Rents are Rising

"[A] large and growing pool of renters is spurring investors to purchase distressed inventory in order to convert it to rental inventory," Between January 2011 and January 2012, median rents increased by 3 percent.

Median rent increased from $1,182 in January 2011 to $1,218 in January 2012. Rents are up in 69.2 percent of the metropolitan areas tracked by Zillow, which bases its numbers on rent estimates from 84.9 million properties.

Why rents are rising as home values fall

http://www.theatlanticcities.com/housing/2012/03/why-rents-are-rising-home-values-fall/1479/

CREATIVE EXCHANGE PROPERTY: EXPLORE A NEW UNIVERSE OF 1031 EXCHANGE OPPORTUNITIES

Sometimes we miss opportunities because we see what we expect to see. An investor that owns an apartment complex is likely to consider selling only if there is another investment property with better cash flow -- usually another apartment complex. A little imagination, however, can open up a whole new world of opportunities. As Willy Wonka noted in Charlie and the Chocolate Factory, “invention, my dear friends, is 93% perspiration, 6% electricity, 4% evaporation, and 2% butterscotch ripple.” Is there room for such creativity in the world of real estate investment?

Yes indeed. With the slow down in real estate sales activity across the United States over the last few years, some investors are utilizing creative investment strategies to generate current income, diversify their real estate portfolios and utilize Internal Revenue Code §1031 to defer capital gain taxes. While traditional sales activity has certainly declined, other real estate investment activity has remained stable or increased. Examples include the purchase and sale of timber rights, agricultural land, mineral rights, oil and gas investments, water rights, conservation easements and renewable wind and solar energy projects. Each of the foregoing investment classes have a common denominator in that they are, more or less, investments in real property and may be sold as relinquished property or purchased as replacement property to complete a §1031 tax deferred exchange. In many instances, these interests can be exchanged for a fee simple interest in other improved or unimproved real estate to be held for investment or used in a trade or business. The IRS has held that many separate interests that are included in the bundle of rights that constitute “real property” under state law, are like-kind to a fee interest in improved or unimproved real property, including:

· A perpetual easement for a fee simple interest in improved or unimproved real property (PLR 9601046);

· A conservation easement in farm property for a fee simple interest in other real property (PLR 9232030, 9621012);

· An agricultural use easement in farm property for a fee simple interest in other farm property (PLR 9851039);

· Mitigation credits for other mitigation credits (PLR 9612009);

· Timber rights for fee simple interest in other real property (TAM 9525002);

· Transferable development rights (rights used to construct improvements on a property)(PLR 200805012);

· Water rights for fee simple interest in other real property (Rev. Rul. 55-749. PLR 200404044).

Thus, the foregoing interests in real property in many cases can be exchanged under Section 1031 for all of the rights constituting a fee interest in real property, or acquired as replacement property following the sale of a fee simple interest. If you look, you will be surprised at the wide range of real property interests that qualify for tax deferral under Section 1031.

Fractional ownership interests in real property provide yet another investment opportunity. An investment as a tenant-in-common (“TIC”) in income-producing property or similar ownership structures created by sponsors using a Delaware Statutory Trust (“DST”) offer investors the opportunity to acquire a slice of a much larger replacement property that is often managed by a third party property manager. In some high density areas, such as New York City, property owners are exchanging their “co-op” investment properties for a fee interest in other investment property. A simple change in the use of property from a non-qualifying use to a qualifying use presents another opportunity that is sometimes not considered. With proper planning, a real property asset that was held for personal use and enjoyment rather than for investment, such as a vacation home or former residence, can be converted into an investment property that can be exchanged for other like-kind property. (See e.g., Rev. Proc. 2005-14). Some exchanges don’t involve any equity at all. In what is sometimes referred to as a ‘no equity exchange’ transaction, a taxpayer who is forced to give a property back to a lender can defer capital gain taxes by acquiring a replacement property and investing the funds that would otherwise be needed to pay capital gain taxes into an income producing property. Finally, many types of personal property held primarily for investment can also be exchanged for like-kind property, including aircraft, collectible cars, artwork and collectible coins.

According to scientists at the Institute of Food Research, researchers may have developed a way to realize Wonka’s plan to combine three meals in a single stick of chewing gum. Apparently, advances in nano-technology now permit several distinct flavors to be packed into food structures (called colloidosomes) that break down over time with chewing. As Wonka surmised, one stick of gum may be able to deliver “tomato soup, roast beef, baked potato and blueberry pie.” A §1031 exchange of a routine investment property can produce a green energy property, a perpetual easement and mineral rights. Now, chew on that.

CONVERTING A RESIDENCE TO A RENTAL: “REVENUE PROCEDURE 2005-14: APPLYING §1031 AND §121 TO A SALE”

REVENUE PROCEDURE 2005-14

The IRS recently gave guidance on Revenue Procedure 2005-14 on how to report exchanges of property used as a principal residence and for business/investment use in the last five years. A property owner can convert a principal residence to a rental property and later sell it and benefit from both IRC §121 (principal residence tax exclusion rules) and IRC §1031 (investment property tax deferred exchange rules). Property owners must comply with all the rules in both sections to qualify.

APPLICATION OF §121 AND §1031

If a property owner has owned and lived in a principal  residence for at least 2 out of the last 5 years preceding the sale of the principal residence, $250,000 if filing as a single ($500,000 on a joint return) of the gain from the sale, except for any depreciation taken on the property since May 6, 1997, can be excluded. IRC §121 does not require the owner to live in the property at the time of the closing to qualify for the gain exclusion.  A principal residence does not qualify if it was purchased in a §1031 exchange within the previous five years.

In essence, the Treasury has declared that if an owner lives in the residence long enough to meet the principal residence requirements, they may then convert the house into a property “held for investment” which can qualify for a §1031 exchange. (Note: Although there is no defined “holding period” to be considered “held for investment,” many tax/legal advisors believe 1-2 years is sufficient barring any factors which contradict an investment intent.) The property owner can perform an IRC §1031 exchange and still be eligible for gain exclusion under IRC §121, even if it is presently being used as a rental.

When the owner sells the home as an investment property, they must still meet all the necessary requirements for a §1031 exchange. This includes hiring a Qualified Intermediary prior to closing on the relinquished property and adhering to all the time requirements of an exchange, such as identifying the replacement property within 45 calendar days from the sale date and purchasing all replacement properties within 180 days, or the owner’s tax filing date, whichever is  earlier. 

DEPRECIATION

The property owner can exclude gain up to $250,000 (filing as a single) or $500,000 (filing jointly) under IRC §121 except for any depreciation taken on the property after May 6, 1997. Realized gain is first excluded under IRC §121 and then is eligible for deferral under IRC §1031.

The revenue procedure provides six examples that include illustrations of the treatment of depreciation and boot in which both the benefit of §121 exclusion and §1031 deferral could be used. Please visit the “Tax Code/Legal References” section at apiexchange.com to read the full text of Revenue Procedure 2005-14.

CONVERTING A RENTAL TO A RESIDENCE: “MANY TAXPAYERS CAN TAKE ADVANTAGE OF TWO TAX CODE SECTIONS”

Some taxpayers take advantage of exchanges and the tax deferral available under IRC §1031 and later convert their former rental house to a principal residence to qualify for the tax exclusion available under IRC §121.

HOW LONG TO RENT THE §1031 PROPERTY?

Section 1031 of the tax code does not provide a defined “holding period” for investment properties. The time period the property is held is only one factor the IRS may look at to determine the taxpayer’s intent to hold for investment. The IRS can examine all the other facts and circumstances that may or may not support the intent to hold for investment.

Some legal and tax advisors recommend that a taxpayer hold a §1031 exchange property for a minimum of at least twelve months. The reason for this is that a holding period of 12 or more months results in the taxpayer reflecting the property as an investment property in two tax filing years. Another perspective is holding the §1031 exchange property for at least two years. In one Private Letter Ruling (PLR 8429039), the IRS stated that a minimum holding period of two years was sufficient. Many legal and tax advisors who believe two years is a conservative holding period, provided no other significant factors to contradict the investment intent.

IRC §121 - PRINCIPAL RESIDENCE EXCLUSION

Exclusion of up to $250,000 of the capital gain on a principal residence for a single taxpayer and $500,000 for a married couple filing jointly. The taxpayer must own and use the home as a principal residence 2 of the 5 years prior to the sale.

HOUSING ASSISTANCE ACT OF 2008

As a result of the Housing Assistance Act of 2008, beginning January 1, 2009, the Section 121 exclusion must be allocated between the period the principal residence was used as an investment property and the period of time the residence was used as a principal residence. Any portion of the exclusion amount that is allocable to the period the property is not used as a principal residence is eliminated.

In general, the allocation rules only apply to time periods prior to the conversion into a principal residence and not to time periods after the conversion out of principal residence use. Accordingly, if a single taxpayer converts a principal residence into a rental property and never moves back in, and otherwise meets the two out of five year relinquished under §121, the taxpayer is eligible for the full $250,000 exclusion when the rental property is sold. This rule only applies to non-qualified use periods within the 5 year lookback period of §121 after the last date the property was used as a principal residence. Therefore, if the taxpayer used the property as a principal residence in year one and year two, then rented the property for years three and four, and then used it as a principal residence in year five, the allocation rules would apply and only three-fifths (3 out of 5 years) of the gain would be eligible for the exclusion under §121. Every taxpayer is urged to seek the advice of a tax advisor to review their specific situation and application of the tax rules.

DO YOU WANT 360 DAYS TO EXCHANGE? “COMBINE A REVERSE EXCHANGE FOLLOWED BY A DELAYED EXCHANGE”

SAFE HARBOR GUIDANCE

Tax deferred exchanges have been part of the U.S. Tax Code since 1921. Since that time, the government has approved certain methods to structure exchange transactions that are so called “safe harbors.” For example, in 1991 the U.S. Treasury issued final regulations that provided important guidance on the structure of delayed exchanges including the 45 day identification period and 180 day exchange period timelines and certain other procedural requirements necessary to complete a tax deferred exchange safely. On September 15, 2000, the Internal Revenue Service released Revenue Procedure 2000-37 that provided guidelines for structuring reverse exchanges (a transaction in which replacement property is acquired by an accommodating party before the sale of the relinquished property and held as replacement property to complete the exchange). A replacement property may be acquired and held (sometimes called “parked”) by the accommodating party for up to 180 calendar days. Recently, the IRS provided guidance (See ILM 200836024) approving the combination of a reverse parking arrangement exchange and a forward delayed exchange resulting in two sequential 180 day exchange periods associated with one exchange transaction.

Since the accommodating party in a reverse exchange can only hold the replacement property for 180 days, the relinquished property must generally be sold by the taxpayer within that 180 day accommodation period. If the parked replacement property is the only property that is desired by the taxpayer to complete the exchange, then the exchange is complete upon the accommodator’s transfer of the replacement property to the exchanger. But what if the parked replacement property is just one of several replacement properties desired by the taxpayer? In that event, the standard delayed exchange that commences with the sale of the relinquished property may be used to acquire other replacement properties over the second 180 day exchange period commencing with the sale of the relinquished property. In this fashion, the exchange transaction spans two exchange periods starting with the accommodator’s acquisition of the parked property and ending on the exchanger’s acquisition of the last replacement property, potentially spanning 360 calendar days.

Many areas in the nation have experienced significant price declines in the past couple of years. Although this trend may leave a seller with less equity in his or her relinquished property, there is a silver lining: prices for replacement property have decreased as well providing investors with a once in a lifetime opportunity to purchase quality real estate at steeply discounted prices.

Suppose that an exchanger owns an office building in Parsippany, NJ which he has contracted to sell for $10,000,000 to close in December, 2009. The exchanger would like to take advantage of a couple of excellent opportunities to purchase property in the Northeast at a significant discount. The investor negotiates to purchase one such property in Westchester, NY for $4,000,000. The investor acquires such property by using a reverse exchange which closes at the end of June, 2009. When the relinquished property in Parsippany is finally sold in December, 2009 as part of a regular delayed exchange, the net sale proceeds are used to purchase the parked Westchester replacement property held by the accommodator. Now, in this second leg of the exchange transaction, the exchanger has 45 days following the sale of the relinquished property in Parsippany to identify other suitable replacement property to spend the remaining $6,000,000 needed to obtain 100% deferral and a maximum of 180 days to close on one or more identified replacement properties.

PRESERVING YOUR INVESTMENT IN YOUR COLLECTIBLE CAR: “A 1031 EXCHANGE CAN DEFER CAPITAL GAIN TAXES”

O.K., so you bought that sweet XKE some years ago just knowing that it would become a rare collectible. Well, it has: according to www.NADAguides.com, the average increase in collectible car values from February 2004 to February 2008 was 36 percent, which is over double the S&P 500 Index for the same timeframe. Collectible cars valued over $125,000 appreciated the highest amount of any pricing category, a sizeable 47%. Appreciation of this magnitude is good news for car collectors. It may seem like a good thing to sell your gem at today’s market value . . . that is, until the tax man cometh.

Gains realized on the sale of collectibles are taxed at a special capital gains rate of 28%. For collectibles held for less than one year, the short-term rate is equal to the seller’s marginal tax rate on ordinary income. To learn more about these tax rates, see the article, Understand the Impact of Tax Treatment: Ordinary Income vs. Capital Gain.

PAY TAXES AT 28% OR 0% WITH A 1031 EXCHANGE?

With high market prices available for collectible cars (and other collectibles such as paintings and photographs), long term investors are discovering that the taxes due on a sale can be substantial. To avoid the tax on the sale of a collectible that has been held for investment, the investor may complete a tax deferred exchange under Internal Revenue Code Section 1031. Real estate investors and business owners have been taking advantage of the tax deferral afforded by Section 1031 since 1921, but investors in collectibles have been slower to utilize an exchange to defer taxes. There is a growing realization among savvy investors, however, that they can reinvest all the profits resulting from the sale of a collectible tax deferred instead of paying capital gain taxes.

The “like-kind” requirements for personal property are much narrower than the standards applicable to real property. Moreover, an investor must establish to the satisfaction of the IRS that the collectible exchanged under Section 1031 was held primarily for investment or for use in a trade or business and not for personal enjoyment. This can be trickier with collectibles that may be purchased, at least in part, for the owner’s personal enjoyment. For more information on the property that can be exchanged under Section 1031, see the article Personal Property Exchanges: Planes, Trains and Automobiles.

To defer paying capital gain taxes, the investor’s replacement collectible car should be equal or greater in value than the car being sold in the exchange. In addition, all of the net proceeds (after paying commissions and closing costs) must be reinvested in qualifying replacement property if there is to be full tax deferral. Finally, an investor has up to 180 calendar days to complete the acquisition of the replacement car. It is important to work closely with a reputable qualified intermediary to facilitate the tax deferred exchange. Ordinarily, the qualified intermediary will prepare the necessary exchange documents and hold the sale proceeds securely in a separate account until they are disbursed on behalf of the investor to acquire the replacement car. We can help you understand your options, so give us a call to learn more.

Buffett Says Buy Single Family Rentals

Billionaire and Berkshire Hathaway CEO Warren Buffett gave out some free investment advice on TV Monday. Buffett said on CNBC that Americans should buy distressed houses, which are really cheap right now, and rent them out (after fixing them up a bit, of course). Buffett said he'd snatch up "millions" of single family homes if it were practical, but said he isn't very handy.

America's investment grandpa also was optimistic about the economy: He said it's bouncing back in almost all sectors, except home construction, but he predicts it will bounce back there, too.