Question (CA): I have a question regarding a 1031 exchange. I have two small single family houses and want to sell both of them and exchange to one bigger and more expensive house. Is that applicable and legal? If so, how should I do this kind of exchange? How do the "45 day" and "180 day" rules apply here?
Answer: Provided that both properties are investment properties (no personal residences involved) you can exchange two "like-kind" properties for one property as either:
1. A "simultaneous exchange" in which the closing of the relinquished property and the replacement property occur on the same day, usually back-to-back. There is no interval of time between the two closings;
2. A "delayed exchange" is an exchange where the replacement property is closed on at a later date than the closing of the relinquished property. The exchange is not simultaneous or on the same day. This type of exchange is sometimes referred to as a "Starker Exchange" after the well known Supreme Court case that ruled in the taxpayer's favor for a delayed exchange before the Internal Revenue Code provided for such exchanges. There are strict time frames established by the Code and Regulations for completion of a delayed exchange, namely the 45-Day Clock and the 180-Day Clock (see detailed explanation below). Delayed exchanges are covered by the Safe Harbor Regulations;
3. A "reverse exchange" (Title-Holding Exchange) is an exchange in which the replacement property is purchased and closed on before the relinquished property is sold. Usually the Intermediary takes title to the replacement property and holds title until the taxpayer can find a buyer for his relinquished property and close on the sale under an Exchange Agreement with the Intermediary. Subsequent to the closing of the relinquished property (or simultaneous with this closing), the Intermediary conveys title to the replacement property to the taxpayer. The IRS has issued new safe-harbor guidance on Reverse Exchanges; or,
4. An "improvement exchange" (Title-Holding Exchange) is an exchange in which a taxpayer desires to acquire a property and arrange for construction of improvements on the property before it is received as replacement property. The improvements are usually a building on an unimproved lot, but also include enhancements made to an already improved property in order to create adequate value to close on the Exchange with no boot occurring.
The Code and Regulations do not permit a taxpayer to construct improvements on a property as part of a 1031 Exchange after he has taken title to property as replacement property in an exchange. Therefore, it is necessary for the Intermediary to close on, take title and hold title to the property until the improvements are constructed and then convey title to the improved property to the taxpayer as replacement property. Improvement Exchanges are done in the context of both Delayed Exchanges and Reverse Exchanges, depending on the circumstances. The IRS has issued new safe-harbor guidance on Reverse Exchanges (including title-holding exchanges for construction or improvement).
Delayed Exchanges -- The Exchange Process and Time Clocks
A taxpayer desiring to do a 1031 Exchange lists and/or markets his property for sale in the normal manner without regard to the contemplated 1031 Exchange. A buyer is found and a contract to sell the property is executed. Accommodation language is usually placed in the contract securing the cooperation of the buyer to the seller's intended 1031 Exchange, but such accommodation language is not mandatory.
When contingencies are satisfied and the contract is scheduled for a closing, the services of an Intermediary are arranged for. The taxpayer enters into an Exchange Agreement with the Intermediary which permits the Intermediary to become the "substitute seller" in accordance with the requirements of the Code and Regulations.
The Exchange Agreement usually provides for:
* An assignment of the seller's Contract to Buy and Sell Real Estate to the Intermediary.
* A closing where the Intermediary receives the proceeds due the seller at closing.
* Direct deeding is used. The Exchange Agreement will comply with the requirements of the Code and Regulations wherein the taxpayer can have no rights to the funds being held by the Intermediary until the exchange is completed or the Exchange Agreements terminates. The taxpayer "cannot touch" the funds.
* An interval of time where the seller proceeds to locate suitable replacement property and enter into a contract to purchase the property. The interval of time is subject to the 45-Day and 180-Day rules.
* An assignment of the contract to purchase replacement property to the Intermediary.
* A closing where the Intermediary uses the exchange funds in his possession and direct deeding to acquire the replacement property for the seller.
The 45-Day Rule for Identification. The first timing restriction for a delayed Section 1031 exchange is for the taxpayer to either close on replacement property or to identify the potential replacement property within 45 days from the date of transfer of the exchanged property. The 45-Day Rule is satisfied if replacement property is received before 45 days has expired. Otherwise, the identification must be by written document (the identification notice) signed by the taxpayer and hand-delivered, mailed, faxed, or otherwise sent to the Intermediary. The identification notice must contain an unambiguous description of the replacement property. This includes, in the case of real property, the legal description, street address or a distinguishable name.
After 45 days, limitations are imposed on the number of potential Replacement Properties which can be received as Replacement Properties. More than one potential replacement property can be identified under one of the following three conditions:
* The Three-Property Rule - Any three properties regardless of their market values.
* The 200 percent Rule - Any number of properties as long as the aggregate fair market value of the replacement properties does not exceed 200 percent of the aggregate FMV of all of the exchanged properties as of the initial transfer date.
* The 95 percent Rule - Any number of replacement properties if the fair market value of the properties actually received by the end of the exchange period is at least 95 percent of the aggregate FMV of all the potential replacement properties identified.
Although the Regulations only require written notification within 45 days, it is recommended practice for a solid contract to be in place by the end of the 45-day period. Otherwise, a taxpayer may find himself unable to close on any of the properties which are identified under the 45-day letter. After 45 days have expired, it is not possible to close on any property which was not identified in the 45-day letter. Failure to submit the 45-Day Letter causes the Exchange Agreement to terminate and the Intermediary will disburse all unused funds in his possession to the taxpayer.
The 180-Day Rule for Receipt of Replacement Property. The replacement property must be received and Exchange completed no later than the earlier of 180 days after the transfer of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the exchanged property was transferred. The replacement property received must be substantially the same as the property which was identified under the 45-day rule described above. There is no provision for extension of the 180 days for any circumstance or hardship (except for disaster areas recognized by the IRS).
As noted above, the 180-Day Rule is shortened to the due date of a tax return if the tax return is not put on extension. For instance, if an Exchange commences late in the tax year, the 180 days can be later than the April 15 filing date of the return. If the Exchange is not complete by the time for filing the return, the return must be put on extension. Failure to put the return on extension can cause the replacement period for the Exchange to end on the due date of the return. This can be a trap for the unwary.
In order to obtain further information, we recommend that you enter "1031+exchange+rules" (without the quotation marks) into your favorite search engine entry bar. There are a lot of firms that specialize in 1031 Exchanges and we recommend that if you qualify and decide to do one or more, that you get your feet wet with a reputable firm. One of the sites that should come up on your search engine is the National Association of Realtors® exchange information site.
Question (ID): As an independent loan officer I realize that I cannot pay a referral fee to a licensed real estate agent or to any other party to the loan transaction under RESPA. However, can I pay a private individual such as a friend or previous client, who refers a new client to me?
Answer: You are correct in that the Real Estate Settlement Procedures Act, also called "RESPA," makes illegal what the federal government refers to as kickbacks or referral fees paid to someone without that person providing services or other things of value. However, the exact wording of 12 USC 2607(a) and (b) and the explanations regarding it from the findlaw.com library, are important because RESPA clearly states that the referrals about which you are asking are illegal and subject to rather stiff penalties:
"We have recently received several questions regarding interpretation of Section 8 of the Real Estate Settlement Procedures Act ("RESPA"). In addition, the FDIC has issued a new Financial Institution Letter ("FIL"), "Practices Which May Result in Potential Violations of Section 8 of the Real Estate Settlement Procedures Act". FIL-103-99 (November 17, 1999). Given the continuing confusion in this area, we thought an examination of several different fact situations might be helpful.
Mortgage Broker Fees
The relevant prohibitions in Section 8 read as follows:
"(a) No person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person.
"(b) No person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed." 12 USC 2607(a) and (b).
Section 8 then goes on to state that the RESPA is not intended to prohibit the payment of fees to attorneys, title companies, or agents for service actually performed, the payment of a bona fide salary or compensation to a person for goods or products actually furnished or services actually performed in the making of a loan, and payments pursuant to cooperative brokerage and referral arrangements or agreements between real estate agents and brokers. Nor is RESPA intended to prohibit controlled business arrangements (common ownership existing between the lender and providers of settlement services) so long as certain disclosures are made and the borrower is not required to use the affiliated provider for settlement services. 12 USC 2607(c).
Penalties for violation of Section 8 of RESPA are rather stiff. Violations are punishable by a fine of not more than $10,000 or a prison term of up to one year, or both. In addition, violators are liable for damages in a civil suit up to three times the amount of any charge paid for the settlement service. 12 USC 2607(d)(1) and (2)."
The entire RESPA Statute can be accessed at HUD's site.
Question (NC): What is the housing market in Raleigh, North Carolina? We are planning to move to Raleigh from Georgia for the schools. However, we’ve heard a lot about 10-25% falling prices in Raleigh as compared to certain Realtor claims that housing prices keep going up. Would you please tell me what is your view? Thank you!
Answer: Despite what you may have "heard," we suggest you access Realty Times and consult the real estate agents who live and work in the Raleigh marketplace. Who would know better about the Raleigh market than those agents who do business every day in the Raleigh market? If you believe "certain Realtor claims" are not true, or if you misunderstood the claims, get the Realtor or Realtors who made them to submit statistical data to you.
You may also wish to access the "Realtor Review," a monthly publication of the Raleigh Regional Association of Realtors®. Through it, you can access the Triangle MLS covering home sales in the area.
Question (WI): For the reader who had a question about Wisconsin school districts, another reader provided this:
"For the reader who wanted to know where to find information to compare school districts, there are several "school ranking/comparison" sites on the Internet. He/she should try typing "school ranking comparison" or similar terms into whatever search engine he or she uses.
One site that I found particularly helpful when my family faced relocation was greatschools.com. Also, the reader can check psk12.com and schoolmatch.com."
Answer: To the anonymous reader who provided the above links we thank you. We would have sent you an email stating that except you sent your email to the RealtyTimes.com staff person who receives and then forwards such questions and/or comments to us. It would be a lot easier to simply access our website and submit your question or comment through the "Ask A Question" button.