Q:

Subject: Exchange Question

My father-in-law owns highly appreciated raw land in Florida which he bought many years ago for $8,000.  He is receiving sale solicitations in the neighborhood of $400,000.  He wants out because he is tired of paying the increasing real estate taxes.

 The Q is: Can he use the 1031 rules to buy fraction shares in both my home and my brother in laws home (reduction in our mortgages) - with the understanding that we would pay him on the note (a monthly dollar amount equal to the non-deductible equivalent of principal and interest amounts - using a 25 year amortization). 

He would conceivably be placed on the deed and would leave us the share of the home in his will if he were to die before the 25 years was up.  He is 80 years old today (in good health)???

Basically we would be paying him 5.00% instead of paying the bank.

Thanks in advance for any help.

A:

There are several complicated twists to the scenario you are proposing, which all parties concerned need to discuss in detail with qualified professional tax advisors.

Your father in law could reinvest into your homes as long he will be acquiring equity ownership interests in them and he will be treating them on his books as investment, business or rental property.  He cannot treat them as personal usage. 

For this to work, you and your brother-in-law would have to report the sales of the partial interests on your 1040s, which may or may not be taxable to you.  There is also a restriction on 1031s between related parties if the replacement properties (your homes) are disposed of within two years, except for extraordinary circumstances (such as death or illness).  

Your FIL would also have to comply with all of the rules for 1031s.  The amount reinvested would have to be equal to or higher than the net sales price ($400,000 less selling costs) and there would need to be proper documentation of all legs of the exchange.  The handling if the cash proceeds would have to be set up so that he doesn't have access to it.

However, the way you are proposing structuring the deal sounds more like he would be investing his money into the mortgages as a lien-holder instead of an actual equity owner.  Such an arrangement would not qualify as a like-kind replacement for his old property.  A lien-holder interest is not the same as an equity ownership.  Your repayment plan makes it even less likely to fly because you would be treating him as a lien-holder by paying him interest and not as a co-owner.

One possible way around this would be for you and your BIL to rent your FIL's share of the homes from him and pay him monthly rent, which he would report on Schedule E of his 1040.  That would properly document the replacement properties as rental, which qualifies a like-kind for his Florida investment property.  This would also give him some monthly cash income to live on.

How your FIL wants to distribute his shares of the homes after his passing is completely up to him and doesn't really affect this possible transaction.

These are just some of the details that all of you need to discuss in much more detail with qualified professional tax advisors.

Good luck.

Kerry Kerstetter

 Follow-Up:

Kerry,

 

Thank you for such a thoughtful response.  Is this the type of work that you could (better yet, would be willing to) do for us if we decide that this is the way to go?

Based upon your response - I think I would sell him my house and pay him rent (I qualify to exclude the gain on my 1040) - my house has an appraised value of in excess of his land purchase.

Best,

My Reply:

My wife, Sherry, has her own company, Tax Free Exchange Corporation, that handles 1031 exchanges all over the USA.

You can learn more about her services, as well as her fees, on her website.

Good luck.

Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 1/29/2006 02:16:00 PM Send this post: