President Declares Disaster in Vermont

President Declares Disaster in Vermont

We have a Client in Vermont who wished to conduct a hybrid Section 1031 Exchange, consisting of both a direct exchange of Relinquished Property for identified Replacement Property (Case #1) AND an Improve-to-Suit Exchange where one or more of the Replacement Properties are to be improved with exchange funds before delivery to the Client (Case #3).

The Client’s exchange began in early June, meaning the 45th day (ID deadline) would occur in mid-July and the 180th day (end of the Exchange Period) would arrive in late November.  The Client timely identified Replacement Properties in Vermont.

Enter Hurricane (later Tropical Storm) Irene, which hit the State over Sunday evening, August 28, 2011.  As of this writing, eight (of fourteen) Vermont counties have been declared a Presidential Disaster Area, including the county containing our Client’s Replacement Properties.  Roads in the area were washed out completely, and buildings and other properties were extensively damaged.

The origins of what happens now occurred on the occasion of September 11, 2001.  As you will remember, the country basically shut down for seven or more days, and all business came to a halt.  However, on September 11th and for the days thereafter, there were thousands of open Section 1031 Exchanges, and the IRS had absolutely no authority to extend any of the due dates; the affected taxpayers were essentially out of luck if they could not complete their exchanges on time.

What is not widely known is that upon the reconvening of Congress about 10 days after the terrorist attacks, its first order of business was to give the IRS retroactive authority to extend its time-sensitive due dates, including the 45 and 180 day deadlines in open Section 1031 Exchanges, for affected taxpayers.

The wording has been changed since then to determine who is affected, and now reads:

……….. taxpayers eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts are those taxpayers …. who live, and businesses whose principal place of business is located, in the covered disaster area. Taxpayers not in the covered disaster area, but whose records are necessary to meet a deadline …. are in the covered disaster area, (and) are also entitled to relief. In addition, all relief workers affiliated with a recognized government or philanthropic organization assisting in the relief activities in the covered disaster area and any individual visiting the covered disaster area who was killed or injured as a result of the disaster are entitled to relief.

….. The IRS also gives affected taxpayers ….. the relief … pertaining to like-kind exchanges of property…….

So how does all of this affect our Client?  Because the county in which the identified Replacement Properties are located is now part of a Presidentially Declared Disaster Area, any Section 1031 – related time deadline occurring after the date of the Declaration is automatically extended by 120 days.  In our Client’s case, this means that the Exchange will end as a statutory matter in late March, 2012, not late November, 2011.

During the exchange process and on various conversations with Clients we have been repeatedly asked if there is any way to extend those pesky 45 or 180 day deadlines, and our answer has always been “No, not unless you can dial up a Presidentially Declared Disaster in the area of your Replacement Property or where you or your records reside.”  Well, in this case, it actually happened………

Alaska, Idaho, South Dakota…..

We Have Another Pin in Our Map!

Many of the readers of this newsletter are past clients, clients who we have never met.  We hasten to point out that we welcome visits by clients and their advisors, but many of you, upon glancing at a map and noting the location of Littleton have said “Let’s do this by phone.”  Nevertheless, for those of you who have beaten a path to get here, one of the first things you will see before we discuss your particular situation is our map.

Our map is a school-sized wall map of the US, mounted on a bulletin board.  We have pins in this map which represent where we have done either side of a Section 1031 Exchange, one multi-colored pin per state except in the cases where we are called upon to own the legal title to one of the properties involved, such as in a Reverse or Build-to-Suit Exchange.

In that case, we use a white pin; so far, there are white pins in New Hampshire, Maine, Vermont, Massachusetts, Rhode Island, South Carolina, Florida, Texas and California.

But what about the multi-colored pins?  We had until the beginning of this summer 48 such pins, lacking only Alaska, South Dakota and Idaho.  This summer, we are proud to add a pin in Idaho with the assistance of Section 1031 Services of Bellvue WA., leaving only two states to go.

If you look at Idaho and neglect its size, it appears like a mirror image of New Hampshire.  Perhaps that’s appropriate……….

Will Section 1031 Be Around for the Long Run?

At first glance, one might be tempted to say that Section 1031 is an overly generous provision of the tax code whose time has passed.  But wait:  Section 1031 was first passed into law on March 8, 1921, in the waning days of the Wilson Administration, and has been reviewed and commented upon in nearly every subsequent Congress.

In fact, in 1923, just two years later, the statute was amended to prohibit securities and the like from being exchanged.  It seems that owners of shares that had made money were exchanging, deferring the taxes due, while owners of shares that had lost money were selling and deducting the loss.  Pretty sneaky.

But after 1923, when would you guess the next change came to Section 1031?  Not until 1971, when paragraph (e) was added to provide that:

“For purposes of this Section (1031), livestock of different sexes are not property of a like-kind”.

So, 48 years passed without a change of any kind.  And, 13 more years would pass before the above noted time periods of 45 and 180 days found their way into the law.

Since 1984, there have been several changes, which may be summarized as the Related Party Rules and the Foreign Property Rules, which were added in 1989.  Since then:  nothing except something in 2008 pertaining to ditches on farmland, a very obscure provision.  So, what is the outlook going forward?

Although Section 1031 originated in 1921 as an administrative convenience to the government in attempting to collect tax on barter or swap transactions, it has remained in the Code for 90 more years for one very simple and powerful reason:  JOBS.  Section 1031 is widely and routinely used by business in plant expansions, relocations and restructuring transactions.

With the highest rate of corporate tax in the world (Japan was higher, and is/has taken steps to lower its rate), there is simply no reason for a company to sell its assets and pay tax, only to later replace the same assets elsewhere in the US.  Fleets of automobiles come to mind, and many other examples.

Another powerful reason is that IRS can use Section 1031 to trump a taxpayer’s claim of a tax loss.  Since Section 1031 is a mandatory (and not an elective) provision of the Code, a taxpayer with a loss has to take careful steps to sell an asset, banking the funds, etc., else the IRS on audit might construe the matter to be a Section 1031 Exchange; since no gain or loss is recognized on an exchange, the taxpayer’s move to claim such would be frustrated.

These and other powerful reasons dictate that Section 1031 will be with us for a long time to come.

Edmund & Wheeler Facilitates Exchange of the 1697 “Molitor Strad”

From 1695 to 1725 Antonio
Stradivari hand crafted his finest instruments. He built some 1,100 instruments during this time (not all were violins)  some estimates indicate that there are still over 600 of these instruments still in existence.

Recently, the Molitor Strad (once reportedly owned by Napoleon) was sold at auction by Tarisio for a record breaking $3.6M.

The instrument was purchased by the famous concert violinist  Anne Akiko Meyers. The seller of the incredible instrument utilized the services of Edmund & Wheeler, Inc. to facilitate a Section 1031 exchange.  We were honored for our role  in this transaction, and have become huge Anne Akiko Meyers fans in the process.

Section 1031 of the tax code is not just for real estate. To learn more about personal property exchanges, call or click.  In the meantime,  enjoy Anne playing her new violin. We can’t wait for her next album with her new Strad!

NH DRA Gives Refunds – TIR 2010-009

By John D. Hamrick

Please TIR 2010-009 outlining the ability for a taxpayer who got snared in the New Hampshire DRA audit of Section 1031 exchanges to get there money refunded!  How sweet it is!

George Foss to the Rescue

By John D. Hamrick

A few weeks ago Governor Lynch signed into Law SB483, which in a nutshell reversed an aggressive move by the NH Department of Revenue Administration (DRA) to tax Section 1031 exchanges with an 8.5% Business Profits Tax differently than the other 49 states. During the past 18 months, over $5M of tax bills were sent to those investors and property owners that used Section 1031 of the US tax code to defer capital gains and invest in new properties, and desired (or where required) to change the entity when they exchanged into these properties.

The passing of SB483 not only reversed this unfair taxation by the DRA, but was also retroactive to 2003 and provided for refunds for those taxpayers that had already responded to their tax bills with payment!

Now that the dust has settled, I wanted to take a minute to pass along some of the “behind the scenes” activity that I’ve witnessed in our office related to the passing of this bill.

Many of you know that George is considered the Section 1031 authority in New England, and has been recognized nationwide as the “Guru” of 1031. I met George 13 years ago when he had already been doing exchanges for 17 years! The first thing that you will note when you meet or talk to George is that rarely do you find a professional that has such passion regarding the area of expertise they have chosen.

Granted, it is difficult to imagine the topic of Section 1031 of the US Tax Code could be exciting; however, when George talks about the subject he does so with an infectious amount of excitement and enthusiasm. Over the years (although it is difficult to measure) he has done thousands of exchanges, and has helped clients defer over $100 Million in capital gains taxes. In fact, many of his clients have exchanged over and over and used tax deferred money to build the nest egg in which they will use for retirement.

When the first client called with the news that New Hampshire was seeking over $500,000 in back taxes from an exchange that was done in 2005, George was on the case! He spent countless hours on the phone, meeting with clients, meeting with real estate professionals and meeting with the Governor himself on this topic. He amassed a database of interested parties and kept them informed on the progress and pooled resources from many organizations to assist in getting this bill through the process, and ultimately signed.

Most impressive is that George spearheaded this effort not for the monetary gain (he has not received any compensation whatsoever for his efforts), not for the notoriety, but simply because it was the right thing to do.

All said and done, the investors in the State of New Hampshire and those considering investments here can now breathe a sigh of relief in knowing that they can use Section 1031 to its maximum potential at the state level.

It has been my pleasure to watch George in action during this time.

Splitting Heirs

The transfer of wealth from one generation to another will hit its peak in just a few years and understanding the tax impact on the heirs is an important consideration.  Traditionally, financial planners have focused most of their efforts on helping clients accumulate wealth, now is the time to plan for the transfer of that accumulation.

It has been reported that more than half of the nation’s personal wealth is held in non-financial assets, such as houses, land, farms and personally owned businesses. Based on past experience, the value of this wealth will grow over the next half century, and at the same time most of it will change hands. The majority of this huge transfer of wealth will go to spouses, children and charitable causes. A significant portion also will go to state and local estate taxes unless a plan is developed to prevent it.

Section 1031 is the perfect strategy to assist clients in moving their active real estate investments into passive investments, without paying capital gains tax.  Tenancy-in-Common (TIC) and Umbrella Partnership Investment Trusts (UP-REIT) properties provide an excellent transfer investment vehicle.  Heirs will gain tax advantage through a stepped-up basis upon the death of the owner and they will not inherit deferred taxes or a management nightmare in the process.   A sale of the property is not necessary; cash flow is easily divisible to the heirs if they elect to hold their newly inherited investments.  Cash flow from passive investments takes little time and attention and there is less arguing between the inheriting parties.

Cashing out of wholly owned real estate requires an agreement of the parties as to broker selection and price.  The sale of passive investments such as TIC’s or REIT shares is simplified; TIC’s are not generally sold until the entire project is sold or refinanced.  A growing majority of REIT shares can be traded openly on the market in a variety of increments thereby negating the need to fully liquidate the investment.  In either case, the sale of investment real estate by the heirs will be at a stepped-up basis so the assets can be passed without the deferred taxes.

Governer Lynch Signs SB 483!

I am delighted to report that Governor John Lynch signed our bill last evening.   The bill, which passed the NH Senate unanimously and which passed the NH House by a vote of 203 – 105, provides that taxpayers may use single-member limited liability companies to hold title to the Replacement Properties they may take to complete a Section 1031 Exchange.  The bill is effective immediately, and applies to transactions taking place on and after January 1, 2004; it quashes any pending assessment cases between taxpayers and the New Hampshire Department of Revenue over this issue.

Here is the text of the final bill:  http://www.gencourt.state.nh.us/legislation/2010/SB0483.html

Without the dedicated and tireless assistance of the New Hampshire Association of Realtors, passage of this legislation would not have been possible.

Sincerely,

George E. Foss III, President
Edmund & Wheeler, Inc.
567 Cottage Street
Littleton, NH 03561
603-444-0020
www.section1031.com
george@section1031.com

Risk & Reward – Stock Vs. Real Estate

In a perfect world your investment portfolio would contain a combination of Real Estate, Stocks, Bonds, Mutual Funds and Cash providing both long-term and short-term instruments. Diversification of your assets is key to riding out the peaks and valleys of investment performance. In today’s changing economic environment, understanding your exposure to risk will ultimately define your expectations of reward. For many of us, the largest investment in our hands consists of our primary residence and (hopefully) a market invested retirement account. More and more retirement accounts consist of real property in an effort by savvy investors to diversify and protect against market volatility. Real estate has the advantage of being tangible and easily understandable; you can see it, touch it and modify it to your own specifications. All investments go through cycles and what is hot today may be ice cold tomorrow, just like the weather in New England.

Numerous studies exist comparing stocks to real estate and the winner on a percentage basis, in the long term, is always stock. However, there are distinct disadvantages and performance is not the only measure to be considered.

Real estate beats out stock on leverage. Since real estate is easily mortgaged, the return on the money invested out of your pocket is higher than if you had not used any leverage. Traditionally, the rate of borrowing on real estate is also lower and longer-term than stock secured borrowing. Let’s not forget that mortgage interest is deductable regardless of whether it is your personal residence or your investment property.

Real estate produces annual tax deductions. Annual depreciation for commercial/investment property, property taxes, and operating expenses are all deductible against the rental property income. This has the effect of lowering your taxable exposure during each and every year of ownership. What if your real estate is actually your personal residence? You have the added benefit of a roof over your head and market appreciation over time. The bonus for personal residences is a $250,000 exclusion from capital gains tax per taxpayer upon the sale of the property and the exclusion can be used every two years as long as the property has been your primary residence for two of the last five years. Sale of stock will be taxed without exclusion at 15%. Dividends are taxed at ordinary income tax rates. Try sleeping under that pile of papers!

Real estate is less volatile than stock. The wild swings of the market based on irrational responses to third party meddling do not affect real property. Location, location, location beats out stock every day, if you have the intestinal fortitude to suffer through toilets, trash and tenants, a reward awaits you; slow and steady wins the race!

What’s In a Name?

If you are conducting a Section 1031 Exchange, “what’s in a name” can be the difference between a successful exchange and one that will fail on its face.  This provision, called the Identity of Taxpayer Rule,  requires that the same person or entity that sold the old or Relinquished Property be the same one that acquires the new or Replacement Property.

On the surface, this seems pretty easy to comply with, however, what if the Relinquished Property is titled to a husband and wife and they desire to acquire the new property in their revocable trust or a single member limited liability company.  Since the IRS is tracking the taxpayer identification number in each real estate transaction, it will be clear that the two numbers do not match and therefore the ownership interest has changed from the old property to the new property and the exchange will fail on its face.

There’s a couple of ways to remedy this situation and preserve the tax deferral that is provided under Section 1031.  The logical approach is to simply acquire the Replacement Property in the exact same format of the Relinquished Property; husband and wife sell, husband and wife buy.  If they want to acquire the new property in their revocable trust or LLC, then prior to sale, the title must be changed to record the property in that manner.  This can layer on the protection needed but it will also add recording and legal expenses.

A second option is to acquire the new property in equal interests in new trusts or LLC’s; one for the husband and one for the wife. In this manner, the taxpayer identification numbers are preserved and will match for exchange purposes.  After a two year period of seasoning, the interests could be merged without affecting the Section 1031 protections.

In the current financing environment, many lenders have no interest in lending to trusts or to  limited liability companies.  If the Replacement Property will require financing, understanding the lender requirements before sale is essential to properly titling the Relinquished Property; so that the lender will be interested in providing the new financing necessary on the Replacement Property.  It may be necessary to preserve the ownership in the name of husband and wife for financing reasons and for tax deferral.

Don’t let the fact that the IRS accepts “disregarded entities” lull you into thinking that the bank will accept them or that your state will either!  New Hampshire has recently asserted that any change in name (except property going into a revocable trust) will trigger state capital gains tax.  This issue will likely be litigated, but in the meantime, be careful.