A bit complicated - 1031 exchange ideas needed
Hi all, I subscribed to this forum for some ideas on how to make this work. In 1963, my father was killed in an accident and our farm passed to us, his kids, with undivided interest ownerships. Our Mom had a life estate and received the income for her lifetime but passed away in 1992 and since then it's been, basically, our hassle. Flash forward over all the years and we are selling the farm, finally, to avoid passing this on to the next generation and creating an even bigger mess. Some years ago I put my own 20% ownership on the farm into a Revocable Trust with myself as trustee and beneficiary, for estate planning purposes. There is no debt on this property and the capital gains tax will be substantial - I was told by my accountant that the tax would be anywhere from $116,000 to $160,000 on my share, if my net from the sale was the estimated ~$600,000. I am a retired federal employee and my income isn't that great but I get by. We own our home with a very small equity loan being the only lien on it. I'm not at the stage in my life to go out on a limb as far as huge risks or turn into some big real estate mogul - just want to do this one thing correctly. :)
So the farm is listed for sale and the State is negotiating for the purchase as State Land inventory, however they just screwed up by hiring an incompetent ag appraiser who didn't pass muster, and so they have to re-do the appraisal and the review of the appraisal. That will cause a delay of the closing till after the time they would need to get a new lessee for the coming year so they want to delay the closing till Oct 1, the end of the next growing season. Meanwhile, I have located the replacement property I truly want.... property I can use for income for a couple of years and eventually build and live there. A small acreage. The owner of the property is an estate and they want to sell to me and are willing to work with me as much as they can, and by that I mean they are willing to put off the closing for a bit, to make it all work. They are also putting off listing the property as well, at least till Spring. I have talked to them about the possibility of leasing with an option - wondering if this is something that is feasible at all and how we could make this work. I was told it might work as far as the exchange, I could buy land as a replacement that I have rented from the owner....but we have to be very careful that it's a bona fide lease and not a purchase disguised as a lease... thoughts?
The price of this replacement property is less than what I would ever receive from the sale of the relinquished property, farm, so I do understand there will be some "boot", as well.
I know I could do a reverse exchange but have already found out that the State can be a glitchy buyer to work with and has postponed closing once already. The problem is, say the EAT acquires the replacement property and "parks" the title on May 1, and the farm sale goes down the tubes or otherwise doesn't close timely and I miss the 180 day deadline? That wouldn't be cool! I am willing to sell my share of the farm out to an investor, even, but where does one find an investor who will step into a 1/5 undivided interest in a farm that's up for sale? I am willing to borrow money (not sure where or how that's done) and the Exchange Coordinator I talked to acted like "yeah, good luck finding a lender." and said that most people who do reverse exchanges either have the cash sitting around or own other property they can put a lien on. Well I'm not really willing to put a lien on our home for that, especially with the risk of a failed 1031 exchange costing huge tax $, plus our home doesn't have $325K in equity anyway.
The exchange company I spoke with mentioned something about forming a one person LLC and having the LLC (somehow) purchase the replacement property, then later when the farm sells (or something) I could do the exchange via buying the property from "my" LLC. Is that really possible? Any other possibilities or creative ideas? The property I want to use as replacement, as I said, is very special to me as it belonged to my dear friend who recently passed away. I am so honored that her family wants to work with me to make this work - I just need to find a way.
I know this is long. I tried to make it shorter but dang it's kind of complicated!
Any ideas at all would surely be appreciated. Thanks in advance!
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Originally posted by @Sandra S.:
I have talked to them about the possibility of leasing with an option - wondering if this is something that is feasible at all and how we could make this work. I was told it might work as far as the exchange, I could buy land as a replacement that I have rented from the owner....but we have to be very careful that it's a bona fide lease and not a purchase disguised as a lease... thoughts?
Yes, a lease option could work as long as it is truly a lease option. If it looks too much like an actual purchase, then it would not qualify.
The price of this replacement property is less than what I would ever receive from the sale of the relinquished property, farm, so I do understand there will be some "boot", as well.
Yes, the difference would be taxable boot. You could also two or more replacement properties that could allow you to defer all of your taxes. You are not limited to buying just one replacement property.
The exchange company I spoke with mentioned something about forming a one person LLC and having the LLC (somehow) purchase the replacement property, then later when the farm sells (or something) I could do the exchange via buying the property from "my" LLC. Is that really possible? Any other possibilities or creative ideas? The property I want to use as replacement, as I said, is very special to me as it belonged to my dear friend who recently passed away. I am so honored that her family wants to work with me to make this work - I just need to find a way.
No, forming a single member limited liability company would not work if you are the sole member. The single member LLC would be classified as a "disregarded entity" and would be treated as if you had bought the property personally. Frankly, I'm surprised that the Qualified Intermediary did not know that already. It would work if the LLC was owned by someone that is completely unrelated to you and they assumed all of the benefits and burdens of ownership. There can be no guarantees or indemnification or covering of expenses, losses, etc. It has to be a bonafide purchase of the real estate.
You know what, it's entirely possible that I misunderstood what the QI was telling me about the LLC! I spoke with him again today and he sent me more information, I just started studying it and I am quite sure I was on the wrong track before...
Regarding the lease option - thinking that it might work if it was structured like an actual lease with a "normal" deposit and monthly amounts, and then a separate document that was an option to purchase.... instead of the lease/option having some huge deposit that could be interpreted by the IRS as a down payment, and then, for example, the "rent" payments being applied to the purchase price...
Just thinking...
Additionally I am wondering how to go about finding a lender for this reverse exchange. I have no debt on my farm interests, but since it is in a different state and is undivided interest, a lender may not wish to put a lien on it. We do not have extra equity in our home, enough to provide that much cash, which is in total more than our home is probably worth anyway. I do have excellent credit. How does a person usually locate a lender who will work with you on a short term loan? Where would I find reputable contacts?
Thanks again for any help you can provide!
Sandra,
Creative idea...consider placing the family farm in a Conservation Easement (CE) a very common practice for properties that work.
(Google national conservation easement database)
There are several Ag-lending banks out there, eager to loan for agricultural properties.
Farm Credit Bank
Regions Bank
Brandan Lail, Georgia
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Yes, the standard lease with an option with normal deposit/payment/option terms is fine, but a large deposit can get you into trouble. You just have to make sure that you have not effectively already acquired the property for tax purposes.
Bill.
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Traditional/conventional lenders, especially those that are conduit lenders will not touch reverse exchange transactions. There concern is that they may not be able to sell the loans to investors. You are more likely going to use a portfolio lender that will keep the loan or a private/hard money lender that is very willing to do a bridge loan.
Thanks, yes will definitely limit the size of deposit to something relatively small. And will check into those types of lenders or see if I can find them in the area. Google....
Brandon, interesting idea on the Conservation Easement, actually part of our farm (nearly 400 acres) is already in a conservation reserve program, but that will be transferred to the buyer - it's not an easement. Having worked for USDA for 30 years I am familiar with the easement programs - they are a very good thing provided the land works for that and you don't really want the full market value out of it, like you are more interested in protecting it, or developing particular special areas, etc. Good and creative idea, though! Thanks!
I did a 1031 exchange this year in Tennessee and it was not nearly as complicated as what you are describing. In my opinion an expert would be well worth your money . The lowest cost Qualified Intermediary in your situation might not be the way to go. I suggest you get some referrals of experts in your state who have experience in this type of transaction.
Best of Luck.
Anne
Sandra, I am no expert. Our family farm exchange was not nearly as complicated as your situation. We worked with Toija Beutler, who now has her own 1031 firm. Our farm was in Oregon, and we considered buying exchange properties in various locations around the NW, including properties in Anacortes and Whidbey. You might at least want to contact her to see what advice she is willing to share with you. We got helpful info up front before committing to her or spending a single dime. We also have a great accountant who knows about laws, including estate work, in many NW states. The two together were an invaluable team that helped us wrap our heads around our options and implications.
http://www.beutlerexchangegroup.com/
Best of luck in putting together all the pieces to make this work! I can appreciate that working with farm properties, in and of themselves, are complicated and transactions that don't move quickly, let alone with multifaceted layers of property ownership.
Put the replacement property in contract and make the close of escrow contingent on the sale of the farm if the seller will agree. You can give them earnest money that can be refunded to you at close of escrow of the farm or if the farm ends up not selling within whatever time frame the seller will agree to then you can agree in the contract that they can keep it for their time and energy. The LLC game you describe won't fly in an IRS audit (I'm a former IRS employee from large case division and a CPA so I know). It's so simple to work with a real estate agent and find an additional property as well to avoid tax on the balance of your gain... Truly... Or alternatively you can also use the leftover boot to build an additional structure or add improvements to that property you plan to buy provided you complete all those improvements within the 180 day deadline. So if you are thinking of moving into the replacement property some day, just do some or all of those improvements within 180 days of your close of escrow on the relinquished property. I've done this, and passed an IRS audit on it. It works. Anyway good luck!
Some really great responses here, which I appreciate so much!
@Christal England I did pretty much exactly what you said, here (and dumped the LLC idea which was lame anyway.) It's hard to believe it's been a year since I asked this question! And now the exchange is done and I have an accountant with the jitters. Maybe rightly so, I don't know. I did as above, purchasing the property through a qualified intermediary, and continuing to make improvements for the 180 days (which just passed.) The improvement funds were held in an account and the title was held by the EAT. As I made improvements, I submitted invoices to the EAT and they cut me checks. As I believe I said before, the relinquished property was a farm with all the usual outbuildings and a residence (which I had not lived in since I was young.) The replacement property is also a small acreage farm, having been a locally well-known commercial herb and flower business for years, and I will continue that business. It also has a loft room above the barn that I have renovated in a major way, for a rental. And we also have been building a residence with some of the leftover exchange funds, (about $100K) and all the work and materials that we have paid for from those funds is complete, however it's still a work in progress and we don't anticipate moving in to the home for some time. In fact, we have had to get a HELOC on our current residence to finance the rest of it. I have no idea when all that needs to be done on the new place will be complete, realistically. It has been 6 months and it may be another 6 months or more, even. Meanwhile we will be renting out the loft of course, and running the flower business. My accountant says he believes that it's possible we could say 80% of the place would qualify and that 20% would be related to the residence we are building, and therefore subject to tax. My question is, though, if the entire place is a farm and there is this side rental business, AND we do not know when we may actually move to the residence that's being constructed, why would we assume upfront that 20% doesn't qualify?
I'm very interested in knowing how this turned out, since April 15 has passed and presumably you have filed your tax return and completed the Form 8824 detailing the transaction for the IRS.
What kind of Exchange was this: a Delayed Like Kind Exchange, a Reverse Exchange, or a Construction/Improvement Exchange?
Why was there an Exchange Accommodation Titleholder (EAT) involved? What exactly did it do?
When did you close on your Relinquished Property and when was the Replacement Property acquired by the EAT (I assume)?
What is the 180-day period you talked about?
You must have a lot of great information to share after what you have accomplished.
Thanks.
@Account Closed it turned out very well. Our accountant completed our tax forms and, since the house is not yet finished and the property purchased has a long history in the area of being a small farm, and it also contains a rental unit, the accountant said he felt more at ease about declaring it 100% Income and Investment at this time. We will just keep operating it as a small herb and flower farm and renting the rental portion, and will delay moving into the house for a while, well it is still unfinished anyway. And in answer to your question, this was a construction/improvement exchange.
There was a need for an EAT to hold title to the replacement property over the period of time from the closing of the relinquished property until all the remaining funds were expended in improvements. (the property purchased was less $ than the amount received for the relinquished) As soon as those funds were expended in improvements, the title passed to me.
Relinquished property closed in August, 2015. Replacement Property was acquired a few days later. The 180 day period is the date the exchange must be completed in entirety. There had to be no more than 180 days from the date of the closing of the relinquished property until the title to the replacement was in my name. Again, there was a delay due to expending remaining funds on needed improvements, thus the need for the EAT. If I hadn't expended all the remaining funds, then whatever remained at 180 days would be taxable "boot." I expended it well before that, so no problem.
As far as how this worked - it has worked great so far! I had good advice and a great Qualified Intermediary and a great accountant too. If anyone is considering doing this, I just have to say, read and read and study the rules till you know them forwards and backwards. Then hire your qualified intermediary and have a long talk with him about your deal and plans, and validate that you understand what you are doing. Then let him do his thing.
Great information. Thanks for sharing. This is how it actually works in the real world.