Monday, January 31, 2011

1031 Tax Deferred Exchanges

WHAT IS A 1031 TAX DEFERRED EXCHANGE?

Section 1031 of the Internal Revenue Code offers the real estate investor a remarkable opportunity to sell one parcel of real estate and use the entire proceeds to acquire replacement real estate, without paying taxes on any gain from the sale.  By careful planning and strict adherence to the safe-harbor provisions of the IRS regulations, investors can protect the full value of their appreciation and equity, expand their holdings of investment property and defer payment of tax on capital gains indefinitely.

Section 1031 of the Internal Revenue Code states:  "No gain or loss shall be recognized on the exchange of property held...for investment, if such property is exchanged solely for property of like-kind which is held...for investment."

Safe-Harbor Requirements of Section 1031:

1.  Replacement property must be properly identified within 45 days of closing on relinquished property.
2.  Replacement property must be acquired within 180 days of closing on relinquished property.
3.  Aggregate replacement property must be equal to, or greater in value than, the relinquished property.
4.  Debt on the replacement property must be equal to, or greater than, debt on the relinquished property.

WHAT DO I NEED TO KNOW ABOUT 1031 TAX DEFERRED EXCHANGES?

What kind of property qualifies for a 1031 exchange?  Any type of investment real estate may be exchanged for any other type of real estate, provided the replacement real estate is likewise held for investment, and not immediately used by the investor as a personal residence.

Can I complete a tax deferred exchange by myself somehow segregating the proceeds from the sale of my relinquished property and then using those funds to acquire a replacement property?  No, actual or constructive receipt by the investor of all or any portion of the proceeds of sale of relinquished property will defeat the tax deferred exchange and require the investor to pay tax on any gain realized.

How can I avoid constructive receipt of the proceeds of sale of the relinquished property so that i can complete a tax deferred exchange?  Through the use of a qualified intermediary, such as KENTUCKY TITLE EXCHANGE, an accommodation party who is not a disqualified person or entity pursuant to IRS regulations, the investor can avoid being deemed to be in actual or constructive receipt of the sale proceeds pending acquisition of the replacement property.

Can I exchange more than one replacement property?  Yes, and in many tax deferred exchange transactions, the investor will leverage the exchange proceeds to acquire more or higher quality properties than what the investor started with.

Can I acquire a vacation or second home in a tax deferred exchange?  No, both the relinquished and replacement properties must be property "held for investment."  Property that is the residence of the investor will not qualify under the IRS regulations.  Nevertheless, a residential property acquired in a vacation area may qualify as long as that property is not used for a period of time after the acquisition as the residence of the investor, but held for investment, such as rental.

How do I identify replacement property in a tax deferred exchange?  Replacement property must be identified in writing to KENTUCKY TITLE EXCHANGE, within the appropriate time period.  The investor may identify up to 3 properties, regardless of value, OR any number of properties, so long as their total value does not exceed 200% of the value of the relinquished property, OR any number of properties of any value, so long as the investor acquires at least 95% of the identified properties in the exchange.

Can I change my mind and not complete the exchange?  Yes, an investor can change his or her mind at any time prior to the completion of the exchange and the sale of the relinquished property will become a taxable transaction.  Any exchange proceeds held by KENTUCKY TITLE EXCHANGE, will be returned to the investor, subject only to compliance with restrictions in the IRS regulations concerning timing for the return of funds not used to acquire replacement property.

How much does a 1031 tax deferred exchange cost?  The costs to set up a tax deferred exchange are minimal.  KENTUCKY TITLE EXCHANGE charges fixed rate fees that are competitive with the lowest fees charged by qualified intermediaries across the country.


If you are interested in a 1031 tax deferred exchange and have any more questions you may contact KENTUCKY TITLE EXCHANGE at (502) 895-9900 or by e-mail at tarac@pittandfrank.com.

Monday, January 24, 2011

Questions and Answers about Title Insurance

1.  What is Title Insurance?

Title insurance is insurance against loss from defects in title to real property and from the invalidity or enforceability of mortgage liens.  Before you purchased your home it may have gone through several ownership changes, and the land on which it stands may have went through many more.  There may be a weak link at any point in the chain that could emerge to cause problems.  For example, someone along the way may have forged a signature in transferring title or there may be unpaid real estate taxes or other liens.  Title insurance covers the insured party for any claims and legal fees that arise from such problems. 

2.  Do I have to Purchase Title Insurance?

If you need a mortgage to acquire a property then the answer is yes.  All mortgage lenders require protection for an amount equal to the loan amount.  It lasts until the loan is repaid.  When acquiring a loan, title insurance is required to protect the lender, but you, the consumer, pay the premium.  The premium is a single payment made upfront at the time of the closing. 

3.  Does Title Insurance Do Anything for Me? 

The required insurance protects the lender up to the amount of the mortgage, but it doesn't protect your equity in the property.  For that, you need an owner's policy for the full value of the home.  In most cases in Kentucky, the buyer will typically purchase the owner's policy simultaneously to purchasing the lender's pPlicy at closing, but it can be purchased at any time.  In Southern Indiana, the seller will typically contribute toward the cost of the premium the buyer must pay for the purchase of the owner's policy.  In any event it is a good idea to purchase both policies simultaneously, because there is a discounted premium when doing so.

4.  Doesn't the Lender's Policy Indirectly protect me?

No, title policies are indemnity policies.  That means they protect against loss.  The lender's policy would, therefore, only cover a loss on the lender's part. 

5.  For How long is the Property Owners Purchasing Title Insurance Covered?

Indefinitely.  The owner's protection lasts as long as the owner or any heirs have an interest in or any obligation with regard to the property.  When they sell, the lender will require the purchaser to obtain a new policy.  That policy protects the lender against any liens or other claims against the property that may have arisen since the date of the previous policy. 

6.  Will Title Insurance Prtoect Me Against False Claims That May Arise After I Purchase the Property?

The standard policy does not.  To compensate for this deficiency a new policy with with expanded has been developed.  This is commonly known as the ALTA Homeowners policy or Enhanced Owner's policy.

7.  Does Title Insurance Rise with Increases in the Value of My Property?

No, but coverage under the ALTA policy referred to in Question 6 increases by 10% a year for the first 5 years after issuance to 150% of the initial amount.  You can buy additional coverage as rider to the policy.

8.  Why Do I Need to Purchase a New Policy When I Refinance?

You don't need a new owner's policy, although it is recommended for added protection for the homeowner.  However, you will be required to purchase a new lender's policy.  Even if you refinance with the same lender, the existing lender's policy terminates when you pay off the mortgage.  Also, the lender may be concerned with any title issues that may have arisen since you purchased the property.  In some cases, if you have previoulsy refinanced or puchased your home within 5 years you may be eligible for a discounted policy.  This is known as a re-issue.  Ask your title company or lender if you qualify.

Wednesday, January 19, 2011

The 2013 3.8% Tax

Starting January 1, 2013, a 3.8% tax on some investment income will take effect.  This tax will affect some, but not all, real estate transactions.  When the tax goes into effect two years from now, it MAY impose a 3.8% tax on some interest income, dividends, rental income (less expenses) and capital gains (less capital losses).  The tax will apply only to those individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with an AGI of more than $250,000.  The new tax would apply to the lesser of the investment income amount or the excess of AGI over the $200,000 or $250,000 amount.

The National Association of Realtors provides the following examples of the how tax will work in certain common situations:

Example 1:  Capital Gain Sale of a Principal Residence

John and Mary sold their principal residence and realized a gain of $525,000.00.  They have an AGI of $325,000.00 (before adding taxable gain).

The tax applies as follows:

AGI before taxable gain:                       $325,000

Gain on sale of residence:                    $525,000
Taxable Gain (added to AGI):               $25,000 ($525,000-$500,000)
New AGI:                                            $350,000 ($325,000+$25,000)

Excess of AGI over $250,000:              $100,000 ($350,000-$250,000)
Lesser Amount (table):                         $25,000.00

Tax Due:                                              $950.00 ($25,000x0.038)

* If John and Mary had a gain of less than $500,000 on the sale of their residence, none of that gain would be subject to the 3.8% tax.  Whether they paid the 3.8% tax would depend on other components of their AGI.

Example 2:  Income Sources Including Real Estate Investment Income

Hank has a "day job" from which he earns $85,000 a year.  He owns several small apartment units and receives gross rents of $130,000.  He also has expenses related to that income.

The tax applies as follows:

AGI Before Rents:                              $85,000

Gross Rents:                                       $130,000
Expenses (appreciation; debt service):  $110,000
Net Rents:                                           $20,000
New AGI:                                            $105,000 ($85,000+net rents)

Excess of AGI over $200,000:             $0
Lesser Amount (table):                        $0

Tax Due:                                             $0

* Even if Hank's combined gross rents and day job earnings exceed $200,000, he would not be subject to the 3.8% tax because his investment income includes net, not gross, rents.

Thursday, January 13, 2011

Back from the Abyss

I haven't posted much on this blog recently due to a glut of closings.  Rates have been very low for the past few months and because of this I've been extremely busy doing refinance closings.  I did post links to two articles on Facebook today, but also thought it'd be a good idea to post these articles over here as well.

Also, I promise that I'll try and update the blog a bit more regularly this year...:-)

Happy Reading!!!!!

Washington Post article on Bank Owend/REO Properties

WSJ article regarding the positive outlook for the coming year.