Contract Exchanges, What are they?

Tax strategies are always evolving. I enjoy keeping up with all the latest methods to help clients save money and taxes. This week I thought I'd pass along a great article by a colleague I respect. Enjoy!

Contract Exchanges: A Money-Saving Shortcut for a Turbulent Market

By Stephen A. Wayner, Esq., CES

Contract exchanges have recently become a hot topic among tax professionals, because many investors desire to cash in on the built in gains from the real estate market. Now, sensing possible dwindling future returns over the paper appreciation already earned, real estate investors want to lock in the gains from their hot investments such as condominium development contracts, and move into less high-flying, high-risk real estate holdings.

A “Contract Exchange” is the tax-deferred exchange of:-The Buyer’s ownership in a Sales Contract on real property, for different real property, or for a contract or option on different real property; or -The Option Holder’s exchange of an Option to purchase real property, for different real property, or for an option or contract on different real property. Essentially, a contract exchange is an exchange of an open option to purchase, or an open Sales Contract, rather than an exchange of the underlying real estate itself.

For the rest of the article, click the link below.

1031 Exchange News


ps. My new and improved sites are almost complete. I hope to be launching them with my next post.

Paula Straub
SaveGainsTax
askpaula@savegainstax.com

Financial Suicide

Something very sad occurred today. I wish I could say I had never seen something similar happen before, but I have. Seemingly smart people make financially devastating and irreversible choices.

The cause, I believe, is partly fear of something new to them, and partly the unwillingness to trust or listen to those professionals they have chosen to guide them.

I realize that once one is burned in a previous situation, it is harder to put yourself in someone's hands again at a later time. However, if you are faced with a potentially critical event, the worst thing you can do is take the path of least resistance when it is you who will suffer the consequences.

First, before I describe the essence of what I am witnessing, let me give an analogy.

Let's say you were diagnosed with a brain tumor that a specialist said was operable and your chances of pulling through and living a productive life were 95% in your favor. Surgery is a scary thought for anyone, and your brain is an important organ.

So, you get several professional opinions and they all agree this is your best chance of living a happy and healthy life. You, however, had a surgery many years ago that didn't turn out exactly as promised. Maybe a knee replacement that never really let you walk without a limp.

Now you distrust surgeons in general because you had an experience that didn't give you the exact results you were hoping for. You are in less pain than before the knee surgery, but not as good as before the original injury. It's left a sour taste in your mouth, so you prefer not to have another surgery ever again.

Your brain tumor will not go away however. Your choices are have the surgery with a very good chance of living a long life, or do nothing and let the tumor run its course. You might have 1 year, 10 years or 1 week left to live. Chances are the longer you live, the more eventual pain you will be in.

So, what do you do? Get over your fear of having another surgery, and most likely give yourself the gift of a longer life (taking into account that 5% chance there may be side effects or even death), or do nothing so you avoid surgery, and hope that some miracle occurs and you are healed and don't have to think about it anymore.

If this were your mom or dad and you loved them, which course of action would you encourage them to take? You can say, "it's your life" and stay out of it, or you can help them understand that it is in their best interests to have the operation so they are healthy and with you for years to come. Remember, this isn't a 50/50 chance here. It's 95/5 in favor of success.

Obviously, most would be in favor of the surgery. However, there are some that will not under any circumstances venture out of the "known" and will opt to let the tumor grow and take their life, rather than take the 95% chance of living comfortably.

Ok, this was a long road to make my original point. It is my business to put together a strategy for anyone facing a large capital gains tax consequence, so that they minimize their tax obligation and enjoy the maximum fruits of their labor when they sell an asset.

Without going into exact specifics, a potential client had a large real estate holding that was actually entrusted to two children years ago. The client no longer owned the asset. The kids did. The client wished the asset sold, so it was. The tax consequences were very large, as the kids had received it at the basis of the parents, which was very low.

The elderly remaining parent wanted control and liquidity of the proceeds. For some reason, they could not understand that they had lost control years ago. The children have control.

A Private Annuity Trust for each of the children is the best solution. It would give them each about 2800.00/mo after taxes for the rest of their lives. A loan could be taken to pay the parent's current mortgage, so the parent would have no payments to make. The kids are willing to give the parent the payments from the trust (gifting them) for the rest of the parent's life. So the parent would receive about $5600.00/mo with no taxes due as long as they lived. After the parent's death, the kids would continue to receive their $2800.00/mo after taxes for the rest of their lives. When the parent dies, the condo they live in can be sold to pay back the loan to the trust. There is a further complication of the property being held in an LLC if no trust is done.

This is an extremely cost effective way to take care the parent as long as they live. The taxes are spread out over about 30 years, so the majority of the funds are continuing to work in the kid's favor.

So here's the tragedy. The parent isn't familiar with the concepts of the PAT. Despite 2 CPA's, 2 Attorneys, and a Financial Advisor being in agreement this is the best method, the parent can only think liquidity and control are being lost. The kids, although highly educated, are inclined to do what the parent feels comfortable with rather than making their own informed decision as to how the parent is best taken care of financially.

If the asset is sold, taxes paid, and the remainder of the funds deposited in the LLC this is what will happen. For the parent to get any money from the proceeds, the kids will have to take the money first as income and pay income taxes on it before they can gift it to the parent. Since each makes a good salary, this means they will pay taxes again at about 40% when the money comes out of the LLC. So to give the parent $1000. they may have to draw out $1650.

When all is said and done, the parent will receive about 30 cents on the dollar for each payment they get. I really don't even know if they totally grasp this, although they have been informed.

Personally, I don't know why anyone would think this is the "simplest" choice. But then again, I'll take the 95% odds any day of the week. How many lottery tickets would I buy if I had a 95% of winning with each one? Let's just say I would not have to worry about money ever again...

Please don't let someone you care about commit financial suicide. Save them from themselves!

Paula Straub
SaveGainsTax
(760)917-0858

Another niche use for a Private Annuity Trust

Last week I wrote about a Private Annuity Trust being used for the sale of oil rights on an individuals property. What are some other uses one might not immediately think of?

How about the sale of a race horse owner's business, including the ponies?

Some might just keep the business in the family, but what if the owner died and his wife just didn't want to maintain that particular lifestyle?

Assuming they built the business up and could make a hefty profit, they would experience a large capital gain and owe tons of taxes if they sold outright.

The Private Annuity Trust to the rescue.

Instead of paying a huge dollar amount immediately, the taxes would be spread over the remainder of the annuitant's lifetime. The headaches of the upkeep of the stables, horses and equipment would be gone, and a sizeable income stream would replace these.

There's a lot more details to the story, but you get the gist.

I had to wonder whether life at the track may have turned into an estate on Maui or something equally inviting.

Paula Straub

SaveGainsTax

760-917-0858

Capital Gains Tax on Unusual Sales

I love my job. Basically, because I get bored easily and I need to keep my mind busy solving problems and with new challenges.

In my quest to help clients save capital gains tax I work with several different professionals and learn about some unusual cases. No names or specific details are exchanged - but I get to hear about cases that I may never personally come across.

For instance, a person owned land, and in fact lived on it, where oil was found. Some tests were done, and he had in fact a very promising oil well. A company who drills for oil offered him a lot of money in return for the rights to drill on his property. He was ecstatic of course, but faced a huge capital gain that year on his taxes. Through a private annuity trust, he was able to spread out that obligation, and in return now enjoys a significant lifetime income. Talk about a great situation to find yourself in!

I'll post another interesting story next time. Who would have imagined this scenario?

Paula Straub
Interview with the Pros -Educational Resource askpaula@savegainstax.com

1031/TIC Exchanges - What are the Advantages?

Read a good article on 1031/TIC exchanges in the Baltimore Chronicle today.

Sometimes it's good to read about them from an independent source. Here's the link to the Boston Chronicle webpage.

I am currently in the process of revamping my SaveGainsTax website and adding another site with more information and articles. The exact time frame for launch is still up in the air, as the "creative" web guy works at his own pace. I'll keep you posted.

I'm going to be hosting a special call in a few weeks with a guest speaker. I'll post more later, but the subject will be on how to evaluate commercial property and where some of the better buys are today. It'll be very informational for all of you looking into being TIC owners who are used to individual rental properties.

That's all for now. Check back for updates!

Paula Straub
760-917-0858

Free Report "7 Secrets to Help You Hang Onto Your Capital Gains"

Vacation and Second Homes- Do they qualify for a 1031 Exchange?

Here is a great article by Stephen Wayner of Bayview Financial Exchange Services. Stephen is the QI expert on my "Interview with the Pros" resource and knows his stuff!

I often get asked if vacation and second homes qualify for a 1031 exchange. Here's what Stephen has to say:

How Can I Qualify my Vacation or Second Home for a 1031 Exchange?
By Stephen A. Wayner, Esq., CES, SVP Bayview Financial Exchange Services

With the recent gains in the real estate market, the approaching retirement
age and increased mobility of the "baby boomer" generation, and the record
wealth transfer now in full flower, professionals are seeing a growth in
pent-up demand for Code Section 1031 Tax Deferred Exchanges. Taxpayers are
frequently asking their professional advisors whether they can qualify
their vacation homes, or primary and secondary residences for a Code
Section 1031 exchange.

Exchange Mechanics. There are two properties that are considered in the
typical exchange: the property being sold (the "relinquished property"),
and the property being purchased (the "replacement property").

Vacation Homes. Vacation homes, primary and secondary residences
(hereinafter referred to collectively as "Personal Use Realty") generally
have not qualified for Section 1031 tax deferral, if either the
relinquished property or the replacement property is Personal Use Realty,
since they are not considered to be "held" for investment or business
purposes. If either: (1) the relinquished property was previously used as
Personal Use Realty; or (2) the replacement property is intended to
ultimately be used as Personal Use Realty; in order to conduct a valid
§1031 exchange it is often necessary to have such property rented to
unrelated parties for a period of time both before and after the exchange.

How Can I Make Sure my Property Qualifies? Section 1031 contains no fixed
amount of time needed to qualify a transaction for tax-deferred status.
Instead, Section 1031 requires that the taxpayer have the intent to hold
the property for either an investment purpose or a business purpose, at the
time of the exchange to avoid a taxable exchange. The case law on Section
1031 follows a line of precedence where courts will attempt to determine
the taxpayer's intent. The court applies a "facts and circumstances" test
to objectively measure whether the taxpayer had a bona fide intention to
hold each property as investment or business property at the time of the
exchange. The taxpayer's actions, written and oral communications, and tax
filings, constitute evidence for examination if the Internal Revenue
Service challenges the tax-deferred status of the exchange. The following
chart illustrates some of the factors that the Internal Revenue Service
will likely examine:

EVIDENCE AGAINST INVESTMENT OR BUSINESS INTENT

The taxpayer puts up a "for sale" sign, lists the property for sale, or
signs a listing agreement soon after its purchase.
The taxpayer applies for "owner occupied" financing on the property.
The taxpayer inadvertently checks a box in the Purchase and Sale Contract
that he intends to live in the property.
The taxpayer moves into the replacement property soon after its purchase.
The property is not rented during the term that the property has been held,
or the leases have been in effect for a brief period.
The taxpayer claims the "mortgage interest" deduction for the property on
his tax return.
The taxpayer "swaps" rental time in the replacement property for rental
time in another party's property.

EVIDENCE FOR INVESTMENT OR BUSINESS INTENT

The taxpayer sells the property on his own, receives an unsolicited offer,
or lists the property for sale after holding as investment for a
substantial length of time.
The taxpayer obtains financing listing himself as a non-occupant investor.
The taxpayer is careful to read the entire Purchase and Sale Contract to
avoid any reference to his occupying the property.
The taxpayer waits for at least two (2) tax filing periods before moving
into the property.
The property has been rented by its tenants for a significant time.
The taxpayer treats the property on his books and income tax returns as
investment or business use property
The taxpayer does not exchange rental time or act in a manner similar to a
"time-share" arrangement.

Changes in Purpose. The purpose for holding the property must be for
investment or business use in order to qualify for Section 1031 treatment;
nevertheless, the purpose may change during the holding period. In Internal
Revenue Service Revenue Ruling 57-244, property that the taxpayer
originally owned as his primary residence and was later converted into
rental property, qualified as investment property. The determination of the
taxpayer's intent is made at the time of the exchange, not at the time of
the property's acquisition.

How Much Personal Use is Permitted? Mere incidental personal use of
property that is otherwise considered investment property may not
disqualify the property from 1031 Exchange treatment, according to Internal
Revenue Service Private Letter Ruling 8103117 (remember that these rulings
are only binding with respect to the taxpayer who requested the ruling,
though they are some evidence of the IRS's position) . "Incidental personal
use" is not defined by the Code, Regulations, or by other guidance issued
by the IRS. If the property is not rented out by the taxpayer, then use of
the vacation home for anything other than "incidental personal use" will
disqualify the property from receiving tax-deferred exchange treatment.

For exchange purposes, subsection (d) of Section 280A contains the primary
test likely to be applied. Personal use of the property does not exceed the
greater of:

1. fourteen (14) days; or
2. ten percent (10%) of the number of days that the property is rented at
fair market value to others.

Is there a Minimum Holding Period? Some commentators have believed that the
taxpayer should hold each exchange property for at least two (2) years. In
Rev. Rul. 84-121, the Internal Revenue Service asserted its position that
relinquished property acquired and exchanged soon after its acquisition
will not qualify for a Section 1031 exchange, because the taxpayer is
deemed to have acquired the property with the intent to dispose of it,
rather than to hold it for investment or business purposes. Some of the
courts, especially those in the Western States have construed Section 1031
much more liberally. In Bolker v. Commissioner, 760 F.2d 1039 (9TH Cir.
1985), the court permitted a holding period of only three (3) months to
qualify for a 1031 exchange. The court opined that the taxpayer satisfied
the holding and intention requirements by owning the property without the
intent to liquidate the investment or to use it for personal pursuits.
However, this case is the exception rather than the majority rule.

===================

As always, each situation must be reviewed in its entirety to determine what options are available.

Warmly,
Paula Straub
SaveGainsTax
760-917-0858

Private Annuity Trusts in the News

Came across a great article today on Private Annuity Trusts I wanted to share.

Saving Money with Private Annuity Trusts

I have been seeing more and more articles in the news as of late, and some are better written and more factual than others. There is the occasional slam, but usually from someone who isn't as knowledgeable or just enjoys bashing.

They don't work for everyone, but when they do, they save a great deal of money for the person(s) involved.

Paula Straub
www.savegainstax.comaskpaula@savegainstax.com