Tax Free Exchange: A Valuable Alternative To A Home Sale

Congress is currently talking tax reform. Two very important real estate benefits are on the so-called “chopping block”, either to be completely eliminated or significantly curtailed.

It is doubtful that the home owner exclusion of up to $500,000 (or $250,000 if you file a single tax return) of profit will be impacted; there are too many homeowner voters who will forcefully object. But investors do not have the same strong lobbyist who can make the case for preserving the “like kind” exchange. So if you have an investment property, now might be the time to consider doing an exchange.

Residential homeowners have a number of tax benefits, the most important of which is the exclusion of up to $500,000 (or $250,000 if you file a single tax return) profit made on the sale of your principal residence. But real estate investors — large and small — still have to pay capital gains tax when they sell their investments. And since most investors depreciated their properties over a number of years, the capital gains tax can be quite large.

There is a way of deferring payment of this tax, and it is known as a Like-Kind Exchange under Section 1031 of the Internal Revenue Code. In my opinion, these exchange provisions are still an important tool for any real estate investor.

The exchange process is not a “tax free” device, although people refer to it as a “tax-free exchange.” It is also called a “Starker exchange” or a “deferred exchange.” It will not relieve you from the ultimate obligation to pay the capital gains tax. It will, however, allow you to defer paying that tax until you sell your last investment property — or you die.

The rules are complex, but here is a general overview of the process.

Section 1031 permits a delay (non-recognition) of gain only if the following conditions are met:

First, the property transferred (called by the IRS the “relinquished property”) and the exchange property (“replacement property”) must be “property held for productive use in trade, in business or for investment.” Neither property in this exchange can be your principal residence, unless you have abandoned it as your personal house.

Second, there must be an exchange; the IRS wants to ensure that a transaction called an exchange is not really a sale and a subsequent purchase.

Third, the replacement property must be of “like kind.” The courts have given a very broad definition to this concept. As a general rule, all real estate is considered “like kind” with all other real estate. Thus, a condominium unit can be swapped for an office building, a single family home for raw land, or a farm for commercial or industrial property.

Once you meet these tests, it is important that you determine the tax consequences. If you do a like-kind exchange, your profit will be deferred until you sell the replacement property. However, it must be noted that the cost basis of the new property in most cases will be the basis of the old property. Discuss this with your accountant to determine whether the savings by using the like-kind exchange will make up for the lower cost basis on your new property. And discuss also whether you might be better off selling the property, biting the bullet and paying the tax, but not have to be a landlord again.

The traditional, classic exchange (A and B swap properties) rarely works. Not everyone is able to find replacement property before they sell their own property. In a case involving a man named Mr. Starker, the court held that the exchange does not have to be simultaneous.

Congress did not like this open-ended interpretation, and in 1984, two major limitations were imposed on the Starker (non-simultaneous) exchange.

First, the replacement property must be identified before the 45th day after the day on which the original (relinquished) property is transferred.

Second, the replacement property must be purchased no later than 180 days after the taxpayer transfers his original property, or the due date (with any extension) of the taxpayer’s return of the tax imposed for the year in which the transfer is made. These are very important time limitations, which should be noted on your calendar when you first enter into a 1031 exchange.

In 1989, Congress added two additional technical restrictions. First, property in the United States cannot be exchanged for property outside the United States.

Second, if property received in a like-kind exchange between related persons is disposed of within two years after the date of the last transfer, the original exchange will not qualify for non-recognition of gain.

In May of 1991, the Internal Revenue Service adopted final regulations which clarified many of the issues.

This column cannot analyze all of these regulations. The following, however, will highlight some of the major issues:

1. Identification of the replacement property within 45 days. According to the IRS, the taxpayer may identify more than one property as replacement property. However, the maximum number of replacement properties that the taxpayer may identify is either three properties of any fair market value, or any larger number as long as their aggregate fair market value does not exceed 200% of the aggregate fair market value of all of the relinquished properties.

Furthermore, the replacement property or properties must be unambiguously described in a written document. According to the IRS, real property must be described by a legal description, street address or distinguishable name (e.g., The Marc).”

2. Who is the neutral party? Conceptually, the relinquished property is sold, and the sales proceeds are held in escrow by a neutral party, until the replacement property is obtained. Generally, an intermediary or escrow agent is involved in the transaction. In order to make absolutely sure the taxpayer does not have control or access to these funds during this interim period, the IRS requires that this agent cannot be the taxpayer or a related party. The holder of the escrow account can be an attorney or a broker engaged primarily to facilitate the exchange.

3. Interest on the exchange proceeds. One of the underlying concepts of a successful 1031 exchange is the absolute requirement that not one penny of the sales proceeds be available to the seller of the relinquished property under any circumstances unless the transactions do not take place.

Generally, the sales proceeds are placed in escrow with a neutral third party. Since these proceeds may not be used for the purchase of the replacement property for up to 180 days, the amount of interest earned can be significant — or at least it used to be until banks starting paying pennies on our savings accounts.

Surprisingly, the Internal Revenue Service permitted the taxpayer to earn interest — referred to as “growth factor” — on these escrowed funds. Any such interest to the taxpayer has to be reported as earned income. Once the replacement property is obtained by the exchanger, the interest can either be used for the purchase of that property, or paid directly to the exchanger.

The rules are quite complex, and you must seek both legal and tax accounting advice before you enter into any like-kind exchange transaction.

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

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2626 Borton Drive – Santa Barbara, CA

SOLD for $1,500,000

Property Website: www.MesaRetreat.com

Property Video:  http://Video.MesaRetreat.com

Interactive 3D Tour:  http://3D.MesaRetreat.com

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

3 Questions to Ask If You Want to Buy Your Dream Home

If you are debating purchasing a home right now, you are probably getting a lot of advice. Though your friends and family will have your best interest at heart, they may not be fully aware of your needs and what is currently happening in the real estate market.

Ask yourself the following 3 questions to help determine if now is a good time for you to buy in today’s market.

1. Why am I buying a home in the first place? 

This is truly the most important question to answer. Forget the finances for a minute. Why did you even begin to consider purchasing a home? For most, the reason has nothing to do with money.

For example, a survey by Braun showed that over 75% of parents say “their child’s education is an important part of the search for a new home.”

This survey supports a study by the Joint Center for Housing Studies at Harvard University which revealed that the top four reasons Americans buy a home have nothing to do with money. They are:

  • A good place to raise children and for them to get a good education
  • A place where you and your family feel safe
  • More space for you and your family
  • Control of that space

What does owning a home mean to you? What non-financial benefits will you and your family gain from owning a home? The answer to that question should be the biggest reason you decide to purchase or not.

2. Where are home values headed?

According to the latest Existing Home Sales Report from the National Association of Realtors (NAR), the median price of homes sold in December (the latest data available) was $232,200, up 4.0% from last year. This increase also marks the 58th consecutive month with year-over-year gains.

If we look at the numbers year over year, CoreLogic forecasted a rise by 4.7% from December 2016 to December 2017.

What does that mean to you?

Simply put, with prices increasing each month, it might cost you more if you wait until next year to buy. Your down payment will also need to be higher in order to account for the higher price of the home you wish to buy.

3. Where are mortgage interest rates headed?

A buyer must be concerned about more than just prices. The ‘long-term cost’ of a home can be dramatically impacted by even a small increase in mortgage rates.

The Mortgage Bankers Association (MBA), the National Association of Realtors, and Fannie Mae have all projected that mortgage interest rates will increase over the next twelve months, as you can see in the chart below:

Bottom Line

Only you and your family will know for certain if now is the right time to purchase a home. Answering these questions will help you make that decision.

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

Thinking of Selling? Why Now is the Time

It is common knowledge that a large number of homes sell during the spring-buying season. For that reason, many homeowners hold off on putting their homes on the market until then. The question is whether or not that will be a good strategy this year.

The other listings that do come out in the spring will represent increased competition to any seller. Do a greater number of homes actually come to the market in the spring, as compared to the rest of the year? The National Association of Realtors (NAR) recently revealed the months in which most people listed their homes for sale in 2016.

The three months in the second quarter of the year are consistently the most popular months for sellers to list their homes on the market. Last year, the number of homes available for sale in January was 1,820,000.

That number spiked to 2,140,000 by May!

What does this mean to you?

With the national job situation improving, and mortgage interest rates projected to rise later in the year, buyers are not waiting until the spring; they are out looking for a home right now. If you are looking to sell this year, waiting until the spring to list your home means you will have the greatest competition for a buyer.

Bottom Line

It may make sense to beat the rush of housing inventory that will enter the market in the spring and list your home today.

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

Open Floor Plan Still Popular

Open floor plans continue to reign. Eighty-four percent of builders say that in the typical single-family home they build, the kitchen and family room arrangement is at least partially open. Fifty-four percent say it’s completely open, according to responses from a September 2016 National Association of Home Builders/Wells Fargo Housing Market Index.

“Completely open” essentially means the two areas are combined into the same room. Partially open signifies areas separated by a partial wall, arch, counter, or something less than a full wall.

Seventy percent of recent and prospective home buyers say they prefer a home with either a completely or partially open kitchen-family room arrangement; 32 percent say they prefer the arrangement completely open, according to an NAHB survey.

Only 16 percent of buyers say they want the kitchen and family rooms in separate areas of the house.

As demand continues to increase for open floor plans, homeowners of existing-homes are also looking to open up their kitchen and family room areas. Professional remodelers report that 40 percent of their projects involved making the floor plan more open by removing interior walls, pillars, arches, etc., according to first quarter of 2016 data in the Remodeling Market Index.

Source: “Builders Satisfy Demand for Open Floor Plans,” National Association of Home Builders’ Eye on Housing blog (Jan. 11, 2017)

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

The Fed Raised Rates: What Does that Mean for Housing?

You may have heard that the Federal Reserve raised rates last week… But what does that mean if you are looking to buy a home in the near future?

Many in the housing industry have predicted that the Federal Open Market Committee (FOMC), the policy-making arm of the Federal Reserve, would vote to raise the federal fund’s target rate at their December meeting. For only the second time in a decade, this is exactly what happened.

There were many factors that contributed to the 0.25 point increase (from 0.50 to 0.75), but many are pointing to the latest jobs report and low unemployment rate (4.6%) as the main reason.

Homebuyers shouldn’t be particularly concerned with last week’s Fed move. Even with rates hovering over 4 percent, they’re still historically low. Most market observers are expecting a gradual rise in home loan rates in the near term, anticipating mortgage rates to stay under 5 percent through 2017.

Bottom Line

Only time will tell what the long-term impact of the rate hike will be, but in the short term, there should be no reason for alarm.

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

2017 Home Design Trends

Housing styles emerge slowly and typically appeal first to cutting-edge architects, builders, and interior designers. As a trend spreads and gains wider interest, it may go mainstream, become almost ubiquitous, and eventually lose its star power. Just look at once-favored granite, which now has been replaced by the equally durable and attractive options of quartz and quartzite.

The economy, environment, and demographics always play a big role in trend spotting. But this year there are two additional triggers: a desire for greater healthfulness and a yearning for a sense of community.

1. Community Gathering Spaces

The combination of more time spent on social media and at work and the fact that fewer people live near their family members has caused many to feel isolated and crave face-to-face interactions.

Multifamily buildings and even single-family residential developments are rushing to offer an array of amenity spaces to serve this need. Some popular options include clubhouses with spiffy kitchens, outdoor decks with pools and movie screens, fitness centers with group classes, and drive-up areas for food-truck socials.

2. Taupe Is the New Gray

White remains the top paint color choice due to its flexibility and the fact that it comes in so many variations. Though white has been upstaged by gray in recent years, this year many will be searching for a warmer neutral, which is why paint manufacturer Sherwin-Williams named “Poised Taupe” as its 2017 Color of the Year. “Poised Taupe celebrates everything people love about cool gray as a neutral, and also brings in the warmth of a weathered, woodsy neutral and a sense of coziness and harmony that people seek,” says Sue Wadden, the company’s director of color marketing.

Many designers consider taupe a smart alternative since it still performs as a neutral with other colors, cool or warm. They expect to see taupe on more exteriors — blending well with roofs, doors, window frames, and surrounding landscape — but it also will turn up indoors on walls, ceilings, kitchen cabinets, furnishings, and molding. It might even work to help update a listing clad in gray, as the two colors work well together.

3. More Playful Homes

Americans work harder now than ever, with many delaying retirement or starting second careers, so they want their homes to be a refuge and a place to unwind.

Spaces that encourage play are trending higher on buyers wish lists, whether it’s a backyard bocce court (the latest outdoor amenity to show up in residential backyards) or a putting green. And sports don’t have to be relegated to the outdoors. Technological advances have allowed for rapid improvement in indoor golf simulators, for example.

4. Naturally Renewable, Warmer Surfaces

The pervasiveness of technology throughout homes has resulted in a corresponding yearning for more tactile surfaces and materials that convey warmth. Natural cork is a perfect expression of these needs, with the bonus of being low-maintenance.

In recent years, cork, a renewable material harvested from the bark of cork oak trees, has resurfaced as a favorite for myriad uses, and for good reason. Aside from aesthetics, the material is appealing since it’s resistant to mold, mildew, water, termites, fire, cracking, and abrasions. Moreover, cork can be stained and finished with acrylic- or water-based polyurethane.

5. Surface-Deep Energy Conservation

As energy costs continue to increase, the search is on for ways to save. Incentives to do so only increase as states and municipalities enact new, stricter energy codes. While energy-wise appliances and more efficient HVAC systems are still appealing to homeowners looking to save on their utility bills, less costly surface upgrades are gaining in popularity.

6. More Authentic, Personalized Use of Space

As home prices escalate — up 5.5 percent, according to CoreLogic Case-Shiller — and baby boomers downsize to retire or cut costs, every inch of available space counts more than ever. To make the best use of space for each resident, design professionals are zeroing in on how clients want to live rather than thinking about how people use space generically.

We are likely to see a greater variety in terms of layouts, building materials, home systems, color palettes, and furnishing choices, both in model homes and in houses staged for sale.

7. The Walkable Suburb

Urban centers have long been a magnet for residents wanting to walk rather than drive to work, shopping, and entertainment. But the trend is now spreading to the suburbs where being close to a town center — and public transit into a larger city — offers similar appeal.

A high walk score has become a recognized real estate marketing tool.  The most appealing towns also incorporate individually owned shops rather than chain stores.

8. Healthier Homes

Consumers have been increasingly aware of hazardous indoor environments over the last few years, but news of the lead-tainted water crisis in Flint, Mich., raised awareness to a nationwide level in 2016. Homeowners are actively seeking out healthy water supplies, purifiers, and HVAC systems, along with nontoxic paints and adhesives. A newer element to this trend in 2017 will include enhanced environmental testing.

A growing number of builders, remodelers, architects, and interior designers expect health to influence their business decisions due to consumer demand, according to studies from both the Urban Land Institute and McGraw-Hill Construction.

9. Shifting Hearths

The traditional log-burning fireplace has lost some appeal as homeowners realize it’s less energy-efficient and can send more particulates into the air. But there are a number of replacement options waiting in the wings.

Homeowners have been switching out their log-burning fireplaces with new gas models for many years. Newer on the market are the ventless alcohol-burning fireplaces that can be placed almost anywhere and without costly construction. Another increasingly popular solution is to build a fireplace outdoors.

10. Counter Options

Much like granite did, quartz and quartzite are predicted to be kitchen favorites until another material comes along. But other green laminate options are gaining in popularity, and they’re no longer just for the budget-minded consumer.

A new countertop can make a big difference in the appeal of a room. Laminate options that mimic stone, wood, distressed metal, and concrete are gaining in popularity. Some newer countertop options offer an additional perk: They lessen the time and cost of installation and also eliminate the need to discard the old countertop. Some manufacturers incorporate recycled granite, glass, and even seashells in its surfaces, which are installed over an existing countertop. Installation can be finished within a day, and prices are competitive with quartz and quartzite. Because these countertops are less porous than traditional stone, they’re also more resistant to stains and scratches.

11. The Transforming Office

Regular work-from-home time among the non–self-employed population has grown by 103 percent since 2005, according to Kate Lister, president of Global Workplace Analytics, a San Diego–based research and consulting group focused on workplace change. Her organization estimates that number will continue to grow at between 10 percent and 20 percent a year.

More of potential buyers  are likely to need a work-from-home space, but due to the diminished size and highly transient nature of technology tools, there’s less need for a dedicated, separate office. Almost any area of a house can become a workplace, but the most functional ones incorporate built-ins and furnishings that serve a dual purpose.

 

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com

Selling in the Winter Attracts Serious Buyers

A recent study of more than 7 million home sales over the past four years revealed that the season in which a home is listed may be able to shed some light on the likelihood that the home will sell for more than asking price, as well as how quickly the sale will close.

It’s no surprise that listing a home for sale during the spring saw the largest return, as the spring is traditionally the busiest month for real estate. What is surprising, though, is that listing during the winter came in second!

“Among spring listings, 18.7 percent of homes fetched above asking, with winter listings not far behind at 17.5 percent. While 48.0 percent of homes listed in spring sold within 30 days, 46.2 percent of homes in winter did the same.”

The study goes on to say that:

“Buyers [in the winter] often need to move, so they’re much less likely to make a lowball offer and they’ll often want to close quickly — two things that can make the sale much smoother.”  

Bottom Line

If you are debating listing your home for sale within the next 6 months, keep in mind that the spring is when most other homeowners will decide to list their homes as well. Listing your home this winter will ensure that you have the best exposure to the serious buyers who are out looking now!

The study used the astronomical seasons to determine which season the listing date fell into (Winter: Dec. 21 – Mar. 20; Spring: Mar. 21 – June 20; Summer: June 21 – Sept 21; Autumn: Sept 21 – Dec. 20).

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Jon Mahoney

Director, Luxury Homes Division

Professional Financial Planner

Keller Williams, Santa Barbara

(805) 689-0532

BRE# 01269717

info@JonMahoney.com

www.JonMahoney.com