Chapter 12 THE LAST LOOPHOLE Flashcards
1
Q
What is a major drawback of using IRC 1031?
A
The timetable and selection process where you have to identify the replacement property within 45 days after the closing of your property.
2
Q
What is the time frame allowed for completing a Starker exchange?
A
45 days to identify the replacement property and 180 days to complete the exchange.
3
Q
What can pressure to close within the time period of a Starker exchange lead to?
A
Making a rushed decision on which identified property to choose.
4
Q
What is a key benefit of using the Starker exchange?
A
It can save you from potential tax payments.
5
Q
How can you delay the closing of your property in a Starker exchange?
A
By including a provision in the purchase agreement that allows for an extended closing.
6
Q
What is a safer alternative to using Starker rules?
A
Simultaneous multiple exchange.
7
Q
What should you be cautious about when using a Starker exchange?
A
Getting pulled into a Starker exchange when it may not be necessary.
8
Q
What are the four key benefits of exchanges?
A
- Tax-free benefit increased
- Increased depreciation
- Expansion of the market
- Cash out
9
Q
What does IRC 1031 allow regarding tax implications?
A
It allows the tax basis of the old property to be transferred to the new property, deferring capital gains tax.
10
Q
What is the definition of ‘like kind property’ in the context of IRC 1031?
A
Any real interest held for use in a trade or business or held as an investment, not acquired for resale.
11
Q
What is the MACRS?
A
Modified Accelerated Cost Recovery System, which standardizes depreciation calculations.
12
Q
How does depreciation affect taxable income?
A
It reduces taxable income by the amount of depreciation deducted.
13
Q
What happens to the capital gains tax upon death of the property owner?
A
The capital gains tax does not carry forward after death; heirs take on property at its present value.
14
Q
What is the significance of increasing depreciation through an exchange?
A
It can provide a tax loss for clients needing it.
15
Q
Fill in the blank: The tax-free benefit under IRC 1031 is actually a _______.
A
deferred tax.
16
Q
True or False: Both parties in a Starker exchange must meet the like kind property test.
A
False.
17
Q
What is the result if property is exchanged without meeting the like kind property test?
A
The exchange may still be beneficial depending on the situation.
18
Q
What is the relationship between property basis and depreciation?
A
Depreciation reduces the tax basis of the property each year.
19
Q
How is the new tax basis calculated after an exchange?
A
Old basis plus net increase in debt.
20
Q
What must be excluded from the tax basis when calculating depreciation?
A
Land.
21
Q
What is the potential tax basis after an exchange for someone who had a previous basis of $45,000 and a net increase of debt of $650,000?
A
$680,000.
22
Q
What should you do if you don’t have a master plan for your property investments?
A
Refer back to setting your goals.
23
Q
What is the importance of understanding the problem before attempting an exchange?
A
To determine if the exchange will solve or move you closer to a solution.
24
Q
What can investors potentially achieve by utilizing Starker exchanges carefully?
A
Successful property exchanges while deferring tax payments.
25
What is a critical consideration for investors when dealing with Starker exchanges?
The initial 45 days for property identification.
26
What is the total new tax base for Keaster after the exchange?
$680,000
## Footnote
This is calculated as the old basis of $45,000 plus the net increase of debt.
27
What is the new annual depreciation after the exchange?
$20,218
## Footnote
This is 134 percent of the new investment cash of $15,000.
28
What is the cash required for a sale followed by the purchase of the apartment building?
$86,750
## Footnote
This amount is required to close the deal after selling the farm.
29
How much annual depreciation is generated from the sale and purchase scenario?
$26,181
## Footnote
This is a 30 percent ratio depreciation to cash.
30
What is the estimated capital gains tax on the sale of the farm?
$71,750
## Footnote
This is based on a 35 percent maximum rate applied to a gain of $205,000.
31
What is the net cash received by the seller after the sale of the farm?
$163,250
## Footnote
This is after deducting the capital gains tax from total proceeds.
32
What is the new base for depreciation after purchasing the apartment building?
$720,000
## Footnote
This is calculated as 80% of the new market value of $900,000.
33
What is the average rate of depreciation for the apartment building?
$26,181
## Footnote
This is based on a straight-line depreciation over 27.5 years.
34
What is the primary motivation for a property owner to engage in an exchange?
To avoid paying taxes on capital gains
## Footnote
This allows property owners to reinvest without tax penalties.
35
What are some reasons people avoid real estate exchanges?
* Lack of understanding of benefits
* Advice from trusted individuals
* Belief that one party gets the raw end
* Misconceptions about pricing in exchanges
* Expectation of getting exactly what they want
* Difficulty accepting intermediate steps
* Fear of taking something undesirable
## Footnote
These reasons reflect common psychological and practical barriers to engaging in exchanges.
36
What is the difference in cash flow for Bob if he sells versus exchanges his property?
Cash from sale: $37,500 vs. Cash from exchange: $60,000
## Footnote
The exchange allows Bob to avoid taxes and realize a greater cash flow.
37
What is a cash-out exchange?
When an owner exchanges a difficult-to-sell property for an easier-to-sell one to obtain cash
## Footnote
This strategy helps property owners access liquidity without selling their original property.
38
What is the primary benefit of exchanging properties rather than selling?
Avoidance of capital gains tax
## Footnote
This allows for greater reinvestment potential and cash flow.
39
What is the primary goal of the initial cash deal mentioned?
To tie together the cash and vacant land for acquisition.
40
What is essential for successful exchanges according to the text?
Patience.
41
True or False: You have to own something to make an exchange.
False.
42
What should you find out about the seller of the property you want?
What they would take as part of their sale.
43
What is an example of a property type that can be exchanged?
Vacant land.
44
What is the importance of zoning in real estate transactions?
It determines what can be built on the land.
45
What are the four steps to ascertain whether a seller can be enticed into an exchange?
* Get to know the goals of the seller
* Look around the marketplace for options
* Tie up the borrowed property before making an offer
* Understand that 'ideal' doesn’t exist
46
What is a common pitfall of using borrowed property in exchanges?
Not having good control of the property.
47
What are the seven primary motivations for people to accept an exchange?
* Must sell, but no buyer has come forward
* Has a tax problem that can be softened or eliminated
* Has zero investment in the property
* Wants out and is over their head
* Is an aggressive investor
* Has nowhere to go and wants to save face
* Can be motivated to own what you have
48
Who are the best sources for finding potential exchangers?
* Local real estate brokers
* Real estate lawyers
* Tax advisors
* Sellers with long-standing listings
* Anyone who offered a previously declined deal
* Those headed toward foreclosure
* Owners of desired properties
49
Fill in the blank: The seller of what you want might be motivated by _______.
[tax benefits]
50
What can broaden your market as a seller?
Offering your property for an exchange.
51
What was the outcome of the exchange involving oceanfront land in Vero Beach?
It resulted in cash and a significant equity recovery.
52
What should you do if a seller is motivated to take your property?
Find a way to make a cashless deal that meets their needs.
53
What is a 'soft deal' in the context of real estate exchanges?
An agreement that ties up property for exchange without immediate cash.
54
What should sellers investigate regarding their property?
Sellers should investigate their opportunities and examine the value of an exchange.
55
What is the cash balance in an exchange?
The cash balance is the amount of cash exchanged to balance the equities.
56
How can one achieve a balance of equities in exchanges?
By using:
* Cash balance
* Mortgage balance
* Combination balance
57
What is the importance of presentation in exchanges?
The presentation sets the tone for the exchange and affects the success of the deal.
58
What should you never ask the other party in an exchange?
Never ask the other party what the exchange value is of their property.
59
True or False: You should presume the other party will turn down anything.
False
60
What is a common mistake to avoid in communication during an exchange?
Avoid too much talk; keep offers concise and professional.
61
What should you include with an offer in an exchange?
Documentation for the other property in the exchange.
62
What attitude should you maintain when making offers?
Be persistent in your offers without being overly conciliatory.
63
Fill in the blank: Exchanges are a ______ for many people.
[new, wide-open game]
64
What should you avoid doing in terms of potential offers?
Never close doors too hard; keep options open.
65
What is the first step to getting into exchanges?
Make exchange offers.
66
What is a common pitfall of exchanges?
Frustration from dealing with misunderstandings and double-pricing situations.
67
Why is understanding tax laws important in exchanges?
To manage tax liability and optimize financial outcomes during exchanges.
68
What should you track to calculate your new tax basis?
Capital expenditures and improvements made to the property.
69
What is the difference between capital improvements and repairs?
Capital improvements increase the property's value; repairs maintain it.
70
What is a significant tax consideration when selling or exchanging property?
The gain is based on the adjusted sales price less the current tax basis.
71
What strategy can reduce or eliminate tax burdens during an exchange?
Using a sale to offset gains with losses from the same year.
72
What should you discuss with your CPA regarding investment properties?
The potential of shifting from capital improvement to repair
## Footnote
This discussion can help in understanding tax implications.
73
How is a personal residence treated differently by the IRS?
You cannot use a loss on your personal residence against investment income.
74
What does capitalizing mean in terms of home improvements?
Adding the cost of improvements to the tax basis, reducing gain upon sale.
75
What is the effect of replacing kitchen appliances on tax basis?
Increases tax basis by the difference in value of new and old appliances.
76
What should you establish when purchasing an existing home?
A value for all items in the house.
77
How can you establish values for items in a house?
By having an inventory list with agreed values or an independent evaluation.
78
What is depreciation in the context of investment property?
A tax break given to investment property, not personal residences.
79
Under what condition can you depreciate part of your residential property?
If you use part of the property for business purposes.
80
What is a potential downside of depreciating property?
It may increase gain tax upon sale of the property.
81
What is important to consider when closing on a 1031 exchange?
Establishing your new tax basis.
82
What is the first step in calculating the new tax basis after a 1031 exchange?
Sale price or value of the old property.
83
What should you provide your tax advisors with?
Factual information about yourself, your goals, and any other property.
84
Why might a lawyer or CPA give negative advice about creative techniques?
They may not be well versed in the field.
85
What is a beneficial move for a seller in an exchange?
Approaching an exchange as a part of the deal.
86
What is one way to improve your ability to make beneficial exchanges?
Be on the lookout for exchanges wherever you go.
87
What should you learn to negotiate with other exchangers?
Their experience and language used in exchanges.
88
What should you not get hung up on during an exchange?
The math of the exchange.
89
How can exchanges be used in financing?
By finding solutions to clients' problems.
90
What should you avoid becoming in real estate exchanges?
A professional exchanger.
91
What should you do to gain experience in exchanging?
Read more about the topic and watch for changes in the law.
92
What is the bottom line regarding real estate exchanges?
They are tools that can help you move closer to your goals.
93
What is the goal of IRS Section 1031?
To allow real estate investors to acquire real estate and later sell it at a gain without paying capital gains tax.
94
What does IRS Section 1031 allow investors to do?
Build wealth by rolling the gain from one investment into another.
95
Is there a limit to how many times an investor can use Section 1031?
No, there is no limit.
96
What is a key benefit of properly executed 1031 exchanges?
All gain from each transaction can be tax-free.
97
What is the purpose of the chapter discussed?
To explain the mechanics of IRS Section 1031 and how to utilize it for wealth building.
98
What is an example of a real estate exchange provided in the chapter?
Fred trades a residential lot in North Carolina for part of the equity in a strip shopping center in Florida.
99
What was Fred's initial offer for the strip shopping center?
$500,000.
100
What was the final agreed price for the strip shopping center?
$625,000.
101
What was included in Fred's offer to make the deal more appealing?
A mountain lot in North Carolina.
102
What is required within 180 days of transferring property in a 1031 exchange?
The property must be identified and the exchange completed.
103
What types of properties are excluded from Section 1031 exchanges?
* Stocks in trade or property held primarily for sale
* Stocks, bonds, or notes
* Other securities or evidences of indebtedness
* Interests in a partnership
* Certificates of trust
* Choses in action
104
True or False: A diamond ring can be included in a 1031 exchange without tax implications.
False.
105
What happens to the basis of property acquired in a Section 1031 exchange?
It is the same as the property exchanged, adjusted for money received and recognized gain or loss.
106
What is a special rule regarding livestock in Section 1031 exchanges?
Livestock of different sexes are not considered property of like kind.
107
What is the consequence of exchanging property with a related person under Section 1031?
Nonrecognition of gain or loss may not apply if the related person disposes of the property within two years.
108
Fill in the blank: IRS Section 1031 provides nonrecognition of _____ or loss from exchanges held for productive use or investment.
gain
109
What is the IRS's view of exchanges that include cash or other property?
Gain is recognized up to the amount of cash or fair market value of other property received.
110
What is the predominant use determined by for personal property in a Section 1031 exchange?
The two-year period ending on the date of relinquishment.
111
What is the significance of personal property used predominantly within or outside the United States in terms of like-kind exchange?
Personal property used predominantly within the United States and personal property used predominantly outside the United States are not property of a like kind.
112
How is the predominant use of property determined in a like-kind exchange?
The predominant use of any property shall be determined based on:
* The two-year period ending on the date of relinquishment for the property given up
* The two-year period beginning on the date of acquisition for the property acquired.
113
What is the rule for property held for less than two years in a like-kind exchange?
Only the periods the property was held by the person relinquishing the property or acquiring the property shall be taken into account.
114
What special rule applies to certain property under Section 168(g)(4)?
Property described in any subparagraph of section 168(g)(4) shall be treated as used predominantly in the United States.
115
What is the IRS's view on a personal residence in the context of investment property?
The home in which you live is excluded from being considered as an investment property for tax purposes.
116
What does 'exchanged solely for property of like kind' mean?
If the property given up in an exchange was held for investment, then the property acquired must also be for investment.
117
True or False: Not all exchanges are beneficial under IRS rules.
True.
118
What must exist to benefit from IRC 1031 treatment?
There must be a potential taxable gain in the event of a sale.
119
What is the primary benefit of a 1031 exchange?
The ability to postpone gains tax.
120
What is 'boot' in the context of a 1031 exchange?
Anything except real property or fixtures attached to the real estate, such as cash or personal items.
121
How is 'gain' on property calculated?
Gain is the sum of everything received in a sale or exchange less the adjusted cost.
122
What is the tax basis of a property?
The tax basis is like book value, determined by the purchase price and adjusted for improvements and deductions.
123
What is depreciation in real estate investment?
Depreciation is a legal tax deduction that reduces taxable income, applied to the buildings and improvements but not the land.
124
What is the typical life span used for depreciation in real estate, as per the example?
40 years.
125
How does depreciation affect taxable income?
Depreciation reduces taxable income without affecting actual income.
126
What is the maximum passive loss that can be applied against active income for real estate investors owning 10% or more?
$25,000.
127
What is the outcome if an investor has $100,000 in active business depreciation?
The taxable earnings can be reduced to zero.
128
What is the impact of passive loss on active income?
A passive loss can be applied against $25,000 of active income.
129
What happens if you have $100,000 in earnings and $100,000 in depreciation from your active business?
Your taxable earnings are zero, although you received $100,000 in earnings.
130
What is the consequence of taking depreciation faster than straight line?
It cannot be used to create capital gain, and the overage will be taxed as ordinary gain.
131
How much depreciation would you have after five years on a $275,000 building using straight-line depreciation?
$50,000 total depreciation ($10,000 per year).
132
What is boot in a 1031 exchange?
Boot is anything other than real estate that is taxable, such as cash or personal property.
133
What happens to boot received in a 1031 exchange?
You will be taxed on the boot portion.
134
Define net mortgage relief in the context of property exchange.
Net mortgage relief occurs when exchanging properties free of mortgages, where no mortgages are given up.
135
What is the taxable gain in an exchange if there is net mortgage relief?
A recognized gain may arise if the mortgage relief exceeds the realized gain.
136
What is the tax basis of Smith's property in the exchange with Greenwald?
$100,000.
137
What is the tax basis of Greenwald's property in the exchange with Smith?
$140,000.
138
What is the required cash payment for Blackburn to balance the exchange with Jones?
$50,000.
139
In the Smith and Greenwald exchange, what is the recognized gain?
Zero.
140
In the Jones and Blackburn exchange, what is the recognized gain for Blackburn?
$100,000.
141
What is a Starker Exchange?
An IRS 1031 qualified exchange allowing the originator to sell first and buy later through a facilitator.
142
What are the advantages of a Starker Exchange?
Allows you to sell property and defer taxes while acquiring desired replacement property.
143
What is the role of the facilitator in a Starker Exchange?
The facilitator holds the proceeds from the sale and uses them to purchase a replacement property.
144
What qualifies as like-kind property in a Starker Exchange?
Only the portion of the property given up and the property taken that meets IRS qualifications.
145
Fill in the blank: Boot is anything other than ______.
real estate.
146
True or False: You can avoid taxes on boot received in a 1031 exchange.
False.
147
What was the total property value exchanged between Jones and Blackburn?
$500,000.
148
What happens if the net mortgage relief is greater than the realized gain?
You will have some tax in the exchange.
149
What is the adjusted tax basis for Hugh's property before the exchange?
$330,000.
150
What is the capital gain if Hugh sells his property for $345,000?
$100,000.
151
What is the purpose of a Starker Exchange?
To allow you to sell property now and exchange later without immediate tax liabilities.
152
What determines the tax benefits of a Starker Exchange?
The benefits apply only to the portion of property given up and the like kind property received.
153
What qualifies as like kind property for the IRS?
Property owned for investment purposes or for use in trade or business.
154
Does the quality or category of property affect its qualification as like kind property?
No, it is based on the intent of ownership.
155
What type of property does not qualify for a Starker Exchange?
Inventory property held by real estate developers.
156
In a Starker Exchange, can you qualify as the giver and receiver of like kind property?
Yes, even if the other party does not qualify.
157
What is the first critical time rule to follow in a Starker Exchange?
Identify a potential property to acquire within 45 days of transferring your deed.
158
What is the second critical time rule in a Starker Exchange?
Take title to the replacement property within 180 days from the transfer of your old property.
159
What happens if you have access to the money from selling your property?
It violates the 1031 exchange process and nullifies tax benefits.
160
Who must hold the money during a Starker Exchange?
A qualified intermediary or facilitator.
161
Why should you avoid using close friends or family as intermediaries?
To maintain an arm's length transaction and comply with IRS regulations.
162
What should you do before entering into any contracts related to a Starker Exchange?
Discuss the situation with your CPA or tax advisor.
163
Fill in the blank: The IRS requires you to identify potential properties within _______ days of transferring your deed.
45
164
Fill in the blank: You must take title to the replacement property within _______ days of transferring your deed.
180
165
True or False: The IRS is only interested in the date you enter into a contract to sell your property.
False
