|
Jersey Realty Exchange Corporation is in their 15th 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, three hundred million dollars of real estate, saving them vast sums of capital gains taxes. During this past year we have seen a tightening of the tax laws regarding conversion of second homes/investment properties to primary homes and in the individual state tax laws. These changes are summarized below.
Qualifying 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) and; (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 falling outside the parameters of this safe harbor may still be granted tax deferment under Section 1031 based on the taxpayer's specific facts and circumstances.
Housing Assistance Tax Act of 2008
The Housing Assistance Tax Act of 2008 includes a modification to the primary home exclusion ($250,000 for individuals and $500,000 for married couples) when the property is converted from vacation/investment ("nonqualified") use to primary ("qualified") use December 31, 2008. The gain on the sale of the property will be allocated between the periods of "nonqualifed" use and "qualified" use. The $250,000/$500,000 exclusion will be applied to the "qualified" use period only, hence, making the "nonqualified " use period taxable. The nonqualifed use prior to January 1, 2009 does not negatively impact the calculaion. Conversions from primary use to vacation/investment use do not have the same tax implications and may be afforded 1031 tax deferment.
Capital Gains Rates
The long term capital gains rate remains at 15 percent for 2009 and 2010 and, at this writing, is scheduled to revert to 20 percent in 2011. Property held for less than one year is subject to ordinary income tax rates upon sale. A section 1031 Like-Kind exchange is still a better alternative to paying taxes.
Intangibles
As a general rule, the goodwill of one entity connot be exchanged under Section 1031 for the goodwill of another entity. The IRS, however, recently declared intangibles such as trademarks, tradenames, mastheads, etc. that can be valued separately and apart from goodwill, may qualify as like-kind property for a Section 1031 exchange.
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. The State of New Hampshire has imposed stricter rules for disregarded entities and may disallow tax deferment at the state tax level.
Related Party Exchanges
Several IRS Private Letter Rulings (PLRs) on the subject of Related Party Exchanges have been issued during the past few years. 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 of within the two year period and 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 (a) two separate structures used concurrently, e.g. Duplex, (b) single structure used concurrently, e.g. Boarding house, and (c) single structure used consecutively, e.g. converting a principal residence to a rental property.
State Tax Issues
Nonresident withholdingTax - Several states collect an estimated state income/capital gains tax at the time of settlement of nonresident individuals selling a property in their state unless an exemption is requested. Most states grant a partial or full exemption for 1031 exchanges. The states that impose a nonresident tax are: Alabama, California, Colorado, Louisiana, Maine, Maryland, Mississippi, New Jersey, New York, Oregon, Rhode Island, South Carolina, Vermont, and West Virginia. Following is the nonresident withholding requirements for 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 (e.g. cash).
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.
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.
Consumer Protection Qualified Intermediary (QI) Legislation - Several states have enacted legislation to protect consumers from the mishandling of 1031 funds by Qualified Intermediaries. These states include: California, Colorado, Idaho, Maine (pending), Nevada, and Washington.
|
