Another 1031 Exchange Question - From Real Estate to RE/Business

2 Replies

Contemplating selling an investment property. Can I 1031 exchange into improvements on another rental property I already own as well as use capital gains for furnishing it?

If I have already began the process of improvements/furnishing (this year) and financed some of it, can I use the exchange to pay off financing or for all of the costs?

Example: $50k gain from selling rental X. I have spent $15k renovating/furnishing rental Y - 5k out of pocket, 10k financed. If I sell X now, can I exchange the $50 towards the 5k or 10k already spent on Y? Can I exchange any towards more renovations/furnishing or other business expenses related to property Y?

Property Y is a duplex vacation rental btw.

No. The exchange has to be for the Purchase of a replacement property.

Hi Isaac,

The answer is no, yes, and no.

Generally, you must 1031 exchange out of real estate and into other real estate, which means that you must acquire real estate as replacement property that you do not already own. So, the standard answer is no.

However, the IRS did issue two Private Letter Rulings in 2002 and 2003 that essentially did allow the taxpayer to 1031 Exchange into property they already owned. There are usually two problems/risks with these. First, they are only Private Letter Rulings, so the rest of us can not rely upon them. In other words, if we do exactly the same transaction exactly the same way, our transaction would still be disqualified. Second, the two PLRs had a specific fact pattern that generally requires some restructuring of the ownership of the property that you would want to build on, which may be deemed as a step transaction unless you have some seasoning (time). So, the answer is mayb yes, but there will be some risk in doing this.

Finally, in your case, you have already started the process, so it is too late to set-up the 1031 Exchange based on the two Private Letter Rulings. So, the final answer is no.

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