1031 to lower priced possible?

11 Replies

Hi BP, is it possible to 1031 exchange an sfr to another sfr of lower purchase price, yet include rehab costs within the 90 or so days (can't remember the time limits) to make it cost more? This may be a common question but I thought I'd ask BP directly.. I remember Alex (catchy last name but can't remember) from Vegas doing something similar to this idea with (HUD?) another class of purchase.. can any one shed some light?

This is very common. Referred to as a build to suit, construction, or improvement exchange (yes, lots of names for one technique). The issue with these is that you have 180 days to use up all your exchange proceeds, and the cost of the QI will be higher. The other question is if you are fixing it up to flip (not 1031 eligible) or to hold (1031 eligible). But what you are talking about is definitely possible. Happy to chat about it. 

@Jonathan Greer , Your 1031 can only be used for the purchase of investment real estate.  However, if the improvements can be made before you take title then your purchase price simply includes the already made improvements.  

1. Sometimes a seller can be talked into doing this and then adjusting the price up.

2. Sometimes a lease/option is a good vehicle to make it work depending on timing.

3. Or a form of a reverse exchange (the specific format depending on your specific scenario)

In all of these cases the key is that you do not take title to complete your 1031 until after the improvements are made.  In the first two the seller retains title but either completes the improvements themselves or allows you to do it while under lease.

In the case of the reverse exchange the Qualified intermediary takes title to the new property while it is improved.  Reverses are complicated and a bit more expensive.  But if your improvements are more than $30K - $50K they can become cost effective.

@Michael Skoczylas ok thanks a bunch. I’ll be completing some flips in the next month, so I’m trying to get ready.. Is it possible to sell 2 flips around the same time and 1031 into 1 investment property? Also, concerning a 1031 not eligible for flipping, is there a time limit on how long you have to hold? I’d like to know whether you can buy a 1031 occupied, then sell within 6 months and 1031 to another investment. Thanks and I appreciate your expertise in this area!

@Dave Foster wow, very understandable! Thank you for the explanation!! I’ve learned a lot of valuable info from the two responses. So does the “build to suit” strategy fit into another catagory? It almost sounds like a build to suit strategy might allow you to close and take title before the 180 days then finish construction or rehab before.. However that may work it sounds like you are saying you can’t take title before improvements are added in any scenario. Thanks for the valuable insight.

@Jonathan Greer

To clarify and expand on the great info already provided on this thread:

  • Technically, no property that is held primarily for sale is eligible for 1031 exchange treatment. Proving intent is very much a "facts and circumstances" matter, which means that there are no bright line rules and each scenario is independently evaluated. For certain scenarios there are either IRS safe harbors or "conventional wisdom" that advocate for holding periods of either 2 years or 1 year. 
  • However, it's important to understand exactly how and when IRS safe harbors or the "conventional wisdom" apply. For a serial flipper that does not even attempt rent out a property 1031 is not a likely option - even if the property takes a while to sell.

Regarding a construction exchange, the rehab work with the exchange proceeds must "completed" before the taxpayer/exchanger takes title to property. Therefore, all such work is done while the exchange accommodation titleholder (EAT) holds title to the property.

@Jonathan Greer , "build to suit " or "construction", and "improvement" are all just variations on the Reverse Exchange. And that's exactly how a reverse exchange works.   The "reverse" part is where the QI takes title and the property is built or rehabbed or improved before you take title.  What's kind of confusing is that both the reverse part of an exchange and the regular 1031 exchange have 180 day time limits.  

So think of the reverse as the QI purchasing a property for you before you'r old property has sold or before that new property has been completed.  From the day that the QI takes title to your new property you have 180 days to complete the improvements/construction, close the sale of your old property and take title to the new property.  

The other 180 day period is for the straight 1031 exchange - from the day you close the sale of your old property you have 180 days to complete the purchase of your new property.  

So there is some overlap.  If you have closed on the sale of your old property and your proceeds are in your exchange account and you've found your new property but it's not enough to absorb your exchange without substantial improvements then you could 

1. Sell your old property

2. Have the QI purchase the new property using proceeds in your exchange account.

3. improve the property using exchange proceeds

4. Lastly take title to the new property which has now been improved and is worth enough to absorb the entire amount of your sale.

What's cool with that scenario is that you can do the entire process without coming out of pocket since your sale has already happened and you have that 180 days to complete the purchase of the new property.  So you spend that 180 days having the QI purchase the new property and you improve it.

Originally posted by @Jonathan Greer :

Hi BP, is it possible to 1031 exchange an sfr to another sfr of lower purchase price, yet include rehab costs within the 90 or so days (can't remember the time limits) to make it cost more? This may be a common question but I thought I'd ask BP directly.. I remember Alex (catchy last name but can't remember) from Vegas doing something similar to this idea with (HUD?) another class of purchase.. can any one shed some light?

 That was  @Alexander Felice and his deal is a little different. 

When he BUYS he puts renovations on the HUD so that the bank will re-fi based on value listed on HUD.


I don't think this would pan out the same way for a 1031. 

However- there is a renovation 1031 where you get to buy a lower priced property as long as property + reno meets your requirements. It means you have a 6 month timeline to get the renovations done though. 

But I wouldn't just pay in $50k to escrow to add to the purchase HUD and confidently say it would qualify as replacement value.

@Natalie Kolodij right! Alexander feliz! I knew it was a catchy last name, if you're Spanish speaking at least. Loved his podcast and thank you for clarifying the add on to HUD purchase vs. 1031. I think the only way to really learn this stuff is to do it and try to see what's possible, but I've got to do some research before the first one. I remember the renovations during HUD escrow was pretty innovative, and I hear some similarities in the 1031 construction value add. I'd say the HUD escrow would be a little more ambitious!

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