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Who Owns My Investment Property?

06/21/22

At the beginning of a real estate transaction the seller is asked, “Who owns the property?” you may think the ...

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<h2>How is your property titled?</h2>

When considering selling your investment property it is required that you know how your property is owned/titled, or said differently, the tax identity. Prior to even listing your investment condo, single family rental home, vacant land, or even your farm, your Realtor(R) will need to know “who truly owns this property”? A 1031 like-kind exchange only works when the owner of the property being exchanged for replacement property is the <a href="/blog/same-taxpayer-requirement-1031-tax-deferred-exchange" title="Same Taxpayer Requirement in 1031 Exchange">same as the owner </a>for the relinquished property.

<h2>How is your property owned for tax purposes?</h2>

Often, owners of investment property assume that the rental home, land, or building is in their name as individuals. Or perhaps along with their spouse. If the property was inherited years ago from a distant family member, are you sure you know how the property is now being held? Was it part of a Marital or Family Trust? Or perhaps your relative left you 50% ownership in a Tenants in Common structure. Was the property transferred to a new LLC structure with a completely different name than your surname?

In addition, some types of ownership are disregarded for tax purposes. For instance, one of the relinquished and replacement properties might be titled differently, but may still be the same for tax purposes. Examples include the taxpayer individually, the taxpayer owning through his/her living trust, the taxpayer holding in a single member LLC, a married couple living in a community property state holding a two member LLC, and the beneficiary of a land trust. All of these are interchangeable and for tax purposes do constitute the same taxpayer. More on this follows below.

<h2>What is the best way to check how your property is held?</h2>

Most of the time, it is relatively easy and typically free, to find out how your property is titled. The first way to do so, is to check with your local Tax Assessor's or Recorder of Deeds official website and search the property address. The tax records may show who or what tax entity is responsible for paying the taxes on the property. Information from the Recorder of Deeds might show the most recent “deed of record”. Another option might be a title search done on the property from a local title company. These searches are very inexpensive and working with a title company is well worth the investment to ensure your property is accurately described prior to listing with a broker and prior to engaging in a 1031 exchange.

<h2>Most Common Ways to Hold Title</h2>

In addition to who might hold title there are numerous ways to hold title of property, but a few of the most common ways in which to hold title, with specific consideration to a 1031 exchange include the following:

<h3>Fee Title</h3>

When the taxpayer holds the title under their name, or a combination of names, such as their name in addition to their spouse’s name, the property is considered held in Fee Title (sometimes called fee simple). For example, the investment property might be titled under John Doe and Jane Doe. Fee simple is the most common form of ownership and the fullest way property can be held. Some lesser holdings for example might be a tenant under a long term lease, the holder of a property easement, a life estate, etc.

<h3>Limited Liability Company (LLC)</h3>

A property could also be titled under an LLC, which could be a single member or multi-member LLC. LLCs are very common for real estate investments because they limit the member's liability to the value of the asset(s) owned by the LLC and not beyond. A single member LLC is taxed to the individual, whereas a multi-member LLC requires an EIN as a partnership, and it reported on an IRS Form 1065 with K-1s being sent to the members to report on their personal return. In a 1031 exchange, a single member LLC can acquire real estate via an assignment of membership interest.

<h3>Revocable “Living” Trust and Land Trusts</h3>

Also known as a Living Trust, Grantor Trust, or Self Declaration of Trust, a Revocable Trust is a common way to hold title in which an individual transfers their asset(s) into a Trust to control it while living, and upon death the asset(s) goes to the individual(s) named in the Trust. The owner of the Trust can revoke or change it at any time while living, hence the name “Revocable Trust”. A Land Trust is also common, and is simply a Living Trust with the only asset being real estate and the Trustee often is a corporate land trust company. A Land Trust uses a simple form provided by the land trust company and provides a simple way to control and pass ownership of real estate. Land Trusts are particularly common in states such as Illinois, Florida, Indiana and Hawaii as well as some others.

<h3>Subchapter S-Corp</h3>

Another common way in which real estate property is held is a Subchapter S-Corp, which provides liability protection for the investor and is reported on the taxpayer’s own tax return. It is very difficult to change to individual ownership and therefore it is not recommended when a 1031 exchange is a consideration.

<h2>Less Common Ways to hold Title</h2>

<h3>Other Trusts</h3>

Less common than the Revocable or Living Trust, is the Irrevocable Trust, which as its name implies, means that it cannot be changed once it is in place. Irrevocable Trusts are sometimes used to protect assets and for tax purposes.

Some other types of Trusts that can hold title include: Testamentary Trust, which arises under an individual’s will, and rather than giving the person who inherits the asset and outright ownership, this trust is established to hold the person’s interest; The Living Trust may contain terms that provide upon death of the person, two types of Trusts “spring” into being. The first of these is the Martial Trust, commonly used in estate planning to set up a trust upon death under the Living Trust for the surviving spouse; The other Trust that comes into being upon the death of the person owning the Living Trust is known as a Family Trust, where the assets are funded into the trust and split with the Marital Trust according to a formula. Typically, the Marital Trust receives the maximum amount that would not be subject to tax and the balance goes into the Family Trust. These kinds of Trusts also effectively double the amount that a couple could pass onto the heirs without taxation.

<h3>Types of Tenancies</h3>

<h4>Tenants by the Entirety</h4>

Another form of ownership for married couples is Tenants by the Entirety, which is limited to spouses and in most states is limited to the residence of the spouses. Just like with Joint Tenants it provides “rights of survivorship” to the owners. It can only be broken by death, divorce, or a mutual agreement. The primary difference between this holding versus joint tenancy is that the property is exempt from being attached by judgement creditors of either spouse. An example would be a doctor who has the potential for malpractice claims.

<h4>Tenants in Common (TIC or Tenancy in Common)</h4>

Real estate can also be held as Tenants in Common by which each owner owns a fractional interest in the whole asset and upon death the interest is passed through the owner’s estate. Additionally, each owner may transfer his or her interest in the asset without regard to the plans of the others. This is useful when two or more investors own a property together, and not all wish to participate in an exchange or do not wish to all acquire the same replacement property.

<h4>Joint Tenants (Joint Tenancy)</h4>

Joint Tenants own an undivided interest in the whole property and each owner is given “rights of survivorship”. This type of ownership is common amongst spouses and other familial relations.

<h3>Type of Ownership Granted By Deeds</h3>

There are a handful of ways in which you can title real estate ownership through deeds, such as:

<ul>
<li>Warranty Deed: The seller warrants to the buyer that he/she is passing good title for all past purposes. In the event there turns out to be matters adversely effecting title, the recipient of the Warranty Deed can go back to the seller since the deed “warranted” that title was clear, but in this modern era going back to the seller is very uncommon as title insurance provides easier and better protection.</li>
<li>Special Warranty Deed: The seller warrants to the buyer that he/she is passing title free of defects during the seller’s period of ownership only and not before.</li>
<li>Quit Claim Deed: The seller is making no representation as to the status of the title, rather the seller is saying “Whatever I have I am giving to you as-is.”</li>
</ul>

<h3>Series LLCs</h3>

Series LLCs allow for sub-LLCs to be held under a parent LLC. This is a less expensive method than opening separate LLCs for each separate property, but still provides protection to the taxpayer who owns multiple properties and wishes to separate them for liability reasons. Series LLCs are state specific; not all 50 states have them.

<h3>C-Corporation</h3>

A C-Corporation is a conventional corporation with its own tax reporting, it is not typically used for real estate investors.

<h2>Why is Ownership so important for a 1031 like-kind exchange?</h2>

Timing is everything. When inventory is tight, buyers and sellers both want to move fast. Under a 1031, the Qualified Intermediary will require exchange agreements and assignments to be executed BEFORE closing. Having all documentation correctly identifying who owns the property will ensure a closing can occur not only on time, but also without last minute changes to the agreement, assignments, checks, etc. Updating seller information last minute will postpone closing, increase fees, and at times, cause the buyers to back out if dates are not adhered to.

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Who Owns My Investment Property?

06/21/22

At the beginning of a real estate transaction the seller is asked, “Who owns the property?” you may think the ...

Accruit Website Design Refresh

06/07/22

We are excited to introduce a new look and flow to our website. The changes just weren’t for appearance’...

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<h2>Home Page Design</h2>

Accruit strives to stay on the cutting edge of the 1031 Exchange industry, our website is no exception. We simplified the overall design of our home page achieving a more modern, bolder look. We push ourselves to be the Qualified Intermediary (QI) revolutionizing the 1031 exchange industry and as such, we made these website modifications to remove distractions and help our clients get to their destination in as few as clicks as possible.

<h2>Main Navigation Menu</h2>

In addition to the website design changes, we consolidated our main navigation menu. By condensing two categories into one, new category, Our QI Services, are now front and center.

Through our research we found that our clients are mainly looking for information on the basics of a 1031 exchange, education on specific 1031 exchange situations, and Accruit’s service offerings as a Qualified Intermediary. With our updated main navigation menu we made all three of these popular topics more accessible.

We look forward to watching you all interact with our revamped website, and we hope you find all the 1031 exchange information you are looking for in as few as clicks as possible.

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Accruit Website Design Refresh

06/07/22

We are excited to introduce a new look and flow to our website. The changes just weren’t for appearance’...

1031 Tax-Deferred Exchanges as an Important Estate Planning Tool

06/06/22

When estate planning, it is important to consider whether or not real estate assets are eligible for a 1031 exchange.

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There are many factors which motivate taxpayers to complete 1031 exchanges when selling real estate.  Such considerations can include:

<ul>
<li>Consolidate many properties into fewer properties</li>
<li>Diversify fewer properties into more</li>
<li>Trade appreciated low cash flow property for high cash flow property</li>
<li>Maximize ability to borrow against properties using bank funds rather than owner’s</li>
<li>Trade for higher basis property to take advantage of depreciation deduction</li>
<li>Acquire property closer to owner in the event of relocation</li>
</ul>

Another very important, but often overlooked, reason to consider a 1031 exchange is to take advantage of a stepped-up basis for heirs upon the death of the property owner.  According to Investopedia a stepped-up basis is defined as:

<blockquote>
“Step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance, determined to be the higher market value of the asset at the time of inheritance.  When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it. The asset receives a step-up in basis so that the beneficiary's capital gains tax is minimized."
</blockquote>

In other words, the heirs receive a new basis in the property based upon its market value at the time of death and the built in gain attributable to the taxpayer essentially disappears.

When someone sells real estate there are a variety of tax components which are generally payable.  These can consist of capital gains, recapture of depreciation taken over the years, applicable state capital gains taxes and, depending on the tax bracket, an additional Net Investment Income tax.  Depending upon the state in which the taxpayer resides, the total taxes can be 30% or more.  As an example, if a taxpayer were to make a profit on the sale of $500,000, the sum of $150,000 would be payable in taxes.  The net amount of $350,000 would be available for reinvestment in real estate or some other investment.  Let’s also assume the new investment paid an annual return of 5%.  The taxpayer could expect an annual cash return on that amount of $17,500.  Upon the eventual death of the taxpayer, the net amount of $350,000 would be passed on to the heirs. However, a successful 1031 exchange can allow the total tax, $150,000 in the example above, to be deferred (although a few states require the state tax to be paid).

Let's dig into this further. Suppose in the example above a couple purchased the property, an apartment building, when they were middle-aged.  The couple maintained the property - the roof, the boiler, appliances, etc., kept it clean, cared for the landscaping, found new tenants, and more.  Said couple lives in International Falls, Minnesota and are tired of the “Three Ts,” toilets, tenants and trash, not to mention the cold. They decide to retire to Florida.  One option might be to sell the property, pay the taxes, invest the net and receive the annual income of $17,500.  Upon the death of the survivor, the heirs would receive the $350,000.

Alternatively, the couple could sell the property as a part of a 1031 exchange and reinvest the full proceeds of $500,000 into a passive real estate investment with an annual yield of 5% or more.  There are numerous such investments available all across the country.  Annual income would be in the amount of $25,000, plus the couple would participate in the appreciation of the property. And should the survivor of them still possess this property (or subsequent trade property) when he or she dies, the heirs would take a stepped-up basis based upon the property’s fair market value at of the date of death and would not be responsible for the deferred taxes.  Accordingly, those heirs would receive $500,000 rather than the non-exchange result of $350,000.

It is often said that the only sure things in life are death and taxes.  We can’t do much about death, but with a “swap ‘til you drop,” you may very well be able to defer taxes indefinitely.

Updated 6/06/2022.

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1031 Tax-Deferred Exchanges as an Important Estate Planning Tool

06/06/22

When estate planning, it is important to consider whether or not real estate assets are eligible for a 1031 exchange.

Infographic: Requirements for Identification of Replacement Property in a 1031 Exchange

05/31/22

The ability to defer taxes through a 1031 like-kind exchange is a valuable taxpayer benefit, but to receive this benefit, the ...

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The ability to defer taxes through a 1031 like-kind exchange is a valuable taxpayer benefit, but to receive this benefit, the rules pertaining to identification and acquisition of replacement property <a href="/blog/what-are-rules-identification-and-receipt-replacement-property-irc-%C2%A71031-tax-deferred-exchange" target="_blank">must be strictly adhered to or the exchange will fail.</a>

This infographic describes the deadlines and rules for identification of 1031 replacement property:

·       The 45-day and 180-day deadlines

·       The 3-property rule

·       The 200% rule

·       The 95% rule

<a aria-label="Requirements for Identification" href="/sites/default/files/2022-05/FINAL-featured-image-Requirements%20for%20Identification%20of%20Replacement%20Property%20in%20a%201031%20Exchange.png" title="Requirements for Identification">View the full infographic</a> or click the image below.

Updated 5/31/2022.

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Infographic: Requirements for Identification of Replacement Property in a 1031 Exchange

05/31/22

The ability to defer taxes through a 1031 like-kind exchange is a valuable taxpayer benefit, but to receive this benefit, the ...

How to Calculate Your Potential Tax Benefits with a 1031 Exchange

05/26/22

Many people know that a 1031 Exchange can allow for tax deferral of Federal and State Capital Gains Tax, Depreciation Recapture ...

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If you are selling an investment or business use property, you should consider a 1031 exchange. Generally speaking, a 1031 exchange allows you to defer capital gains tax at the federal and state level, depreciation recapture tax, and net investment income tax when you sell an investment or business use real estate and reinvest those proceeds into another business or investment use property. If that isn’t compelling enough, wait until you see your potential benefits by calculating your various tax totals and deferral potential.

<h2>How to Calculate Capital Gains Tax</h2>

Many people ask, how is Capital Gains Calculated, the Capital Gains Tax Calculation is as follows: Sales Price - the TOTAL of Original purchase price (cost basis) + improvements to the property + selling expenses = Total Capital Gains

Federal Capital Gains Tax = Total Capital Gains multiplied either 15% or 20% depending on your annual household Income. Currently for persons married filing jointly the 20% rate would begin on income of $517,001. Remember the sale of the property itself is considered part of the income.

State Capital Gains Tax = Total Capital Gains multiplied by your State Capital Gain Tax Rate which varies by state. <a aria-label="State Capital Gains Tax Rate Chart" href="https://www.realized1031.com/capital-gains-tax-rate" title="State Capital Gains Tax Rate Chart">Look up your State’s Capital Gains Tax Rate</a>.

By adding the total of your Federal Capital Gains and State Capital Gains Tax you get your total Capital Gain Tax that would be owed if you did not complete a 1031 Exchange.

While it is important to understand the figures and calculations that determine your potential Capital Gains Tax, we made it easy for you to calculate using our <a aria-label="Capital Gains Calculator" href="/capital-gains-calculator" title="Capital Gains Calculator">Capital Gains Calculator</a>. The calculator will also calculate Net Investment Income Tax, an additional tax at 3.8% incurred when the taxpayer’s annual investment income is $200,000+ for a single taxpayer or $250,000+ for married taxpayers filing jointly.

<h2>How to Calculate Depreciation Recapture Tax</h2>

Your tax liability doesn’t stop there, without a 1031 exchange you will also be responsible for Depreciation Recapture Tax. How do you calculate depreciation recapture tax? First, we need to calculate the Depreciation taken on the property over the course of ownership.

Annual allowable depreciation is based off whether the property is residential or commercial, from there you need to know your original purchase price (cost basis), land value (value of the land minus building/structure value), and cost of improvements.

The calculation for annual allowable depreciation is as follows:

Original purchase price - land value + cost of improvements = Total Depreciable Value

Annual Allowable Depreciation = Total Depreciation Value divided by either 27.5 (residential) or 39 (commercial)

Once you know your Annual Allowable Depreciation, you can calculate the Depreciation Recapture Tax you would be liable for without a 1031 exchange.

The calculation is as follows:

Annual Allowable Depreciation multiplied by the total years you have owned the property = Accumulated Depreciation

Accumulated Depreciation multiplied by 25% deprecation capture tax rate = total Depreciation Recapture Tax that will be due along with the capital gain tax to the IRS without a 1031 exchange.

Utilize our <a aria-label="Depreciation Calculator" href="/depreciation-calculator" title="Depreciation Calculator">Depreciation Calculator</a> to determine your annual allowable depreciation and Accumulated Depreciation that can be plugged into our 1031 exchange calculator for determining your total tax deferment possible with a 1031 exchange.

*The calculators are for informational purposes only and provide an approximate estimate. Consult with your Tax Advisor for an accurate calculation based on your specific situation.

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How to Calculate Your Potential Tax Benefits with a 1031 Exchange

05/26/22

Many people know that a 1031 Exchange can allow for tax deferral of Federal and State Capital Gains Tax, Depreciation Recapture ...

Case Study: A Property Improvement Exchange of Real Estate

05/17/22

The purpose of a 1031 exchange is to trade up in value of your real estate, otherwise, there is no gain ...

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<h2>The Facts</h2>

On August 1, 2014, we received a call from the exchange department of a national banking association.  She had a client for whom she was facilitating a conventional exchange of real estate.  The exchange account had been opened on July 21, 2014, and the net proceeds from the sale of the relinquished property located in Bellmore, New York were $1,075,000.  The client intended to acquire a replacement property in Massapequa, New York for $640,000.  If nothing further was done the client would be trading substantially down in value and would be realizing little or no tax deferral from the exchange.  Since the replacement property required significant improvements, we suggested to the client that a build-to-suit, or improvement exchange, may be advantageous, as it would potentially allow her client to defer some, if not all, of the gain that would otherwise be recognized.

<h2>The Problem</h2>

Under IRS rules, once a taxpayer takes legal ownership of the replacement property any additional expenditures used to make improvements to the property do not count towards its value in the exchange.  Real estate exchanges have to involve disposing of and acquiring “like-kind” real estate.  When a taxpayer sells relinquished real estate and acquires replacement real estate, any improvements made thereafter are considered payment for labor and materials.  Labor and materials are not like-kind to the sale of real estate. Unable to include the cost of improvements to the replacement property, many taxpayers are unable to make exchanges for property of equal or greater value.

<h2>The Solution</h2>

The IRS issued <a href="/exchange-library/rev-proc-2000-37-reverse-exchanges">Revenue Procedure 2000-37</a> in part to accommodate the need for inclusion of improvement costs in the value of replacement property. Under the Revenue Procedure, an independent third party may take title to the replacement property in the taxpayer's stead and make the desired improvements on the taxpayer's behalf.  Build-to-suit exchanges refer to exchanges in which improvements are made on a vacant parcel of property, whereas property improvement exchanges refer to exchanges in which improvements are made to an existing structure on a parcel of real estate.  The procedures for facilitating a build-to-suit and property improvement exchanges are identical.

When the exchange company services a routine exchange, it acts as a qualified intermediary or QI.  When an exchange company services a property improvement, or build-to-suit exchange, it is acting as an exchange accommodation titleholder or EAT. The EAT takes title to the new property and parks, or holds, that title until the earliest of the following:

<ul>
<li>180 days from when the relinquished property is sold</li>
<li>The improvements are completed</li>
<li>180 days from when the replacement property was parked by the EAT</li>
</ul>

The client entered into a property improvement exchange with an EAT and directed the QI to send funds periodically to the EAT, which were used to purchase the Massapequa property and to improve it according to the client’s instructions.  Before any payments were made to any party, written confirmation by the client was obtained to make sure he was satisfied regarding the particular piece of work.  When the balances held by the EAT declined, instructions were given to the QI to send more funds to the EAT.

Over the course of the transaction more than ten persons and companies were paid by the EAT for services related to the improvements.  By the time 180 days had elapsed from the sale of the relinquished property, most of the improvements were completed. The client had $39,000 left in the forward exchange account and only that sum was subject to capital gains taxes.  This allowed this taxpayer to defer taxes on the $396,000 used for the improvements.

<h2>The Result</h2>

The client’s old property had a zero basis.  Had the client only purchased the replacement property for $640,000, he would have faced taxes on the remaining amount of $435,000. At an approximate rate of 40%, this would have cost him $174,000.  By completing a property improvement exchange, he was able to improve the replacement property while deferring most of the tax that would otherwise be payable.

Updated 5/17/2022.

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Case Study: A Property Improvement Exchange of Real Estate

05/17/22

The purpose of a 1031 exchange is to trade up in value of your real estate, otherwise, there is no gain ...

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