Hi all! My husband and I are currently selling an investment property with the goal of a 1031 exchange and have some questions around the debt component.
For simplicity's sake, if the property will sell for $1.5m and there is $500k of debt currently, we are trying to understand our options. How do these numbers (mostly the debt amount) work If we want to put some of the profit into a syndication and some of the profit into a multifamily partnership (I understand that you need to purchase something of equal or greater value), ie - if we are just a small part of a down payment in a syndication and / or partnership deal, where the total purchase amount is greater than $1.5m and the debt is greater than $500k, are we ok?
I'll also add that my husband and I are self-employed (last 1.5 years) so partnerships vs. loan vehicles are probably the better bet for us at this juncture.
@Cameron Snyder pleased to meet you! So basically the rules with regard to your 1031 exchange are that you want to "exchange up" as they say â matching your equity and debt components, equal or greater. So, in your example whatever is sitting in escrow with the QI after closing costs would need to be fully deployed to gain the maximum tax benefit on your 1031. Similarly, the LTV would need to be retired as well, in equal or greater amount. DSTs are great because they can match debt and equity to the penny and are highly modular in nature. Hope this helps, will be happy to expand upon this at any time. Best of luck!
@Cameron Snyder very pleased to meet you! You are correct, in the context of a 1031 exchange you need to “exchange up” as they say, which means you need to match your debt and equity components, equal or greater. In the example you gave, whatever is sitting in escrow with the QI would need to be deployed down to the last penny to gain the maximum tax benefit. Furthermore, the loan amount you indicated would also be need to retired at an equal or greater amount. DSTs are a form of IRS recognized fractional ownership interests which can help achieve these goals. Best of luck in your endeavor Cameron! =)
Hi @Cameron Snyder ,
First, properties must be held for rental, investment or business use in order to qualify for 1031 Exchange treatment. Properties acquired and held for sale such as flips, rehabs, developments, etc., will not qualify for 1031 Exchange treatment. Was the relinquished property held for rental or investment or was it one of your flips/rehabs?
Second, you must trade equal or up in value by acquiring one or more replacement properties that are also held for rental, investment or business use. You must acquire a direct interest in real estate, so purchasing membership interests or partnership interests in an entity will not satisfy the like-kind property requirement. You are selling real estate and must therefore acquire real estate in order to be like-kind.
Third, only the portion or percentage of any real property that you acquire directly will qualify. It is not the entire purchase price, but the percentage of the purchase price that you are directly buying.
So, in your case, you are selling for $1.5 million in sale price you must acquire a direct interest one or more replacement properties with a total value owned by you of at least $1.5 or greater (I'm ignoring closing costs to make the discussion easier), and you must reinvest all of your equity of $1.0 million in the replacement properties. The difference would be the amount of new debt or out-of-pocket cash that you will need to put into the property.
@Bill Exeter , thank you, very helpful!
Yes, the relinquished property was a rental / investment property, not a flip.
@Cameron Snyder , There's actually a couple different issues wrapped up in your question. First the issue reinvestment and debt.
It is not true that you must replace your debt in a 1031 exchange. The two requirements to defer all tax are that you purchase at least as much as your net sale (the contract price minus closing costs and commissions) and that you use all of the net proceeds (the net sale minus any mortgage pay off) in the purchase of your replacement properties. In your example that probably represents a net sale of a little less than $1.5 mil and net cash of a little less than $ 1mil. You can use your own cash reserves if you want to replace some or all of the debt and still defer all tax. Most people do not have those reserves so they do take out more debt. But not required. You can also purchase less than what you sell (reducing debt) or take cash out of the exchange. You will pay tax on the difference without jeopardizing the rest of your exchange.
This all becomes important as you look at your overall financial situation and lendability as self employed professionals. If you're limited in borrowing capability you can always adjust your loan down to accommodate your abilities and pay a little tax but still shelter some gain.
The second issue is that of where you reinvest. You can allocate your proceeds ($1 mil ish in any way you want in the purchase of replacement investment real estate. So you could purchase two properties and pay for one in cash and take out the maximum leverage on the other. Allocate those proceeds how you wish.
But the purchase must be actual investment real estate. And here's where you have some issues with your plan to go into partnerships and syndications. Most of what are called "syndications" now are being structured as limited partnerships to accommodate debt, management, and profit structure. Unfortunately you cannot use 1031 proceeds to purchase an interest in an LP doing a syndication because that is not seen as purchasing the real estate itself. Same general concept with a partnership. If you're buying an interest in a registered partnership you are not buying real estate so no 1031. If you can a "partner" buy a property together as tenants in common then you are buying actual real estate and that would qualify.
Syndication types that qualify for 1031 are those which you take title to actual property as a tenant in common (TIC) or you purchase a share of a Delaware Statutory Trust (dst) because the dst was specifically blessed by the IRS in 2004 to count as purchase of real estate itself.
@Dave Foster , thank you so much, this is exactly answering the questions racing around my mind! I really appreciate the response. Would love to connect!
@Rob Pecha , thank you so much, Rob! I did not know about DST's until now. I very much appreciate the response!
@Cameron Snyder sure thing! Happy to lend a hand!
@Cameron Snyder, By DST Not only can you defer capital gains taxes until death (at which point they are forgiven), you may also be able to benefit from depreciation and other deductions which shelter some of your investment income from taxes.
While Dave has already given a very thorough feedback on 1031, I'd like to point out that if the intent to defer and lower your tax burden, you should potentially look into Opportunity Zones.
As far as DST's go, this is a viable option for someone who wants to be passive. While it sounds like you're both active investors, I don't want to make assumptions as to whether you/your husband are active or passive investors. So perhaps that should be the 1st question to be answered for yourself prior to laying out the options ahead.
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