§1031 Exchange Intermediary

This is a follow-up to a posting written yesterday about Return on Equity. In that blog, I promised to return to offer solutions for increasing the investor’s Return on Equity, and that is the subject of this post.

Please check out yesterday’s blog if you have any question about what Return on Equity is and why it is so important to monitor the ROE of an investment. Assuming that you’re up to speed on that, let’s investigate what can be done to maximize Return on Equity.

To increase your ROE in the world of real estate, you must re-leverage your equity periodically. In English, that means you need to get the equity out of your investment and use it as a down payment for another investment. How can that be done? I can think of three ways:

• Sell the property.
• Refinance the property.
• Exchange the property.

One by one, let’s discuss these alternatives:

Sell the property. A logical solution, but there are tax ramifications. A healthy portion of your equity is going to be eaten up by those pesky taxes. While it is certainly possible to re-leverage your investment this way, it’s not a smart way to increase your ROE.

Refinance the property. Better, but still some problems. In most cases, you will not be able to pull out 100% of your equity. Your lender may limit you to 80% loan-to-value, or some other percentage. If you have great enough equity in your property, you may be able to raise a significant amount of money by refinancing, but you generally will not be able to get at all of it. Nor may you want to even if you can; the potential negative cash flow that could result may be burdensome.

Exchange the property. Since my company is in the exchange business, it may seem a forgone conclusion that I might claim that exchanging is the best way to re-leverage equity to increase ROE. But let’s dig deeper. A successful exchange allows the investor to release all of his equity from a property to use in new property (minus the costs of the sale; there are costs associated with virtually any solution). This can be a tremendous wealth generator. Take an individual who owns a $100,000 property free and clear. Setting transactional costs aside for a moment, by releasing that equity into a new investment, the investor could conceivably purchase a $500,000 property using his $100,000 equity as a 20% down payment. Again, setting aside the other benefits of ownership addressed in the previous blog (CFBT, Principal Reduction, and Tax Savings), if the two properties appreciated at the same rate, let’s say 4% per year, in five years his old investment would be worth $121,665. By exchanging into the new property, in five years the new property’s value would be $608,326. His equity would be $86,661 more than had he left it in the old property ($108,326 minus $21,665).

Stated another way, his $100,000 equity would have grown to $121,665 if he had stayed in the old property. By exchanging into the new one, his $100,000 equity grew to $208,326. And again, this disregards the other benefits of ownership cited in the paragraph above, which would likely all be higher in the new property as well.

To conclude, examine your Return on Equity every year or so. When you can do better in a new investment, exchange out of the old and into the new. Don’t get married to your properties! Move on and move up!!

******

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Solutions to Increasing Your Return on Equity * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.  

Return on Equity is the subject today. In an earlier blog, I promised to get back to the ideas that were presented last Saturday at the Omaha Landlord Association’s event that featured Tom Lundstedt, “the funniest investment and tax guy in America.” The crux of what I took out of the seminar was that we should all examine our RETURN ON EQUITY periodically (Tom suggests once annually) and shift our equity into more lucrative investments when it is clear that a better return can be obtained.

First off, let’s highlight the four means of making money in investment real estate:

1. Cash Flow Before Taxes (CFBT)—what’s left over after you’ve fulfilled all of your obligations relating to the property.
2. Principal Reduction—each month that you make a mortgage payment, your tenants are buying the property for you.
3. Income Tax Savings—you get to tell the government that you’re losing money
4. Appreciation—while the property is going up in value (most of the time…).

Let’s now go to an example. Here are the assumptions: Fifteen years ago, you bought a rental house for $100,000. You made a $15,000 down payment on the house. The first year, your CFBT, Principal Reduction, and Tax Savings amounted to $2,800. Before even considering any appreciation, your Return on Equity in the first year was 19% ($2,800 divided by $15,000). As Tom would say, “Plus appreciation? You’re an investment genius!”

Next set of assumptions: CFBT increases annually. Principal continues to be reduced every year. Taxes continue to be treated in the same manner as they were in Year One.

Here’s a pop quiz—after fifteen years of this pattern, is your Return on Equity higher than in Year One, or lower than in Year One? Think about that while you review the next set of assumptions:

Year Fifteen Assumptions: CFBT has increased from the first year’s figure of $934 to $2,500. In the first year, principal reduction was $784; in Year Fifteen it is $2,232. The property is still sheltering some of its income from taxes, but not all. The depreciation of $3,091 per year is not enough to completely shelter the $4,732 in CFBT plus Principal Reduction. In a 35% bracket, $574 will have to be deducted from the $4,732, which results in a net of $4,158 (excluding any appreciation again). So the net from the property before appreciation has gone from $2,800 to $4,158. Now to answer the question in the previous paragraph.

If you apply the Year Fifteen return of $4,158 to the initial investment of $15,000, you’d have a pretty nice return of 28%. But is $15,000 still your equity in this investment? Hardly…

At a rate of appreciation of 3.5% (certainly not stellar appreciation over the long term) and assuming that the $100,000 you paid in Year One was fair market value, after fifteen years the house would be worth $167,500. And after fifteen years, your loan balance would be paid down to $64,113 (that’s at 7.5% with a 30 year amortization). Your gross equity in Year Fifteen has risen from the $15,000 that you invested to $103,387! ($167,500 minus $64,113.) Applying the $4,158 return to that number results in a Return on Equity of only 4.0%!! ($4,158 divided by $103,387.) That’s a traditional passbook savings rate, but you have to manage the property to get it—not my idea of a good investment.

This blog has gotten very long and very cumbersome with all of the numbers, so let’s close it out with a promise to do the next blog on the solution to the declining Return on Equity. I’ll give you a hint in advance—it has a lot to do with my business of tax-deferred exchanges. Thanks for reading.

******

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Return on Equity * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.  

Last Saturday, March 29, 2008, the Omaha Landlord Association put on a great event. The day featured speaker Tom Lundstedt (www.tomlundstedt.com), who is billed as “the funniest investment and tax guy in America!” Based on my experience on Saturday, if he is not the funniest, I don’t know who is. (By the way, I am posting this after the fact because I did not find out about the event until last Thursday.)

The reason I was there, from two hours away in West Des Moines, was to be one of the exhibitors who were able to expose their services and products to the 200 or so attendees, all of whom were involved in real estate investments in some way or another.

Mr. Lundstedt spoke for about two hours on “How to Build Wealth in Real Estate.” Some of the topics that he touched on were purchasing real estate within your IRA, how to analyze a potential investment, and how to determine when it is time to move your equity into a new investment. Most importantly for my business, Tom spent about the last five minutes of the talk espousing the benefits of Section 1031 exchanges. My table was a fairly popular place after the presentation came to an end and the attendees moved into the room of exhibitors thanks to Tom’s comments.

I’m planning a blog or two in the next week or so that are based on Tom’s comments. As a long-time investor and qualified intermediary for Section 1031 like-kind exchanges, I found them very insightful.

******

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Omaha Landlord Association Event, March 29, 2008 * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States. 

A recent survey of farmland real estate brokers shows that the price of Iowa’s best farmland rose by an average of 12 percent from September 2007 through February 2008. This survey was conducted by the Iowa Farm and Land Chapter 2 Realtors Land Institute, as it has been done every March and September since 1978. The RLI is composed of real estate brokers who specialize in farm and land sales, farm management, and appraisals. The results were cited in an article in the Sunday Des Moines Register on March 20, 2008.

Troy Louwagie, the survey chairman as well as a real estate coordinator at Hertz Farm Management in Mount Vernon, had this to say about the results of the survey: “This was the highest dollar-per-acre number we’ve ever had, the second-highest six-month gain, and the third-highest annual increase over the 30 years since the survey began.”

Mr. Louwagie cited the following factors as contributors to the increase:

• increased corn and soybean prices
• ethanol industry expansion
• a limited amount of land available for purchase
• good crop yields during the last growing season
• a generally positive attitude about agriculture
• relatively low long-term interest rates
• higher cash rents for farmland

Some of the concerns mentioned by respondents to the survey were uncertainty about the outcome of the current debate in Congress about the government farm program, ever-increasing fuel and fertilizer costs, and the decreasing returns of the livestock industry.

For the survey, the state is divided into nine districts. Five of those districts had per-acre averages of more than $5,000 in this survey, compared to only one district with such an average in the September 2007 survey.

Even timberland, often purchased as recreational and hunting ground, showed the same 12% average rate of increase over the six-month period, averaging $2,045 per acre.

Please consider IOWA EQUITY EXCHANGE as your source for answers to your questions about Section 1031 like-kind tax-deferred exchanges. Contact us at your convenience for prompt, accurate information. Please think of us for your next exchange.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Iowa Land Price Survey Shows 12% Rise in Six Months * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

I have been honored with an invitation to speak at the Two Rivers Real Estate Investor’s Association monthly meeting on Wednesday, March 19, 2008. The meeting will be held at the Agribusiness of Iowa Building, 900 Des Moines Street, Des Moines, IA, from 6:00 pm to 7:30 pm. Click for map.

There is a nominal fee of $10.00 to attend the meeting (goes to the association, not me!), or you can elect to pay $20.00 that will cover you for the entire quarter.

We’re going to talk about the basics of Section 1031 tax-deferred like-kind exchanges, plus we’ll get into some more advanced areas, too. Andrew Lietzow, Grand Pubah of the association, has specifically asked me to discuss reverse exchanges. In addition, I’m going to get out my buy-and-hold versus buy-and-exchange spreadsheet and see if I can get some input numbers from the attendees to crunch. Andrew has also asked me to consider singing my alma mater’s fight song; if I do so, it will take place at the very end of the meeting; any earlier and it would drive everyone away.

There will be take-home materials distributed, and a good time will be had by all.

Come visit, learn about tax-deferred exchanges, and see why IOWA EQUITY EXCHANGE is the company you should use for your next Section 1031 tax-deferred exchange.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Two Rivers Real Estate Investor’s Association Meeting * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Recently, the Internal Revenue Service put out a nice little summary of Section 1031 like-kind, tax-deferred exchanges. “FS-2008-18” (FS = Fact Sheet) does a great job of summarizing the requirements, pitfalls, and advantages of like-kind exchanges.

The article starts off by observing that generally the seller of business or investment property is liable for tax on any gain, but Section 1031 allows for an exception for those who perform a tax-deferred exchange. Further, exchanges can result in full or partial tax deferral, depending upon whether cash, relief from debt, or non-like-kind property was received in the transaction.

The article is presented in a FAQs format, answering questions such as, “Who qualifies for the Section 1031 exchange?” (Answer: Owners of investment and business property, who can be individuals, C-corps, S-corps, partnerships [general or limited], LLC’s, trusts, or any other taxpaying entity.) Also commented on is who doesn't qualify for a Section 1031 tax-deferred like-kind exchange?

The different exchange structures (simultaneous, delayed [referred to as ‘deferred’ in the publication], and reverse) are briefly explained. Also, qualifying properties are described, including the requirement that properties be of “like-kind.” A list of excluded types of properties is included (such as stocks, partnership interests, etc.).

The next question deals with the timing requirements for completing a Section 1031 tax-deferred like-kind exchange. The 45-day Identification Period and the 180-day Closing Period are briefly addressed. Other restrictions, such as who can function as a qualified intermediary, are discussed as well. A caveat to be careful in your selection of a qualified intermediary is included.

The article wraps up with a discussion of how to calculate the basis in the new property, how to report the exchange to the IRS, and the long-term impacts of exchanging. The last paragraph is another caveat to beware of individuals who promote the improper use of Section 1031 tax-deferred exchanges; for instance, the encouragement to exchange vacation or second homes that do not qualify for an exchange. (The IRS released Rev. Proc. 2008-16, published today, that sets forth specific guidelines on the exchange of vacation homes. Rev. Proc. 2008-16 makes it much clearer what can be done to qualify your property as worthy of an exchange. That procedure should be reviewed thoroughly if you are going to attempt to exchange a vacation home.)

In short, this Fact Sheet is a nice summary of exchanging as it exists in the United States today. It’s a quick read and could be of help to you in learning about Section 1031 tax-deferred like-kind exchanges. You can read it in its entirety here.

March 13, 2008 update: I now have this IRS update available in MS Word format. If you would like your own copy, please get in touch with me and I will be happy to forward it to you.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * New IRS Summary Publication on Tax-Deferred Exchanges * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Do you want an easy way to learn why you and your clients should consider a Section 1031 tax-deferred exchange? Over the past few weeks, I have been fine-tuning a couple of Buy and Hold vs. Buy and Exchange Spreadsheets. I think they are finally ready for prime-time, so I want to make them available to you, my Active Rain friends. These spreadsheets compare the idea of buying property and holding it to buying the same property but using a Section 1031 tax-deferred exchange after five years to releverage the investment into more valuable property.

I think the value of these spreadsheets will be realized in two ways. First, it will help you personally understand the incredible power of Section 1031 tax-deferred exchanges. And second, it will serve as a listing tool for you when you are discussing the possibility of selling an investment property or piece of land with a prospective seller. If you can show that seller how to increase his wealth by selling today, might that put you a step ahead of the guy down the street who’s just bugging him to list his property?

I’ll spend a few minutes describing the spreadsheets below. Let me disclose two things upfront: 1) there is no charge for these spreadsheets, of course, but 2) you have to put up with my logo and contact information on them if you want them. So assuming that you don’t mind a guy doing a little advertising with a free handout, let’s delve into them…

I mentioned there are two different spreadsheets. The first is for a standard property investment such as an apartment building or single-family home. The second one is specifically set up for land investments and deals in price per acre, not overall price. Please specify which spreadsheet (or both) you would like in your request! And be sure that I have your email address to send it to you!!!

The spreadsheets are based on the idea of comparing two different scenarios: 1) Buy a property and hold it for ten years, and 2) Buy that same property but exchange out of it after five years and see what happens in another five years. The comparison of gross equity after ten years is what we’re attempting to compare in these spreadsheets. The calculations are based upon assumptions that you make. One last comment before we get into this—when you get the spreadsheet, I promise it will be easier to understand than by reading all of this run-through below, but I felt like it was necessary to give you some idea of what was being offered.

Here is a screenshot of the assumptions required: (each one of these assumptions is made by the user; the ones shown are simply the last ones I made):

The entries in the yellow-shaded area are the assumptions you will need to make to generate a comparison. (The assumptions shown are simply the last ones I made.) Let’s discuss them one at a time

• Rate of appreciation—Enter the rate you expect the particular type of property you are working with to appreciate over the next ten years. This number can be negative, but it will remain constant throughout the ten years
• Interest rate on debt—What rate of interest will be paid on the debt over the next ten years. (This rate will remain constant over the ten years.)
• Number of payments—Over how many months will your loans be amortized?
• Purchase price—How much will you pay for this investment
• Fair market value—How much is the property actually worth today? If you are buying under the market value, your investment stands a much better chance of success. The old saying applies, “You make your money when you buy,” although I prefer, “You make your money when you buy and then buy again down the road through an exchange.”
• Amount of down payment—Enter your down payment, if any. You can enter zero if you are getting in with no down payment.
• Percentage of sale price paid in closing costs—Now we move on to the second five years on the exchange side of the equation. What is being asked here is for you to determine what percentage of your sale price is going to go to sales costs. If you expect to sell the property and pay a real estate commission, the commission itself will be 5-7% of the sales price. Based on your experience, what will the other costs add to that percentage? In my area, 10% is a reasonable estimate. Use what you think makes sense.
• Equity used as ______% down payment—When you sell after five years, we expect that you will have some money as a result of so doing. With that money, you are going to theoretically purchase a new, more valuable property (or properties). What percentage of the purchase price of the new property will your equity represent? In other words, if you will use your proceeds as a 25% down payment on the new property, enter “25.” The assumption on the screen is for a 20% down payment.

Now that the assumptions have been made and entered in the shaded area, let’s look at the comparison. The screenshot below shows the results on the Buy and Hold side based on the assumptions made above.

You can see that after ten years, the initial investment of $42,000 turned into Gross Equity of $184,170. Not bad! Let’s look at the Buy and Exchange side now:

Because I can’t get all of the Buy and Exchange side on my screen at once, you’ll have to trust me that the first four years of this side are identical to the Buy and Hold side. The fifth year is part of screenshot and you can verify for yourself that it is the same as the Buy & Hold side. What happens after the fifth year on the Buy & Exchange side is interesting, though. You can see that the Gross Equity after five years is $125,110. From that, $25,535 is deducted for costs of the sale of this property (based on the 10% assumption made), leaving $99,575 to reinvest into new property. At this point, it must be pointed out that if the investor did not use a Section 1031 exchange to reinvest into new property, a sizable portion of the $99,575 would go to capital gain taxes! Exchanging allows the investor to defer ALL of those taxes. Now, based upon the assumption that the proceeds of the sale were going to represent a 20% down payment on new property, the investor purchases a $497,873 property. This investor hasn’t gotten any dumber over the past five years, so he purchases the new property at the same proportion of Purchase Price to Fair Market Value as the first one was purchased. This means that the property he purchased for $497,873 has a Fair Market Value of $594,682. Remember, this is all based on the assumptions you make at the outset; if you don’t believe you can do as well, set the Purchase Price closer to Fair Market Value. The assumptions I’ve given you here are based on a real world deal that I am presently involved in, so it can be done! You can see that after ten years, the Buy & Exchange side realizes Gross Equity of $330,386, far in excess of the Buy & Hold side’s $184,170. This illustrates the POWER OF SECTION 1031 TAX-DEFERRED EXCHANGES!

One of the interesting things I have found by playing around with this spreadsheet is that you do not need to have all of the factors lined up in a positive way for exchanging to result in a better outcome. Try changing the Rate of Appreciation to -1.0% (negative 1.0%). The outcome is still better if you exchange after five years. (I hope you don’t expect your market to go down every year for the next ten years, by the way.) You can play around with the numbers and find scenarios where exchanging after five years doesn’t come out on top, but you have to invent some weird circumstances.

In closing, if you would like a copy of either or both of the spreadsheets, please remember to provide your email address and indicate which of the spreadsheets you would like to receive (one or both). I hope you enjoy working with them and that they result in greater equity for all!!

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Free Spreadsheet to Learn Why Your Clients Should Consider a Tax-Deferred Exchange * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Midwest farmland prices increased an average of 16% in 2007, according to the Chicago Federal Reserve Bank’s  annual survey of agricultural lenders. The 7^th Federal Reserve District that is based in Chicago consists of all of Iowa and half or more of four other states: Michigan, Wisconsin, Indiana, and Illinois.

According to the 265 surveys that were returned by agricultural bankers in this district, farmland prices during the last quarter of 2007 rose 6 percent.

Iowa farmland was consistent with that average, also rising 6% during the quarter. Iowa is divided into five areas by the Chicago Federal Reserve Bank for reporting purposes. The area encompassing most of north and west-central Iowa reported a 24 percent gain over calendar 2007. The area of western Iowa adjoining South Dakota and Nebraska, from the Minnesota border to the Missouri border, increased 20 percent over the same time frame. Rounding out the five zones are the three zones made up of south-central, eastern, and northeastern Iowa at 19 percent, 15 percent and 14 percent.

Section 1031 exchanges are slipping out of the blame for higher land values, and with good reason. Cash corn prices in December were 25 percent higher than December of 2006, and cash soybean prices showed an even greater jump at 62 percent higher. Ethanol, bio-diesel, and increased demand from China and India are the leading blame-getters these days, not tax-deferred exchanges.

Fifty-six percent of the survey respondents (remember, these are agricultural lenders) said that they expect farmland prices to continue their pace of increase into the first quarter of 2008. A scant 2 percent expect land values to decrease, and 42 percent anticipate prices to remain the same from January to March. Since we are already into March, it looks like a pretty safe bet that we are not going to see that decrease the wacky 2 percent expected.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Midwest Farmland Prices Increased an Average of 16% in 2007 * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

Guidance on the exchange of vacation homes via Revenue Procedure 2008-16 was provided recently by the Internal Revenue Service. This procedure was brought about as a result of last year’s case in Tax Court Moore v. Commissioner, (T.C. Memo 2007-134) and a subsequent report by the Treasury Inspector General for Tax Administration that called for more IRS guidance on the subject. The revenue procedure creates a Safe Harbor for these exchanges; i.e., if an exchange is conducted in compliance with the parameters set forth, it will not be challenged. It is effective for exchanges commencing on or after March 10, 2008, which is also the date the procedure will be published in Internal Revenue Bulletin 2008-10.

The purpose of this revenue procedure is to create guidelines under which the taxpayer can establish that the property in question qualifies as held for investment, not simply owned for the personal use of the taxpayer with the hope for future appreciation.

Boiled down, the revenue procedure says that in order to qualify within the safe harbor, a dwelling unit, whether it is the relinquished property or the replacement property in the exchange (or both), must be owned by the taxpayer for at least 24 months before (in the case it is relinquished property) or after (in the case it is replacement property), and within each of the two 12-month periods immediately before and/or after the exchange: 1) The taxpayer rents the property to another person at fair market rent for 14 days or more, and 2) The taxpayer uses the property for personal use not more than the greater of 14 days or 10 percent of the number of days during the 12-month period that it is rented at fair market rent.

I realize that's a little cumbersome, but when does the government make things easy to understand? How about an example to clarify things some? You’ve owned a vacation home for three years. You put it on the market and it sells. Going backward from the date of sale (which is also the date your exchange begins), you did the following: 1) During the previous 12-month period, rented the property a total of 250 days at fair market rent and used it for personal use not more than 25 days (10% of the total days it was rented), and 2) During the 12-month period prior to that, rented the property only 100 days at fair market rent and used it for personal use not more than 14 days (the maximum allowable use given the fact that you only rented it for 100 days). If you can substantiate these facts in a satisfactory manner, this property falls within the safe harbor described above.

Food for thought… you own investment property today. You exchange out of your investment property into a vacation home that you operate within the safe harbor described above for two years. You then move into the vacation home as your personal residence… and live happily ever after?

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

INTEGRITY.  PRECISION.  SECURITY.

Copyright © 2008 By Ken Tharp, All Rights Reserved. * Guidance on the Exchange of Vacation Homes via Rev. Proc. 2008-16 * Contact Ken Tharp for information on Section 1031 tax-deferred exchanges anywhere in the United States.

The first Iowa Land Investment Expo was held in West Des Moines, Iowa, last Friday, February 15, 2008, at the West Des Moines Marriott. The event brought together a diverse group of investors, farmers, exhibitors and others.

The day started off with a discussion between Don DeWaay of DeWaay Capital Management and Moe Russell of Russell Consulting Group on the future of land prices. Both were essentially bullish on the prospects of continued escalation in the value of agricultural land, although both felt that any increases will be muted somewhat in comparison with the past couple of years. Mr. DeWaay was slightly more cautious than Mr. Russell, in my opinion. He noted that there is bound to be a top somewhere. Mr. Russell pointed out that each situation must be considered on its own merits. There are good deals out there, and there are deals that the buyer should steer clear of.

As an exhibitor, I was there to meet people and establish relationships, so I was not able to attend a lot of the events. There were plenty of people milling about during the morning breakout sessions, so I manned my table throughout that time period.

Lunchtime arrived, and with it a nice meal of lasagna. (By the way, the food itself at this event was worth the $35.00 entrance fee. A nice breakfast was available, then lunch, then an afternoon cookie, followed by two drinks during the cocktail hour, at which excellent hors d’oeuvres were served. Throughout the day, water and pop were readily available. What a deal!)  Ken Root (of WHO radio, the long-time blowtorch of the Midwest when it comes to farm radio) was the master of ceremonies throughout the day, and I use the term “master” in its truest sense. He kept the program on time and on point, and did it deftly and with expertise. I particularly appreciated something that happened at lunch. Outside of church and perhaps family gatherings, when is the last time you heard a prayer before a meal? Ken Root, master of ceremonies, gave praise for a great nation and its hardworking people to a silent room of 350-400 attendees, all of whom added “Amen” together at the end. I was moved.

At the lunch gathering, several speakers gave presentations. Mark Reisinger from USDA Rural Development essentially ceded his time to a last-minute special guest, Tom Dorr, Under Secretary at the U.S. Department of Agricultural Rural Development. Unfortunately, I missed most of that presentation and the one that followed, Wendy Gady of Pohaku. I made it a point to be there for Elizabeth Williams’s comments on the farm bill, which I will address in a separate post.

I did make it to one of the afternoon breakout sessions. “Estate Planning Discussion,” was run by David Albrecht and Chad Stevens, both from City State Bank, two new friends made at the expo, and Scott Simpson, attorney with Dreher, Simpson and Jensen, P.C., an old friend. This was an excellent discussion on entities, trusts, succession planning, and so forth.

The final group session dealt with a little more crystal-ball-gazing about land values. Discussions were held about world grain supplies and their impact on land values in the Midwest. With China and India’s peoples moving more and more toward middle-class lifestyles, the continued strain on land for more and more production bodes well for sustaining and increasing value of that land. Mike Walsten of LandOwner Newsletter (another new friend from this event) gave a great overview of recent land sales in the Midwest (including a sale in northwest Iowa of agricultural land for almost $9,000 per acre). If you are interested in monitoring land values, Mike publishes a fantastic newsletter that comes out twice per month at the bargain basement price of $119.00 per year. You can contact him at mwalsten@profarmer.com. Mike Duffy, the venerable gentleman Professor of Economics at Iowa State University, rounded out the day with some brief comments, most of which were again bullish on the future of land values. 

All in all, this was one fantastic event. It was wonderful to be a small part of it as an exhibitor. I met lots of great folks there and can hardly wait until the next one. Salutations to Peoples Company and Steve Bruere for organizing this day!

Ken Tharp

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