1031 Exchange with Parents

7 Replies

Hey BP community, 

I have a question regarding a 1031 exchange with my parents. They want to sell an investment property and use the 1031 exchange proceeds to help with putting a down payment on a house for my family. We will be living in the house and will be paying rent to accommodate the 1031 exchange.  I read that I can be on the title and the home loan with my parents, but am getting conflicting answers from my lender. So my questions are as follows.

- Can I be on the title of the home with my parents and pay them rent? 

- Can I be on the home loan for the house with my parents?

- If I can be on the title, but not the loan how long does the property need to be a rental property before we can refinance and I can be on the home loan?

Hey Calvin, 

I hope you're doing well. 

I'm a realtor in TN & CA and have some experience w/ 1031's. The place you will probably get the best answers  is from the accommodator that your parents will be using. They will be able to give you all the in's & out's. 

Where are you located? Do you know the accommodator they will be using? 

Hi @Calvin Chan

Yes, your parents can sell investment property, complete a 1031 Exchange by acquiring property that your family will live in, and charge your fair market rent. It is important that you pay your parents fair market rent for the portion of the property that your parents will own. 

Yes, you can be on title, too, as long as the percentage of the purchase price that your parents buy is equal to or greater than the sale price of their relinquished property. They need to be able to trade equal or up in value to satisfy their 1031 Exchange reinvestment requirement.  You can be on title for the balance of the purchase, generally as tenants-in-common. 

Yes, you can be on the loan, too. 

For example, if your parents bought 75% of the property and you bought the remaining 25% of the property you would need to put 25% of the down payment, be responsible for 25% of the debt, etc.  

@Calvin Chan , This is more likely going to be a lender underwriting issue.  Your parents can do a 1031 and  buy a property together with you.  They need to take title to at at least as much as their net sale.  And their replacement portion needs to be treated as investment - so rented to you.  But if they really don't want to charge you for it they can use the regular annual gifting limits to get that rent back to you.  But they need to treat it as investment.

Another option would be for them to simply sell, 1031, and buy the entire property and again "rent" it to you.  The only down side to this is that their loan would probably have to be investment grade.  But if you can talk your lender into it you can probably get primary residence financing if you're on title with them.  The IRS does not care about the source of funds for the 1031 purchase.  The concern is only that they see the replacement property being used for investment.

I am glad this question was asked.  It is a very interesting one that I believe many others may eventually come across the same situation.  I have done three 1031s this year, and I can see many more in my future, but as my children grow, this could be a challenge. Thank you to all the respondents. 

I have a follow up question as I have 3 young children of my own and I am always looking ahead... would it not be possible for the parents (investors) to just simply do the 1031 on their own to simplify taxes. Then either putting it into a trust or an LLC that the child as added to soon or later? This would allow the child to have begin the real estate investment journey as well with a protective foundation. I am curious because I have been running many scenarios in my head for the most advantageous outcome when it involves children. In this case, I have 3 and they are all about a year apart and so I imagine when they are older, I have to be careful with how I treat one and whether I have the means to do the same for the others in a short time frame.

Thanks again for you suggestions and insight.

Hi @Sam Yin

It would be simpler if the parents did the 1031 Exchange on their own, but the children would not be building their own equity, net worth or have pride of ownership.  In addition, if the child owns part of the property as their primary residence they would be able to take advantage of the $250,000/$500,000 tax free exclusion on the portion of their taxable gain when they sell.  They could also inherit the portion of the property that the parents own upon their death and receive a step-up in cost basis.  There are lots of moving parts, and no one answer is right for everyone. 

The living trust is important to protect the children from probate, but does not provide any tax benefits by itself.  

Again, lots of moving parts, so it is important to do careful legal, tax and financial planning before jumping into one strategy.