1031 Exchange to build ADU on family owned property

Member since 2025 · 1 post · 1 vote

Hello,

I’m looking for guidance on if a 1031 exchange is applicable in my situation.

I currently own a single family rental property that I’m planning on selling. The sale price will most likely be around $500,000 and the mortgage is currently about $200,000.

I plan on using the profits (let's just say $300,000) to build an ADU on property that my family owns in Central Oregon. The property is under a family trust. The ADU would then be used as a long-term rental.

Does this qualify as a “like-for-like” property exchange even though I’m technically not buying another property and does a 1031 apply?

Thanks!

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Todd Anderson Thanks for that shout out. @Kyle Knudsen, There's a couple reasons why this wont work unfortunately.

1. The 1031 must be a sale of investment property followed by the purchase of investment property. Improvements on property you own do not qualify.

2. In order to defer all tax you must purchase at least as much as your net sale ($500K ish). And you must use all of your proceeds ($300K ish). If you buy less or take cash out you will pay tax on that amount. In your scenario you'd have a potential tax event on that $200K difference.

Here's a creative way to access most of that money tax free however. Do a 1031 exchange and buy two replacement properties - one for $250K cash and one for $250K using the remaining $50K of proceeds as your down payment.

Once this is done your 1031 is complete. You purchased $500K in real estate. And you used all $300K of proceeds in the purchases. Then you can immediately put a loan on. the free and clear property and pull that cash out to get close to what you need for the ADU. You deferred all tax in the 1031. And the refinance is not a taxable event.

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Denver McClurePro Member
Financial Advisor · Dallas, TX · Member since 2018 · 659 posts · 479 votes
1y
Hey @Kyle Knudsen, I recommend giving @Whitney Nash a call. I don't believe you would properly replace the debt in this situation. Best to talk to her and understand your options.
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Todd AndersonPro Member
Real Estate Agent · Cape Coral, FL · Member since 2023 · 392 posts · 175 votes
1y
@Kyle Knudsen I agree with Denver, with a 1031 you must move all the proceeds to a new "like kind" property. In my experience it cannot be used as construction funding. I would reach out to @Dave Foster to confirm.
Best of luck
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
1y
@Todd Anderson Thanks for that shout out. @Kyle Knudsen, There's a couple reasons why this wont work unfortunately.
1. The 1031 must be a sale of investment property followed by the purchase of investment property. Improvements on property you own do not qualify.
2. In order to defer all tax you must purchase at least as much as your net sale ($500K ish). And you must use all of your proceeds ($300K ish). If you buy less or take cash out you will pay tax on that amount. In your scenario you'd have a potential tax event on that $200K difference.
Here's a creative way to access most of that money tax free however. Do a 1031 exchange and buy two replacement properties - one for $250K cash and one for $250K using the remaining $50K of proceeds as your down payment.
Once this is done your 1031 is complete. You purchased $500K in real estate. And you used all $300K of proceeds in the purchases. Then you can immediately put a loan on. the free and clear property and pull that cash out to get close to what you need for the ADU. You deferred all tax in the 1031. And the refinance is not a taxable event.
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Calbeny Willfred
Member since 2026 · 15 posts · 3 votes
1mo
Curious how this played out for you since it’s been a while. Did you actually manage to pull off the 1031 exchange onto the family trust land?

I'm looking into doing something very similar right now, but the IRS rules around building on land you don't outright own seem completely exhausting to navigate.

While I'm still trying to find a CPA who understands this specific loophole, I started pricing out the actual ADU build to see if the project is even worth the headache. I ended up using some guides from PDX Renovations just to map out the baseline construction costs and local permitting hurdles for Oregon. It gave me a much clearer picture of the budget I need before I lock my money up.

Would love to hear an update if you ended up getting the ADU built, or if the tax rules killed the idea!
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Dan HandfordPro Member
Investor · Lexington, SC · Member since 2018 · 779 posts · 501 votes
1mo
The ownership and sequencing issues deserve attention before the rental is listed for sale. Building an improvement on property already owned by a family trust is materially different from acquiring a replacement property through an exchange. I would have a qualified intermediary and tax professional review the trust ownership, proposed construction, property values, and timeline before any sale occurs. The plan should be documented in advance rather than trying to adapt the transaction after the exchange clock begins.
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