Savvy real estate investors know that the 1031 Exchange is an important tool that, when utilized properly, allows the investor to defer capital gains tax on property that is sold at a gain. So what is a 1031 Exchange? A 1031 Exchange is an exchange of one property (referred to as the “relinquished property”) for another like kind property (referred to as the “replacement property”) under the rules of Internal Revenue Code §1031. In a 1031 Exchange, the investor places the proceeds of a property sale in escrow with a “qualified intermediary.” These funds are then used to purchase the replacement property, and the investor does not pay tax on income gained from the sale of the relinquished property.

The requirements of a 1031 Exchange include: (i) the transaction must be an exchange through a qualified intermediary as opposed to a sale and purchase; (ii) the replacement property must be like kind to that of the relinquished property; (iii) the same taxpayer must dispose of the relinquished property and acquire the replacement property; (iv) both properties (i.e. the relinquished property and the replacement property) must be held for investment purposes or for use in the investor’s business; (v) to defer all tax the replacement property must be greater in value, equity, and debt than the replacement property; and (vi) replacement property must be properly identified pursuant to IRS §1031 within 45 days of the closing of the relinquished property.

While it has been established that a personal residence is not eligible for a 1031 Exchange as it would violate the requirement that the property be held for investment purposes, IRS Revenue Procedure No. 2008-16 has created a safe harbor for property held for productive use in a trade or business or for investment under Section 1031 even though the taxpayer occasionally uses the property for personal purposes. However, the property must meet certain qualifying use standards, which include, for both relinquished and replacement property, minimum requirements for length of ownership and days rented, as well as maximum requirements for days used for personal use. The other key aspect of the qualifying use standards is that the relinquished and replacement properties must be rented at fair market value.

Through proper planning and analysis, real estate investors can leverage the 1031 Exchange to their advantage. However, that analysis and the rules governing it can be quite complex. Therefore, please consult with your legal and tax advisors as you contemplate your next 1031 Exchange.

Through the home buyer tax credit of the American Recovery and Reinvestment Act, an $8,000.00 tax credit is available for first-time home buyers on a primary residence purchased during calendar year 2009. While much has been written about the benefits of the credit, the following is intended to provide a high-level snapshot of the program’s requirements:

• A person is considered a first-time buyer if he/she has not had any ownership interest in a home in the three years prior to the day of the 2009 purchase.

• The amount of credit is determined by: (i) the purchase price (credit = 10% of purchase price); and (ii) the buyer’s income level (individual buyers with an income of $75,000.00 or less and couples with a combined income of $150,000.00 or less are eligible for the full tax credit).

• The credit is then phased between $75,000.01 and $95,000.00 for single taxpayers and $150,000.01 and $170,000.00 for married couples filing a joint tax return.

• The credit does not have to be repaid provided buyer occupies the home for 3 years or more.

• The credit is a “refundable credit” – if the purchaser’s total tax liability in the given year is less than $8,000.00, the IRS will send a refund for the balance (If, for example, the purchaser’s total tax liability = $7,000.00, the purchaser would receive a check for $1,000.00)

• A 2009 purchase may be claimed on the purchaser’s 2009 return or in the alternative, the purchase may be treated as if it occurred on December 31, 2008 thereby giving the purchaser the option of filing an amended 2008 tax return (see Form 1040X at www.irs.gov).

The Offer to Purchase is generally regarded as the first step in the real estate transaction. The Offer to Purchase will include the purchase price, required deposits, a proposed closing date, and any terms which the purchase is contingent upon. Common examples of contingencies include the mortgage, inspection, and appraisal contingencies.

Unfortunately, many home buyers and sellers do not realize that with the acceptance of the Offer to Purchase, Buyer and Seller may very well have entered into a legally binding contract. Where the following three (3) elements are met, Buyer and Seller have entered into an enforceable contract: (i) the Offer to Purchase includes all of the essential terms of the contract; (ii) the Offer to Purchase is in writing and signed by the parties; and (iii) the parties intend to be bound by the Offer to Purchase.

Moreover, the general conception appears to be that any errors or omissions in the Offer to Purchase can be rectified in the more formal Purchase and Sale Agreement (the “P&S”). However, this is somewhat erroneous as it is the Offer to Purchase that sets the outer parameters for the P&S. For example, should the Offer to Purchase fail to include a mortgage contingency, it will be extremely difficult to convince the Seller to agree to such a contingency in the P&S. Why? Because the Seller has based acceptance of the Offer to Purchase on the terms presented in said offer. To change the terms after acceptance is to change the rules of the game. This is not to say that additional terms and contingencies are categorically denied during the negotiation of the P&S. They are not. However, to ensure the inclusion of these contingencies, the Buyer will want to be absolutely sure that they are addressed in the Offer to Purchase.

To best achieve a properly structured Offer to Purchase, the Buyer should consider having their real estate attorney review the offer prior to transmitting it to the Seller. Most real estate attorneys will include this service as part of their flat fee, which has become the industry standard. Likewise, the Seller would be wise to have his attorney review the Offer to Purchase prior to the Seller’s acceptance.

With a properly structured Offer to Purchase and acceptance of that offer, the Buyer and Seller will have identified the terms of the agreement and thereby established the expectations of the parties; a critical first step in what is often one’s single largest investment.