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1031 Exchange Information

September 19, 2007 by Todd R. Pajonas, Esq.
Many times taxpayers are advised that there are no extensions to IRC §1031 tax deferred exchange time deadlines, but technically this is not correct. In general, a taxpayer’s individual circumstances or problems are not taken into consideration by the Internal Revenue Service in determining whether or not a deadline for an exchange should be extended. However, there are mechanisms to provide for relief for multiple taxpayers affected by certain extraordinary circumstances.
Accordingly, the IRS has issued an extension for Queens and Brooklyn (Kings County), New York,for the August 8, 2007 storms. [Note that the IRS originally stated the extension only applied to Queens County, and may add additional counties later if FEMA adds counties. If you are near the affected area, you should check the disaster announcement website for updates.]
Both the following criteria must be met to get the extension under Revenue Procedure 2007-56, Section 17:
(1) The taxpayer is located in one of these counties, regardless of where the relinquished property or replacement property is located, or the taxpayer otherwise has difficulty meeting the exchange deadlines under the conditions in Revenue Procedure 2007-56, section 17; AND
(2) The relinquished property was transferred (or the parked property was acquired by the EAT in a reverse exchange under Revenue Procedure 2000-37) on or before August 8th, 2007.
If the taxpayer meets these criteria, then any 45 day or 180 day deadline that falls within the period on or after August 8, 2007 through November 15, 2007, is extended for 120 days from such deadline.
Please see Revenue Procedure 2007-56, Section 17, and the notice below for further details. Click Here
February 21, 2005 by Todd R. Pajonas, Esq.

Primary residences are normally not a consideration when talking about IRC §1031 tax deferred exchanges, but some recent rulings have clarified what the results are when these two areas intersect. In order to structure a valid 1031 exchange a taxpayer must exchange like-kind property which is defined as property held for business or investment purposes. When properly structured a 1031 exchange yields a deferral of the capital gain tax which would normally have been recognized upon the sale.

Although most people tend to think of their home as an investment, in addition to a place in which they live, a person's primary residence is initially excluded from IRC §1031 tax deferred exchange treatment. The overlap occurs when taxpayers convert a business or investment property into a primary residence or vice versa. Revenue Procedure 2005-14 (1/27/2005, corrected February 3, 2005) provides for clarification and additional benefits for those taxpayers converting property between a primary residence use and a business and investment. In addition, it also provides guidance for properties used partially as a primary residence and partially as a business or investment property.

Unlike an IRC §1031 tax deferred exchange, which defers a gain upon the sale of business or investment property, IRC §121 provides for an exclusion of the capital gain tax upon the sale of a principal residence. The maximum exclusion under §121 is $250,000 for those filing as single and $500,000 for those filing a joint return. Effective October 22, 2004 the primary residence exclusion contained in IRC §121 was amended to provide for a five year waiting period for property which was acquired using an IRC §1031 exchange. In other words, if a business or investment property acquired using an IRC §1031 tax deferred exchange is later converted to a primary residence the capital gains tax exclusion of IRC §121 can not be applied until the taxpayer has lived in the property as its primary residence for at least two years in addition to a five year period of ownership. It is important to note that a taxpayer's initial intent must be to acquire the replacement property as business or investment property and not as their primary residence.

Prior to Rev. Proc. 2005-14 when taxpayers converted a property from a primary residence to a business or investment use, or vice versa, taxpayers had to choose between IRC §121 and IRC §1031 treatment if both were available to them upon a sale. For example, if a taxpayer used a property as a primary residence for three years and thereafter rented the property for two years the taxpayer will have satisfied the requirements of §121, which provides that a taxpayer must use the property as a primary residence in two out of the preceding five years; as well as satisfying §1031 by renting out the property for over a year. It is important to keep in mind that in order to qualify for a §1031 tax deferral the taxpayer must have the intent to hold the property for business or investment purposes and no specific holding period is defined as sufficient by the Internal Revenue Service. With this ruling taxpayers may now combine the benefits of these two code sections.

Where a taxpayer satisfies the requirements of both IRC §121 and IRC §1031 the taxpayer must apply §121 to the realized gain before applying §1031. The forgiveness of gain available through §121 "does not apply to the gain attributable to depreciation deductions for periods after May 6, 1997, claimed with respect to the business or investment portion of a residence." This amount, however, may be deferred through the use of §1031. In addition, for purposes of §1031 the amount of cash or non-like kind property (also known as boot) which would traditionally yield a taxable event, taxpayers are able to exclude the amount under §121 with respect to the relinquished business property. This allows taxpayers an even greater benefit when combining the two sections by minimizing the gains tax, which would normally be recognized during a §1031 exchange, if there was cash or non-like kind property.

Lastly, taxpayers who utilize the benefits of Rev. Proc. 2005-14 to get the combined treatments of §121 and §1031 also obtain a benefit when computing their basis. Normally a taxpayer would carry over its basis from the relinquished property into the replacement property when structuring the transaction as an IRC §1031 tax deferred exchange. By combining the benefits of §121 and §1031 the basis of the replacement property is increased by the amount of gain recognized by §121. Accordingly, the basis of the replacement property is higher due to the application of §121 which means that the taxpayer will recognize less of a gain if it chooses to sell, instead of exchange, the property in the future.

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Security 1031 Services, Inc. is a Qualified Intermediary for IRC 1031 Tax Deferred Exchanges and a member of the Federation of Exchange Accommodators. As a Qualified Intermediary Security 1031 Services, Inc. may not give tax or legal advice. Exchangers should review their transaction with a tax and/or legal advisor.

Todd R. Pajonas, Esq.
Security 1031 Services, Inc.

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