Can Seller 1031 into a new partnership with buyer of old property

14 Replies

Hello, 

I am wondering if a seller of an existing property, say a 4 plex, can do a 1031 into a 'new' property with the same person or entity that he sold the 'old' property to? 

Think of it this way, I buy 4plex from 'Frank' for 300K, and he and I partner on a new different property(s) that cost 600K where he puts in the 300K from the sale and I come with 300 K cash or financing for my share. Would there be an issue if my share were a 'seller finance' on share of things?

Thanks, Dan Dietz

I'm sure some of the 1031 facilitators on here will correct me if I'm wrong and amplify what I say if I'm right.

I'm pretty sure that the title of the acquired property will have to be in EXACTLY the same name as the title on the sold property. The last exchange I did was a CA house that I'd bought with my first wife but had bought her out of during our divorce. I never put my new wife on the title to it, no other heirs so who cares about inheritance. When we acquired the 3 TX properties with the proceeds I took title in my own name and it never created any problems. Although I'm pretty sure the Title company required my wife to sign off on the sales because TX is a community property state.

@Daniel Dietz , I think what you're describing is just fine as long as you can do it as a TIC with "Frank". He is selling a townhouse to you for $300K. This is not a related party transaction he is simply selling a property to you and starting a 1031 exchange. You guys get along and decide to go together on a new piece of property that is worth twice as much as the 4 plex he sold to you. He takes title to 50% of it as a TIC and you take title to it as 50% TIC. His cash provides the down payment and you provide the rest of the stroke either with cash or owner financing.

Looks fine.

@Dave Foster

I think I am making some headway :-) 

Now two questions that I think I am not going to like the answers to! Assumptions if you will;

1) Frank sold me Property 1 for 300K. But he only wants to reinvest 150K of it towards the new property we are going to buy together and take the rest as 'boot' to get some cash out for spending. I assume 50% of recapture tax will be due and 50% of capital gains dues at that point? 

Now on to the new place - Frank puts down the 150K as a 25% down payment on the new 600K property and we get a loan on the rest. We use a TIC agreement for his 1031 to work. We borrow the other 450K. I am detecting that with a TIC there is NOT the flexibility as in a LLC to 'assign' each of us a 50% interest in the new property?

2) I understand that the Frank and I can invest together in the new one even though *I* am the one that bought the old property from him. Could we but a different property jointly that *Frank* already owns? The thought would be that he wants to get out of the day to day but keep some of the appreciation potential. This would allow him to do that. I understand that he would ALSO have to then 1031 that sale into something else too. 

I hope that makes sense. "Frank" has a lot of properties that he would like to somehow lessen the work load on :-)

Thanks, Dan Dietz

@Dave Foster

In the case of the 150 sale, would he be paying full taxes until he hits his basis.  So if his basis is 150k, and he takes 150 k boot, he would pay full taxes instead of the 50% as suggested.

Mark

@Daniel Dietz , This is like Theseus' string in the labyrinth :)

Easy one first - Frank can't exchange his sale for a property he owns.  

Frank can also do a partial 1031 and only reinvest $150 into the $600K building.  He could take whatever% tic was appropriate.  If it was a $600K building and he is putting $150K down and assuming at least $150K of the debt (jointly or severally) then he could buy 50% tic.  BUT.... @Mark Creason is absolutely right - he has a $150K boot problem.  And in a 1031 exchange Boot is considered all profit first.  So all $150K would be taxable.

Frank could purchase something else with the remaining $150K.  Maybe part of something else you own (but you'll have to watch out for a potential step transaction and profit on your end), or a passive fractional cash producer.

Keep thinking I think you're close to getting a great scenario together for Frank.  And I hope other readers are paying close attention.  This is a great late market strategy for dealing with tired, old landlords.  Or are they like gunslingers.  There are old land lords and tired land lords but few old tired landlords?

Hello All, 

So if I am understanding you guys right @Mark Creason & @Dave Foster what you are saying is that if someone sells a 300K property that they have 150K of 'adjusted basis' in, and they want to take out 150K of 'boot', there is essentially no point in doing a 1031? 

I think I *wrongly*  assumed that there would only be taxes on 1/2 of the departure & capital gains, since 'half' of the money was being reinvested.

Thanks, Dan Dietz

@Daniel Dietz , I've never been more sorry to be right :(.  The first dollars out as boot are taxable as profit not a proration.

@Dave Foster I wish you were wrong too ;-)

As far as the 'first out being taxed as profit".....

Let's say a property is being sold for 150K. It was bought for 120K, and 30K of depreciation has been taken. So the 'profit' is 50% depreciation recapture and 50% capital gains. 

Say the seller does a 1031 and reinvests 120K and takes 30K "in boot". So I understand THAT is all profit. Is it then taxed as all 'recapture' since that is typically 'due at sale' (as in seller financing situations) or is is 'prorated' as part recapture and part capital gains? It seems that for some people those rates could be quite different. 

Thanks again, Dan Dietz

@Daniel Dietz , that's where the art of the cpa lies.  As far as I know there is no set convention on whether the first out is depreciation recapture or profit.  I've seen both.  My argument on mine has always been that I want to do the 1031 in order to carry forward my basis from the old property.  If I take money I'm wanting to take some profit as boot.  

@Daniel Dietz

Perhaps you can have Frank put the 300k down and take out a 300k loan to purchase the property and then shortly thereafter cashout refinance it  at 75%ltv (450k).

This would allow you to return 150k to Frank.

By structuring the transaction this way, Frank will have access to the cash he wants while enabling him to defer taxes on the whole 300k.

I believe this would be a permitted transaction but I'm not an expert on 1031 so you should definitely double check with @Dave Foster.

@Ari Bauer I will have to look into that. I get the idea of what you are saying here and will talk to lender and lawyer for thoughts. 

Thanks, Dan Dietz

@Dave Foster or others..... I was doing some reading last night when I couldn't sleep. That can be dangerous with all the new ideas that pop up :-) 

I came across 721 Exchanges when reading on 1031s. I DO understand how these can work moving up into 'Full Fledged REITs' as an 'end game' so to speak. I think. 

What I am wondering is that it *sounds* to me like an owner who is wanting to exchange up can either put their physical property or the funds from the relinquished property into a 'temporary partnership'. (that is my paraphrase). It *seems* like this might be a work around as to the need for the *exact* same titling being needed on sold property and new property. 

The thought in my mind is that what I think is the 'normal' way to do things if you want the new property to be a partnership is to use a TIC entity. It *seems* like there is more flexibility of how that new property is held with the 721 Exchange.

What I *dont* understated is if a 721 Exchange can be/is ever used on a 'tiny scale' (relative to REITS) of just 1 to maybe a few properties to add more flexibility going into the newly aquired property(s)?

Thanks, Dan Dietz

@Daniel Dietz I think you'll find that the 721 or upreit exchange usually involves either

1. the reit selling you a tenant in  common interest in properties it owns to complete your exchange.

2. You exchange into a property that is later contributed to the REIT for a membership/ownership/stock interest.

These are all pretty awkward for a reit to invest in with small investors.  The more zeros the more options of course.

What you really keep circling back to is partnership interests via a tenant in common ownership structure.  Easily doable with a 1031 and flexible and affordable.  Just has to be crafted one off for each situation. 

@Dave Foster or others too, 

Back to the question of the 'partnership' part of things.....

I think this is not allowed, but thought I would check before I throw the idea out the window ;-)

Seller A wants to get rid of one of his individually held rentals so he can start to slow down. Lets say a 150K duplex. Seller A is ALSO a 33.33% owner of an LLC that buys and holds rentals, along with two non related parties.

Can that LLC which he is 1/3 owner of buy his existing individually owned property? He would then take those proceeds from selling his individually owned unit and 1031 that into a new project, such as a 300K 4 Plex?

I realize that on the 'back end of the exchange' Seller A cannot use the 1031 proceeds to buy into anything that he owns (assuming either individually or a share of either) but is seems like this would be 'on the front side of things'. 

Thanks, Dan Dietz

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