Strategy for a 1031 exchange?

3 Replies

We have successfully made a deal on an REO home, but have some questions on a 1031 exchange for it. The idea is to take the home (purchased for $50k), put $15-20k into it and sell it for up to $100k.

1) The purchase price of the home was all of our cash plus $8k on a credit card.  We will use credit for the rehab as well (totaling about $28k).  Lets just say we sell the house for $100k, making a $50k profit.  Is there a way to pay off the credit cards with the profit, without paying taxes?  If we do have to pay taxes on the portion we paid the debts off with, can the remaining be kept in the 1031?

2) Does my realtor work with an intermediary?

An accountant told us it would be cheaper to just pay the taxes on the profit (whether its in our LLC or personal name) than to "pay the lawyers to do a 1031 exchange". Any thoughts on that statement?

First, it sounds like you are rehabbing and then flipping the house, so it does not qualify for 1031 Exchange treatment.  Properties that are bought, rehabbed and then sold ("flipping") are held for sale and not held for investment, which is why they do not qualify for 1031 Exchange treatment. 

Second, if you did qualify for a 1031 Exchange, credit card charges can not be paid off from the sale of proceeds without incurring taxable gain on those amounts.  It could be done, but will trigger part of your taxes as taxable boot. 

Third, you and your Realtor would work with a Qualified Intermediary. 

Fourth, I think you need to change accountants.  The accountant should have been aware that rehabbing/flipping does not qualify for 1031 Exchange treatment, and most regular 1031 Exchanges only cost $795.00. 

1st, if you buy it for $50k and put $20k into the rehab and then sell it for $100k, you haven't made $50k in profit.  You've made $30k in profit.  But you actually haven't.  You've got buying and selling costs to be considered.  How much interest did you pay on the debt on the credit cards?  Any inspection prior to buying?  There will certainly be some taxes, closing and other costs.  They all have to be deducted.  You'll almost certainly have some realtor/broker fees when you sell.  You might end up with $15 profit on this deal the way it sounds.  You can pay off all the credit card debt with the proceeds from the sale before taxes since those are just business expenses assuming all the cc debt is from the purchase and rehab of the property.  You might be able to roll the profit into your next purchase with a 1031 exchange, but you're likely best to pay the taxes and move on, but I don't know the costs for a 1031 exchange.  You would need to pay close attention to the rules.  You have a strictly limited window to sell the 1st property and buy the 2nd.

You'll also have holding costs.  Utilities, trash, property taxes and insurance for the duration of the rehab and selling cycle to consider...

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