1031 to payoff mortgage?

6 Replies

Hi,

I have a condo that has been a rental property for a few years that I am getting ready to sell  in the next couple of months.

I also own a piece of land on which we are currently paying a mortgage. We may build on this site or sell it off... depends on our personal situation.

Q: Can I use the proceeds of the sale as a 1031 exchange to pay off the remainder of the mortgage?

@Sanghamitra S. , a 1031 exchange is always a sale followed by a purchase.  You can't take the proceeds from a sale and pay off a mortgage on a property you own.

But there's a couple possible options that might work for you.

1. It sounds like you're not totally set on keeping that lot.  You could sell both the condo and lot and do 1031 exchanges on both to buy a totally different lot that already has a house on it.  Combining exchanges like this is called consolidation.  In order for it to work and defer all tax you would need to make sure that the timing dates coincide appropriately.  And you would need to purchase at least as much as the net sales price of both the condo and lot and use all of the cash generated in both sales in the next purchase.

If you go this route you'll need to make sure to use the new property for investment purposes for a while to satisfy the intent requirements of sec 1031.

2. You could also do a 1031 on the condo and then after purchasing your new property cash out a refi on it and use the refi proceeds to pay off the lot mortgage or pay for the new construction if you chose that route.  Once that construction was complete you could then refi the lot and new house and pay off the new rental if you wanted.  It's a lot of moving parts but depending on the size of gain from your condo it might be worth considering.

Hi @Sanghamitra S. ,

Unfortunately, no.  You must buy real estate since you have sold real estate.  The pay off of a mortgage is not considered the purchase of real estate and would therefore not qualify as like-kind property. 

There are three (3) IRS Private Letter Rulings that essentially allowed the taxpayer to sell existing property and construct new buildings/improvements on land that they already owned through a 1031 Exchange.  We refer to this as an Advanced Improvement 1031 Exchange because it will involve risk. 

An Advanced Improvement 1031 Exchange essentially allows you to sell one or more properties (“relinquished property”) and subsequently build or make improvements on land that you already own (“replacement property”).  The general idea is that you must acquire an interest in real estate that you do not already own, and since you already own the land we have to structure an Advanced Improvement 1031 Exchange so that you can acquire an interest in real estate that you do not already own (in fact, it does not exist yet).

Essentially, your new replacement property will consist of (1) a long-term ground lease on your existing land, and (2) the new improvements made on the land that you already own.  The ground lease and improvements represent the interest in real estate that you do not already own (and that is being created through this structure).

There are risks with this advanced strategy, so you must discuss this with your legal and tax advisors to ensure that you understand and are willing to take the risks.