This is also from March 2005:

Q-1:

Subject: Exchange Question

 

I just ran across your site and found it very interesting.  I was wondering if you could help us with this question.  My husband and I purchased a home in 1987.  We lived there until 1994.  We are a military family and have been stationed away from this home ever since.  It has been rented from 1994 until now.  We plan to sell it.  It is in Florida.  We plan to move to Branson, Missouri.  We were wondering if we could reinvest in a small hotel type business, for example 10 rooms or a B&B type business  and or a 4-plex.  We would wish to live in the business.  We would like to use the proceeds to pay off existing mortgage, car, and college loans, while financing the business with a modest down payment.  Is any of this possible without paying huge chunks of taxes?

Thank you for your advice.

 

Sincerely,

A-1:

To have a valid tax deferred exchange, you will need to reinvest all of the cash proceeds from the disposal of your Florida rental property into new like kind property, which could be a hotel type property in Branson, as long as enough of that purchase price is allocated to the real property portion of the property to meet or exceed the selling price of the Florida property.

Any portion of the new property that will be used as your primary residence cannot be counted.

No part of the cash proceeds can be used for non-reinvestment things, such as paying off other debts that are not secured by the Florida rental.  It is possible, after you have taken title to the Branson property, to refinance it and use the new loan proceeds to pay off other debts without any tax consequences.

You really need to consult with a tax pro to work out the best strategy for your plans and circumstances.

Good luck.

Kerry Kerstetter

Q-2:

Kerry,

Thank you so much for your advice.  Since it appears that we have to move in this direction, we were wondering about buying another house for rental purposes.  We plan to sell our home in Florida for a net of $167,000.  We are looking at houses in the Branson area and are considering purchasing one and paying cash in the neighborhood of $120,000 and then purchasing a small hotel/live in business with the remainder of the proceeds acting as the down payment for the investment. This would be making an exchange with two properties in mind.  Is this possible? If so of the $167,000, $120,000 goes to pay in full for rental property with a remainder of 47,000 or so toward the purchase of the hotel units.  Since the hotel that we are looking at is around $215,000, there is no way to pay for this business in full, but we would rest easy knowing at least one property is completely paid in full and with the opportunity to bring in income. 

Another question is, can you count closing costs in the transactions of the $167,000 or must the entire amount go into the properties themselves?  And am I understanding what I've read on the internet correct in that we need an Accommodator for these transactions?  If so, which would be best, to obtain one from Florida where we are selling or from Branson, where we are moving?

I know I have a lot of questions and I do so appreciate your time.  Thank you so much.

Sincerely,

A-2:

You have me a bit confused here.  Is the home you are planning to sell for $167,000 your primary residence or a rental?

If it's your primary personal residence, there is no replacement requirement.  You can see all of the rules on my website.
 

Kerry Kerstetter

Q-3:

Kerry,

This house which was our primary residence for seven years,(due to military orders), became a rental property and has been for the last 10 years.

Thanks again for the help. 

A-3:

Thanks for the clarification.  Terminology is critical; so describing it as "our home" muddies the issue tremendously. 

After ten years as a rental, it long ceased to be your primary residence and a 1031 exchange would be necessary to avoid any taxation of the profit you will be having.

Another ambiguous term that you used is "net of $167,000."  If you are referring to the cash after paying off existing loans, you are off track.  The requirement for a completely tax free exchange is the net sale price after deducting the direct selling costs, such as commissions and escrow fees. Payments of loans and operating costs, such as interest and property taxes, do not lower the target replacement price. 

That said, the answer to your original question about using the proceeds to acquire two replacement properties is yes.  That is quite common.  As long as the total combined cost of the new properties meets or exceeds the net sale price of the old property, you are covered.  The only thing you would need to be concerned with is that you can't count the cost of the property in which you will be living as suitable like kind.  This means that you will need to allocate the purchase price of that property between the business portion and the primary residence portion to see if you are reinvesting an adequate amount.

You can count the closing costs on the acquisition legs as part of the reinvestment.  Anything that would normally be capitalized as part of the property cost qualifies.

You do need to use an exchange accommodator to hold the proceeds and prepare the proper documentation for all legs of the exchange.  If you touch any of the money yourself, even for a split second, you will be taxed on it, even if you do apply it to the new property. 

You can use an accommodator anywhere in the country.  It really doesn't matter.  For example, most of the exchanges my wife's company, Tax Free Exchange Corporation, handle are not even close to Arkansas, and are between states all over the country.

Good luck.  I hope this helps. 

Kerry Kerstetter

Q-4:

Thanks Kerry for all the valuable information.  Before we clicked on your site, we were clueless about what all was involved in selling and reinvesting.  My husband is retiring from the military and we are leaving Germany is a few weeks and are really looking forward to getting involved in the business side of things.  Thanks so much for your help.

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- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 10/23/2005 06:40:00 PM Send this post: