Invariably, when I give a seminar or speech on 1031 exchanges, a question on mixed use exchanges is queried.
What is a mixed use? Pretend my last name is McDonald. Further pretend that I am a farmer. AND on my farm--E- I, E- I - O, --ENOUGH of the nursery rhyme--but if I had a farm and I lived in the farm house, but farmed the surrounding land, I would have a mixed use property. The farm house would be my personal residence and the surrounding farm land would be property that I used in my trade or business (in this case, farming) or was being held as an investment.
I could sell the property and use both sections 121 and 1031 of the Internal Revenue Code (IRC). How does that work you ask? Under section 121 of the Internal Revenue Code(IRC), a taxpayer can sell their personal residence, and if they lived in the personal residence 2 of the last 5 years, up to $250,000 of profit per person or up to $500,000 per married couple, can be received TAX FREE. That of course is presuming that the personal residence (in this case the farm house) went up that much in increased equity. The remaining portion of the sales price could be allocated to the farm land, which would qualify for a Section 1031 exchange.
Let me give you an example. Mr. and Mrs. McDonald (the taxpayers) purchase a farm for $300,000 in 2001. It has a farmhouse on it and 50 acres of farm land. The farmhouse is valued at $200,000 and the land is valued at $100,000 (that of course equals $300,000). In 2009 they agree to sell the farmhouse and the 50 acres for $1,100,000. If they can justify the value of the farmhouse at $700,000, they could receive the profit on the farmhouse TAX FREE(sales price of farmhouse $700,000 less original purchase price of $200,000 equals a TAX FREE PROFIT of $500,000 under IRC Section 121).
The farm land which was originally purchased for $100,000 is now worth $400,000, so there was a profit of $300,000 on the land. The taxpayer could transact a IRC Section 1031 exchange on the $400,000 of land and purchase another real estate investment for $400,000 or more. If taxpayers did that, they would defer any and all taxes that would be due on the sale of the farm land (that of course is covered under IRC Section 1031).
It's a convoluted example--but WOW--what a way to save money, pay no tax on the personal residence profit and defer paying tax on all of the other profit. I'll say it again, acting as the Qualified Intermediary on a Section 1031 exchange is a wonderful job--the client is always happy because you have helped him/her save payment of taxes and, in some cases, they will never pay any tax.
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