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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  • Rahul Mepani
    Member since 2020 · 3 posts · 3 votes
    6y

    @Dave Foster Does the IRS or bank care about method of financing for new property?

    e.g. 500k rental property is sold and exchanged into a $2.5mm owner-occupied rental property (let's say the rental portion is an ADU to be used exclusively as an AirBnB worth 600k of the purchase price). So far, all seems fine for a 1031.

    If I finance this purchase with a mortgage and 20% down (using only the 500k of proceeds), does the IRS or bank care that I purchased my primary residence with essentially no money down? Or does the owner-occupied portion have to come up with some equity as well?

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

    @Rahul Mepani, Distilling your scenario down it looks like you would be selling a rental property for $500K and doing a 1031 into a mixed use property (part primary and part investment) where the allocation for the investment portion would be $600K.  That works for the 1031 exchange.  It is the actual use of the property that the IRS is concerned with not the financing.  As long as your lender is OK with you using 1031 proceeds for the entire down payment then that would be fine.

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  • Rahul Mepani
    Member since 2020 · 3 posts · 3 votes
    6y

    @Dave Foster

    Thank you! A follow-up on financing - Using the above example, the mortgage would be $2mm. The portion of the mortgage that would be attributable to the rental would only be $100k and the balance of $1.9mm to the primary residence, correct? I'd have to track that because I couldn't over-allocate interest expense to the rental. Am I thinking about that right?

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

    @Rahul Mepani, I think you're thinking about that correctly.  That is certainly a crystal clear trail of cash and interest flow.  Just verify with your tax preparer .  

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  • Jodi Low
    Rental Property Investor · Eugene, OR · Member since 2019 · 22 posts · 7 votes
    6y

    Just finished reading through this thread. It has been tremendously illuminating in figuring out my next step with a NOO SF that I would like to 1031 into a property that I can OO a portion of and stop paying rent!!! I am narrowing my search to a SF with ADU where the home is valued at my net from the NOO SF and would then OO the ADU. Thank you @Rahul Mepani and @Robert C. for asking the questions that I had and for @Dave Foster and @David Krulac for sharing your expertise along with everyone else's feedback.  

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  • Nati HanukaPro Member
    Member since 2018 · 10 posts · 4 votes
    5y

    Thanks for all the contributors to this thread, tax code can be really confusing and I am now doing my first 1031 exchange (I am all about learn by doing), but to make sure that I understood some of the information provided here. My scenario is:

    Sold a SF investment property for 97k and have a capital gain of 39k which I plan to use those funds in 1031 exchange. I found a triplex (385k) with two of the units already tenant-occupied and tenants are intend to stay. My plan is to move into the vacant unit and claim it as my primary residence as soon as I closed on the property.

    1. Is this allowed? or do I have to wait before I can claim it a primary residence? 

    2. Since it's a triplex (assuming all units are equal) then the 1031 exchange funds is ok to be used up 66% of the property and the rest must come out of my pocket? Am I understanding it correctly?

    Thanks in advance

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  • David Krulac
    Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    5y

    @Nati Hanuka

    1.  You said you "sold" a SF property.  You need to NOT received any funds from that transaction, and your sale contract should state that you are doing and exchange, NOT A SALE.  and that the buyer of the SF cooperates in the exchange at no cost to the buyer.  There is some paper work the buyer should sign.

    2.  You must NOT received any proceeds from the sale which needs to go to a Qualified Intermediary.

    3.  I'm not an attorney and am not giving legal advise, you should be consulting your own attorney, CPA, and Qualified Intermediary.  But I think that when you acquire the 3 unit, the portion you occupy is not part of the 1032, which is NOT for personal residences.  If the square footage of the 3 unites are equal, then the 1031 only cover 2/3 of the building and 2/3 of the purchase price.  And as long as that is more than the sale price of the relinquished property, no capital gains tax is due Federally. 

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  • Nati HanukaPro Member
    Member since 2018 · 10 posts · 4 votes
    5y

    Thanks David.

    Yes, I did not receive any proceeds from that transaction and it was defined as an exchange in the sale contract, the buyer was aware and cooperated (also signed on the form you mentioned just don't remember the name of it). The funds are currently held at the intermediary and I am within the 45 day window to identify a like-kind property which is the triplex I am currently under contract.

    To your third point, based on the purchasing price and the down payment requirement the 39k I have in the 1031 exchange fund will still not be enough to cover 2/3 of square footage of the property so I will need to add personal fund to cover the rest of the 2/3 which will be used as rentals and the other 1/3 that will be my primary residence.

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  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    5y

    Hi Nati,

    The realistic scenario would be the following:
    1. You sell the house as 1031
    2. You buy that triplex immediately as 1031 swaps
    3. rent  an apartment or live somewhere for 1-2 year
    4. move to that triplex after 2 years

    The reason being is the IRS may consider your 1031 as invalid since you don't have the intention to make triplex as full investment. So wait for a full calendar year before moving to the triplex. Don't immediately move.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Nati Hanuka, You are absolutely able to 1031 into 2/3rds of that triplex. You can even use FHA financing for the entire thing if you want. What must happen to satisfy the 1031 is that you purchase at least as much as your net sale ($97K) an that you use all of your proceeds in the down payment.

    Since you are purchasing the triplex for $385 each unit is probably worth around $130K each.  So you could easily move into one of them and use the other two to satisfy your 1031.  

    These are the kinds of questions that should be readily answered by your QI for the 1031.  They are to be your guide to keep you within the lines.  Hopefully they're telling you the same thing here.  From the numbers you have given this is a fantastic opportunity for you to 1031 into 2/3rds of a triplex and move into the other 1/3rd.

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  • Nati HanukaPro Member
    Member since 2018 · 10 posts · 4 votes
    5y

    @Dave Foster

    Thanks Dave! That pretty much the same answer I received from the QI but also wanted to post here so I can get some other opinions and look at things from all angles with the amount of the experience this forum brings.

    Thanks for the reply!

    1Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    5y

    Dave, If I'm reading it correctly, to do 1031 from NOO to OO MF safely :

    The unit of MF family must be greater than the net sale.

    So if Net Sale is 500K, I can buy OO duplex for a 1 mil

    (Somehow I read before it's not possible but now it's also possible with caveats).

    Also is it allowed if I sell primary and a rental at the same time ? So for primary, I'll capture 500k tax-free ; and  1031 for other rental almost simultaneously; with the new acquired property is a duplex as mentioned above ? Is timing will be an issue ?

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Carlos Ptriawan, Yes that could work as long as the value of each side of the duplex was roughly equal.  Your duplex would actually be two pieces of property - one $500K investment property and one $500K primary residence.  You satisfy your exchange requirements with the purchase of just the one side of the duplex.

    This is one of the greatest opportunities in investment financing. FHA financing is allowed on any multi property of 4 or fewer units. They see it as a purchase of your primary residence and an investment property all under one loan with very favorable terms.

    When you sell the same property after living in it for at least two years you will get 50% of the gain (the part attributed to the primary res side) tax free up to $500K.  You do a 1031 exchange on the other 50% and that gain is all tax deferred.

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  • Michael K.
    Investor · Chicago, IL · Member since 2018 · 352 posts · 176 votes
    4y

    What about a duplex in which one unit is rented and the other is ower occupied? How would this be treated? It's a fairly common situation.

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  • David Krulac
    Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    4y

    @Michael K. The rented half could be recognized as part of the 1031, whereas the owner occupied half would not qualify for the 1031, but would qualify for the owner occupied tax benefit under section 1225.

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