Sell investment property to buy multi-unit split use (rent/prim)

6 Replies

Hello,

We are currently in the process of selling an investment rental property for $200k (in escrow) and purchase a split use property for $1 mln (also in escrow). The property will serve as a split use as it has 2 entirely separate units with one common wall (1 house number and 1 parcel). We are planning on renting out the older home (1953) and live in the newer construction (2007). To make things even more complicated, we are also planning on listing another rental property within the next months ($300k). We would really appreciate is if we could get some expert advice on whether a 1031 would be possible at all. And if possible, would such need to be indicated in the current sales and purchase contracts? The proceeds from the first sale will go directly into the escrow account of the purchase. Please let me know if any other info is needed. Thank you in advance.

@Kimi Ho , Great scenario shaping up for you.  Here's some things to think about.

1. Regarding the first sale - you're responsibility to defer all tax would be to purchase at least $200K of investment real estate.  A split use property where the investment allocation is $500K and the primary side is $500K would be a perfect replacement.

2. Regarding the second sale.  If you can juggle some dates this too would be a perfect 1031 to add to the replacement property.  The issue you're going to run into is that you cannot exchange into a property that you already own.  So if you take title to the property in the first exchange you can't later exchange the second property into it.

However, if you can delay the purchase of the property so that it can fall after both sales it is a relatively simple process to combine the two 1031 exchanges.  You are selling $500K of investment property and purchasing $500K of investment property so that would work out perfect for you.  It's all about the timing.

A reverse exchange might be used to extend the process for a few months.  Reverses are more costly but could be your life saver in this scenario.  A lease option to the seller for a short time might also work.  And of course, the quicker you can sell that second investment property the easier it would be to combine all.

Well thought out strategy!

Hi David,

Would I be able to do a reverse exchange after I bought the property and sold the other 2? As mentioned the first investment is scheduled to close anytime soon (maybe this week) and the purchase is scheduled to close July 31. The other property for sale will be on the market within the next week. My other question is regarding the allocation of value. Does the value of both sides depend on the appraisal or is that simply divided in half as in your example. The original property was built in 1953 and another unit was added in 2007. Greatly appreciate your help. 

@Kimi Ho , All parties must be notified in writing of the 1031 exchange.  But we provide documents at the closings that satisfy that.  So technically it doesn't have to hold anything up or create a delay.

You're not too late to get something going.  Your calendar would look something like this.  

1. Sell old property #1 next week and start a regular exchange. (that starts a 45 and 180 day clock for the exchange.

2. We set up an entity that will take title to the new property (called an exchange accommodating title holder).  You must provide the funds for this but we can use your exchange proceeds for part of it. The key is that the EAT owns the new property not you.  (that starts a 180 day clock for the reverse exchange.

3. You sell your 2nd old property in 3 months (Say October) and start a 1031 exchange.

4. You have two active exchanges now so you complete those two exchanges by purchasing the property held by the EAT (the parked property in the reverse).  And now you have a split use property where you sold $500K of investment real estate and purchased $500K of investment real estate and a house for personal use.  Complete tax deferral!!

Regarding valuations:  There's no strict convention.  Most common is to divide the value by square footage.  This might be to your advantage if one property is significantly newer but smaller. Your accountant will have a preference.

Thank you David. So just for clarification:

1. The exchange has to start before the close of the property?

2. What are associated costs transferring title to EAT and then us (will there be transferring cost twice?). How will lender respond to that and how does that affect escrow? Is parking in EAT totally independent from lender, current purchase contract, etc.?

@Kimi Ho , A lot of this is probably most appropriate to handle outside the public forum.  But for #1 yes your QI has to be in place prior to the closing of your sale (or the closing of the purchase if attempting a reverse exchange).

There are usually several options for parking the property.

1. In your case at least half can come from the exchange account for your first sale.

2. Many folks will advance their own funds from another source - other cash accounts, private lenders, etc.  These get repaid at the end of the exchange so they are very short term in duration.

3. Normal lenders to sell to the secondary market will not do these types of loans.  But portfolio lenders can and like them.  So look to smaller community banks or private lenders in a space.  When it is explained to them that they are lending less than 50% secured by the property and you they generally go along.  Sometimes they'll also want a security interest in the other property you are selling.  But that is fine because again it is short term.

4. It doesn't affect escrow because you simply assign your purchase rights to the EAT.

5. In a reverse you have the option of either purchasing the property from the EAT (assuming the loan and taking deeded title to the property). Or you can purchase 100% of the membership interest of the LLC that is the EAT. This satisfies 1031 requirements but also saves you a second real estate closing and transfer taxes and gives you a free LLC to use also.

5. In general think of a reverse exchange adding $4k - $6K to a regular exchange