Inherited property into a 1031 exchange

7 Replies

I have a unique situation with property owned by my Mother (still in her name). She currently owns a 10 acre parcel in rural Southwest MO with a 2,000 s.f. 3/2 SFR. Due to neglect, this house is a serious fixer-upper & will need a complete renovation. We both live in different states and at this time are not interested in flipping the house, but selling as-is. As a cause of the neglect, the home is currently unoccupied, not her primary residence and Mother is currently renting a home from a private landlord. My brother & I (the only benefactors) are trying to help her do some estate planning and want the best strategy that makes the most financial sense. A 1031 Exchange on the surface seems like a good option that we could then roll into an additional investment property for her to occupy (house-hack). If my Brother and I can use the proceeds to purchase say- a duplex property, Mom can live on one-half, we can rent the other half out & it will save her a large portion of her fixed-income. The main goals with selling the property are to: 1.) shelter the proceeds from sales/inheritance tax 2.) alleviate the monthly expenditure to an outside landlord 3.) provide a long-term investment for both siblings 4.) shelter (by transferring of title) what has become Mom's sole asset from being garnished should she need long-term care (nursing home, etc.). We are anticipating a sell price of $75k-$90k that can then be used as a down-payment for a rentable property.

    Here are my questions:

1.)  If we sell the house & transfer it into our names, do we need to transfer Title before the sale/1031 Exchange, or can this be done after?

2.) By selling the home and purchasing a home for her to "rent", are there any problems created with 1031?  I am assuming since the property will be in our names and not hers, we will not run into primary residence issues with 1031?

3.) The plan is most likely to sell the existing property and invest the proceeds in a different state- does this make any difference?

4.) In transferring the property to the sibling's names', what is the timeframe that the assets will be protected from garnishing from long-term care, etc.?  I know each state is different.

I am sure a lot of these questions would be best dealt with a financial advisor/estate planner, but this seems like a good opportunity for my brother and I to begin a  portfolio of long-term investing that will benefit everyone much more than the traditional sale of property with sales taxes paid and put into an account.  Thanks in advance for all of the help, go easy on me, it is my very first post!

  

@Donnie Mac , Did she live in the house for 2 out of the previous 5 years?  if so then she needs to sell it now and take advantage of the primary residence exclusion. 

You're way beyond the need for a 1031 exchange on this one. She could do a 1031 but If she tries to sell and 1031 herself she would be precluded from living there and it would be a hindrance to meeting the rest of your stated goals.  Transferring property from your mom to you in any way is a related party transaction and fraught with all kinds of risk let alone holding issues, a lease back to a related party,  and the need to meet the rest of your goals.

If you take title from her you're going to need to hold that property for productive use before you can utilize a 1031 on sale.  Otherwise you took title primarily to resell.

Get a competent estate planning attorney to work with you on a transfer of the asset appropriately in a manner that protects her estate.  There are some serious hurdles that have to be overcome and some specific steps you need to take.  But there are some things you can do to protect her and you and mitigate the tax burden.

Thanks Dave, your info. was very helpful and kickstarted me in a completely different direction.  The 1031 was definitely the wrong approach, it was easy to overthink it.  I appreciate the newbie help!

Originally posted by @Dave Foster :

@Donnie Mac , Did she live in the house for 2 out of the previous 5 years?  if so then she needs to sell it now and take advantage of the primary residence exclusion. 

You're way beyond the need for a 1031 exchange on this one. She could do a 1031 but If she tries to sell and 1031 herself she would be precluded from living there and it would be a hindrance to meeting the rest of your stated goals.  Transferring property from your mom to you in any way is a related party transaction and fraught with all kinds of risk let alone holding issues, a lease back to a related party,  and the need to meet the rest of your goals.

If you take title from her you're going to need to hold that property for productive use before you can utilize a 1031 on sale.  Otherwise you took title primarily to resell.

Get a competent estate planning attorney to work with you on a transfer of the asset appropriately in a manner that protects her estate.  There are some serious hurdles that have to be overcome and some specific steps you need to take.  But there are some things you can do to protect her and you and mitigate the tax burden.

@Dave Foster, thank you for all the insights on 1031's. I'm interested in purchasing a property in Los Angeles County from a seller who's in much the same situation described above. The property is a SFR that the seller took title to from his father (via parent/child transfer) and the father continued living in the house up until last month. The seller has since obtained power of attorney over his father's affairs, due to failing health, and has now relocated his father to live with him in San Diego. I am interested in purchasing the house. I know the seller will need to convert the property to productive use in order to take advantage of the 1031 Exchange. My question is, can we enter into a "lease to own" type arrangement without precluding the use of 1031 down the line?

Thanks in advance, Dave.

@Felipe Camacho , lease to own or a "land sale" arrangement is tough because the IRS is going to look at a concept called "Risk of Loss" to determine when the sale really happened.  If you simply bought the property then it's easy to see that Risk of Loss occurred when money changed hands, the closing statements were all closed and the deed recorded.  So that is when the 1031 has to be in place.  

With a land sale or lease to own it is much more difficult to determine what bundle of rights you actually have that would equate to "Risk of Loss passing".  It is very conceivable and has happened in past cases that the Service has determined that the sale actually occurred with the initial down payment and that the lease was actually simply an installment sale even though the deed changing ownership wasn't recorded yet.  This puts the seller in a tough position because the lease to own counts as a sale and the start of a 1031 period but they have not received any proceeds to continue with their exchange.

One twist that can work is to do a simple lease option.  You pay an option fee for the right to purchase the property at a set amount or within a set time.  Simultaneous to that you sign a lease for a pre-determined amount.  It's much harder to say that risk of loss has passed when you simply have a market lease and the option to purchase at a later date if you choose but no additional funds are continuing to lock up the sale.

@Dave Foster , thank you for the quick response, much appreciated. You've also now helped me clarify/differentiate between "lease to own" and "lease option", i thought they were the same. One more question, is there a specific amount of time required as the "productive use" period?

@Felipe Camacho , There's no statutory holding period, only the issue of intent. Most conservative folks say a year and a little is OK since that crosses two tax periods, and creates a hold period more reminiscent of a capital gain.  

@Dave Foster , I follow. I'm hopeful I can strike a deal here. I can see from your area code that its the late hours on your end, really do appreciate the helping hand...thanks again!

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