1031 Exchange for 50% of Owner-Occupied Property

[David Pedersen]

I own a 4 unit apartment building, live in 50% of the building and rent out the remaining 50%. I'd like to sell the building and do a 1031 exchange for the 50% share that is income property by purchasing a like-kind property, and take the $500k personal capital gains exemption (married) for the other 50% in which I reside. Is this possible? Thank you for any insight you can provide.

[Dave Foster]

@David Pedersen, - Doable and advisable.  A very sound move providing you meet the residency requirements for the primary residence exclusion of sec. 121.  If you've lived in that 50% for two of of the last 5 years then you are good to go.  

Your accountant has already established basis for each side and the investment side is being reported on your schedule E.  From there it will be an easy matter for them to use the form 8824 to record the 1031 exchange on the 50% rental and re-establish basis and defer tax on that. The 50% residence will be tax free.

You don't indicate that you'll be using part of the 1031 to purchase another residence but make sure you don't.  Use the full proceeds from the investment portion to purchase all investment replacement property.  The rule of like kind are such that any type of investment property will qualify. 

 If you do want to purchase another mixed use property you will want to make sure that the allocation for the investment portion will cover the net sale allocation for the investment part of what you are selling.  

The tax free money is obviously yours to use however you want including purchase another residence.

[David Pedersen]

Thank you Dave! This is fantastic. Yes, I have lived in the 50% for two of the last five years and my Schedule E does reflect the income portion of the building. My plan would be to buy a less expensive multi-unit investment property, ideally all cash, as a 1031 exchange and put the $500k personal exemption down on a nice single-family home to live in. Does this all sound right still?

[Dave Foster]

Yep, great plan - your reinvestment target in the 1031 to avoid all tax on the investment side will be the amount of your net sale - gross sales price of investment portion less costs of sale for the investment portion but before any mortgage pay off..  If you want to buy less than that you can but the irs will view that as taking profit and you will pay tax on the difference. 

Your family will appreciate the nice pot at the end of the rainbow after doing the owner on site thing won't they?!  Holler if I can be of further service.

[Jesse Lamar]

Great content here and I realize this thread is 8 years old but hear goes nothing.  Hoping Dave is still in the 1031/QI space and can advise (and prospectively execute) on an upcoming exchange.

If the new subject property is not yet owned and is contemplated for new construction of 1) Primary residence SFH and 2) ADU Rental Property can 1031 funds be applied specifically to the new build expense of the ADU? Zoning would presumably require both new build structures on the same parcel with single TMS.

Thanks!

[Dave Foster]

@Jesse Lamar, Still alive and kickin in the 1031 space!  There are a couple of ways to make this happen.  But first you want to make sure that you do not take title to the lot for the new property and then get a construction loan for the construction.  Because you cannot 1031 into improvements on property you own.  If you take title to the lot you cannot take title to the construction after.

If you've simply gone into contract for new construction that consists of a main house and two ADUs then yes there is a way to treat this "split use" property so that your 1031 goes to the purchase of the ADUs and qualifies for the 1031 exchange.

1. If the purchase could be split up into two parcels that is certainly the cleanest.  Many times zoning will not allow.  But if you can then the ADUs and the land under them become one purchase.  And the residence becomes the other.

2. your accountant can also split off the purchase and allocate the ADU % to be reported as investment on your schedule E. And the residence to be reported on your Schedule A.

Situations like this are very similar to a farm where part of the farm is the primary residence.  And the rest is the farm land.  But the residence sits inside the farm land.  Or a self storage facility with an owners quarters.  Or even a bed and breakfast or rooming house where the owner lives on site.