1031 exchange on split use property with 1 house number only

9 Replies

Hello everyone,

I am having trouble getting answers regarding a split use property that I am about to purchase. The property only has one house number and per appraisal is a single family residence. However, there are actually two complete units with one shared common wall only. One is a 3 bedroom 2 bath built in 1953 and the other is a 4 bedroom 2.5 bath built in 2007  (built as addition with full permits). We are intending on moving into the 2007 unit and rent out the other one. I am trying to get an answer from my exchange intermediary who says that is a question for my CPA. Upon asking my CPA, I am being told that is the job of the intermediary. Following is a description from the realtor selling the house: This is actually 2 totally separate, complete homes with one common wall!!! Original single story home, built 1953, has been totally remodeled with 3 bedrooms, 2 bathrooms, wood burning fireplace, covered rear patios & more. Secondary home built in 2007 is two story with 4 bedrooms, 3 bathrooms. I would appreciate any input into this

@Kimi Ho , The code specifically addresses personal residence/split use properties with shared common areas.  These can be problematic when there are shared living areas.  But this doesn't sound like the case.  You may have some state or local ordinance issues with zoning etc but the 1031 doesn't live there.  It's at the federal level.  It's going to be about  the facts of the case.

But my guess would be that your accountant can separate that area out and allocate a certain % to investment use - and depreciate and allocate expenses and adjust basis accordingly.  If so then you would be purchasing that portion as investment no different than a family farm with primary residence and agricultural land all on the same parcel - or a home office = or a BNB.  At sale time a % is allocated to the primary residence and the remainder of the parcel is considered investment/1031 property.

I don't think you'll get any kind of answer from your intermediary and your CPA may not want to hang their hat on something that doesn't have a ton of case law backing.  But this looks pretty straight forward.  And you're going to have to break out that sq footage for income/expenses/and depreciation anyway.  If your accountant will do that you should be OK.

@Kimi Ho

While you're having trouble getting answers, I'm having trouble getting questions. :)  What is your question about this exchange?

As @Dave Foster said, you will basically split one purchase into two. One will be an investment property, part of the exchange, and the other will simply be a purchase of a personal homestead.

@Kimi Ho similar to 1031 exchange name change where everything tied with buyer/seller SSN/EIN and you cant mix funds for 2 separate EINs/SSNs , properties needs to have separate account as tax paying entity to county office (i.e. 2 separate tax bills aka 2 addresses).  Splitting your property into allocation methodology will not hold up for any audit. 

To make thing clean, you should separate the address . Call up your city planning team and ask them what you need to do to add another address , may not cost you much and this was you will have 2 tax paying accounts where you buy 1 and use exchange fund for 2nd one. 

@davefoster i understand that splitting can be done but wouldnt that be overkill in this scenario ?

Originally posted by @Shahriar Khan :

@Kimi Ho similar to 1031 exchange name change where everything tied with buyer/seller SSN/EIN and you cant mix funds for 2 separate EINs/SSNs , properties needs to have separate account as tax paying entity to county office (i.e. 2 separate tax bills aka 2 addresses).  Splitting your property into allocation methodology will not hold up for any audit. 

To make thing clean, you should separate the address . Call up your city planning team and ask them what you need to do to add another address , may not cost you much and this was you will have 2 tax paying accounts where you buy 1 and use exchange fund for 2nd one. 

@davefoster i understand that splitting can be done but wouldnt that be overkill in this scenario ?

Yes, splitting the property tax accounts would be cleaner, but it is not required for the IRS purposes. I would certainly feel strongly defending such a case in an IRS audit.

@Shahriar Khan , You're absolutely right that creating two legal addresses would be beneficial to all.  It would also raise the property value significantly.  But even with one I gotta think like @Michael Plaks said that it's very defendable.  I don't think you would necessarily have to split into two actual sales.  It's more that in the purchase/sale agreement and supporting documents of the one sale there is a split or allocation between the two types of property - personal real estate and investment real estate.  

Hi Dave, thank you again for your valuable input. What kind of supporting documents would I need? The first appraiser actually did the appraisal as a multi-unit (duplex) but put it contingent on permits and papers from the city/title company. We were not able to do that as the seller did the construction as an addition to a SFR and therefore another appraisal had to be done as a SFR. The property is located in CA in a multi-unit zoning. The first appraisal contingent on city papers allocated the square footage to both the older (~1,300) and newer (~2,000) construction. 

Thank you.

Originally posted by @Dave Foster :

@Shahriar Khan , You're absolutely right that creating two legal addresses would be beneficial to all.  It would also raise the property value significantly.  But even with one I gotta think like @Michael Plaks said that it's very defendable.  I don't think you would necessarily have to split into two actual sales.  It's more that in the purchase/sale agreement and supporting documents of the one sale there is a split or allocation between the two types of property - personal real estate and investment real estate.  

@Kimi Ho .  That's really two questions.

1. Separating out for purposes of the 1031 is done as a paper allocation by your accountant.

2. Creating a separate legal address is going to be an effort of love between you and the city.  It may not be as difficult as you think.  If the property is zoned for MF and if the construction is decent at all you may be able to pull permits in retro and pay a small fine but have it then reinspected and approved.  No city wants to see construction torn down if there's a way to avoid.  But they also don't want non-permitted construction going on either.  Talking to them about pulling a permit to approve the work already done might let them save a bit of control and you get a legal two property building.

Hi Dave,

Yes, we will be working on converting the unit down the road. There was just not enough time before closing. Any ideas where to start from? Go check with the city or hire a contractor who may be able to check and do necessary changes?
Thank you.

Kimi

Originally posted by @Dave Foster :

@Kimi Ho.  That's really two questions.

1. Separating out for purposes of the 1031 is done as a paper allocation by your accountant.

2. Creating a separate legal address is going to be an effort of love between you and the city.  It may not be as difficult as you think.  If the property is zoned for MF and if the construction is decent at all you may be able to pull permits in retro and pay a small fine but have it then reinspected and approved.  No city wants to see construction torn down if there's a way to avoid.  But they also don't want non-permitted construction going on either.  Talking to them about pulling a permit to approve the work already done might let them save a bit of control and you get a legal two property building.