Jersey Realty Exchange Corporation is in their 14th year of providing consulting services and documentation to real estate investors, their accountants and tax attorneys. Since our incorporation in 1994, we helped investors exchange over two billion, two hundred million ($2,201,530,101) dollars of real estate, saving them vast sums of capital gains taxes. Following are some of the topics we encounter on a daily basis:
Exchanges of Vacation Homes
Effective March 10, 2008, the IRS issued a Revenue Procedure providing a safe harbor under which an exchange of a vacation home will not be challenged. The highlights of this safe harbor are: (1) The taxpayer owns the relinquish and replacement properties for at least 24 months immediately before/after the exchange and; (a) The taxpayer does not use the property for pleasure more than 14 days per year (or 10% of rental period, whichever is greater) in each of the two years before/after the exchange (repairs and maintenance days do not count towards personal use days) or; (b) the property is rented to an unrelated party for at least 14 days per year in each of the two years before/after the exchange. (Rentals to related parties are permitted if the related party utilizes the property as a principal residence and pays a fair market value rent.) An exchange may still fall outside the parameters of this safe harbor and meet the requirements of a Section 1031 Exchange. Taxpayers are encouraged to review their specific facts and circumstances with us to determine if they meet the statutory requirements.
Capital Gains Rates
In 2008, if your taxable income, including long term capital gains, is in the 10 percent or 15 percent brackets, your long term capital gains will not be taxed. If your taxable income, including long term capital gains, is in the 25 percent or higher brackets, a portion of the long term capital gains will not be taxed and a portion will be taxed at a 15 percent capital gains rate. In 2008, the 25 percent bracket begins at a taxable income of $65,200 for married couples and $32,600 for single individuals. This benefit to low income taxpayers is scheduled to be repealed at the end of 2008.
Transferable Development Rights and Land-Use Credits
In a Private Letter Ruling, the IRS, relying entirely on the classification under the respective state and local law, ruled that transferable development rights and land-use credits were "like-kind" to a fee interest in real estate and therefore, qualified in an exchange with real property under Section 1031.
Disregarded Entities
In a Private Letter Ruling, the IRS ruled the acquisition of a membership interest of a single member disregarded entity did not violate the 1031 prohibition of exchanging into partnership interests on the basis the sole member taxpayer is deemed to have acquired an interest in the real property of the disregarded entity and not an interest in a partnership.
Related Party Exchanges
Several IRS Private Letter Rulings (PLRs) on the subject of Related Party Exchanges have been issued during the past year. Within the 1031 regulations, a taxpayer may sell property to a related party as long as both parties comply with a two-year holding period. A 2002 IRS Revenue Procedure indicated a taxpayer may not buy replacement property from a related party. The recent IRS PLRs have resulted in favorable outcomes for property disposed within the two year period and also for taxpayers wishing to purchase replacement property from a related party. Although PLRs have no basis in law, it appears the IRS is allowing exceptions to the related party rules where it is evident the parties are not “cashing out” or “basis shifting”. (Related parties include linear relatives and entities in which the Taxpayer owns more than a 50 percent interest. Not related are aunts, uncles, in-laws, cousins, nephews, nieces and ex-spouses.)
Mixed Use Property
In 2005, the IRS issued a Revenue Procedure clarifying the exclusion of tax on properties used for both business/investment use (Section 1031) and as a principal residence (Section 121). The procedure provided guidance and examples for mixed use properties consisting of (1) two separate structures used concurrently, e.g. Duplex, (2) single structure used concurrently, e.g. Boarding house, and (3) single structure used consecutively, e.g. converting a principal residence to a rental property. The benefit of this Revenue Procedure is the exclusion of the principal residence gain ($500,000 for married couples and $250,000 for single individuals) under Section 121 before the deferral of the business/investment gain under Section 1031, hence avoiding all tax liability upon sale and allowing the taxpayer to obtain tax-free cash.
State Tax Issues
New Jersey - In September 2006, the New Jersey Administrative Code was amended to state: “A deed transferring real property from one legal entity to another legal entity that has common ownership is subject to the realty transfer fee.” Taxpayers wishing to convey property to/from an LLC, Subchapter S-Corporation, Partnership, etc. may find themselves subject to a significant transfer tax.
New Jersey - Nonresident individuals, estates or trusts selling an investment property in New Jersey after August 1, 2004, are subject to an estimated withholding tax remitted to New Jersey at the time the deed transfer is recorded. The estimated tax is a minimum of two percent of the gross sales price or 8.97% of the gain on the property. Exemptions to the withholding tax include property held by a corporation, partnership or LLC, or non-resident individuals, estates or trusts selling an investment property under a 1031 exchange. Effective November 16, 2007, nonresident individuals, estates or trusts must make an estimated tax payment for the fair market value of non "like-kind" property received. Examples of non "like-kind" property in a real estate exchange would include cash "boot" received by the taxpayer in a partial exchange, seller financing or property excluded from the real property exchange such as personal property, goodwill, and covenants not to compete with a fair market value. If the above circumstances exist, the taxpayer is required to submit the Residency Form GIT/REP-3 for the "like-kind" portion exempted under IRC 1031 and also Form GIT/REP-1 for the non "like-kind" portion of the sale not exempted under IRC 1031 along with an estimated gross income tax payment. The Sellers Residency Certification/Exemption form GIT/REP-3 has been revised to reflect this change. The exemption to the withholding tax for individuals, estates and trusts is located on the Seller’s Residency Certification/Exemption form, box 7.
Pennsylvania – All taxpayers domiciled in Pennsylvania, except C-Corporations, who exchange real and personal property within the fifty states, must recognize gain on the sale of the property on their Pennsylvania tax return. The deferral of gain under Section 1031 still applies for federal taxes and the remaining forty-nine states.
Maryland – Nonresidents of Maryland who have not reported rental income in Maryland are being denied a waiver of the six percent withholding tax when exchanging property.
South Carolina – Nonresident Taxpayers exchanging property in South Carolina must place an estimated withholding tax in escrow with a Qualified Intermediary in the event the exchange fails or results in “boot”. The buyer of the taxpayer’s property is ultimately responsible for remitting the tax to the South Carolina Department of Revenue.
Oregon -
Beginning January 1, 2008, nonresident individuals conveying certain real property will be subject to a withholding tax unless the seller submits an exemption form to the state. Included as an exemption are Section 1031 exchanges.
West Virginia - Beginning January 1, 2008, nonresident individuals conveying certain real property will be subject to a withholding tax unless the seller submits an exemption form to the state. Included as an exemption are Section 1031 exchanges.
Nevada - Effective July 1, 2007, Nevada signed a law to protect 1031 exchange consumers by placing the licensing and regulation of Qualified Intermediaries under the Nevada Department of Business and Industry's Financial Institutions Division, which has oversight of state-chartered lending and depository institutions.
