Can I invest in my Cousin's 1031 exchange?

Question

Hi - My cousin is closing on a family farm he inherited and is looking to do a 1031 with a multi-family. He'd like me to be involved to manage the finances of it for a bit of sweat equity and I'd also like to put in perhaps 10% of the investment. Let's imagine that would get me 15% of the investment.

Is that possible on his 1031? What would be the best way to structure that, if so? An LLC? Here in CA they are $800 per year so not a small percentage of our potential yearly net income. If it is an LLC or other type of corporation, would we take the mortgage out in the name of the LLC? How would that work for his 1031?

Many thanks!!

Dave Foster · Answer

@Wesley Brown, nailed by @Katie Lepore and @Brandon Bruckman.  The only thing to add is that when you adjust the percentages so your each tenants in common his 85% tenant in common interest will need to be an amount that is at least as much as his net sale if he wants to avoid all tax.

Katie L. · Answer

@Wesley Brown

Buyer and seller on both ends of the 1031 need to be the same.  So your brother could not sell in his own name and then purchase in an LLC that is partially owned by you and partially owned by him.  He likely could take title to a smaller percentage, so brother sells farm, brother as to an 85% tenant in common interest owns multi family with Wesley as to a15% tenant in common interest or something like that.  BUT you absolutely want to run this by your CPA or attorney who knows the full scope of the situation and all the facts to give you personalized advice.  These forums are great for idea generating but not a substitute for personal advice.  Also, be wary of sweat equity and how it affects the accounting and taxes... can be very complicated.  Sometimes you can only receive a profits interest for your services such that the 5% might not be entitled to collect rent and only capital gains upon sale.  You may be better off receiving a management fee and only receiving equity for actual capital that you put into the deal.  Be very careful with everything you're suggesting... worth the cost of hiring a professional to cross your t's and dot your i's.

*this post does not create an attorney-client or CPA-client relationship.  The information contained in this post is not to be relied upon.  Readers are advised to seek professional advice.

Bill Exeter · Answer

Hi @Wesley Brown,

@Katie Lepore and @Brandon Bruckman are right on the money (pun intended!).  This can be done and is relatively common and straight forward.

The person or entity that buys the replacement property must be considered to be the same taxpayer that sold the relinquished property.  Purchasing the replacement property in a limited liability company that you both would own translated into your cousin selling as an individual and then buying a partnership interest (not a real property interest) and would not qualify for 1031 Exchange treatment.

The two of you would would likely buy together as tenants-in-common.  Your cousin must ensure that he buys a sufficient percentage in the replacement property so that he has traded equal or up in value based on what he sold.  You can have the rest.

Financing can also be an issue.  Some lenders will no longer lend on a tenant-in-common structure, but some will.  You need to shop around in advance so that you have a lender that will work with you.  You do not want last minute surprises.

Bill B. · Answer

Did he inherit in the last 5 years? If so he got a stepped up basis. Therefore he should just skip the 1031 and pocket the cash.

Ps. Don’t forget. If he insists on the 1031 because he inherited many many years ago. You said he “is closing” as in the sale is in progress. He can’t touch that money. The 1031 QI has to already be in place and take the money at closing. Then he’ll have 45 days to identify his new property. So this isn’t hey maybe, I think possibly, I might want to territory. He has to already be setup before the sale and prepared to buy a property worth at least $1 more than his net proceeds using all his cash.

Brandon Bruckman · Answer

You could use a tenant in common structure.  It's important for your cousin to keep the same entity that he's using in the multi-family into the family farm.

Wesley Brown · Answer

Thank you, All. This was very helpful!

Can I invest in my Cousin's 1031 exchange?

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