This is the personal version of the corporate or commercial sale and leaseback strategy for real estate that can be a very useful and powerful cash and tax planning tool that can help your parents generate liquidity (cash) on a tax free basis.

No More Tax Benefits From Home Ownership

Let's assume, for example, that your parents are in their 70's and own a single family house in which they live as their primary residence.  Their home has appreciated significantly over the years.  However, they can no longer take advantage of the tax breaks from owning their own home because they are in a much lower income tax bracket.  Perhaps they even need cash to live on. 

Buy Your Parents Home

You can structure a transaction whereby you buy your parents' home from them, and then subsequently lease or rent the home back to them.  It is a classic personal sale and leaseback strategy, and is a win-win situation for everyone. 

Your parents have effectively withdrawn their trapped equity out of their primary residence, and they can then reinvest and diversify the cash into other investments that can generate monthly cash flow as needed.  The transaction would be tax free provided your parents qualify for a 121 Exclusion (refer to Section 121 of the Internal Revenue Code).

And, you now own rental property and can deduct the related depreciation and operating expenses on your income tax return against the rental income paid to you by your parents. 

Structuring The Sale and Rent Back

You have to be careful here.  You do not want to run afoul of the IRS.  The sale of your parents' home to you must be at fair market value.  This can easily be documented by obtaining an appraisal to support your purchase price. 

The rent payment from your parents to you should be made at fair market rental rates.  However, under a Tax Court Decision (TC Memo 1983-411) landlords can charge related party tenants up to 20% under the going fair market rent since the related party is handling all of the property management and maintenance. 

This tax planning strategy can work very nicely as part of an overall estate planning strategy as well, so consult with your legal and tax advisors to see if it might be right for you. 

You can then decide what to do with the property when your parents move out and no longer live there.  It is your rental property, so you can sell it, convert it to your home (primary residence) or 1031 Exchange out of it and into another rental property that might be more suitable for you.

The Federal Reserve Bank's FOMC did not address signs of improvement in the U.S. housing market, which it had after its previous FOMC meeting. The Federal Reserve Bank said that it still expects to discontinue a $1.25 trillion program aimed at keeping mortgage interest rates low as scheduled on March 31, 2010.  But, the Fed did reiterate that it remains open to changing that timetable if necessary.

Reports on home sales this week pointed to a still-fragile housing market.

One Federal Reserve Board FOMC member dissented from the decision to retain the pledge to hold the Fed Funds Rate at record lows. Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, says the economy has improved sufficiently to drop the pledge, which has been in place for nearly a year.

Fed policymakers said economic activity has continued to "strengthen," the deterioration in the job market is easing and consumers are spending moderately. But they warned that high unemployment, lackluster income growth and tight credit could crimp that spending.  The Federal Reserve has kept its target range for its Fed Funds Rate at zero to 0.25 percent, where it has been since last December, 2009.

In response, commercial banks' prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will remain about 3.25 percent. That's its lowest point in decades.

Super-low interest rates are good for borrowers who can get a loan and are willing to take on more debt. But those same low rates hurt savers. They're especially hard on people living on fixed incomes who are earning measly returns on savings accounts and certificates of deposit.

With the economy on the mend, the Federal Reserve Bank this year can focus on how and when to pull back the stimulus money pumped out to fight the financial crisis.  Federal Reserve Chairman Ben Bernanke will lead that effort now that his prospects for confirmation for another four-year term have improved.

We thought that we would whare their 10 predictions for housing in the United States for 2010:

1. "Fundamentals will remain 'choppy' in the first half of the year, with conflicting data points making it difficult to ascertain whether we’ve actually reached the trough in housing."
2. "Headline risk, primarily driven by the government's efforts to extract itself from the mortgage market, will drive the homebuilding stocks down 15% or more from current levels…With the longer term path for fundamentals offering limited clarity, we expect the homebuilding stocks to remain quite volatile and extremely sensitive to news flow."
3. "The previous prediction notwithstanding, the government is going to do everything in its power to protect home prices...In the end; we believe that concerns about higher rates and declining mortgage market liquidity won't amount to much. In our opinion, the government continually made it clear that it is working to limit further home price declines given the serious ramifications these declines would have for both consumers and lenders."
4. "Although we forecast that as many as 7 million foreclosures are likely to occur over the next several years, we believe the pace at which these homes will come to the market will be consistent with current levels. As such, the concerns around the negative impacts of rising inventory levels are overdone."
5. "An improvement in unemployment is the single most important predictor for the longer term health of the housing market - only by focusing on this variable can we truly understand the timing for a recovery."
6. "An improving jobs picture will d4rive greater price stability and better demand. That said, given the level of excess inventory, the pace of price appreciation will be below trend for some time."
7. "The builders will see sequential improvements in their quarterly results."
8. "Given the limited amount of high quality, finished lots coming to market, we expect the builders to increasingly consider purchasing undeveloped parcels, which represent a greater value. This trend will be magnified if conditions start to accelerate more meaningfully in the near term as builders look to rebuild their operations over time."
9. "Although residential construction lending standards might loosen in 2010, liquidity will be insufficient to drive starts toward current consensus estimates."
10. "The longer term outlook for housing will increasingly dominate investors focus toward the end of 2010."

November’s unchanged reading broke a string of seven consecutive increases for the USD Index.  There is no change though in the previously reported outlook for 2010.  The first few months of the year may be weak, with the local unemployment rate edging up to approach 11 percent.  Things will improve in the second half of the year, with a net overall gain of between 3,000 to 5,000 jobs for the year.  An improving housing market will boost employment in construction, while research and development and health services will remain relatively strong.  Rebounding local and national economies will stabilize employment in retailing and in the leisure and hospitality sector.  However, job losses are expected to continue in manufacturing, which has lost jobs in 10 of the last 11 years.

Never, never, under any circumstances, structure and close on any real estate investment transaction, whether it is a purchase or sale, without consulting your legal and/or tax advisors first, so that you know what you are getting into.  

The bad news that I'm about to discuss regarding this subject could have easily been avoided if the investors involved had consulted with their tax advisors first and learned what the property steps were in order to structure a 1031 Tax Deferred Exchange. 

Already Sold My Real Estate

The calls fielded by our tax-deferred and tax-exclusion experts generally start off with a question that goes something like this:

I just sold my rental property and I want to defer the capital gain taxes, and I was told that I could do so with the 1031 Tax Deferred Exchange.

What Do You Mean By Sold?

The first thing that our experts do is define what the caller means by "sold."  Sold can mean many different things to many different people.  Sold could mean that they just listed their property for sale, or they just accepted an offer from a buyer, or they just closed escrow and the rental property has been deeded to the buyer.   We need to accurately determine exactly what stage the caller is at in his or her real estate transaction in order to determine whether a 1031 Tax Deferred Exchange will work.

Generally, sold means that the investor has accepted an offer to buy his or her property and he or she has a binding Purchase Agreement to sell the property to a specified buyer, or in other words, the investor is under contract, but it does not automatically mean that he or she has closed on the sale of the rental property.

Sale Must Not Have Closed

The most important issue that we are looking for is to make sure that the caller has not actually closed on the sale of his or her rental property.  By closing, I mean that the sale of the real estate has been completed, a settlement statement (HUD-1) has been issued, and the property has been deeded to the buyer of the real estate. 

It is too late to set-up a 1031 Tax Deferred Exchange if the sale of the real property has already closed and the buyer has the property.  The reason is simple.  The investor who is selling the property can not have constructive receipt or control over the net proceeds from the sale of the rental property.  They have the ability to direct the closing officer/agent/escrow officer where to direct the funds once the sale has closed and therefore have constructive receipt of the 1031 Exchange funds. 

Therefore, in order to properly structure a 1031 Tax Deferred Exchange the Qualified Intermediary used to handle the 1031 Exchange must be in place and "assigned" into the Purchase Agreement and related documents before the sale has closed in order to avoid the constructive receipt issue. 

So, going back to the original question.  It is too late to set-up 1031 Tax Deferred Exchange if the sale has closed and the property deeded to the buyer.  It is not too late, and you can defer the payment of your capital gain taxes with a 1031 Exchange, as long as the sale transaction is still in process and has not closed. 

Although more expensive and complicated, the Reverse 1031 Exchange is an exceptionally powerful tax deferred strategy that allows the investor to buy his or her replacement property first and then worry about selling his or her relinquished property later.  It can be especially effective in the current market cycle where buying first is virtually required. 

Click here to learn more and register for this Reverse Exchange webinar, or any of our other tax deferred or tax exclusion webinars.

It is important to consult with your legal, tax and financial advisors before implementing any specific tax strategy to ensure that you have selected the most appropriate structure for your needs.  Consultations are also available through The Exeter Learning Institute in conjunction with your existing advisors.