1031 Exchange to Owner Occupied multi-family

1031 Exchanges
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1031 Exchange to Owner Occupied multi-family

Account Closed
Investor · Saint Louis, MO · Member since 2012 · 46 posts · 19 votes

I'm curious to know if it is possible to use a 1031 Exchange to go from a non-owner occupied multi-family to an owner occupied multi-family. Are there rules prohibiting that?

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Dave Toelkes
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
13y

i disagree with Dion. Occupancy is a factor in 1031 exchange. You cannot exchange into an owner occupied residence. Investment use and personal use are not like-kind real estate.

If you find a multi-unit property you want to exchange into, and you want to live in one of the units as your primary residence, you can still exchange into the portion of the property that will be your investment rentals.

For example, you found a four-plex you want to acquire with a 1031 exchange. You want to live in one of the units and use the other three as rentals. Allocate 75% of the cost of the property to the investment rentals, then use your exchange funds to acquire those three units making sure that the purchase price for those three units is greater than or equal to the value of the property you relinquished.

Money to buy the unit you want to live in has to come from outside your exchange.

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  • Leo B.
    Investor · Hercules, CA · Member since 2015 · 208 posts · 47 votes
    10y

    It's good to find this post. From what I've read so far you can do a partial exchange into the portion of the property that is for investment. What if you exchange from a full NOO investment property into a 4 bed SFR where you live in one room and rent the other 3. The home would be purchased through FHA financing. Would this be possible?

    @Bill Exeter

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  • Zack Dudley
    Phoenix, AZ · Member since 2017 · 1 post · 0 votes
    9y
    Originally posted by @Leo B.:

    It's good to find this post. From what I've read so far you can do a partial exchange into the portion of the property that is for investment. What if you exchange from a full NOO investment property into a 4 bed SFR where you live in one room and rent the other 3. The home would be purchased through FHA financing. Would this be possible?

    @Bill Exeter

    Bumping for any answers to this question!

    0Reply
  • Tommy Dang
    Real Estate Investor · Boston, MA · Member since 2015 · 20 posts · 5 votes
    8y

    @Bill Exeter

    @David Krulac

    @Dion DePaoli

    Ok can i do a 1031 exchange from the triplex to two single family?

    I bought the triplex at 400K, sell for 1.25M, let say i have 800K capital gain.

    Now i buy one single house at 800K and another single house at 400K.

    let say if i rent both single house for two years.

    Then can i convert the 800K single house  to primary house(owner occupied)?????.

    Tommy

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    8y

    @Tommy Dang, That's the holy grail of 1031 investing.  

    You're going from investment to investment - that works.

    You're selling for 1.2 and buying for 1.2.  That works.

    You're going to use both for productive investment use - that works.

    You may convert one of them to primary residence after two years ( not statutory holding period but two years is a safe harbor from Rev proc 2008-16) - that works.

    After you live in that property for the specified amount of time (right now it's two years but the tax reform bill may change that to 5 years)  you can sell it and take the first $250K of profit ($500K if married) tax free.  You'll still have to recapture depreciation.  But that's a lot of gain tax free. - that works.

    And who knows, in the interim you may sell another 1031 property and buy another really nice rental that might make a good primary residence down the road....  That works too!

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  • Tommy Dang
    Real Estate Investor · Boston, MA · Member since 2015 · 20 posts · 5 votes
    8y

    @Dave Foster.

    I dont want to pay about 40% tax on 800K capital gain.

    The three family i bought 3 year ago at 400K and now is worth about 1.2M-1.4M and i know soon the the price will drop. So i want to do 1031 exchange, so i can rent out for 2 years then convert it back to owner occupied maybe for 20 years. More like to live in a big house with most of the money from capital gain. Then sell 20 to 30 years later (with 500K tax free) or inherit to my kids.

    I talk to one of the CPA they said i cant do that, i dont know if he knows what he is talking about.

    Now you confirm it works.

    Thanks,

    Tommy

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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    8y

    @Tommy Dang,

    Just to clarify @Dave Foster's response.  In 2004, Congress changed Section 121 as it appies to property acquired in a 1031 exchange.  Under the tax code now in effect, If property initially acquired in a 1031 exchange is converted to a primary residence, you qualify for the §121 capital gains exclusion after 2 years of occupancy AND 5 years of ownership.  Until Congress changes the tax code, the 5 year ownership test only applies to property acquired in a 1031 exchange.  

    1Reply
  • Carlos Alcala
    Los Angeles , CA · Member since 2018 · 1 post · 0 votes
    8y

    Here goes one for you....

    Two owners (1) husband and wife (2) wife’s sister both their own entities on title on a 7 unit apartment building that was inherited and both owners lived in the building in two separate units. When the building was acquired in 2004 only $230K was left owed on the building and in the course of 13 years $580K was pulled out of equity raising the grand total to around $810K. Building is in escrow and will be closing end of February and sold for $3M so total capital gains is close to $2.8M so each will be liable for $1.4M in capital gains tax. They are each walking away with $1M cash from the proceeds. Obviously that is a lot money to get taxed on so if we can defer it that would be best option but keep in mind they still need to purchase somehwere to live. I found a 3 unit multi plex building for $2.1M and my mom and dad would be putting the $1M on the multi plex that has (2) 4 bedrooms and one (1) 3 bedroom unit and the fair market value for those units being that it’s west Los Angeles, Ca is around $4200 each. Under a 1031 would my mom and dad be able to owner occupy the (3) bedroom and rent out the (2) 4 bedroom units under 1031 without violating the terms of a 1031? Any guidance or recommendation on how to go about this the best way would be greatly appreciated! Or should we just take the tax hit and take out time on purchasing, would love to invest in the multi unit but keep in mind they need to be able to move into something because the money would all be tied up into the multi plex if we go 1031. Thanks again!

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  • Joseph Clemmons
    Member since 2018 · 2 posts · 0 votes
    8y

    I if buy a duplex with my 1031 Exchange money and live in one of the units, will I have to pay capital gains tax on 50% of all the exchange money? Of course, I would have to buy the entire duplex in one transaction as it would not be sold as separate units. From the posts I've been reading, it looks like I would be able to move into one of the units after 1-2 years establishing original intent to rent. But what would be the capital gains liability if my wife and I moved into one side of the duplex right after purchase? Please help! :)

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    8y

    @Joseph Clemmons, it depends on the valuations.  If you are selling an investment property for $200K then you must purchase at least $200K of investment property to defer your tax in a 1031.  But you could purchase a MF property for $400K and live in half of it.  You're still purchasing investment property worth at least what you sold.  The remainder you can use however you want.

    And you can also convert a property from investment to primary residence.  If you do it immediately then it is obvious that your intent when you purchased it was to buy your primary residence and not an investment property so your exchange would be in jeopardy.  But if you did the 1031 and rented the new property for a year or two then your intent was obviously to purchase investment property and you are now changing your mind.  There's even a safe harbor for this from the IRS of 2 years.  But no statutory guidance of how much less than that is OK.

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  • Joseph Clemmons
    Member since 2018 · 2 posts · 0 votes
    8y

    Thank you immensely, Dave! That is extremely helpful. 

    Bless you, 

    Joseph

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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    8y
    Originally posted by @Laura Janosko:

    Oh, I understand. Thank you all for clarifying. Can you only do the 121 exchange after you have owned the property for 5 years?

    You only need two years ownership and occupancy within a five year lookback window to qualify for the §121 exclusion.  

    There is a five year ownership rule that applies to investment property initially acquired in a 1031 exchange that was subsequently converted to a primary residence.  For this property to qualify for the §121 exclusion, the tests are two years of occupancy and five years of ownership prior to the sale.

    2Reply
  • Armando Martinez
    Flipper · Lincoln, NE · Member since 2017 · 4 posts · 0 votes
    8y

    @Dave Foster Going off of your most recent response to Joseph Clemmons, you are able to use a 1031 exchange to buy a MF residence and Owner Occupy? 

    I purchased a flip in September of last year for 69k and put about 20k into it (all cash). I am currently in contract to sell for 115k and looking at a profit of about 25k. I was hoping to 1031 into a Duplex, live on one side and rent the other. I've seen mixed results but with your response above, it seems like this is possible. The duplex price would more than likely be around or above the 300k mark. 

    I have also read that the entire amount of the gains needs to be invested in to the other property if doing a 1031 exchange. I just want to confirm that it would only be the 25k of profit needing to be rolled over to the other investment property? 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    8y

    @Armando Martinez, As long as you are taking title to as much investment real estate as you sell it does not matter what you do with the extra.  If you sold a property of $100K and are buying a duplex for $200K then you could live in 50% of the property.

    The valuations n your scenario seem to  work but iI think you've got a different potential problem.  If you purchased that property with the primary intent to resell then a 1031 exchange is not appropriate.  1031 property is property you purchased with intent to hold for productive use.  

    The IRS does not care how much profit you have.  If you want to use a 1031 and defer all tax you must purchase at least as much as your net sale, and you must use all of the proceeds in the next purchase or purchases.  You can buy less than you sell and you can take cash out but you don't get to take out non taxable original capital first.  You will always take out profit first (according to the IRS).

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  • Mike Hinton
    Property Mgmt/Investor · Marietta, OH · Member since 2017 · 29 posts · 13 votes
    8y

    My daughter purchased a duplex and has lived in one unit for over 2 years and selling for a nice $100k capital gain.  She has used the property as investment (Sch E, etc) property.

    When she sells, will she get the full capital gain exclusion or only half?

    If only half, can she 1031 the other half to avoid any capital gains taxes?

    Thx to all 

    0Reply
  • Mark Creason
    Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes
    8y

    @Mike Hinton

    She will be able to take half of the gain using the 121 exclusion and can 1031 exchange the other half.

    Mark

    2Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    8y

    @Mike Hinton, @Mark Creason's absolutely right.  She will take the gain from the primary residence portion and exercise the exemption so it is tax free up to the limits.  The other side is eligible for a 1031 exchange (as long as that sale hasn't closed yet).  The 1031 defers indefinitely both profit and depreciation recapture.  But is not tax free like the primary residence side.  

    Still this is one of the awesomest things about split use properties and house hacking multi family properties.

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  • Mike Hinton
    Property Mgmt/Investor · Marietta, OH · Member since 2017 · 29 posts · 13 votes
    8y

    Yeah it's awesome.  Thanks for the confirmation guys!!

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    6y

    Do you know where to find multi-family that's ready as 1031 exchange (not DST though) ?

    0Reply
  • David Krulac
    Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    6y

    @Carlos Ptriawan  Yes, talk to a Qualified Intermediary like @Dave Foster

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @David Krulac, thanks for the shout out.  @Carlos Ptriawan, Not sure what you mean by "1031 ready".  If you're doing a 1031 and looking for your replacement any property that you are gong to hold for investment.  So you'd want to pick your geographical area and sector (MF sounds like) and go to town.  Realtors, meet ups, letter campaigns, door knocking and door knockers (I think there may be a country song here somewhere :) .

    Any property you want can be used to complete a 1031.   Is that what you're asking?

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  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    6y

    Yes, I see a website somewhere that lists multifamily/SFH ready for 1031 exchanges with all the cash flow analysis, but I lost the website.

    For example,Hughes Realty offer 1031 Exchange property ready, but their LTV is capped at 50%.

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  • Robert C.
    Investor · San Francisco, CA · Member since 2016 · 338 posts · 444 votes
    6y

    @Dave Foster (and anyone else who wants to chime in). This is an old thread but it answers my initial question. I have some follow ups, if you can help out.

    Based on the response of the 1031 experts, it would be okay to 1031 exchange from a NOO single family into a 4-unit building where one unit is used as primary residence, so long as the 3 rented units are equal in value to the exchanged NOO single family. (Please correct me if I'm wrong) So...

    1.) What documentation is needed to prove that the value of 3 units is equal or greater than the exchanged property?

    2.) Any ideas how to show this is a legitimate process to a bank in order to obtain an owner-occupied loan (lower rate)? I'm encountering lenders that won't do owner-occupied loan on a 1031 because they assume you are taking the new property as a rental and not as a primary residence. 

    Thoughts?

    2Reply
  • David Krulac
    Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    6y

    @Robert C.

    yes can exchange a noo SFR into 4 unit where 1 unit is o/o The value of the 3 units should be more than the adjusted sale price of the noo SFR. But if it is less that just means there will be some tax for the "Boot", the difference between the lesser amount of the 3 unit value.

    1.  You can justify the value different ways, 3/4 of the appraised value if all 4 units are similar size and value, you can use 3/4 of assessed value, you could base it on percentage of square footage, or you could base it on percentage of rents. Or some other value that you could justify to the IRS if audited.

    2.  Explain it to the bank as best you can if they are still unwilling to lend, then find another bank.  If you are using a Qualified Intermediary, ask them for some recomendations.  

    3Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @Robert C., Great suggestions by @David Krulac.  The rationale will be determined by you and your CPA.  It has to be a rational rationale :) so that your accountant feels they can defend.  But they way they set up your Sched E and allocate that property on the form 8824 is the documentation that the IRS sees.

    If the property is 4 units or less then it can even be an FHA loan which specifically mentions and allows the use of part as residence and part as investment. So that should not be a problem with most banks.

    The key of course is to make sure that your accountant agrees that the valuation of the investment portion equals or exceeds the sales price of your relinquished property.

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  • Robert C.
    Investor · San Francisco, CA · Member since 2016 · 338 posts · 444 votes
    6y

    @David Krulac @Dave Foster, thanks for the feedback. Very helpful!

    1Reply
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