1031 Exchange on a flip

Real Estate Investor · Baltimore, MD · Member since 2008 · 619 posts · 75 votes

I have 2 properties that are getting ready to Settle in the next 30 days, I would like to do a 1031 Exchange either into another flip or into rentals. I have read conflicting info on this topic in regards to flips, can anyone provide more insight or direction? Thanks!

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Steve Babiak

Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes

12y

Originally posted by @Anthony Dooley:

In the future, if you want to use 1031 exchanges, let your closing attorney know this when you are buying the property, don't just wait until you want to sell it. You must use an attorney when doing a 1031 exchange. They hold the money from the sale and will release it to buy another like property. There is a time limit. You cannot touch the money or else you have to pay the capital gains taxes.

I think there is some confusing info in that post.

You don't have to use an attorney to close a 1031 exchange - but you must use a Qualified Intermediary (QI) who may or may not be an attorney.

When I buy a property to hold as a rental, I have no idea whether it is going to be relinquished down the road via 1031 exchange, so why would I involve a QI at that point as that post suggested? Sure, when I buy a replacement property, i know it is part of a 1031 exchange so it goes through the QI, but otherwise buying a property does not involve a QI.

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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
11y
@Steve Buchanan
and the personal exemption is a Tax FORGIVENESS, where as the 1031 is a Tax DEFERRAL, big difference.
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Steve Buchanan
Rental Property Investor · Los Angeles, CA · Member since 2013 · 119 posts · 51 votes
11y
Originally posted by @Jesse T.:

Originally posted by @Steve Buchanan:
@David Krulac
Now what if you live in your primary residence for 2 years, move out, rent it for the next 10 years and then want to sell? Since your 5 years has expired you are disqualified for the primary residence exemption but can you qualify for a 1031 exchange now? I know the answer lies in the intent you had when you initially purchased the property. Can you argue that your initial purchase of the house as a primary residence was also for investment purposes?
What you did in that scenario was acquired the property for personal use and then converted it to a rental property. As a rental property it is eligible for a 1031. The relevant "acquisition" is the conversion to a rental property. One note on the basis is if your property was at a lower value at the time of conversion you have to use that vs. the purchase price(also for depreciation calculations).
So are you saying 10 years down the road if I sell I have to go back and determine the fair market value of the property when I converted from primary residence to rental and use that as the basis for the 1031 exchange? If that basis is higher than my initial purchase price do I pay immediate tax on the spread between the initial price and the basis (value at the time of conversion to rental) and defer the rest of the tax so long as I find an eligible 1031 exchange property to move into?
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Jesse T.
Herndon, VA · Member since 2014 · 1k+ posts · 324 votes
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Originally posted by @Steve Buchanan:

Originally posted by @Jesse T.:
Originally posted by @Steve Buchanan:

@David Krulac
Now what if you live in your primary residence for 2 years, move out, rent it for the next 10 years and then want to sell? Since your 5 years has expired you are disqualified for the primary residence exemption but can you qualify for a 1031 exchange now? I know the answer lies in the intent you had when you initially purchased the property. Can you argue that your initial purchase of the house as a primary residence was also for investment purposes?
What you did in that scenario was acquired the property for personal use and then converted it to a rental property. As a rental property it is eligible for a 1031. The relevant "acquisition" is the conversion to a rental property. One note on the basis is if your property was at a lower value at the time of conversion you have to use that vs. the purchase price(also for depreciation calculations).
So are you saying 10 years down the road if I sell I have to go back and determine the fair market value of the property when I converted from primary residence to rental and use that as the basis for the 1031 exchange? If that basis is higher than my initial purchase price do I pay immediate tax on the spread between the initial price and the basis (value at the time of conversion to rental) and defer the rest of the tax so long as I find an eligible 1031 exchange property to move into?
In situations where the purchase price is lower you will use that for the basis calculations. There isn't a taxable event in the conversion. As long as your acquired property is more expensive in a 1031 you defer taxes(both capital gains and recapture) - although you will have a lower basis.
Lets say you buy a property for 150K. It is worth 200K when you convert to a rental. You use 150K for your basis. Then after 10 years you have depreciated it by 40K. At that point your basis will be 110K and you have a 40K recapture. If you sell for 300K you will owe capital gains on 150K of the proceeds and recapture tax(close to income levels) on 40K.
If you go the 1031 route and acquire a property worth 400K - you will have a basis of 210K(original 110K + 100K in additional funds) and 40K that would be recaptured in a taxed sale.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
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Originally posted by @Steve Buchanan:

@David Krulac
Now what if you live in your primary residence for 2 years, move out, rent it for the next 10 years and then want to sell? Since your 5 years has expired you are disqualified for the primary residence exemption but can you qualify for a 1031 exchange now? I know the answer lies in the intent you had when you initially purchased the property. Can you argue that your initial purchase of the house as a primary residence was also for investment purposes?
Hi Steve,
Intent can change, so in your example, the original intent was to use for personal use, but the intent has clearly changed and you have 10 years of proof that you held for rental purposes. You should have no problem qualifying for a 1031 Exchange unless any other documentation demonstrates that you still had the intent to live there later, etc.
Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
11y
Originally posted by @Steve Buchanan:

Originally posted by @Jesse T.:
Originally posted by @Steve Buchanan:

@David Krulac
So are you saying 10 years down the road if I sell I have to go back and determine the fair market value of the property when I converted from primary residence to rental and use that as the basis for the 1031 exchange? If that basis is higher than my initial purchase price do I pay immediate tax on the spread between the initial price and the basis (value at the time of conversion to rental) and defer the rest of the tax so long as I find an eligible 1031 exchange property to move into?
No, the cost basis will be what you original paid for the property (not when you converted the property to rental property). You will start to depreciate the property when you convert to a rental property and that will reduce the cost basis (original cost less depreciation is your adjusted cost basis).
Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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Steve Buchanan
Rental Property Investor · Los Angeles, CA · Member since 2013 · 119 posts · 51 votes
11y
Thanks @Bill Exeter and @Jesse T. for your responses!
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