Friday, April 29, 2005

Monterey County Real Estate Statistics

To view current statistics on sales in Monterey County, please go to the following link:

http://mcar.com/stats.html

Tax Incentives for Homeowners

Deductible Property Taxes and Interest: Most homeowners can deduct property taxes and interest paid on their mortgage every year of ownership. In fact, the tax code allows homeowners to write off interest on first and second mortgages -- including equity lines and loans -- up to $1.1 million worth of the overall mortgage debt. That is expected to amount to $72.6 billion in tax deductions this year alone.

Borrowing Against Equity: Homeowners can borrow against the equity they have built up in their homes. Equity from a home can be used to improve the property, buy a car or pay for education. Homeowners may also have the ability to deduct the interest from their federal taxes. Renters never have this opportunity.

Real Estate Tax Exemption: Depending on the state, certain real estate tax exemptions apply for homeowners who meet specific criteria. Homeowners should check with local assessors and tax consultants to see if any exemptions apply to them.

Yearly Home Appreciation: Although it is not a tax advantage, homeowners build equity and realize yearly appreciation of their property over time. Renters receive no financial return on their monthly rental costs.

Recent Federal Government Changes: During the last few years, the federal government has made owning a home even more financially favorable. Recent improvements enacted include the following:

-In 2005, the 15 percent tax bracket for married couples will increase from $46,700 to $55,900, so that many families currently in the 27 percent bracket will drop back a level allowing for more tax savings.

-The federal government has recently relaxed rules on IRA and 401(k) retirement accounts, permitting first-time homebuyers to tap into their retirement funds for their down payment without paying penalties on early withdrawal.

-The federal government now offers exclusions of capital gains on sales of principal residences, which has resulted in $22.9 billion in tax benefits over the last several years. This category has ballooned since 1997, when Congress first sanctioned tax-free treatment of up to $250,000 (for single filers) or $500,000 (for married joint filers) on home-sale profits. The exclusions are available on homes owned for just 24 months, and can be used without limit every 24 months.

Rates Hold Stready

The benchmark 30-year fixed-rate mortgage fell 1 basis point to 5.85 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.32 discount and origination points. One year ago, the mortgage index was 6.07 percent. The benchmark 15-year fixed-rate mortgage stood unchanged at 5.42 percent. The benchmark 5/1 adjustable-rate mortgage fell 5 basis points to 5.26 percent. Source: Bankrate.com

Private Annuity Trust - The Alternative to a 1031 Exchange

Private Annuity Trust (P.A.T.): An individual transfers property to irrevocable trust. In return for the trustees promise to make annual payments to the transferor for life, there is no gift tax on the transfer, so long as the value of the property does not exceed the present value of the payments. There is no income tax consequence, so long as the transfer is made prior to a sale. The private annuity trust will let you convert highly appreciated assets into a lifetime annuity, and thereby avoid estate tax and differ capital gain tax.

1031 Exchanges

Tax Deferred Exchanges

Internal Revenue Code, Section 1031 provides that no gain or loss is recognized when business or investment property is exchanged for another business or investment property of like kind. A tax deferred exchange is one of the few methods available to defer income taxes on the sale of real property.

The advantage of a tax deferred exchange is that the taxpayer can sell income, investment or business property and replace it with like-kind property without having to pay federal income taxes on the transaction. There must be an actual exchange of property. A sale of property followed by a reinvestment of the proceeds does not qualify under Section 1031.

General Requirements

Business or Investment Property. The property sold (“relinquished property”) and the property received (“replacement property”) must both be held for productive use in a trade or business or for investment purposes.

Property Excluded. Neither property can be: stock in trade or other property held primarily for sale; stocks, bonds or notes; interests in partnerships; certificates of trust or beneficial interests; or choses in action.

Like-Kind Property. The relinquished property and the replacement property must be of “like kind.” Generally speaking, any real property exchanged for other real property should qualify as like kind. For example, an apartment house property can be exchanged for raw land.

Exchange. There must be an exchange of property, not a sale and a reinvestment of the proceeds in another property.

Types of Exchanges

A simultaneous or two party exchange is an exchange in which the relinquished property and the replacement property are exchanged on the same date, with each party swapping its property in exchange for the other party’s property. This type of exchange is not common in the real estate area.

A non-simultaneous or two party delayed exchange is an exchange in which the taxpayer closes on the sale of the relinquished property on one date, but does not close on the purchase of the replacement property until a later date. The exchange is not simultaneous or on the same day. This is sometimes referred to as a "Starker Exchange" after a Supreme Court case which ruled in the taxpayer's favor for a delayed exchange. A Starker Exchange is utilized where the taxpayer must close on the sale of the relinquished property but has not yet located or is not yet able to close on the purchase of the replacement property. This is the most common type of exchange in the real estate area.

A reverse exchange is an exchange in which the taxpayer needs or desires to close on the replacement property before he has found a buyer to buy his relinquished property. Generally an intermediary takes title to the replacement property and holds or “parks” the property until the taxpayer has sold the relinquished property. These are sometimes called “parking transactions.”

There are many ways to structure an exchange and with proper planning almost any transfer of real estate can be structured as an exchange. However, like-kind exchanges must be carefully planned with appropriate documentation and adherence to the applicable Code provisions and Regulations.

Special Rules for a Starker or Non-simultaneous Exchange

The most popular form of exchange is a non-simultaneous or Starker exchange in which the taxpayer closes on the sale of the relinquished property and at a later date closes on the purchase of the replacement property. Section 1031 and the applicable regulations permit Starker exchanges with the use of a qualified intermediary and set out the procedures which must be followed.

A taxpayer who wants to do a Starker exchange under Section 1031 will typically market his property just as he would without consideration of the exchange. A sales contract is signed which contains language requiring the buyer to cooperate with the taxpayer in the intended exchange. Prior to closing, the taxpayer enters into an exchange agreement with a qualified intermediary which permits the qualified intermediary to substitute for the taxpayer in accordance with the requirements of the Code and Regulations. Among other things, the exchange agreement contains provisions for:

-An assignment of the taxpayer's contract to the qualified intermediary.
-Payment of the proceeds of sale at closing to the qualified intermediary instead of to the taxpayer.
-Deeding of the property directly by the taxpayer to the buyer.

After closing on the sale of the relinquished property, the taxpayer locates replacement property. There are special rules relating to the manner of identification of the replacement property, time limitations on identification and acquisition of replacement property, and the use of qualified intermediaries.

Identification Period. The taxpayer must either close on replacement property or identify the Replacement property within 45 days from the date of transfer of the relinquished property. This requirement is satisfied if replacement property is received before 45 days has expired. Otherwise, the identification must be made in writing signed by the taxpayer and hand-delivered, mailed, faxed, or otherwise sent to the Qualified Intermediary, or other persons named in the regulations. After 45 days have expired, it is not possible to designate any additional replacement properties.

Identification Notice. The identification notice must contain an unambiguous description of the replacement property. This includes, in the case of real property, the legal description, street address or a distinguishable name.

The taxpayer may identify more than one property as replacement property but the maximum number of replacement properties that the taxpayer can identify is (i) any three properties regardless of their market values (the 3-Property Rule); (ii) any number of properties as long as the aggregate fair market value of the replacement properties as of the end of the identification period does not exceed 200% of the fair market value of the relinquished property (the 200 Percent Rule); or (iii) any number of replacement properties but only if the taxpayer receives identified replacement property constituting at least 95% of the aggregate fair market value of all identified replacement properties (the 95% Rule).

Exchange Period. The replacement property must be received and the exchange completed no later than the earlier of 180 days after the transfer of the Relinquished property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was transferred. The replacement property received must be substantially the same as the property which was identified under the 45-day rule described above. There is no provision for extension of the 180 day period.

If an exchange commences late in the tax year, the 180-day exchange period can end later than the April 15 filing date of the taxpayer’s tax return. If the exchange is not complete by the time for filing the tax return, the taxpayer must obtain an extension of time to file. If the taxpayer does not obtain an extension, the exchange period will end on the due date of the return.

Qualified Intermediary

During the exchange period, the taxpayer must avoid actual or constructive receipt of money or other property from the sale of the replacement property. Any receipt of money or other property before the acquisition of the replacement property will disqualify the exchange. This means that the taxpayer may not receive cash in hand, nor may the taxpayer derive economic benefit from cash or other property held by an intermediary in an exchange escrow account. The funds in escrow cannot be pledged as security for a loan to the taxpayer.
Accordingly, at the closing on the sale of the relinquished property, a qualified intermediary (instead of the taxpayer) receives the cash proceeds and holds the proceeds in an escrow account for use in acquiring replacement property.

A qualified intermediary may not be the taxpayer or a “disqualified person.” The Regulations define a “disqualified person” as any “agent of the taxpayer”, meaning generally any employee, attorney, accountant, investment banker, real estate agent or broker who had such relationship with the taxpayer during the two year period leading up to the exchange, as well as family members.

The qualified intermediary enters into an exchange agreement with the taxpayer to acquire the relinquished property from the taxpayer, transfer the relinquished property to its buyer, acquire replacement property, and transfer the replacement property to the taxpayer. The qualified intermediary holds the proceeds from the sale of the relinquished property and applies the proceeds to the acquisition of the replacement property.

In practice, the taxpayer may enter into a contract to sell the relinquished property and thereafter assign the contract to the intermediary. The deed may pass directly from the taxpayer to the buyer. Similarly, the taxpayer may enter into a contract to purchase the replacement property. The contract is then assigned to the qualified intermediary, the seller is notified of the assignment, and the replacement property is deeded directly to the taxpayer.
The exchange agreement should clearly spell out the intention of the taxpayer to engage in a tax deferred exchange, the duties and obligations of the qualified intermediary, and limit the right of the taxpayer to receive money or other property held by the qualified intermediary.

Conclusion.

When an owner of real estate wants to dispose of one business or investment property and acquire another property, consideration should be given to structuring the transaction as a like-kind exchange under Section 1031. With careful planning and appropriate documentation, most transactions can be structured as exchanges. The savings realized by deferring taxes can be substantial. However, an exchange should not be undertaken without a thorough consideration of all alternatives and discussion with the taxpayer’s accountants, attorneys and tax advisers.