or other evidences of indebtedness or interest;

3) Stocks, bonds, or notes;

4) Certificates of trust or beneficial interests;

5) Interests in a partnership (Note: the partnership can elect out of partnership status under IRC §761(a));

6) Choses in action (this is a right to receive money or other personal property by judicial proceeding).

It is important to note that the intent by the Exchanger to hold the property for personal use will prevent the property from qualifying for exchange treatment. Therefore, second homes will not qualify for tax deferred exchange treatment unless the taxpayer changes how they treat or use the second home. For example, a taxpayer could “convert” their second home to a valid exchange property and establish this intent by properly renting the property and holding it as a legitimate rental property. See Rev. Rul. 57-244, 1957-1 C.B. 247. However, the taxpayer cannot just simply rent the taxpayer’s residence and expect it to automatically qualify for exchange treatment. Bolaris v. C.I.R., 776 F.2d 1428 (9th Cir. 1985). Many taxpayers own vacation homes, which are rented out during the time when the taxpayer is not using the home. Even though under IRC §280A a vacation home may have a portion of its deductions disallowed if it is used for personal purposes under the “14-day rule”, an Exchanger can argue that if the vacation home is partially used in a trade or business (renting it), the vacation home should be eligible for tax deferred exchange treatment upon it sale. However, there may need to be a bifurcation of uses as is also required for a home office use in a personal residence. Rev. Rul. 82-26, 1982-1 C.B. 115.

In many instances taxpayers use a part of their personal residence for a home office for business purposes. In this case when the taxpayer sells the personal residence, the transaction must be split such that the portion used for business purposes is treated separately for tax purposes from the portion used for a personal residence. Rev. Rul. 82-26, 1982-1 C.B. 115. The taxpayer could then qualify the entire transfer for tax-free treatment; the business portion could qualify for a tax deferred exchange under IRC §1031 and the personal residence portion could qualify for a tax-free sale under IRC §121 provided the transaction otherwise met the exemption requirements of IRC §121. Naturally, consultation with a tax advisor is important whenever a taxpayer changes how they intend to hold property.

1031 Do’s and Don’ts

DO advanced planning for the exchange. Talk to your accountant, attorney, broker, lender and Qualified Intermediary.

DO NOT miss your identification and exchange deadlines. Failure to identify within the 45 day identification period or failure to acquire replacement property within the 180 day exchange period will disqualify the entire exchange. Reputable Qualified Intermediaries will not act on backdated or late identifications.

DO keep in mind these three basic rules to qualify for complete tax deferral:

Use all proceeds from the relinquished property for purchasing the replacement property.

Make sure the debt on the replacement property is equal to or greater than the debt on the relinquished property. (Exception: A reduction in debt can be offset with additional cash; however, a reduction in equity cannot be offset by increasing debt.)

Receive only “like-kind” replacement property.

 DO NOT plan to sell and invest the proceeds in property you already own. Funds applied toward property already owned purchase “goods and services,” not “like-kind” property.

 DO attempt to sell before you purchase. Occasionally Exchangers find the ideal replacement property before a buyer is found for the relinquished property. If this situation occurs, a reverse exchange (buying before selling) may be necessary. While the IRS has recently provided guidance for reverse exchanges in Revenue Procedure 2000-37, Exchangers should be aware that reverse exchanges are considered a more aggressive exchange variation because some other entity must hold title to either the Exchanger’s relinquished or replacement property for up to 180 days pending the completion of the exchange transaction.

DO NOT  dissolve partnerships or change the manner of holding title during the exchange. A change in the Exchanger’s legal relationship with the property may jeopardize the exchange.

Obama Administration Announces Financial Incentives and Uniform Process for Short Sales National Association of REALTORS® Government Affairs Division 500 New Jersey Avenue, NW, Washington DC, 20001 REALTOR® is a registered collective membership mark which may be used only by real estate professionals who are members of the NATIONAL ASSOCIATION OF REALTORS® and subscribe to its strict Code of Ethics

 Responding to the call of the National Association of REALTORS®, on May 14, 2009, the Obama Administration announced incentives and uniform procedures for short sales under its new Foreclosure Alternatives Program (FAP). For borrowers who are unable to retain their home under the Making Home Affordable Loan Modification Program, the servicer may consider a short sale or, if that is not successful, a deed-in-lieu of foreclosure. Participating servicers must comply with program requirements so long as they do not conflict with contractual agreements with investors.

Borrowers (Homeowners). Borrowers/homeowners qualify under the FAP if they meet minimum eligibility requirements for the Home Affordable Modification program but don’t qualify for a modification or do not successfully complete the three month trial period. Before proceeding with a foreclosure, servicers must determine if a short sale is appropriate.

Incentives. Incentives include: (1) $1,000 for servicers for successful completion of a short sale or deed-in-lieu of foreclosure; (2) $1,500 for borrowers/homeowners to help with relocation expenses; and (3) up to $1,000 toward the cost of paying junior lien holders to release their liens (one dollar from the government for every $2 paid by the investors to the second lien holders).

Standardized Documents. The program will include streamlined and standardized documents, including a Short Sale Agreement and an Offer Acceptance Letter. The goal is to minimize complexity and increase use of the short sale option.

Property Valuation by Appraisal or BPO. Servicers will independently establish both property value and minimum acceptable net return, in accordance with investor requirements. The price may be determined based on an appraisal or one or more broker price opinions (BPOs), issued no more than 120 days before the date of the short sale agreement.

Timeline. In the Short Sale Agreement, servicers must give borrowers/homeowners at least 90 days to market and sell the property, or up to one year, depending on market conditions. Property must be listed with a licensed real estate professional with experience in the neighborhood. No foreclosure may take place during the marketing period (at least 90 days) specified in the Short Sale Agreement.

Commissions. The Short Sale Agreement must specify the reasonable and customary real estate commissions and costs that may be deducted from the sales price. The servicer must agree not to negotiate a lower commission after an offer has been received.

No Borrower Fees. Servicers may not charge fees to borrowers/homeowners for participating in the FAP.

Program Expiration. The program is in effect through 2012.

Deed-in-Lieu of Foreclosure Option. Servicers have the option to require the borrower/homeowner to agree to deed the property to the servicer in exchange for a release from the debt if the property does not sell within the time allowed in the Short Sale Agreement (plus any extensions).

First-Time Home Buyer Tax Credit

 

$8,000 Home Buyer Tax Credit at a Glance

 

The tax credit is for first-time home buyers only.

The tax credit does not have to be repaid.

The tax credit is equal to 10 percent of the home’s purchase price up to a maximum of $8,000.

The credit is available for homes purchased on or after January 1, 2009 and before December 1, 2009.

Single taxpayers with incomes up to $75,000 and married couples with incomes up to $150,000 qualify for the

full tax credit.

FIRST-TIME HOME BUYER TAX CREDIT

FEATURE CREDIT AS CREATED JULY 2008 –

Applies to All Qualified Purchases On or After April 9, 2008

REVISED CREDIT –

Effective for Purchases On or After

January 1, 2009 and Before December 1, 2009

Amount of Credit Lesser of 10 percent of cost of

home or $7,500.

Maximum credit amount increased to $8,000

Eligible Property Any single family residence

(including condos, co-ops,

townhouses) that will be used

as a principal residence.

No change

All principal residences eligible.

Refundable Yes. Reduces (or can eliminate)

income tax liability for the year of

purchase. Any unused amount of

tax credit refunded to purchaser.

No change

Purchasers will continue to receive refund for unused

amount when tax return is filed.

Income Limit Yes. Full amount of credit available

for individuals with adjusted gross

income of no more than $75,000

($150,000 on a Joint return). Phases

out above those caps ($95,000

and $170,000).

No change

Same income limits continue to apply.

First-time

Homebuyer Only

Yes.
spouse) may not have owned a
principal residence in 3 years
previous to purchase.
No change
Still available for first-time purchasers only. Three-year

rule continues to apply.

Revenue Bond

Financing

No credit allowed if home financed

with state/local bond funding.

Purchasers who utilize revenue bond financing can

use credit.

Repayment Yes. Portion (6.67% of credit or

$500) to be repaid each year for

15 years, starting with 2010 tax filing.

No repayment for purchases on or after January 1, 2009

and before December 1, 2009.

Recapture If home sold before 15-year

repayment period ends, then

outstanding balance of repayment

amount recaptured on sale.

If home is sold within three years of purchase, entire

amount of credit is recaptured on sale. Applies only to

homes purchased in 2009.

Termination July 1, 2009

(But note program changes for 2009)

December 1, 2009

Effective Date Purchases on or after April 9, 2008

and before January 1, 2009.

Repayment to begin for 2010 tax year.

All revisions are effective as of January 1, 2009.

FIRST-TIME HOMEBUYER
TAX CREDIT 2009
QUICK REFERENCE
 
 

As Modified in the American Recovery
and Reinvestment Act – February “##$
Major Modifications Shaded
 
 

UNDERSTANDING
THE INCENTIVES
In !””#, Congress enacted a $%,&”” tax credit
designed to be an incentive for first-time homebuyers
to purchase a home. The credit was designed
as a mechanism to decrease the over-supply of

homes for sale.

For !””(, Congress has increased the credit to $#,”””

and made several additional improvements. This

revised $#,””” tax credit applies to purchases on or

after January ), !””( and before December ), !””(.

TAX CREDITS – THE BASICS
 
 
 
 

%. What’s this new homebuyer tax incentive for “##$?
In !””#, the $%,&””, repayable credit is increased to
$#,””” and the repayment feature is eliminated for !””(
purchasers. Any home that is purchased for $#”,””” or
more qualifies for the full $#,””” amount. If the house
costs less than $#”,”””, the credit will be )”% of the cost.

Thus, if an individual purchased a home for $+&,”””,

the credit would be $+,&””. It is available for the purchase

of a principal residence on or after January ), !””( and

before December ), !””(.

“. Who is eligible?
Only first-time homebuyers are eligible. A person is considered
a first-time buyer if he/she has not had any ownership
interest in a home in the three years previous to the day of
the !””( purchase.
 

 

&. How does a tax credit work?
Every dollar of a tax credit reduces income taxes by a
dollar. Credits are claimed on an individual’s income tax
return. Thus, a qualified purchaser would figure out all the
income items and exemptions and make all the calculations
required to figure out his/her total tax due. Then, once the

total tax owed has been computed, tax credits are applied

to reduce the total tax bill. So, if before taking any credits

on a tax return a person has total tax liability of $(,&””, an

$#,””” credit would wipe out all but $),&”” of the tax due

($(,&”” – $#,””” = $),&””).

‘. So what happens if the purchaser is eligible for an $),### credit
but their entire income tax liability for the year is only $*,###?
This tax credit is what’s called “refundable” credit. Thus,
if the eligible purchaser’s total tax liability was $2,”””, the
IRS would send the purchaser a check for $!,”””. The
refundable amount is the difference between the $#,”””

credit amount and the amount of tax liability ($#,””” –

$2,””” = $!,”””). Most taxpayers determine their tax liability

by referring to tables that the IRS prepares each year.

+. How does withholding affect my tax credit and my refund?
A few examples are provided at the end of this document.
There are several steps in this calculation, but most income tax
software programs are equipped to make that determination.
 
 

 

*. Is there an income restriction?
YES. The income restriction is based on the tax filing
status the purchaser claims when filing his/her income tax
return. Individuals filing Form )”3″ as Single (or Head of
Household) are eligible for the credit if their income is no
more than $%&,”””. Married couples who file a Joint return

may have income of no more than $)&”,”””.

/. How is my “income” determined?
For most individuals, income is defined and calculated in
the same manner as their Adjusted Gross Income (AGI)
on their )”3″ income tax return. AGI includes items like
wages, salaries, interest and dividends, pension and retirement
earnings, rental income and a host of other elements.

AGI is the final number that appears on the bottom line

of the front page of an IRS Form )”3″.

). What if I worked abroad for part of the year?
Some individuals have earned income and/or receive
housing allowances while working outside the U.S. Their
income will be adjusted to reflect those items to measure
Modified Adjusted Gross Income (MAGI). Their eligibility
for the credit will be based on their MAGI.

 

$. Do individuals with incomes higher than the $/+,### or
$%+#,### limits lose all the benefit of the credit?
Not always. The credit phases out between $%&,””” –
$(&,””” for Singles and $)&”,””” – $)%”,””” for married
filing Joint. The closer a buyer comes to the maximum
phase-out amount, the smaller the credit will be. The law

provides a formula to gradually withdraw the credit.

Thus, the credit will disappear after an individual’s income

reaches $(&,””” (Single return) or $)%”,””” (Joint return).

For example, if a married couple had income of $)2&,”””,

their credit would be reduced by %&% as shown:

Couple’s income: $%*+,###
Income limit: $%+#,###
Excess income: $%+,###
The excess income amount ($)&,””” in this example) is
used to form a fraction. The numerator of the fraction
is the excess income amount ($)&,”””). The denominator

is $!”,””” (specified by the statute).

In this example, the disallowed portion of the credit

is %&% of $#,”””, or $2,””” ($)&,”””/$!”,””” = %&% x

$#,””” = $2,”””).

Stated another way, only !&% of the credit amount would

be allowed. In this example, the allowable credit would be

$!,””” (!&% x $#,””” = $!,”””).

%#.What’s the definition of “principal residence?”
Generally, a principal residence is the home where an
individual spends most of his/her time (generally defined
as more than &”%). It is also defined as “owner-occupied”
housing. The term includes single-family detached housing,
condos or co-ops, townhouses or any similar type of new or

existing dwelling. Even some houseboats or manufactured

homes count as principal residences.

%%. Are there restrictions on the location of the property?
YES. The home must be located in the United States.
Property located outside the U.S. is not eligible for
the credit.
 
 

 

%”. Are there restrictions related to the financing for the mortgage on
the property?
In !””(, most financing arrangements are acceptable
and will not affect eligibility for the credit. Congress
eliminated the financing restriction that applied in !””#.
(In !””#, purchasers were ineligible for the $%,&”” credit if

the financing was obtained by means of mortgage revenue

bonds.) Now, mortgage-revenue bond financing will not

disqualify an otherwise-eligible purchaser. (Mortgage revenue

bonds are tax-exempt bonds issued by a state housing

agency. Proceeds from the bonds must be used for below

market loans to qualified buyers.)

%&. Do I have to repay the “##$ tax credit?
NO. There is no repayment for !””( tax credits.
 
 
 
 

 

%’. Do “##) purchasers still have to repay their tax credit?
YES. The $%,&”” credit in !””# was more like an interestfree
loan. All eligible purchasers who claimed the !””#
credit will still be required to repay it over )& years, starting
with their !”)” tax return.
 

 

SOME PRACTICAL QUESTIONS
 
 
 
 

%+. How do I apply for the credit?
There is no prepurchase authorization, application or similar
approval process. All eligible purchasers simply claim the
credit on their IRS Form )”3″ tax return. The credit will
be reflected on a new Form &3″& that will be attached to
the )”3″. Form &3″& can be found at http://www.irs.gov.

 

%*. So I can’t use the credit amount as part of my downpayment?
NO. Congress tried hard to devise a mechanism that
would make the funds available for closing costs, but found
that pre-funding would require cumbersome processes
that would, in effect, bring the IRS into the purchase and
settlement phase of the transaction.

 

%/. So there’s no way to get any cash flow benefits before I file my
tax return?
YES, there is. Any first-time homebuyers who believe they
are eligible for all or part of the credit can modify their
income tax withholding (through their employers) or adjust
their quarterly estimated tax payments. Individuals subject

to income tax withholding would get an IRS Form W-3

from their employer, follow the instructions on the schedules

provided and give the completed Form W-3 back to the

employer. In many cases their withholding would decrease

and their take-home pay would increase. Those who make

estimated tax payments would make similar adjustments.

SOME “REAL WORLD” EXAMPLES
 
 
 
 

%).What if I purchase later this year but can’t get to settlement
before December %?
The credit is available for purchases before December ),
!””(. A home is considered as “purchased” when all events
have occurred that transfer the title from the seller to the
new purchaser. Thus, closings must occur before December

), !””( for purchases to be eligible for the credit.

%$. I haven’t even filed my “##) tax return yet. If I buy in “##$,
do I have to wait until next year to get the benefit of the credit?
You’ll have a helpful choice that might speed up the process.
Eligible homebuyers who make their purchase between
January ), !””( and December ), !””( can treat the purchase
as if it had occurred on December 4), !””#. Thus, they can

claim the credit on their !””# tax return that is due on April

)&, !””(. They actually have three filing options.

If they purchased between January ), !””( and April )&,

!””(, they can claim the $#,””” credit on the !””# return

due on April )&.

If they filed an extension for their !””# income taxes, they

can file their return as late as October )&, !””(. (The IRS

grants automatic extensions, but the taxpayer must file for

the extension. See http://www.irs.gov for instructions on how to

obtain an extension.)

If they have filed their !””# return before they purchase

the home, they may file an amended !””# tax return on

Form )”3″X (Form )”3″X is available at http://www.irs.gov).

Of course, !””( purchasers will always have the option of

claiming the credit for the !””( purchase on their !””(

return. Their !””( tax return is due on April )&, !”)”.

“#. I purchased my home in early “##$ before the stimulus bill
was enacted. I claimed a $/,+## tax credit on my “##) return as
prior law had permitted. Am I restricted to just a $/,+## credit?
NO, you would qualify for the $#,””” credit. Eligible
purchasers who have already claimed the $%,&”” credit on
a !””# return for a !””( purchase may file an amended

return (IRS Form )”3″X) for the !””# tax year. This

amended return will enable them to obtain the additional

$&”” credit amount.

ACCESS TAX FORMS ONLINE AT WWW.IRS.GOV

VISIT OUR SITE AT

WWW.REALTOR.ORG/HOME_BUYERS_AND_HOME_CREDIT
WW D_SELLERS/
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“%. If I claim my “##$ $),### credit on my “##) tax return,
will I have to repay the credit just as the “##) credits are repaid?
NO. Congress anticipated this confusion and has made
specific provision so that there would be no repayment of
!””( credits that are claimed on !””# returns.
 

 

“”. I made an eligible purchase of a principal residence in May “##)
and claimed the $/,+## credit on my “##) tax return. My brother,
who has never owned a home, wishes to purchase a partial interest
in the home this spring and move in. Will he qualify for the $),###
credit, as well?
NO. Any purchase of a principal residence (or interest in a

principal residence) from a related party such as a sibling,

parent, grandparent, aunt or uncle is ineligible for the tax

credit. Since you and your brother are related in this way, he

cannot qualify for the credit on any portion of the home that

he purchases from you, even if he is a first-time homebuyer.

“&. I live in the District of Columbia. If I qualify as a first-time
homebuyer, can I use both the $+,### D.C. credit and the
$),### credit?
NO; double dipping is not allowed. You would be eligible
for only the $#,””” credit. This will be an advantage
because of the higher credit amount, plus the eligibility

requirements for the $#,””” credit are somewhat more

easily satisfied than the D.C. credit.

“‘. I know there is no repayment requirement for the $),### credit.
Will I ever have to repay any of the credit back to the government?
One situation does require a recapture payment back to
the government. If you claim the credit but then sell the
property within three years of the date of purchase, you are
required to pay back the full amount of any credit, including

any refund you received from it. A few exceptions apply

(see below, #!&). Note that this same three-year recapture

rule applies, as well, to the $%,&”” credit available for !””#.

This provision is designed as an anti-flipping rule.

“+. What if I die or get divorced or my property is ruined in a natural
disaster within the three years?
The repayment rules are eased for many circumstances.
If the homeowner who used the credit dies within the first
three years of ownership, there is no recapture. Special
rules make adjustments for people who sell homes as part

of a divorce settlement, as well. Similarly, adjustments are

made in the case of a home that is part of an involuntary

conversion (property is destroyed in a natural disaster or

subject to condemnation by eminent domain by an authorized

agency) within the first three years.

“*. I have a home under construction. Am I eligible for the credit?
YES, so long as you actually occupy the home before
December ), !””(.
 
 
 

 

WITHHOLDING
EXAMPLES
Situation One
as close as possible to what she anticipates as her income tax liability
for the year. When she fills out her %2’2, her liability is $*,222. She
has had $*,222 withheld from her paycheck. She also qualifies for the

$),222 homebuyer credit.

Sally plans her withholding so that her withholding isResult: Sally’s withholding satisfies her tax liability and reduces

it to zero. She will receive a refund of the full $#,”””.

Situation Two
and makes estimated payments; Nora has taxes withheld from her
salary. When they compute their taxes, their combined withholding
and estimated tax payments are $%%,222. Their income tax liability is
$$,)22. They also qualified as first-time homebuyers and are eligible
for the $),222 refundable tax credit.

Nick and Nora file a Joint return. Nick is self-employedResult: Ordinarily, their combined estimated tax payments

and withholding would make them eligible for a refund of

$),!”” ($)),””” – $(,#”” = $),!””). Because they are eligible

for the refundable tax credit as well, they will receive a refund

of $(,!”” ($),!”” income tax refund + $#,””” refundable tax

credit = $(,!””).

Situation Three
from their salaries and file a Joint return. When they file their
income tax return, their combined withholding is $+,222. However,
their total tax liability is $/,”22, generating an additional income
tax liability of $”,”22 ($/,”22 – $+,222). They also qualify for the
$),222 first-time homebuyer tax credit.

Cesar and LuzMaria both have income taxes withheldResult: Cesar and LuzMaria have been under-withheld by

$!,!””. Ordinarily, they would be required to pay the additional

$!,!”” they owe (plus any applicable interest and penalties).

Because they are eligible for the refundable homebuyer

tax credit, the credit will cover the $!,!”” additional liability.

In addition, they will receive an income tax refund of $&,#””

($#,””” – $!,!”” = $&,#””). If they owed penalties and/or

interest, that amount would reduce the refund.

Note: The impact of estimated tax payments would be the same.
QUESTIONS?

 

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