1031 exchange advice

9 Replies

I’m looking for some advice about 1031 exchanges. My grandfather in Massachusetts is going to sell his house to take advantage of the tax break he gets since he lost his spouse (my grandmother). He’s 89 years old and wants to travel and live out the remaining years of his life by traveling and enjoying himself. The house, however, is a 4 bedroom 3.5 bath, 3,500 sq. Ft house on Nantucket Island and was recently appraised at 1.7 million. I’m wondering, and I hope this doesn’t come across as shrewd or greedy, is there a way he can get what he wants without selling the house or at least parlaying it into something bigger than he could leave behind to his grandkids and that we could benefit from for the next however many years/generations. Maybe a 1031 exchange is way off base but there has to be something better than selling a house of that size and value on and Island that has very high appreciation rates. Any advice/ideas/suggestions would be greatly appreciated!

@Tyler Santos Does your Grandfather own the property outright? Would he consider renting the property? I know Nantucket has very steep rental prices during the summer months. A 1031, in my opinion, would be a legacy move, but in order to use it, you would have to sell that property and buy propertie(s) of greater value at which point he could than pass down those assets.

Hi Sam, yes he does own the property outright. I also thought the rental idea could work too but since my brother and I have become interested in real estate I thought there would be a better way to use the sale of his house to leave something for his grandchildren. Because right now, from what my mother has said, he plans on leaving each grandchild with something like $10k. My idea, and I don't know enough about 1031's to know if this is how it works, would be for him to find a multi-family unit or units somewhere, live in one, rent out the others and let my brother and I manage that aspect of it for him. But yes, maybe for now the best thing would be for me to convince him to rent the house rather than sell it. We all just think it would be a shame to let that beautiful house and piece of property go and not keep it in the family or at least turn it into something that creates cash flow for years to come and is something for my brother and I to start building our own portfolio of rental properties (not on Nantucket).

@Dave Foster would definitely have some insight in this. 

Short answer to your question is yes, long answer is that it sorta depends .. 

High level parameters of 1031 Exchange is that it is real estate and you are moving once income producing property into another. Can your grandfather prove that he used it as an investment property? That's one metric and then he can sell and move it into another investment. Given that he likely has a lot of capital gains here, it would be a good idea for him to participate in a Opportunity Zone Fund where he can take it gains and defer it into a Fund and erase the gains after 10 years. There's also Tenancy in Common (REIT) style exchanges where he doesn't have to be a 'landlord' but still satisfies the exchange metric without the headaches of tenants.

@Lien Vuong I am not sure if he could prove it was used an investment property but I will look into that a little bit more closely. I will also mention to him the REIT exchange as well, he might be open to that idea as well. Thank you so much for taking the time to respond, I learned something new today!

The linchpin here would be if he could prove that the property was investment property. If he can't a 1031 is not possible. 

I do think you have some great options though. Rent it out now to give him some income, and then if he decides to switch into MFH he can then 1031 (since he used it for investment purposes) at that time. He can also rent it out now until death, then his heirs can decide if they want to continue renting it or sell it - and since they get a step up in basis they would pay no tax. 

Overall its a good situation to be in, and he is lucky that you are thinking about this already.  

Sell and take the tax free gain, that beats tax deferred every time. 

Unless you’d tell your 80 grandpa to go out and buy a $1.7million house if he inherited cash, there’s no reason for him to keep the one he owns. The psychological name for the bias escapes me but the fact that he already owns it makes it seem like a better deal to keep something he would never go out and buy. 

Thanks for the shout out @Lien Vuong@Tyler Santos , there actually is a way depending on how flexible your Grandfather can be.  In general here's what we know without too many numbers.

1. Half of that property got a step up in basis when your Grandmother so half of the gain went away.

2. Grand pa could sell now and take another $250K of profit tax free.

3. Even doing this he's probably looking at a taxable event because of the size.

4. Right not it would not qualify for 1031 treatment as it was his primary residence.

But there is a scenario where he may be able to get it all.  If he wants to travel now and you could  fund him for a year or so.  He moves out of that house and with your help turns it into a rental.  Now its an investment property so after a year he could sell it.  But the landscape will have changed dramatically.

1. He can still get the step up in basis benefit from your grandmother's passing.

2.He will still get an additional $250K tax free because he still meets the 2 out of 5 residency requirment

3. But now he can do a 1031 because it's an investment property.  So he can 1031 into a good investment property that you can manage, or he can 1031 into passive opportunities that will provide him income for the remainder of his life.  

This is just another twist on exit strategies that we wrote about here - https://www.biggerpockets.com/blog/1031-exchange-files-3-buy-hold-exit-strategies

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