1031 rental to a 2 unit property and live in one?

5 Replies

Can someone educate me on the guidelines and help me determine if this option is possible? I'm looking to understand what the determining factors are to decide if it fits a 1031.

I'm selling a rental condo to 1031 exchange. I've found a property with a main house and a rental cottage on the same property. I'd like to move into the main house as my primary residence and use the cottage as my rental. The cottage is currently rented.

Is it possible to make this work?

@Maria D'Aura It could work perfectly fine depending. On valuations. In a 1031 you must purchase at least as much replacement investment real estate as you sold if you want to guilt defer taxes. So if the value of the investment portion of the new property is worth at least as much as your sale and you report it that way you will be fine.

Originally posted by @Dave Foster :

@Maria D'Aura It could work perfectly fine depending. On valuations.  In a 1031 you must purchase at least as much replacement investment real estate as you sold if you want to guilt defer taxes.  So if the value of the investment portion of the new property is worth at least as much as your sale and you report it that way you will be fine.

Thanks, Dave. How do you determine the value of the investment portion? Is is sale price per sqft x sqft of rental portion the only way? Is there any other acceptable formula? Also, does it matter if the person on title of the original investment property is not the sole person on title on the replacement?


y @Dave Foster:

I'm asking because if I calculate by $ per sqft. I'm about $100k short of covering the exchange.

However, the replacement cottage is larger than the original investment property and rental income would be very close to the same. 

@Maria D'Aura , It's a great question. Theres no required way but most common is Square ft price. Your accountant is the one who will set up your depreciation/investment accounts. So you'll have to convince them. But an argument could be made for special amenities or larger part of the grounds or whatever makes sense as a good rational.

Even if you end up short you can still either purchase a second property to fill up the exchange.  Or do a partial exchange and pay some tax on the difference.

Hi @Maria D'Aura

Yes, it is certainly possible. We call it split use property where a portion of the property is used for Qualified Use (rental, investment or business use) and the balance of the property is used as your primary residence. It is important to note that only the portion or percentage of the replacement property that is actually used for Qualified Use will qualify for 1031 Exchange treatment.

Generally, tax advisors will allocate the purchase cost between investment and personal use based upon square footage, but other methodologies are acceptable as long as your tax advisor deems them to be defensible under an audit.  There may be ways to alter the allocation based upon common areas such as rooms shared (kitchen, bathrooms, living rooms), a garage restricted to use by one or the other party, etc.

You can certainly acquire the replacement property with other individuals. Generally, legal advisors would have each buyer acquire an undivided percentage interest in the replacement property as tenants-in-common. Only the portion or percentage of the property owned by you as a tenant-in-common would qualify for your 1031 Exchange.

The portion of the replacement property allocated to rental or investment use must have a value that is equal to or greater than the value of the relinquished property in order to defer all of your taxes.  You can trade down in value, and this may be the case if the portion of the property held as rental or investment property is less than the value of you relinquished property, but you WILL pay taxes on the amount that was not considered reinvested for rental or investment use.  Trading down in value does not hurt your 1031 Exchange, but you will pay taxes on the amount that was not reinvested and the 1031 Exchange may not provide any benefit if you trade too far down in value.