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www.marejournal.com M id A tlantic R eal E state J ournal By Pamela A. Michaels, Esq. Asset Preservation, Inc. The importance of fair market rent in a 1031 Exchange 1 up the costs of these repairs out- of-pocket. 031 exchange activity is con- tinuing to pick up along the East Coast for commercial
IRS challenged this exchange and claimed the property was con- sidered a ‘family home’ since the actual rent paid from the son to his father was considered slightly below market rent. However, in Adams, the re- placement property was in poor condition at the time of the taxpayer’s exchange. The tax- payer’s son had experience as a contractor and personally made extensive repairs to the property, and the son paid for the materials needed to perform the repairs. In addition, the taxpayer’s son lived in the property for the next four years and continued to maintain and repair the property, picking
The Tax Court determined that the rent received from the son, plus the value of the im- provements made by the son, constituted fair market rent. Consequently, the Court ruled there was no bargain rent. This case highlights the importance of receiving fair market rent when renting a property to a family member. Revenue Procedure 2008-16 Revenue Procedure 2008-16 addresses a safe harbor for vaca- tion homes held for investment and whether or not a dwelling unit qualifies as property held for productive use in a trade or business or for investment under Section 1031 of the Inter- nal Revenue Code. In Revenue Procedure 2008-16, it is noted that the dwelling unit must be rented “at a fair rental.” Later in this Revenue Procedure, in Sec- tion 4, Fair Rental is specifically defined, “For the purposes of this revenue procedure, whether a dwelling unit is rented at a fair rental is determined based on all the facts and circumstances that exist when the rental agreement is entered into. All rights and obligations of the parties to the rental agreement are taking into account.” The definition in this Revenue Procedure indicates that the IRS will look at all the facts and circumstances of a particular exchange to ascertain whether or not fair market rent was re- ceived. Planning Considerations When Renting To A Family Member 1. Rent at a price that is com- parable to other similar rental properties in the market. 2. The taxpayer should enter into a rental or lease agreement in the same manner they would with any tenant of an investment property. If a longer term rental, make sure the relationship is solely that of a landlord and tenant, the rent received is ap- propriate to the local market, and the terms of the rental agreement strictly construe the rights and responsibilities of the parties as a landlord and tenant. As always, investors should consult with a reputable tax and/or legal advisors about any proposed 1031 exchange and seek input from a knowledgeable Qualified Intermediary. Pamela A. Michaels, Esq. is VP and northeast division manager for Asset Preserva- tion, Inc. n
real estate in- vestors. A re- cent 2013 Tax Court decision, Adams v. Com- missioner, T.C. Memo 2013-7, demonstrates the importance
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of a taxpayer receiving fair mar- ket rent when desiring to obtain the tax deferral benefits of a 1031 exchange. InAdams, the taxpayer exchanged into a replacement property that was rented to the taxpayer’s son and family. The
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