NestEgg Investing: 1031 Tenants in Common Exchanges

1031-121 Exchange-Don't Rush to Sell When a Spouse Dies

Full Article: http://www.centredaily.com/mld/charlotte/living/home/11468875.htm?source=rss&channel=charlotte_home

ROBERT BRUSS

Q. My wife and I, now in our 80s, own our home worth around $800,000. After one of us passes on, how long does the survivor have to sell the house before losing half of the $500,000 principal-residence sale exemption?

After one principal residence co-owner dies, the survivor should not rush to sell the home.

Internal Revenue Code 121 says a surviving spouse has until the end of the year of the other spouse's death to sell the principal residence and claim up to $500,000 tax-free profits. The tax reason is the year of a spouse's death is the last year a surviving spouse can file a joint-income tax return with the deceased spouse.

However, IRC 121 doesn't mention the stepped-up basis benefit for a surviving spouse who inherits the deceased spouse's half of the principal residence.

Suppose you and your wife are both on the title to your home. You die. Your widow will receive a new stepped-up basis to market value for the half of the residence inherited from you.

In a community-property state, the entire value of the house will be stepped up to market value on the date of your death.

Please ask your tax adviser for full details.

Tax-deferred exchange

Q. I own a modest apartment building, which I can sell for a net profit of almost $1 million. I would like to make an Internal Revenue Code 1031 tax-deferred exchange for a nice retirement home for my wife and me plus a rental property. Can we do this in a tax-deferred exchange? Not immediately. All properties in an Internal Revenue Code 1031 tax-deferred exchange must be held for investment or use in a trade or business. That means the properties you acquire must be held for rental or use in your business.

You can make a direct tax-deferred trade for a "nice retirement home." To qualify, it must be a rental property at the time of acquisition and for at least six to 12 months thereafter.

Later, the tax law does not prevent you from converting one of those rental properties acquired into your retirement home. No tax will then be due upon conversion from rental to personal use. For full details, please consult your tax adviser.

Hedging Your Real Estate Investment/ Betting on the Bubble Bursting

Here's a slightly dated article on new instruments that Robert Shiller, an economist out of Yale, is creating to hedge against real estate price declines.  The indexes will be listed on the Chicago Mercantile exchange and rumor is that LA will be the first test market.  Can't wait until they create one for the Bay Area!

Another set of derivative products linked to home prices was introduced in October by HedgeStreet, which specializes in online trading of pint-sized contracts it calls ''hedgelets" for each of six cities: New York, Miami, Chicago, Los Angeles, San Francisco and San Diego.  However, these "bets" are only for $10 which, unless I'm missing something, make them all but worthless

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December 12, 2004 Sunday Times

IF you have owned a home for several years, you may be sitting on a sizable increase in equity. And if you are worried that the run-up in housing prices can't last much longer, you may think the only choice is to call a broker, rent a moving van and head for the (less expensive) hills.

But through an increasing number of new investments, you may be able to limit future erosion of your home's value.

Macro Securities Research, a company affiliated with Robert J. Shiller, the Yale economist, has reached an agreement with the Chicago Mercantile Exchange to list pairs of derivative instruments that are essentially index funds linked to home prices in certain markets. One instrument in each pair will rise as its market index rises; the other will rise as the same index falls. That will let investors bet on the direction of housing prices. Similar, but less sensitive, vehicles are being offered by HedgeStreet, a firm in San Mateo, Calif., that offers small-scale derivatives speculation online.

For homeowners looking for alternatives to the risks and complications of derivatives trading, there are also insurance policies that pay out if home prices fall, but they are only available in certain areas, and the conditions for collecting are highly restrictive.

In fact, none of these approaches are likely to provide anything close to a perfect hedge, eliminating all risk of loss. And while the options available to nervous homeowners are growing in number and sophistication, some advisers warn that they may provide minimal protection from the vicissitudes of the real estate market.

But other, simpler strategies may help you prepare for a softening of the market, they add. One is to avoid variable-rate mortgages before any serious increase in interest rates -- an event regarded as a possible trigger for a reversal in home prices.

Macro Securities hopes to list its instruments in Chicago before such a reversal, but the exchange's announcement this month was short on details, like a starting date. Mr. Shiller, the company's chief economist, said that his securities would track home price indexes in cities yet to be chosen, although strong candidates include New York, Los Angeles and Las Vegas, he said.

The minimum investment for the securities and the amount of leverage built into them are also not yet known. A one-percentage-point move in the index, he said, may produce a change of two percent or three percent in the value of the securities.

An important feature of the Macro securities, he said, is that they will come in twos -- one moving in tandem with the index and the other in the opposite direction. Having a single index fund would require a hedger to sell short, raising the theoretical prospect of an infinite loss. (That could happen only if housing prices rose to infinity -- not a far-fetched idea to many people who are looking to buy a co-op in Manhattan.)

Another set of derivative products linked to home prices was introduced in October by HedgeStreet, which specializes in online trading of pint-sized contracts it calls ''hedgelets.'' Each is a yes-or-no wager that a housing index will be in a certain range on a given date within three months. After that period, the contracts expire, and losing bets are worthless.

There are three residential property bets, representing percentage moves in an index whose level may be higher, lower or even with the recent trend in home price movements, for each of six cities: New York, Miami, Chicago, Los Angeles, San Francisco and San Diego.

But the value of each contract is a paltry $10, and they are infrequently traded, at best, so unless you live in a matchbox, it would be difficult -- and very expensive -- to buy enough of them to provide a practical hedge.

Russell Andersson, a vice president of HedgeStreet, said that the products were new and were still seeking an audience. He conceded that their three-month life span was too fleeting for use by many homeowners and said that HedgeStreet was planning to introduce vehicles that would trade much like futures contracts and last for one and three years.

''With a combination of these two products, you can hedge out very aggressive short-term movements as well as longer-term movements,'' Mr. Andersson said.

Mr. Shiller says his approach to defending against price declines is meant to be useful even for people with modest incomes. ''We're looking for a vehicle with widespread acceptance,'' he said. The device of two separate funds is one way to gain it, in his opinion. ''It means there is no loss beyond the initial outlay, no margin calls,'' he said.

That may not be true if leverage is built into the instruments, as Mr. Shiller envisions. But homeowners looking for further protection may consider borrowing against their equity, knowing that it will rise enough to make up any decrease in the fund's value, he said. Should home prices fall, the value of the fund that is inversely correlated to the housing market will rise, mitigating the loss.

''Volatile markets are increasingly becoming a part of our lives,'' Mr. Shiller added. ''The home market itself is becoming more volatile. We're in the biggest real estate bubble in history, I believe.

''We haven't seen a swing down yet, but it could be coming,'' he warned. ''There are people with big houses and big mortgages who are going to feel the pinch.''

Jonathan Golub, a strategist at J.P. Morgan Fleming Asset Management in New York, agreed. The culprit in a downturn, he believes, will be big mortgages, more than big houses. Variable-rate mortgages, in particular, could be a problem.

When interest rates are low, buyers can afford more house for the same monthly payment, said Mr. Golub, who himself is a renter in Manhattan. He said that any holder of a variable-rate mortgage must understand that ''if interest rates drop, the house is worth more to me, and vice versa; if rates rise, I'm toast.''

Burned on both sides, too, because the higher mortgage payments tend to depress home prices. ''You get hit with a double whammy,'' he said. ''The cost of carrying goes up and the value goes down.''

NATIONWIDE, he noted, home prices rose 7 percent a year, on average, from 1999 to 2003, roughly double the rate for rental prices. Over the previous 15 years, the two rose more or less in tandem, with one outpacing the other for a while before the pattern reversed.

Mr. Golub says he expects home prices to hold up until mortgage rates rise further, so there is time for homeowners to prepare. His advice is to ''lock down that fixed-rate mortgage.''

As for the hedging vehicles being offered, he has doubts about their utility for most current and prospective homeowners. ''The adviser who would sell them won't be able to understand them,'' he said. ''They're the kind of thing you see pushed at the top of a market.''

For someone considering buying a home now, ''the smart thing to do is rent,'' he said.

''It probably does not make sense for someone who owns a home and plans to stay there to sell it and rent it back,'' he added. ''But what probably makes sense is for that first-time homebuyer or guy planning to retire to Florida to rent instead of buy.''



URL: http://www.nytimes.com

1031-721 Exchange: Conditions to Qualify

How to avoid or defer paying capital- gains taxes on the sale of your primary residence.  See prior posts (Avoiding Capital Gains on Your Primary Residence, A 1031-121 Example)

1031-721 Conditions to Qualify

•           You must have lived in your house for at least two of the past five years.

•           The profit on the sale of your home must be greater than the capital- gains tax exclusion -- $500,000 for married joint filers.

•           You must have established a home office or converted your home into a rental property, and you must purchase a similar property when you sell.

How to avoid or defer paying capital- gains taxes on the sale of your primary residence.

  -- Set up a home office or rent out your property. To qualify for a federal home-office tax deduction, you must use part of the home exclusively and regularly as your principal place of business, meaning for administrative or management  activities; as a place where the owner meets or deals with

patients, clients or customers in the normal course of trade or business; or for rental use.

  -- Make sure you file Form 8829 to claim the home-office deduction, or the IRS may not recognize the office portion of your home.

  -- When you are ready to sell, you can claim the standard capital-gains tax exclusion, up to certain limits: $250,000 (for most singles) and $500,000 (for joint filers). To qualify for the full exclusion, you must have lived in the home and used it as your primary residence for at least two of the five years

prior to the sale. If your gains exceed those limits due to the commercial portion, you can defer taxes on those gains by buying another commercial property, if that property is worth as much or more than the value of the commercial portion of the house you are selling.

A 1031-121 Exchange Example

1031-121 Example

Suppose you own a commercial property in which you have a

$400,000 capital gain. But rather than trade up for another investment property, you want to exchange for a "dream home" where you and your spouse can enjoy the good life. This can be done with careful planning and a Starker exchange.

The first step is to sell your investment property and have the sales proceeds held by a qualified third-party accommodator. The second step is to use those sales proceeds to acquire your ultimate dream home.

But that property must be a rental at the time of acquisition. Most tax advisers suggest renting it for at least six to 12 months after purchase to show rental intent. Then you can move in and convert it to your personal residence.

However, before you can sell the acquired residence and claim your $250,000 or $500,000 principal residence exemption of IRC 121, the Oct. 22, 2004 tax changes of Internal Revenue Code 121(d)(10) now require you to own the acquired residence at least five years and live in it as your principal residence at least 24 of the 60 months before its sale.

Next:  Making Sure You Qualify Conditions to Qualify Link

Avoiding Capital Gains on Your Primary Residence- 1031-121 EXCHANGE

1031-121 EXCHANGE

Under Section 121, you can sell your primary residence and exclude from taxable income up to $250,000 (single taxpayers) or $500,000 (married taxpayers filing jointly) in capital gains

A 1031-121 exchange allows the owner of, for example, an expensive house to use one benefit to exclude part of the gain from tax and the other to defer tax on the rest. And the gain excluded -- up to $250,000 for a single homeowner and $500,000 for a couple -- can be added to the "basis" of the new house, reducing the potential tax if it is sold.

The new break doesn't apply to all homeowners, only to those who have home offices, or those who convert their house -- or a portion of it – into a rental. The deferral applies only to the portion of the house used for commercial purposes.  In general, you must use part of the home "exclusively and regularly" as your principal place of business, or exclusively and regularly as a place to meet or deal with patients, clients or customers in the normal course of work -- or for rental use. If you are an employee, your business use must be for your employer's convenience, not yours.

Next:  A 1031-121 Example 1031-121 Example

            Making Sure You Qualify Qualifications

Avoiding Capital Gains on Your House: Wall Street Journal Article

A great article on deferring capital gains on your primary residence.  Check out our more formal analysis:  1031-121 Analysis Link

2/10/05 Wall St. J. D1
2005 WL-WSJ 59840615

The Wall Street Journal
(Copyright (c) 2005, Dow Jones & Company, Inc.)

Thursday, February 10, 2005

IRS Decision Aids Home Sellers

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Recent Move Allows Those With Home Offices, Rental Units, to Defer Taxes on
Some Gains

By Ray A. Smith

A RECENT decision by the Internal Revenue Service could provide considerable relief to many homeowners facing huge price gains when they sell. The sharp appreciation of house prices in recent years means many people could face steep capital-gains taxes. But in late January, the IRS put forth new guidelines that allow certain homeowners to defer paying taxes on a
significant portion of those gains. The new break doesn't apply to all homeowners, only to those who have home
offices, or those who convert their house -- or a portion of it -- into a rental. The deferral applies only to the portion of the house used for
commercial purposes.

Still, that affects a substantial amount of people. According to the IRS, the number of individual tax returns filed claiming deductions for home offices
rose to about 2.5 million in 2002, the latest data available, from about 1.7 million in 1997. In a 2004 survey, the National Association of Realtors
found that 12% of respondents said they were buying other houses, but keeping their existing homes -- presumably for investment purposes.

Some observers say the IRS's move will lead more people to rent their homes or set up a home office -- or lead people who already have such offices to
report them. "People in the past would always question whether it was worth it to deduct a home office," says Julie A. Welch, an accountant and director of
the tax department at Meara, King & Co., a Kansas City, Mo., auditing and accounting firm. "But now with this new pro-taxpayer guidance, it makes a
whole lot more sense. If you structure it right, you can exclude or defer gain in almost all cases."

Next week, the IRS is scheduled to formally publish the new guidelines. Previously, homeowners weren't sure which circumstances allowed them to
defer or exclude the gains from the "commercial" parts of their residences.

The guidance comes at a time when many homeowners, especially those who have lived in their houses for a number of years, are sitting on huge price
gains. Home prices in the U.S. have risen 63% from the third quarter of 1999 to the third quarter of 2004, according to home-price research company Fiserv CSW
Inc., of Cambridge, Mass. A number of housing markets have seen increases far beyond that.

Given the complexity of the guidelines, known as Revenue Procedure 2005-14, it makes sense to consult with a lawyer or tax adviser before attempting to
take advantage of them. For one thing, the IRS has complex rules on claiming expenses for business
use of your home. In general, you must use part of the home "exclusively and regularly" as your principal place of business, or exclusively and regularly
as a place to meet or deal with patients, clients or customers in the normal course of work -- or for rental use. If you are an employee, your business
use must be for your employer's convenience, not yours.

Additionally, in order to take advantage of the deferral, the owner must purchase another property through what is called a 1031 "like-kind"
exchange, and it must be either a commercial property or have a commercial component equal or greater to the value of the commercial portion of the property
being sold. For people selling a home, the top capital-gains rate, currently 15%, typically applies to profits of more than $250,000 for most single people
and $500,000 for married couples filing jointly. For owners who bought in fast-appreciating markets five years ago, the profits from a sale could
easily exceed those limits, meaning they would have to pay capital-gains taxes. When the current limits were set in 1997, lawmakers assumed few people would
cross the profit threshold.

Here is how it works: If a married couple sells for $900,000 a house that cost, say, $200,000, the couple can exclude $500,000 of their $700,000 gain.
Assuming they had rented the entire house before the sale, they could defer paying taxes on their remaining $200,000 gain by buying a replacement
commercial property costing at least that much through a 1031 exchange.

If the couple had instead maintained a home office that was valued at $75,000, they could defer paying taxes on that amount if they purchased a commercial
property of the same or greater value.

"It's a good thing for homeowners who also have a home business because it clarifies that they can later sell the house and still use the principal
residence exclusion for the entire house, even if they were using part of it for business," says Randy Markowitz, an accountant and partner with FGMK
LLC, in Bannockburn, Ill.

Another benefit: The couple also can defer back taxes on any depreciation deduction they took earlier on the commercial part of the property. Gains
from depreciation deductions are taxed at 25%, much higher than the 15% capital-gains tax.

While the new guidance helps homeowners, it also can open up a legal and accounting minefield. "Trouble could come from trying to claim the
home-office treatment when it's not eligible, claiming too large a percentage of a residence as a home office, or not satisfying the highly technical 1031
rules," says Louis S. Weller, of Deloitte & Touche LLP's national real-estate tax services group in San Francisco.
Some homeowners may find the road to qualifying for this new break a little daunting. For example, when trying to sell a home and defer the gains on the
commercial portion, it no longer is simply selling a house but structuring an exchange transaction, which means filling out more tax forms and adhering to
strict deadlines and rules. It is more akin to being a commercial investor than a homeowner.

In a 1031 exchange, the replacement property has to be identified within 45 days, and the exchange has to be completed within 180 days, or the tax
deferral is forfeited. A specialized 1031 intermediary has to be retained to handle the transaction. Fees for intermediaries run as much as $1,000.

"If you don't set it up as an exchange, then you won't get the tax-deferral treatment," says Adam Handler, of the like-kind exchange services group with
PricewaterhouseCoopers in Los Angeles. "Most people, if they're thinking about selling a house, are not thinking about the exchange machinery."

New Tax Break

A new decision by the IRS could help cut your taxes when you sell your home.

Here's who benefits:

-- You must have lived in your house for at least two of the past five years.

-- The profit on the sale of your home must be greater than the capital- gains tax exclusion -- $500,000 for married joint filers.

-- You must have established a home office or converted your home into a rental property, and you must purchase a similar property when you sell.

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How to Lower Your Home Capital-Gains Taxes

New guidance from the IRS clarifies how to avoid or defer paying capital- gains taxes on the sale of your primary residence.

-- Set up a home office or rent out your property. To qualify for a federal home-office tax deduction, you must use part of the home exclusively andregularly as your principal place of business, meaning for administrative or
management activities; as a place where the owner meets or deals with patients, clients or customers in the normal course of trade or business; or
for rental use.

-- Make sure you file Form 8829 to claim the home-office deduction, or the IRS may not recognize the office portion of your home.

-- When you re ready to sell, you can claim the standard capital-gains tax exclusion, up to certain limits: $250,000 (for most singles) and $500,000
(for joint filers). To qualify for the full exclusion, you must have lived in the home and used it as your primary residence for at least two of the five
years prior to the sale. If your gains exceed those limits due to the commercial portion, you can defer taxes on those gains by buying another commerical
property, if that property is worth as much or more than the value of the commercial portion of the house you are selling.