Want to sell home to tenant. Does 1031 come into play?

3 Replies

We own a home that we have rented out.  We are considering selling it to the tenant.  Does a 1031 come into play?  Are the payments considered income on your taxes?  

The 1031 exchange (also called a like-kind exchange or a Starker) is a swap of one business or investment asset for another. Although most swaps are taxable as sales, if you come within 1031, you'll either have no tax or limited tax due at the time of the exchange as long as you identify a property within 45 days and then close on a new like-kind property in 180 days. 

I am assuming you are referring to the rental payments from the tenant, and yes that money is taxable on your income and is treated as passive income.

@Carole G. Yes, a 1031 can come into play and create a wonderful tax solution. If you have a rental property and would like to sell most people will see tax and depreciation recapture around 30-40%. If you complete a 1031 exchange you can defer those liabilities. There are a number of requirements that must be followed in order to successfully complete a 1031 exchange. I would recommend speaking with a 1031 exchange accommodator to see if your transaction qualifies. I will send you a PM in case you'd like to discuss.

@Carole G. , some very good comments here by @Bob Okenwa and @Lauren Speidel .  I'm kind of sensing that the "payments" you're talking about are actually payments for the sale of the property and what you're contemplating is an Owner carry or installment sale.

You can sell that property on a note and you will end up paying all the tax but it will be spread out and only taxable as it comes in as payments.  So an owner carry can mitigate but not eliminate an immediate tax burden.  The other thing to remember is that in an owner carry situation you do have to recapture all depreciation up front when you well.  So if that house is highly depreciated you could still see a significant initial tax payment.

A 1031 exchange is exactly what you want to defer tax on gain and depreciation recapture.  However, the 1031 will start with the sale of your old property and you have a total of 180 days to complete your purchase using the proceeds from your sale.  The proceeds from your sale will be some cash probably from a down payment and the note.  This makes a 1031 hard to do because you have a seller is unlikely to accept the note as partial payment for a sale of their property to you.

However, if you have access to some cash you can still make the 1031 work by replacing the note with cash from the outside and then completing your 1031 with all cash.  When you do this the note is now outside your exchange and none of it is taxable other an the interest being paid.  It's a very elegant solution that has several benefits to you.   But it's a little complex and needs a QI with experience in this process.

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