Representing investors: what you need to know plus 1031 exchanges

I. FinCEN’s Geographic Targeting Order: filing of registration form to NYS Dept of Law: (purpose is to guard against money laundering and fraud) and reveal the individual and their social – Financial Crimes Enforcement Network

A. Applies to ALL CASH deals by a Corporate Entity (LLC, S-Corp, etc) as follows:

i.$300,000 and higher

II. FORMATION OF LLC AND PARTNERSHIP AGREEMENTS:

A. Great for investors by providing a liability shield (although not bullet proof) and limiting the amount of damages to solely the assets of the LLC or Corp as opposed to the individual owner himself, and also for tax deduction purposes.

i. NOTE: a judge can still pierce then “corporate veil” and go after the owner’s personal assets if he finds that substantial negligence exists

ii. Tax Benefits : flow through taxation for single member LLC & S-Corps (avoids double taxation on a personal and corporate level), the rental income will be reported however owner may still write off improvements, repairs, maintenance expenses, taxes, mortgage interest against that income

B. Partnership Agreements : beneficial for multiple individuals who partner up for a real estate investment and don’t want to form a corporate entity. Designates the duties and roles of each member and the disposition of cash flow and overall investments.

C. Stop Shop: TAB Law Firm can form the LLC for your client for a flat fee of $1250.00 in 48 hours which includes the filing fee to the State along with the Certificate of Formation , Operating Agreement , and TAX ID# from the IRS all of which is required for reporting purposes, and by the title company for clearance to close, and in order to open a bank account in the name of the LLC so that the rental income funds are not comingled for tax filings.

III. The Foreign Investor : How FIRPTA Affects Your Client

A. What does it Mean? – FIRPTA stands for the Foreign Investment in Real Property Tax Act and regulates taxation of nonresident alien individual on sales or other disposition of US real property interests. (Section 1445 of the Code)

B. The Tax ONLY applies upon the time of SALE , not PURCHASE.

C. Effects of FIRPTA – any purchaser of US real property from a foreign seller (non US resident) must withhold 15% of the gross purchase price and remit such amount to the IRS within 20 days of closing. NOTE: Seller must pay 15% of sales price, but burden falls on the PURCHASER to file Form 8288 Withholding Tax Form , and send payment to IRS. Otherwise, Purchaser is liable for any uncollected withholding tax, penalties and interest charges. (I suggest ATTY ESCROW as opposed to Certified Bank check for tracking purposes)

D. Out of State NY Seller Tax : IT2663– NY state capital gains tax is paid IN ADDITION to Firpta, and NY tax is 10.90% of NET profit (after all deductions)

IV. EXCEPTIONS TO FIRPTA

A. Multiple Sellers: Foreign and US owners – instead of taxing the entire gross sales price 15%, only the amount allocated to the foreign seller will be subject to FIRPTA.

B. Residential Use Exception– foreign Seller is exempt from FIRPTA if the Purchaser is a US individual and intends to use the property and the existing structure as their primary residence AND purchase price is under $300,000.

C. Treaties– foreign sellers are subject to 30% capital gains tax, but can be reduced by up to half (ie: 15%) if US holds treaty with foreign country.

D. VISA’s– if seller is here on work Visa and pays US income tax then they are exempt

E. LOSS – If seller sells at a LOSS then they are exempt

V. TAXATION OF RENTAL INCOME

A. Rental Income Tax for Foreigners “INVESTORS”: foreign investors are subject to a flat rate of 30% of all gross rental income and must be withheld by the party paying rent proceeds to the owner (ie: property managers).

i. Exceptions:

a. Tax treaties may be in effect to reduce this amount up to 50%.

b. Income is connected with a US business.

c. May elect to have passive rental income taxed as if it were connected with a US trade or business by timely filing with income tax return.

B. Rental Income for Foreign “BUSINESS OWNERS”: foreigners who purchase property, earn rental income and are “engaged in a U.S. trade or business” will be taxed on a net income basis.

i. Standard of Proof: cannot consist of merely passive activity such as net leases in which renters pays rent, taxes, operating expenses, and interest on mortgages and insurance.

ii. Acceptable Business Uses: many commercial uses such as operating a shopping center, hotel, etc. where owner pays all operating expenses, taxes, and so forth. Thus, will not be subject to 30% withholding, and will be taxed at ordinary progressive rates on the NET INCOME.

I. WHAT IS 1031 EXCHANGE?

● Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of “like-kind”, while deferring the payment of federal income taxes and some state taxes on the transaction.

● The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

II. BENEFITS OF EXCHANGE VS SELLING:

● A Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.

● By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.

● You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

III. DIFFERENT TYPES OF EXCHANGES

● Simultaneous Exchange: The exchange of the relinquished property for the replacement property occurs at the same time.

● Delayed Exchange: This is the most common type of exchange. A Delayed Exchange occurs when there is a time gap between the transfer of the Relinquished Property and the acquisition of the Replacement Property. A Delayed Exchange is subject to strict time limits as provided below.

● Build-to-Suit (Improvement or Construction) Exchange: This technique allows the taxpayer to build on, or make improvements to, the replacement property, using the exchange proceeds. However, the taxpayer is not permitted to build on property he/she already owns. Therefore, an unrelated party or parking entity must take title to the replacement property, make the improvements, and convey title to the taxpayer before the end of the exchange period.

● Reverse Exchange: A situation where the replacement property is acquired prior to transferring the relinquished property. The IRS has offered a safe harbor for reverse exchanges. In a typical reverse exchange, the “Exchange Accommodation Titleholder” (EAT) takes title to (“parks”) the replacement property and holds it until the taxpayer is able to sell the relinquished property. The taxpayer then exchanges with the EAT, and now owns the replacement property. Must occur within 180 days (6 mo).

IV. EXCHANGE REQUIREMENTS

● Qualifying Property – Certain types of property are specifically excluded from Section 1031 treatment: property held primarily for sale; inventories; stocks, bonds or notes; other securities or evidences of indebtedness; interests in a partnership; certificates of trusts or beneficial interest. In general, if property is not specifically excluded, it can qualify for tax-deferred treatment.

● Proper Purpose – Both the relinquished property and replacement property must be held for productive use in a trade or business or for investment. Property acquired for immediate resale will not qualify. The taxpayer’s personal residence will not qualify.

● Like Kind – Replacement property acquired in an exchange must be “like-kind” to the property being relinquished. All qualifying real property located in the United States is like-kind, international property is not.

● Exchange Requirement – The relinquished property must be exchanged for other property, rather than sold for cash and using the proceeds to buy the replacement property. Most deferred exchanges are facilitated by Qualified Intermediaries, who assist the taxpayer in meeting the requirements of Section 1031.

V. TIME RESTRICTIONS

● Identification – A taxpayer has 45 days after the date that the relinquished property is transferred to properly identify potential replacement properties.

● Exchange: The exchange must be completed by the date that is 180 days after the sale of the relinquished property.

VI. GENERAL GUIDELINES

● The value of the replacement property must be equal to or greater than the value of the relinquished property.

● The equity in the replacement property must be equal to or greater than the equity in the relinquished property.

● The debt on the replacement property must be equal to or greater than the debt on the relinquished property.

● ALL of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.

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Taliya Bashani ESQ

Are you tired of spending so much time and energy running around with buyers showing them properties only for them to jump ship or not pull the trigger ? Are you getting into contract only to lose deals and have them fall through midway? I have helped thousands of agents just like you refocus their energy on sellers and win more exclusive listings. They are doubling their commission with a lot less time and stress. I have spent the last 15 years as a broker and real estate attorney closing over 10,000 deals and over $1 billion in real estate.

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