1031 Exchange - Investing total proceeds and having a partner?

Question

Does anyone know the requirements on 1031 exchanges?

What I do know is I must name my property within 45 days of closing and must actually close within 180 days.

What I don't know is must I invest total proceeds? Also if property purchase price exceeds, and I have a partner, is that allowed?

Example property costs $9M. I invest $2M. My friend invests $2M. We finance $5M or assume existing financing for now. If so, how soon after closing can we refinance to "cash out"?

Thanks in advance!

Dale Osborn · Answer

For a 1031 exchange - you have to take title in the same entity as the entity that owned the relinquished property. If you held title as an LLC for the sold property, the new property you buy needs the same entity. To get around this to use a partner - you put your proceeds into the peoperty under your entity and your partner can then put in his money under his entity. You would have to use Tenants in Common (TIC) for this not a partnership agreement or name. CPAs will argue on the time frame for taking cash out, but to be on the safe side most agree a minimum of a year and a day. Others argue that as long as it shows up on 2 tax returns it is enough time. Checking with a 1031 exchange facillitator will help. Another key item is to make sure your 1031 exchange funds are held in a SEPARATE account for you by the 1031 exchange intermediary. There was a case in VA where they placed it in the companies general account. The company then went bankrupt. The individual went to court to get his money out and was told that since it was in the general account it had to be dispersed to all stock holders and creditors - not back to him.

Dave Toelkes · Answer

You can do a cash out refinance as soon as possible after the exchange.  There is no requirement to wait any period of time after the exchange has closed.  As a practical matter, however, most lenders have a one year title seasoning rule if you want to cash out refinance.

The most common exchange today is the Starker delayed exchange, often called a forward exchange.  In this exchange, A sells his relinquished property to B, then uses the proceeds of the sale to purchase the replacement property from C.

There are only two general rules to have a fully deferred forward exchange.  (1) The replacement property value must equal or exceed the value of the relinquished property, and, (2) all of exchange proceeds must be reinvested in the replacement property acquisition.

There is no requirement to have any debt on the replacement property.  As long as all of the proceeds from the sale of the relinquished property are used to acquire the replacement property, the exchangor can use cash out of pocket to complete the replacement property acquisition.  Although, no new debt is required for the replacement property, in practice, very few exchangors will commit to an all cash deal;  most will use new debt to finance the replacement property acquisition.

The first general rule is that the replacement property value must be equal or greater than the relinquished property.  As long as you don't identify more than three replacement properties and purchase one or more of the identified replacement properties, the replacement property value could be 100 times greater than the relinquished property, and the exchange would still be valid.

There is a 200% rule when more than three replacement properties are identified, but it does not apply in the context of this discussion.

Angelo Russo · Answer

No one seems to have answered the other part of your question, how soon can you "cash out".  a year is generally a safe bet.  Generally a cash out refinance done before an exchange is what would trigger tax consequences.

As for the rest, everyone is correct, you do not have to invest all of your proceeds, but taxes will be paid on whatever you take out, or whatever liability you are relieved from and do not take on.  (ie  $2M property, $1M cash, $1M debt, new property has to have at least that much debt, or you get taxed on the "boot")

Also, there are restrictions on how much larger the property can be, so double check. I believe it is 200%.

Account Closed · Answer

You also have to purchase a property of higher value than the one you are selling and it must meet the like kind requirements.  There are are a lot of issues and often an exchange should be planned well in advance.

A good exchange facilitator is almost essential.

Mitch Kronowit · Answer

Try contacting Steve Exeter. He is a 1031 expert and a BP member.

http://www.exeter1031.com

I believe, yes, all proceeds, every single dime must go into another property. I don't believe having a partner relieves you of that. There are also a ton of "gotchas" that you need to avoid, so an adviser like Steve is highly recommended.

Dave Toelkes · Answer

The waiting period to refinance will be governed by your lender, not the IRS.

Yes, provided you meet these two general requirements, you still have a fully deferred exchange intact:  (1)  The value of the replacement property must equal or exceed the value of the relinquished property, and, (2)  All of the exchange proceeds must be reinvested in the replacement property acquisition.

Aly W. · Answer

Hi folks,

I was actually posting this for another BP member, and cut 'n pasted in the first person. Their ex-spouse may be trolling the boards so I need to keep this anonymous:

The follow up question:

If the relinquished property nets $2M, I take in a partner who also invests $2M, we borrow cash of $5M to purchase a $9M replacement property with us both equal partners using the "friend's cash" to close quickly - once the closing takes place - can I arrange for and obtain "new" financing on the property say for $7.2M or 80% LTV and close right away or must I wait the one year seasoning period to refinance or cash out??  If I cannot refinance immediately, can I assume the existing Seller's debt of $5M, put our $4M in, close the deal and still qualify for the exchange?

Aly W. · Answer

Thanks so much everyone, and sorry for the duplicate post Jon!

Dave Toelkes · Answer

This is not really the argument.  The discussion is how long must you hold the replacement property and use it for a qualified purpose to validate the exchange.

This would come up when property acquired in a 1031 exchange is converted to a primary residence in an effort to qualify for the capital gains exclusion on the sale of a primary residence.  The consensus is generally one year for the more agressive, and 18 months to two years for the more conservative.

Mitch Kronowit · Answer

Thanks for the correction. When somebody mentions using a 1031 exchange, I naturally assume they're looking to maximize their tax-deferred benefit, i.e., roll their entire gain into another like-investment.

I suppose there isn't much harm in skimming a little off the top if you're looking to put the cash to good use, but otherwise paying tax on a large portion of the proceeds kind of defeats the purpose of the 1031 exchange.

1031 Exchange - Investing total proceeds and having a partner?

Most Popular Reply