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1031 Exchanges: How to Avoid Capital Gains on the Sale of an Investment Property
Tue 11/10/09 09:43:25 am
by Christopher Benedict

Do you have an investment property that you would like to sell, but defer the capital gains taxes? If so, then you need to consider a 1031 exchange:

A 1031 exchange, otherwise known as a "tax deferred exchange" is a strategy and method for selling one investment property and then proceeding with an acquisition of another property, all of which must happen within a specific time frame as set by the rules of the Internal Revenue Service. It is because you will be "exchanging" and not simply buying and selling a real estate investment property that allows the taxpayer(s) to qualify for a deferred gain treatment. Sales of real estate are taxable with the IRS and 1031 exchanges are not.

NOTICE: Due to the fact that exchanging a property represents an IRS-recognized approach to the deferral of capital gain taxes, it is very important for you to understand the rules involved. It is within the Section 1031 of the Internal Revenue Code that you can find the appropriate tax code necessary for a successful exchange.

Why consider a 1031 Exchange?

If you are a real estate investor, or have real estate investment properties, you should consider an exchange when you expect to acquire a replacement "like kind" property subsequent to the sale of your existing investment property. A simple sale of the property would necessitate the payment of a capital gain tax to our friends at the IRS, which can range from 20% to 40% depending on the federal and state tax rates. By selling your property using a 1031 exchange, you are leveraging your purchaing power by keeping all of your funds intact.

To qualify as a 1031 exchange, you must adhere to these two rules:

1) The total purchase price of the replacement "like kind" property must be equal to, or greater than the total net sales price of the relinquished, real estate, property.

2) All the equity received from the sale, of the relinquished real estate property, must be used to acquire the replacement, "like kind" property.

Should either of these rules (above) be violated, then then a qualified tax attorney will have to help you determine the tax liability accrued to the person executing the Exchange. In any case which the replacement property purchase price is less, there will be a tax responsibility incurred. To the extent that not all equity is moved from the relinquished to the replacement property, there will be tax. This is not to say that the (1031) exchange will not qualify for these reasons. Keep in mind, partial exchanges do in fact, qualify for a partial tax-deferral treatment. This simply means that the amount, of the difference (if any), will be taxed as "non-like-kind" real estate property.

THE 1031 Exchange Rule

A property transaction can only qualify for a deferred tax exchange if it follows the 1031 exchange rule laid down in the US tax code and the treasury regulations.

The foundation of 1031 exchange rule by the IRS is that the properties involved in the transaction must be "Like Kind" and Both properties must be held for a productive purpose in business or trade, as an investment.

The 1031 exchange rule also lays down a guideline for the proceeds of the sale. The proceeds from the sale must go through the hands of a Qualified Intermediary and not through your hands or the hands of one of your agents or else all the proceeds will become taxable. The entire cash or monetary proceeds from the original sale has to be reinvested towards acquiring the new real estate property. Any cash proceeds retained from the sale are taxable.

The second fundamental rule is that the 1031 exchange requires that the replacement property must be subject to an equal or greater level of debt than the property sold or as a result the buyer will be forced to pay the tax on the amount of decrease. If not he/she will have to put in additional cash to offset the low debt amount on the newly acquired property.

1031 Exchange Rules and Timelines:

There are 2 timelines that anybody going for a 1031 property exchange:

The Identification Period: This is the crucial period during which the party selling a property must identify other replacement properties that he proposes or wishes to buy. It is not uncommon to select more than one property. This period is scheduled as exactly 45 days from the day of selling the relinquished property. This 45 days timeline must be followed under any and all circumstances and is not extendable in any way, even if the 45th day falls on a Saturday, Sunday or legal US holiday.

The Exchange Period: This is the period within which a person who has sold the relinquished property must receive the replacement property. It is referred to as the Exchange Period under 1031 exchange (IRS) rule. This period ends at exactly 180 days after the date on which the person transfers the property relinquished or the due date for the person's tax return for that taxable year in which the transfer of the relinquished property has occurred, whichever situation is earlier. Now according to the 1031 exchange (IRS) rule, the 180 day timeline has to be adhered to under all circumstances and is not extendable in any situation, even if the 180th day falls on a Saturday, Sunday or legal (US) holiday.

Christopher Benedict coined the brand, Ask The Big Guy in 2001. Something of a maverick on the ritzy Main Line, Christopher is developing a network of young, high-energy professionals who share his "Strength In Numbers" philosophy. Christopher Benedict specializes in working with investors, as well as continuing to provide real estate services for buyers and sellers on the Main Line and the greater Philadelphia region. Visit www.AskTheBigGuy.com to learn more. For more information about exchanging your investment real estate, please contact Christopher Benedict at 610-779-5300.


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30 Days of Successful Due Diligence

By Frank Rolfe and Dave Reynolds     -     219 Pages


Don't make mistakes that could cost you thousands.
FROM MOBILE HOME PARK
"Due Diligence Experts"

Dave Reynolds and Frank Rolfe, Industry Professionals with a combined total of over $100,000,000 of completed mobile home park deal experience!

Dear Fellow Investor,

Many people who purchase their first mobile home park investment grind it out, paying for the "privilege" of being in the mobile home park business with every hour of their day, and every ounce of their energy.

 And guess what?  Many of these mobile home parks do not work as expected - their owners do... And they spend hours and hours spinning their wheels doing the WRONG things, for the WRONG reasons.

 

Bottom line, if you want to get into the business and not make mistakes that could end up costing you thousands, if not hundreds of thousands of dollars and wasted time and energy, and if you are open and honest about this "reality check" then we are giving you a chance to wiggle free from this trap you have burrowed yourself into... or are about to dig yourself into.

Now how do you know if you are "trapped" or "will soon be trapped"? 

 

Well, simply check off any of these thoughts that may have crossed your mind from time to time:

  • "Does this mobile home park actually make as much money as the owner has reported it does?  Is the owner cooking the books?"
     
  • "How do I check on the water lines or sewer lines?"
     
  • "How do I check on the market?"
     
  • "What questions should I ask the seller?  The city?  The electrician?
     
  • "What about all those Park Owned Mobile Homes?"
     
  • "Am I missing something?"
     
  • "What will I do if (fill in the blank)?
     
  • "I wish there was someone else that could help me this stinks!"
     

We have covered it all in this manual.

 

   Now, how many times after you made a mistake did you hear or think "You should  learn from your mistakes" or "I won't ever do that again"? 

Frank and I have definitely done this many times.  But there was never someone there to steer us in the right direction.

   Instead of wasting time and potentially thousands of dollars wouldn't it be nice to keep that hard earned money and make a wise investment?   

Instead of learning from your Mistakes... why not avoid making them in the first place?

 

So let us ask you -

  • Do you want to invest in the right Mobile Home Park and not regret it later?
     
  • Do you know how to determine if the park is a "Deal" or "No Deal"?
     
  • Are you sure you have not missed something?
     
  • Are you ready to get some advice from an unbiased and experienced third party?

    
Included in this manual is a day by day schedule that will help you plot our your strategy and schedule everything in the most cost effective manner.

Here is an excerpt from the beginning of the book...

FOREWORD

This manual is designed to give you a roadmap, from start to finish, in achieving a successful due diligence examination of a mobile home park.

Since the failure of any one step of due diligence might result in your decision not to buy the park, we have organized the order of steps in such a manner as to minimize expense and effort. We have chosen the order to put the items most likely to fail at the front end of your examination, to get the bad news early on and to act on it accordingly.

We have organized the manual in a day-by-day manner and while this makes for good organization, not every deal is going to fit into this order and if possible you would like to have 45 or 60 days to do the diligence, or at least a provision in your contract that allows you to extend the period in case some of the third party reports are not able to be completed in thirty days.  The real key is to make sure to complete all the steps in a complete and timely fashion.

Is 30 Days of Diligence Adequate?

Thirty days of diligence is an industry standard, but there is no rule that the due diligence period must be exactly thirty days. Of course, the longer the diligence period, the better it will be for you, the buyer. Sixty days is far superior to thirty if you can get it. And, of course, you can't get it unless you ask for it. Most people ask for thirty days because they are afraid that sixty days will scare the seller off, and less than thirty is way too short. That being said, I have done fourteen days of diligence on deals that I really wanted but that had a difficult seller. Less than fourteen days and you may just be wasting your time, since it is near to impossible to get a lot of third party reports completed that quickly, not to mention just the regular stuff that you perform yourself. If you are willing to forfeit your earnest money, then you can go as short as you want, and then walk the deal prior to closing, at the end of the financing period, if you don't want it after all.

If you have not completed your diligence in the required amount of time, say thirty days, it is sometimes possible to get the seller to give you an extension of time. If that is the case, the best way to get the extension is to meet with the seller and show him all of the work you have performed, so that he knows that your request is legitimate. When you propose such an extension to the seller, he is normally concerned that you are just wasting his time, and that you have no intention of buying it, or that you lack the money. It's your job to convince him that you can close, and will close, if he just gives you a few more days to complete your diligence. And you can even tell him what you have left to do, so that he knows you are not pulling his leg. If he says no, and you really want the deal and feel 99% positive it will work for you, you may elect to go forward anyway, and risk losing your earnest money if you walk before closing. Make sure that the contract does not require "specific performance" to buy the park. In that event, you cannot go past the diligence period without having to buy the park, even if you don't want it. You never want to sign a contract with specific performance in it for the buyer. The seller, on the other hand, should almost always face specific performance if he fails to consummate the sale to you.

Diligence periods in excess of sixty days are pretty unheard of, except in cases of extreme lack of park stability, such as not having any books, rent roll, etc. For example, it would not be unusual to ask more than 60 days to sort out bank foreclosure. However, except in that type of difficult environment, you will probably do some degree of damage to your reputation by asking for more than sixty days of diligence.

You will find in the due diligence process that there is no perfect park. While successful due diligence will help you formulate an idea on the true economics and risks of a mobile home park, it will still ultimately be your business decision as to whether or not to proceed with the purchase. Often, after assembling all of the data, you will still be unsure as to whether or not you want to proceed. This manual only helps you to collect that data. The decision to go forward is one that you will have to make on your own.

We receive more questions on due diligence than on virtually any other topic at MobileHomeParkStore.com and have written this manual to address those questions in great detail. If you follow all of the guidelines in this manual, you should be able to perform a satisfactory due diligence examination.

If this is your first park or you are looking for a second opinion we offer consultation on deal review and due diligence.  You can check out the various programs on www.mobilehomeparkstore.com.

Good luck on your due diligence!


Frank Rolfe & Dave Reynolds

 

BEFORE YOU START


TO DO LIST

      Purchase Contract

      Due Diligence Clause

      List of Items to Request from Seller
 

Your Purchase Contract

One of the most important items that you will need to have is a good purchase contract that has been reviewed by your attorney.  Don't ever just take a purchase contract you find on the internet or receive from the seller or seller's broker and sign it without first having your attorney review it.

A good purchase contract will have, at a minimum, the following:

      Full and Correct Legal Name of Seller (the correct name or company)

      Name of Purchaser and right of Purchaser to Assign Contract to an entity owned by Purchaser

      Legal Description and Address of the Property

      Description of Personal Property to be Included with Sale

      Purchase Price and Terms

      How Prorations are Handled

      Right of Purchaser to Conduct Due Diligence for a Period of at least 30 Days

      Right of Purchaser to Cancel and Receive a Refund of the Earnest Money and be Released from the Contract for any Reason during the Diligence Period

      Right of Purchaser to Cancel and Receive a Refund of the Earnest Money and be Released from the Contract if Financing cannot be Obtained at Reasonable Terms Approved by Purchaser.

      Who Pays for What:  Survey, Appraisal, Title Policy, Phase I, Closing Costs, Broker's Commission, etc.

      Date of Closing and Possession

      Representations of Seller

      Representations of Purchaser

      Acceptance Deadline

      Signature Block

In the past I have provided a copy of the contract that I use to buy mobile home parks and if you would like a copy of my contract, I am more than happy to send a copy to you with the understanding that before you use it that you will have it reviewed by your attorney. 

Due Diligence Clause

In your purchase contract you want to make sure that you have a good due diligence clause.  Here is a copy of the clause that I have in my contract:

PURCHASER'S RIGHTS OF INSPECTION, LOAN APPROVAL, AND CANCELLATION.

(a)       PURCHASER may inspect or cause to be inspected the condition of the Real Estate and all improvements and Personal Property;

(b)               PURCHASER may inspect or cause to be inspected all other documents and materials relating to the Real Estate and Personal Property;

(c)              
Within seven (7) days after the effective date of this agreement PURCHASER shall make a written request of SELLER to deliver all documents and materials needed from SELLER for inspection and evaluation.  Upon receiving this written request from PURCHASER, SELLER shall deliver any such documents or materials requested within seven (7) days of PURCHASER'S request; 

(d)               After all documents and materials have been delivered to PURCHASER, PURCHASER may cancel this Agreement for any reason, at the sole discretion of PURCHASER, within Thirty (30) days  after receiving all documents and materials from SELLER.  After the initial Thirty (30) day inspection period, PURCHASER may cancel this Agreement during the next Thirty (30) day period in the event that PURCHASER does not obtain a loan approval for the purchase of the Real Estate and Personal Property that is satisfactory to PURCHASER, and the determination of an acceptable loan shall be in the PURCHASER'S sole discretion. 

(e)              
In the event that any Third Party Reports are required by Purchaser or Purchaser's lender, and these Third Party Reports are not completed during this initial thirty (30) day inspection period, the inspection period will automatically be extended for an additional thirty (30) day period and PURCHASER shall have the same rights of cancellation as PURCHASER has during the initial thirty (30) day inspection period.          

SELLER shall allow PURCHASER, or PURCHASER'S representatives, access or provide documents for review, whichever the case may be, to the Real Estate and Personal Property, at all reasonable times and cooperate with PURCHASER'S efforts to conduct the inspections permitted herein.

 


And that is why we have written this manual... We want you to learn from our Mistakes... and not make the same ones we have made!


We don't want you to feel frustrated and broke!

      And it doesn't have to be this way... not for you...


LOCAL GUIDES
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