1031 Exchange Problem Fixed

This New Hampshire Senate Bill, which is now law, corrects the problem associated with 1031 Tax Deferred Exchange transactions involving the sale of relinquished property located in the State of New Hampshire.

Problem Created by New Hampshire Department of Revenue

The problem was created when the New Hampshire Department of Revenue ruled that the sale or disposition of relinquished property located within New Hampshire and held in a specific single member LLC combined with the subsequent acquisition of replacement property through another (different) single member LLC would not qualify for 1031 Exchange treatment because the sale and purchase were structured in different entities.

This new law prevents the New Hampshire Department of Revenue from applying the Business Profits Tax on the sale of relinquished properties located within the state.  The State of New Hampshire had been one of only two states that were attempting to tax such 1031 Tax Deferred Exchanges involving so-called "disregarded entities."  This new law is retroactive and permits investors to report real estate transactions in the recent past as a 1031 Tax Deferred Exchange without paying the New Hampshire Business Profits Tax.

Reinvestment Requirement

The first question that you need to ask yourself is whether or not you you want to defer all of your capital gain taxes and/or depreciation recapture taxes or just some of your income tax liability?  Do you want to buy more real estate or less?  Generally, you will want to defer all of your taxes, but you can complete a partial 1031 Exchange and only defer some if you wish. 

Deferring All Of Your Taxes

If you want to defer all of your capital gain taxes and depreciation recapture taxes, you must reinvest your entire net sales price.  Your net equity doesn't matter; only your net sales price.  This means that you take your actual sales price ("gross sales price") and substract your routine closing costs to arrive at your net sales price.  This is the amount that you must reinvest. 

You often hear people say that you only have to reinvest your cash equity and your debt/mortgage, but this formula often inadvertently ignores certain deductions from your gross sales price that are not routine closing costs and therefore skews the amount required for reinvestment.

Trade Equal or Up in Value

You must acquire one or more replacement properties that are worth at least this much (or more, you can always trade up and acquire more property).  You must also reinvest 100% of your net equity (net cash) in your replacement properties.  You can always pull cash out upfront or at the back end of your 1031 Exchange, if you want to, but it will result in taxable boot. 

Partial 1031 Tax Deferred Exchange

You can trade down in value if you choose to do so, but you will trigger some taxable boot and have to pay depreciation recapture taxes and/or capital gain taxes on the amount that you trade down by.  This can often be a tactical strategy when dealing with a distressed portfolio of properties. 

For example, you may sell a $5 million portfolio of investment property and trade down through a 1031 Tax Deferred Exchange by acquiring only $3.5 million in replacement properties in order to put you in a position that is easier to service (i.e. reduction of debt).  This strategy allows you to defer some of your capital gain taxes, but also reduce the amount of your debt service. 

There are many changes, in fact about 350 separate rules, for which the administration and regulators will have to define and write regulations in order to implement.  However, there is one that I thought was worth mentioning. 

FDIC Insurance Limit Hiked to $250,000

The banking overhaul bill, in its present form, would include a permanent increase to the FDIC insurance limit from the old $100,000 per bank, per depositor limit to $250,000 per bank, per depositor.  This is great news because the old limit was way outdated and needed to be brought current.

Business Checking Accounts Can Pay Interest

It also would eliminate the current ban on paying interest on business checking accounts, so that banks could decide to pay businesses on the funds deposited and held in their business checking accounts. 

The Taxpayer is in the routine business of selling, renting, servicing, and financing equipment, which the Taxpayer classifies as held for rental (investment) or held for sale (inventory) upon purchase from the manufacturer.

Rental equipment that was initially classified as held for rental (investment) upon purchase may be subsequently sold to a renter or other purchaser at a later date.  There is no prior purchase and sale agreement or other contract in place with the renters as to how much of the rental payments, if any, will be applied toward the purchase price of the subject rental equipment.  The price is negotiated at the time that the renter decides to acquire the rental equipment. 

The Taxpayer has been structuring 1031 Tax Deferred Exchanges on the sales and dispositions of the subject rental equipment when sold to the renters or other purchasers. 

The IRS Chief Counsel concluded that the rental equipment that had been classified as held for rental (investment) was not actually held for for rental purposes, but was actually held as inventory in the Taxpayer's business and was therefore held for sale and not investment.  Temporarily withdrawing equipment from inventory held for sale does not convert the equipment from inventory held for sale into equipment held as rental property.

The determination of whether property is held as rental property, investment property or used in a trade or business must be made on a property-by-property basis. 

As our contractors and builders through out the country struggle to get banks and other lenders to loan money for land development and construction, a North Carolina House of Representative Member has asked the U.S. Government to step up to the plate and start guaranteeing loans for viable construction and building projects.

We’ve gone from indiscriminate lending to indiscriminate refusal to lend, and it’s killing jobs, says Brad Miller.

Congressman Miller in concert with Congressmen Joe Baca (D-CA) and Steny Hoyer (D-MD) introduced the House of Representatives Bill 5409 (H.R. 5409), officially known as the Residential Construction Loan Guarantee Program.

We can’t tell 16% of the [Gross Domestic Product] to just hang around and wait for a while, says Miller, referring to the housing industry and its economic output.

H.R. Bill 5409 would require that the U.S. Government set aside $15 billion over a three (3) year period to be used for loan guarantees for land and building projects.  H.R. Bill 5409 is an amendment or tack on to another House of Representatives Bill that is currently moving through the House that, if passed, would extend $30 billion to small commercial banks for small business loans (SBA Loans).

The House Bill aims to reduce commercial bankers' or other lenders' risks by providing them with U.S. Government loan guarantees for eligible projects deemed to be "viable" by commercial banks and other lenders and the U.S. Department of the Treasury.  The builder or developer (borrower) must have a minimum financial net worth equal or greater than the guaranteed loan amount, and the loan itself can be used only for the acquisition, development, and construction of approved residential real estate projects.

The current House Bill provides the following:

• Loan to value ratio cannot exceed 75%
• Actual loan amount can not exceed the total building and development costs or 80% of the FMV of the real estate project
• 80% of the loan amount would be covered by the Federal loan guarantee

One-third of the guarantees would be made in areas where the lack of financing is most pronounced, as determined by the Department of the Treasury Secretary.  The loan guarantee program would expire three years after it is enacted.

I suggested that she wait and close on the sale of her relinquished property and start her 1031 Exchange after June 30, 2010 instead of before month end.  The reason is simple.  You never know whether you will be able to complete your 1031 Exchange.  The sale of your relinquished property and the start of your 1031 Exchange triggers your capital gain tax.  Your 1031 Exchange will fail if you can not acquire replacement property with the 180 calendar day exchange period, and the failed 1031 Exchange becomes a taxable transaction.

However, your taxable gain can be pushed into the following tax year if you do not have the right to your 1031 Exchange funds until after your 180 calendar period has passed and the 181st day lands in the following tax year.  This is the reason that I recommended that she wait to close on the sale of her relinquished property until July 2010.  Closing after month end would push her 180th day into 2011 and would at least allow her to defer her capital gain into 2011 even if her 1031 Exchange fails.  This is a little known tax planning tool that is relatively easy to implement unless you absolutely need to close by month end for other reasons. 

Parts of the financial rescue plans are already wrapped up or will be soon. A money market fund guarantee from the Federal Reserve disappeared months ago. Programs for purchasing commercial paper, lending to securities firms to keep them afloat, loaning dollars to foreign banks to help thaw credit and purchasing debt backed by small business, car and other loans have all served their purpose and will end shortly, with little cost to taxpayers.  Other changes will be permanent…a hike in FDIC insurance of bank deposits, for example.

And many big-bucks programs will linger. Subsidies for Fannie Mae and Freddie Mac to keep home mortgage funds flowing will continue through at least 2013, for example.  So far…about $145 billion. And the final tab could climb to as much as $400 billion by the time the quasi-governmental institutions wring out all the bad loans made.

Washington has $13 billion left to help homeowners avoid foreclosures. A total of $50 billion is dedicated to the program, which has been operating for a year.  The Federal Reserve holds a total of $2 trillion in long-term bonds…mortgage backed securities, Treasuries, Fannie Mae and Freddie Mac bonds…bought to hold down mortgage rates.

The Cash Holding Escrow or Cash Holdback Escrow is a very simple escrow solution to an often complicated problem.  These problems often arise at the last minute and can delay, complicate or even result in the cancellation of some already fragile real estate transactions. 

Putting a Cash Holdback Escrow or Cash Holding Escrow in place at the last minute can save these transactions.  But, many independent escrow companies, title insurance companies, trust companies, banks and other financial institutions will often decline to administer these Cash Holding Escrows or Cash Holdback Escrow account transactions because they do not have adequate systems to track the various requirements for the Cash Holdback.

Given current economic environment of a slow recovery combined with declining inflationary concerns, the FOMC has indicated that they will keep the Fed Funds target rate low for an extended period of time.

The FOMC would like to see some staying power in the economic recovery process, as well as further employment growth and lower unemployment before making any changes to the Fed Funds rate.  Therefore, Fed Funds rates appear to be staying where they are through 2010 and probably into 2011.