1031 with land owned outright

11 Replies

I'm going to be selling some land that I own w/o a mortgage and will be doing a 1031 exchange with the proceeds.  Am I allowed to finance another property with the proceeds?  For example, my proceeds will be about $200k.  Could I use that as a 25% down payment on an $800k property?  Would there be any kind of negative tax consequences with this strategy or maybe I wouldn't be able to deduct mortgage interest?

@Andrew Merritt the 1031 requires that you purchase at least as much as your net sale ($200K) and use all of the proceeds ($200K) to defer all tax.

You can always purchase more using a mortgage.  And you can purchase more than one replacement using the proceeds as multiple down payments.  

One particularly neat trick in your situation to shelter against a down turn and mitigate the tight timelines of a 1031 would be to purchase say two properties with your proceeds - one for cash and the other with maximum leverage.

Has the effect of eliminating the risk of leverage from at least one property so if the market goes south you have one protected. But you still get the ROI boosting effect on the other. And if you want in the future you can put financing on the free and clear one. the cash out doesn't have to be used in any certain time. So it's not urgent and pressured like the 1031.

Originally posted by @Dave Foster :

@Andrew Merritt the 1031 requires that you purchase at least as much as your net sale ($200K) and use all of the proceeds ($200K) to defer all tax.

You can always purchase more using a mortgage.  And you can purchase more than one replacement using the proceeds as multiple down payments.  

One particularly neat trick in your situation to shelter against a down turn and mitigate the tight timelines of a 1031 would be to purchase say two properties with your proceeds - one for cash and the other with maximum leverage.

Has the effect of eliminating the risk of leverage from at least one property so if the market goes south you have one protected. But you still get the ROI boosting effect on the other. And if you want in the future you can put financing on the free and clear one. the cash out doesn't have to be used in any certain time. So it's not urgent and pressured like the 1031.

I am buying a property from a seller who wants to do a 1031 exchange. I want to buy the property on seller financing. Can the seller sell to me on a Land Contract and still get the 1031 benefit?

Thank you @Dave Foster .  I was told that I might be penalized for getting a mortgage with the proceeds since I didn't have a mortgage on the property I'm selling or I might not be able to deduct mortgage insurance, something like that.  Is that true or are there no restrictions other than having to purchase something(s) of greater value?

@Mike Hern , A land contract and owner carry financing can both be used with a 1031 - sometimes!!  The requirement is that the exchanger first sell their old property then take title to their new property.  Obviously a lease with an option to purchase by you wouldn't work.  But owner financing would.  

A land contract may also work as long as enough of the burdens and benefits of real estate ownership pass to you in the land contract.  This is also called "risk of loss passing".  In essence you need to be the owner in all things except that deed does not convey until the last payment is made.  The property is really sold to you.  But the deed stays with the seller acting as security for the debt.

The problem the seller will have is that a 1031 with a land contract starts with the execution of the contract.  So many times the seller will have a large reinvestment requirement but only a little cash from the down payment to compete their exchange.  And there is also the issue of how to handle the payments that come in during the exchange period.

@Andrew Merritt , it's a common misunderstanding out there.  The amount of debt you have on a replacement property does not matter - as long as you purchase at least as much as your net sale.  And as long as you use all of your proceeds in that purchase or purchases.  So you can supplement your sale proceeds with your own money to buy a replacement for all cash.  And you can use your proceeds as the minimal down payment and purchase a much larger property than you sold with a very large mortgage.  

Normal write offs will still be available.  they have nothing to do with the 1031.  About the only thing that does change is that the costs of financing (origination, buying of points etc) are not considered expenses to purchase the property.  So the 1031 proceeds cannot be used for that without paying tax on that amount.

Originally posted by @Dave Foster :

@Andrew Merritt the 1031 requires that you purchase at least as much as your net sale ($200K) and use all of the proceeds ($200K) to defer all tax.

You can always purchase more using a mortgage.  And you can purchase more than one replacement using the proceeds as multiple down payments.  

One particularly neat trick in your situation to shelter against a down turn and mitigate the tight timelines of a 1031 would be to purchase say two properties with your proceeds - one for cash and the other with maximum leverage.

Has the effect of eliminating the risk of leverage from at least one property so if the market goes south you have one protected. But you still get the ROI boosting effect on the other. And if you want in the future you can put financing on the free and clear one. the cash out doesn't have to be used in any certain time. So it's not urgent and pressured like the 1031.

I like this approach when I have 1031 out of free and clear and near zero basis land.. just pay cash for the next asset it cash flow handsomely and you now get some tax bene's that land  ( not timber land) does not give you  and your risk profile is very minimal.. I get very nervous with all these folks that want to leverage to the max :)  but hey I am old and conservative.   And I dont think we will have another Armageddon like 08 to 2011.. but man  there were some real damage done to very good investors when the banks froze and called their debt and no one to replace it..  If you get 20 or 30 year debt with NO call that is much safer.. the 20 due in 5 folks had some real issues 

@Jay Hinrichs Thanks for your input.  I'm a bit younger so I'm ok being more aggressive, but I've identified two properties that I could purchase with these funds.  I'd be putting down about 40% on each, which is more than I usually like to, but it seems like it would be a good compromise between your conservative approach and my aggressive one.  

I can definitely use the cashflow though after supporting two tenants in some of my other units though after the past year!

Originally posted by @Andrew Merritt :

@Jay Hinrichs Thanks for your input.  I'm a bit younger so I'm ok being more aggressive, but I've identified two properties that I could purchase with these funds.  I'd be putting down about 40% on each, which is more than I usually like to, but it seems like it would be a good compromise between your conservative approach and my aggressive one.  

I can definitely use the cashflow though after supporting two tenants in some of my other units though after the past year!

there ya go reasonable sustainable debt on a quality assets.. 

Originally posted by @Dave Foster :

@Mike Hern, A land contract and owner carry financing can both be used with a 1031 - sometimes!!  The requirement is that the exchanger first sell their old property then take title to their new property.  Obviously a lease with an option to purchase by you wouldn't work.  But owner financing would.  

A land contract may also work as long as enough of the burdens and benefits of real estate ownership pass to you in the land contract.  This is also called "risk of loss passing".  In essence you need to be the owner in all things except that deed does not convey until the last payment is made.  The property is really sold to you.  But the deed stays with the seller acting as security for the debt.

The problem the seller will have is that a 1031 with a land contract starts with the execution of the contract.  So many times the seller will have a large reinvestment requirement but only a little cash from the down payment to compete their exchange.  And there is also the issue of how to handle the payments that come in during the exchange period.

The property is on the west coast. Is this something you can transact from FL?