Dear Mr. Azrael:
In August 1996, I applied for a mortgage. The transaction was to be rolled into the new property and the new mortgage was to be for the remainder owned [a figure half as large as the amount rolled over].
We were within a week of settlement when [the mortgage company] found that the original property was titled in the name of my revocable trust, which meant that the new property also would be so titled [to abide by 1031 regulations]. The company then reneged on the whole deal, claiming it would be too complicated and risky.
I had to quickly sell investments [in a very untimely market] and really scramble to get enough cash together for the settlement.
They never offered to return my money [for credit report and appraisal]. Am I not entitled to a refund of my $363?
Joan S. Howe-Foster, Annapolis
Dear Mrs. Howe-Foster:
You were trying to take advantage of a tax-free property exchange, permitted by Section 1031 of the Internal Revenue Code.
Section 1031 allows an owner of certain types of real estate or business property to exchange it for "like kind" property without recognizing gain or loss for income tax purposes. To qualify, real property must be used in a trade or business or held for investment.
Here's an example:
You own investment land that originally cost $50,000. It's now worth $200,000. You want to sell it and purchase different investment real estate costing $200,000 or more. Without Section 1031, when you sell the first property, you'll recognize a capital gain of $150,000, even though you use the entire proceeds to purchase another property. Section 1031 allows you to delay recognizing a capital gain if you structure the transactions as an "exchange" of the first property for the second. Instead of paying a capital gain on $150,000, you can roll over the tax basis of the first property to the second property. Section 1031 can work even if the property you acquire in exchange is owned by a third party to the transaction.
The real dollar savings of a Section 1031 property exchange can be very substantial. But a tax-free exchange is a complex transaction. It should not be entered into without competent legal and tax advice.
For instance, a seller who wants to secure the benefits of Section 1031 must include special language in the contract of sale regarding the property exchange.
And since the sale of the first property and the acquisition of the second property often do not happen simultaneously, special escrow agreements must often be prepared.
As you found out, there are many pitfalls in a Section 1031 exchange.
Your problem involved financing for the second property. I expect that an experienced lawyer or tax accountant would have foreseen this problem and made sure the mortgage company knew up front that the trust was the exchanging party.
As an alternative, the property could have been transferred from the revocable trust back to you prior to the exchange.
Your letter states you paid $363 to the mortgage company for an appraisal and credit report. You're not entitled to an automatic refund of these charges under the circumstances you describe.
But you may have legal rights if you were misadvised by the mortgage company.
My advice is to chalk the $363 up to experience. Next time you want to try fancy tax footwork, hire a lawyer or tax accountant to assist you.
Pub Date: 1/31/99