1031 Exchange into Mixed-Use Property?

6 Replies

We will receive a net gain of $250,000 from the sale of a relinquished investment property and the funds will be held by a QI. We want to purchase a mixed-use replacement property for $750,000--a home with a detached apartment to rent out alongside a primary residence we'll move into as owners. The value of the replacement property is apportioned using a ratio of 66% residential to 33% investment—or $500,000 residential value to $250,000 investment value. Can we finance the purchase of the replacement property using the $250,000 in exchange funds as the down payment for the loan on the new property? Does this satisfy the requirement that the investment portion of the property (33% or $250,000) be paid for with exchange funds while the residential portion of the property (66% or $500,000) be paid for with only non-exchange funds—in this case, the funds borrowed from the lender? (I've set aside closing costs for the moment--let's say that the seller of the replacement property has agreed to pay all closing costs).

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@Tim Turner , In a mixed use situation like you are describing it is helpful to think of it as two different properties - one is your primary and one is investment.  You've done some great calculations to determine the % allotment.  And as long as the investment allocation meets your reinvestment target you will complete a successful 1031.  

But there's a couple potential issues here

1. The requirement to defer all tax is that you purchase at least as much replacement investment real estate as your net sale.  And that you use all of the proceeds from the sale to accomplish that.  

     a. This means that you can indeed use your proceeds as a down payment on the entire property as long as the investment allocation is at least equal to your net sale.

.    b. But I'm concerned because you use the word "gain" of $250K.  In your scenario the investment portion equals this number nicely.  But if your sale was actually for more then you may have a valuation problem.  Because the purchase requirement to meet to defer all tax is your net sale.  Not just the gain.  

So that could be a potential issue.  But your premise is solid and doable.

@Dave Foster , thank you for your reply! I may not be using the term "gain" properly...or maybe I am and I'm getting the valuation ratio wrong. Here are the details:

  • Relinquished Property Sale Price = $310,000
  • Closing Costs = $25,000
  • Mortgage Payoff = $35,000

So, after the two transaction costs listed above, we'll walk away with $250,000 deposited into the QI fund.

That would be 1/3 of the new property cost, roughly equivalent to the value of the investment portion...or does the investment portion need to be equivalent to the actual sale price of the relinquished property--in this case, $310,000?

One thing I think I did learn yesterday is that based on my original calculation, putting the $250k toward the investment portion would result in taxable book on the mortgage payoff of $35,000 because no equivalent debt will be left on the investment portion (only the mortgage debt acquired to obtain the residential portion of our purchased property). However, we can live with that in exchange for being able to put the bulk of this payout into this combo investment/residence purchase.

@Tim Turner , your reinvestment target is going to be the net sales price which is the contract price minus closing costs - 310 - 25K.  Or $285K.  You'll have $250K of proceeds that you need to purchase at least $285K of real estate to defer all tax.

You don't have to replace debt specifically.  You can use cash of your own to replace the debt.   But you still have to purchase $285K of replacement real estate.  So if the valuations only work out that the investment portion of the new property is worth $250K you'll either need to purchase another property to make up the difference, Or pay tax on the difference between the sale and purchase price.

You're not far off.  You may want to really scrutinize the property with your accountant and see if you can find another $35K of value for the investment portion