I have a potential investment partner who would like to 1031 into a property that I currently own and then the plan would be to develop the property. She would be bringing in $325k of proceeds and need to fulfill a replacement value of $450k ... $450k is a good approximation of the sale price of the replacement property (that I own) as well. If I loaned the $125k balance of sale, then her 1031 would seemingly be covered (proceeds into replacement property, along with debt taken on).
Now, we'd like to end up in the development project at 50/50 partners. Let's say development costs are $1M. This could come from a mix of additional capital contributed by me and also a construction loan. The question is: How could her 1031 remain intact while getting this property into a 50/50 split in this development process?
We will both need to be titled on the property, as this is required construction financing and I am the stronger 'financial' partner. Improvement exchange is not possible due to timeframes, i.e. need more than 180 days.
I've searched through and can't quite find this scenario. LLC might be possible, but I'm understanding this is a bit complicated and could affect the 1031.
@Kevin Battey A lot depends on what you mean by "development". Are you developing a property to build and hold. Then her 1031 is fine. If you're developing to resell lots or build homes and resell then the 1031 won't be appropriate since she'll incur all the tax on the sale of the lots.
But assuming that your intent is to develop and hold, the key is that she purchase and take title to at least as much real estate as she sells (450) and uses all of the proceeds from the sale in the purchase (325). She has to take title to that but it could be as a tenant in common with you. If you want a 50-50 split then the property would have to be worth $900 is you want to stay that way. But if not then a different entity structure could be used but an LLC with the two of you would have to be done after the 1031. She will need to purchase $450/worth of property from you using $325 as the down. You can absolutely carry the note on that.
Once that is complete the 1031 is over and you can work with your accountant on how to craft a holding/borrowing entity for your on-going needs that represents the ownership you desire without triggering a sale.
Got it. Thanks @Dave Foster ... Yes, it is build and hold. Follow up ... You say an LLC could be used "after the 1031". Is that after the 1031 executed and then showed ownership of that $450k portion for a tax period or two? It's my understanding that any LLC formation sooner that adjusts ownership percentages would cause issues for the 1031.
@Kevin Battey , There is no statutorily mandated period. The circumstances of the situation will dictate. The IRS is particularly concerned with any transfer of ownership that is the equivalent of generating gain. Accountants are all over the map on when they're comfortable doing a simple contribution of capital in exchange for membership interest. Most just like to see a tax return for consistency.
But it would also work in your case to remain tic and take the loan out as such. A lender might look favorably on that. Especially if there was a separate management entity set up to be the executor of the TIC owners wishes. And if a lender required LLC ownership that could be a compelling reason for why the property was contributed into the LLC sooner rather than later.