1031 Exchange

16 Replies

Can the proceeds from an investment property (held in an LLC where I am the sole manager), be used to purchase my new primary residency to avoid capital gains tax? "We occasionally stumble over the truth but most of us pick ourselves up and hurry off as if nothing had happened." Winston Churchill

1031 exchanges are for investment properties, not properties intended to be your primary residence. 

Check with the pros, but I believe you can do a 1031 exchange for another rental property which, after a few years as a rental, can be converted to your primary residence.

1031 Exchanges allows you to exchange real or personal property that was held for rental or investment purposes, or that was used in your trade or business for other real or personal property that will also be held for rental or investment purposes. It does not apply to your primary residence.  

Thanks everyone! If the net proceeds from th property are $25k (170k sale price minus 145k mortgage) and I put the entire $25k into a $75k property (leaving a new 50k mortgage) I won't be subject to the penalty correct? Or does the new property have to be a higher purchase price (ie $171k or more)?

@Tyler Williams

Theres several layers of concept you need to flesh out to see if the 1031 will work for you.

1. The 1031 is only for investment property.  You may sell investment property that you own and purchase other investment property.  You may not sell your primary residence and buy investment real estate (you don't want to the rules are better for primary).  You may not sell investment and buy your primary residence.  However there is a way to sell investment and then buy investment and later a year or two down the road move in to it and thus change it from investment to your primary residence.

2. To do a 1031 exchange the taxpayer for the old property must be the tax payer for the new property. It doesn't matter who is the guarantor of the mortgage. In your case, the LLC is a pass through entity to your personal return so you could go with selling as the LLC and buying as the LLC or selling as the LLC and buying as yourself personally.

3. The rules for 1031 say that in order to defer all tax you must purchase at least as much as you sell and you must use all of your proceeds from the sale in the next purchase.  In your case you need to buy investment property worth roughly at least 170K (the net sales price before mortgage pay off) and use all 25 K in that process.  If you buy less than what you sell the IRS views that as taking profit out and you pay tax on that.

4. There are other nuances with 1031 that will effect you but the single most important thing you need to keep in mind is that the 1031 has to be in place with a qualified intermediary before you close the sale of your old property.  

Hope that helps a little

Originally posted by @Tyler Williams :
What about using the proceeds for 2 properties (90k each) totaling 170k? Or does it have to be a single property?

You can exchange one relinquished property into multiple replacement properties. You can also exchange multiple relinquished properties into one replacement property. And you can exchange multiple relinquished properties into multiple replacement properties, where the number of relinquished properties differs in quantity from the number of replacement properties. 

@Tyler Williams

@Steve Babiak is right on.  The Service does not care about the number of properties only the valuation.  So going from one to several or from several to one are both possible given some requirements that must be met timing wise.

As a matter of fact some of our more conservative investors now are using the opportunity to sell properties with significant gain and use the diversification exchange to buy one property in cash and continue to use leverage by maxing out the leverage on the second property.  For instance a sale of a 200K property with 80K in debt.  Our conservative investor would buy one property for 100 in cash and use the remaining 20K as down payment on a second 100K property.  So at the end they have purchased 200K in property and have used all 120K in cash but they now own free and clear one property while continuing to leverage on the second.  

For those looking for security and protection this is not a bad play at all. And by putting a revolving LOC on the free and clear property the investor keeps their powder dry in case the next perfect property comes along.

Does it matter if part of the new property is seller financed? My understanding is 1031 mostly deals with the net proceeds of the old property and the purchase price of the new property being more than the sale price of the old property.

Example: 

Sale-$190k with $35k net

New purchase 1-$65k condo with $5k down remaining 60k seller financed.

New Purchase 2-$130k SF home with $30k down, conventional financing

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Total $35k down and $195k combined purchase price for new purchases.

Hi Tyler,

No, as long as you are trading equal or up in value (based on the net sale price) and you are reinvesting all of your cash equity that came out of the sale of the relinquished property, the debt can be traditional lender debt/financing or can be seller carry back financing.