Need to know 1031 Transfer rules.

My question relates to the transfer of assets from the sale of a
rented (10 yrs.)condo,  closing date Jan 2004. Can I shelter any
portion of the capital gain if I reinvest the assets into another
rental property in the building I plan to buy and reside in as well?

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Request for Question Clarification by taxmama-ga on 25 Sep 2003 05:34 PDT

Dear Callabay,

Could you please clarify for me?

You want to sell a rental condo.
You want to buy another rental condo and live in it?

Or 

You want to buy a building with several units,
live in one and rent out the other units?

Your answers will make a big difference in the treatment. 

Thanks,

Your TaxMama-ga

Hello and thank you for your question.

I'm going to assume that you're in the process of selling a condo that
you've rented out for the past 10 years (so you haven't lived there
yourself in 10 years) and you're buying a building that includes
multiple condo units in it.  You're going to own all the units in the
building -- one unit you're going to live in and the rest you're going
to rent out.

The answer is yes, you can get 1031 deferral of your gain on the unit
you're selling, because it matches up with one or more units in the
new building (but not the one you're going to live in.)  The two
condos are like-kind property held for investment.  The unit you're
going to live in doesn't qualify because it's held for your personal
use.

<Background>
Section 1031(a)(1) of the Code provides that no gain or loss is
recognized on the exchange of property held for productive use in a
trade or business or for investment if such property is exchanged
solely for property of like kind that is to be held either for
productive use in a trade or business or for investment.

Please read the following article - - you can disregard the talk about
'reverse exchange' and 'tenancy in common.'  I cannot copy and paste
it here due to copyright concerns.
Section 1031 exchange can reap big tax saving
http://cincinnati.bizjournals.com/cincinnati/stories/2003/07/14/focus3.html?t=printable

Another good (copyrighted) article appears at
Defer tax on real estate gains with 1031 exchanges
http://www.bizjournals.com/southflorida/stories/2003/05/05/editorial3.html?jst=s_rs_hl

You'll note that in the simplest case, the person who is selling you
the condo units simply deeds them to you, and you deed your current
investment property to him or her as part of your purchase price.  If
the seller doesn't want to buy your condo, you need to find a third
party buyer.  Then you'll need a qualified intermediary who will set
up an escrow, take title to your property, sell it to your third party
buyer, and pay those funds to the seller of the building you're buying
as part of the purchase price (earmarking those funds for units other
than the unit you're planning to live in).

In using the qualified intermediary, you need to watch the 45 day and
180 requirements referred to in the above articles.

By the way, if your current unit has a mortgage you'll need to pay it
off first, unless the exchange property that you're taking for it
comes with a mortgage in that or a greater amount.

Here's a 40-page publication on the subject directly from the IRS;
note especially the first example on page 4.  Your case will be
simpler if you never used the condo you're selling as your home.
Publication 544
http://www.irs.gov/pub/irs-pdf/p544.pdf


Search terms used
"section 1031"
like-kind exchange site:irs.gov

Thanks again for bringing us your question.  If you find any of the
above unclear, please request clarification.  I would appreciate it if
you would hold off on rating my answer until I have a chance to reply.

Sincerely,
Google Answers Researcher
Richard-ga

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Request for Answer Clarification by callabay-ga on 30 Sep 2003 12:19 PDT

Dear Richard-ga

Thank you for your answer.

Clarification on my part may change your response.

The property I'm planning to sell is a condo. The property I "hope" to
purchase
is a three unit/apartment building in SF,CA. 

These three unit/apartments have not been converted to condo's yet.
Does the 1031 transfer still apply due to the fact that 2 out of the
three units will be rented to generate income and not used for
personal use. Will this set of facts fit into the "productive use in
trade or business or for investment" as stated on page 2 pp 2 in your
9/26/03 response?

I will await for your response before I dive into the other links
provided me

Thank you,

CallaBay-ga

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Clarification of Answer by richard-ga on 30 Sep 2003 13:47 PDT

Hello again.

The condo and apartment building are considered like-kind, so the
exchange will qualify.

But because you are buying one building rather than three condo units,
the part of the building that you are taking as a residence does not
qualify, that is, its value is treated as cash.

Example:  You bought your condo for $100,000, you've depreciated it to
$75,000 (I'll assume for simplicity that there's no depreciation
recapture on the sale), and today it's worth $300,000.  You're
exchanging it for a $300,000 building that contains three apartments,
one of which you're going to live in.

Without the exchange, your taxable gain is $300,000 - $75,000 =
$225,000

With the exchange, you're receiving qualifying property worth $200,000
(I'm assuming that's 2/3ds of the building) and non-qualifying
property wroth $100,000.

So you have to pay tax on $100,000 of the gain.  You're deferring
$125,000 of the gain.  Your tax basis in the new building will be
$75,000 + $100,000 = $175,000.  The proof that's the right answer is
that if you sell the building for the $300,000 that it's worth you'll
owe tax on the gain that you deferred
 $300,000 - $175,000 = $125,000.


See, for example,
PARTIAL TAX FREE EXCHANGE
http://www.1031.us/What_are_the_Rules_/Reinvestment/reinvestment.htm#Boot
"It is possible that the situation will arise when the Exchangor wants
or ends up receiving BOOT --that is taxable income.  There are three
basic sources of boot. These are --

Cash Boot.  Cash proceeds received at settlement or at the end of the
exchange process are taxable income up to the amount of the total
realized gain.

Mortgage Boot.  Mortgage relief (the mortgages on the replacement
properties are less then the total mortgages on the relinquished
properties) also becomes BOOT and taxable income.
Remember!!   New cash can offset Mortgage Boot

Non-Like Property Boot.  If the exchangor were to receive non-like
property in the transaction, say an automobile, it is considered as
taxable income at market value."

-R

You may read the 1031 rules at
http://www4.law.cornell.edu/uscode/26/1031.html - I am not well-versed
in the interpretation.  I hope that a Researcher familiar with the law
will be able to further assist you.

Best regards,
journalist-ga

Thanks for your frank response

callabay