1031 Exchange Questions

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alexcr
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1031 Exchange Questions

Post by alexcr »

Among other real estate holdings, my wife and I own an apartment unit that a family member has lived in for the past five years. We have not charged the family member any rent; even factoring that in, it has been a good investment for us, as real estate values in the area have appreciated meaningfully in recent years.

We're considering selling the unit and using the proceeds to purchase a home, which this family member would continue to live in rent-free.

Naturally, a 1031 exchange is appealing to us, as it seems like it might allow us to defer any capital gains tax on this sale. A few questions on this, though...

1) Would this property currently qualify for a 1031 exchange? My wife and I have not lived in the unit at all. And we consider it an investment holding. But we also haven't been generating any near-term income from the unit.

2) If the unit does not currently qualify due to the fact that we haven't been charging any rent, can we rectify this? I read on Investopedia that "To meet that safe harbor, in each of the two 12-month periods immediately AFTER the exchange: You must rent the dwelling unit to another person for a fair rental for 14 days or more." This refers to the unit purchased in the exchange, but does similar logic also apply to the unit sold as part of the exchange? That is, can we simply charge this family member rent for 14 days for the current apartment (and then charge them 14 days of rent in each of the two years after they move into the new property), and then we'd qualify for a 1031 exchange? If so, are there any parameters on what this rent needs to be, e.g. can it be substantially below market rates?

3) How do 1031 exchanges work if the property being purchased costs more than the proceeds of the property being sold? (We're not talking about a substantial difference, let's call it a 25% difference in value.)
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Sandtrap
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Re: 1031 Exchange Questions

Post by Sandtrap »

Generally, 1031 exchanges must be "like" to "like" and the IRS is very strict on it.
So, apartment building (do you own the whole building?) to residential home....is iffy.
If you have a "condo" or an "apartment "single unit", in an apartment building and it is not your residence, or maybe a second home that family lives in, If not a rental and no rental agreement (right), and then 1031 to a SFH then maybe.

Can you check with your CPA?
Realize that not all SFH or any R/E for sale "seller" is willling to do a 1031 exchange. Also that there are certain time limitations between the sale of one property and the purchase and closing of the other new R/E. An excellent tttle/escrow company can handle this well and a lousy escrow/closing/title company can mess it up. (imho) so check.

Again, ask you CPA.
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Topic Author
alexcr
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Re: 1031 Exchange Questions

Post by alexcr »

Sandtrap wrote: Wed Oct 30, 2024 11:00 am Generally, 1031 exchanges must be "like" to "like" and the IRS is very strict on it.
So, apartment building (do you own the whole building?) to residential home....is iffy.
If you have a "condo" or an "apartment "single unit", in an apartment building and it is not your residence, or maybe a second home that family lives in, If not a rental and no rental agreement (right), and then 1031 to a SFH then maybe.
Sorry for not clarifying. This is a condo in an apartment building. We do not own the whole building. We have never lived in the unit in question.

There is currently no rental agreement and the family member isn't paying rent, but if necessary to facilitate a 1031 exchange, we could always put a short-term rental agreement in place for the current property and, eventually, the new property. But part of what I'm wondering here with my questions above is whether that kind of approach would work, and if so, how specifically we'd need to go about it.
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Sandtrap
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Re: 1031 Exchange Questions

Post by Sandtrap »

alexcr wrote: Wed Oct 30, 2024 11:07 am
Sandtrap wrote: Wed Oct 30, 2024 11:00 am Generally, 1031 exchanges must be "like" to "like" and the IRS is very strict on it.
So, apartment building (do you own the whole building?) to residential home....is iffy.
If you have a "condo" or an "apartment "single unit", in an apartment building and it is not your residence, or maybe a second home that family lives in, If not a rental and no rental agreement (right), and then 1031 to a SFH then maybe.
Sorry for not clarifying. This is a condo in an apartment building. We do not own the whole building. We have never lived in the unit in question.

There is currently no rental agreement and the family member isn't paying rent, but if necessary to facilitate a 1031 exchange, we could always put a short-term rental agreement in place for the current property and, eventually, the new property. But part of what I'm wondering here with my questions above is whether that kind of approach would work, and if so, how specifically we'd need to go about it.
ok
so if it is a "family residence" sold then 1031 to another "family residence" then it is like to like.
but
generally.... A "rental" to a a "family residence " is not like to like.

you should really confirm this with your cpa to do it properly. The IRS is unforgiving when ir comes to 1031s
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SubPar
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Re: 1031 Exchange Questions

Post by SubPar »

You may consider it an investment holding, but you haven't evidenced that fact in your tax returns. Substance over form, IMO. You've treated this as a secondary personal residence, which would not qualify for 1031 exchange.
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Sandtrap
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Re: 1031 Exchange Questions

Post by Sandtrap »

SubPar wrote: Wed Oct 30, 2024 11:19 am You may consider it an investment holding, but you haven't evidenced that fact in your tax returns. Substance over form, IMO. You've treated this as a secondary personal residence, which would not qualify for 1031 exchange.
+1
yes
if the property s were held for investment or rental
j
Last edited by Sandtrap on Wed Oct 30, 2024 11:24 am, edited 1 time in total.
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123
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Re: 1031 Exchange Questions

Post by 123 »

This sounds like nothing close to an investment property used as a rental. It is simply a personal asset being sold and being replaced with another personal asset.

If it were a rental unit you would also have the potential issue of depreciation recapture whether or not you claimed depreciation for the years as a rental property.

It would seem that if a 1031 exchange were attempted at tax time the IRS could readily identify a problem based on the absence of rental income on the OP"s tax returns since the time of property acquisition.

You could gift the property to the family member who resides there (filing an appropriate gift tax return) and potentially rid yourself of the tax consequences. Maybe they would be content to continue to reside there.
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alexcr
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Re: 1031 Exchange Questions

Post by alexcr »

123 wrote: Wed Oct 30, 2024 11:22 am It would seem that if a 1031 exchange were attempted at tax time the IRS could readily identify a problem based on the absence of rental income on the OP"s tax returns since the time of property acquisition.
The reason I'm a little confused is that Investopedia makes the requirements for qualifying sound less onerous: "To meet that safe harbor, in each of the two 12-month periods immediately AFTER the exchange: You must rent the dwelling unit to another person for a fair rental for 14 days or more."

Is this information incorrect? And if it is in fact accurate, I assume the requirements for the current property being sold are similar?

Because I can easily get a 14-day rental agreement in place for the current property prior to sale, and for the purchased property after.
Last edited by alexcr on Wed Oct 30, 2024 11:30 am, edited 1 time in total.
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Sandtrap
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Re: 1031 Exchange Questions

Post by Sandtrap »

123 wrote: Wed Oct 30, 2024 11:22 am This sounds like nothing close to an investment property used as a rental. It is simply a personal asset being sold and being replaced with another personal asset.

If it were a rental unit you would also have the potential issue of depreciation recapture whether or not you claimed depreciation for the years as a rental property.

It would seem that if a 1031 exchange were attempted at tax time the IRS could readily identify a problem based on the absence of rental income on the OP"s tax returns since the time of property acquisition.

You could gift the property to the family member who resides there (filing an appropriate gift tax return) and potentially rid yourself of the tax consequences. Maybe they would be content to continue to reside there.
this introduces a creative solution

maybe mane a provision in the family trust to address that housing issue per family member etc. Sort of like adult special needs provisions etc but for this scenario.
perhaps consult with your estate legal counsel.
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MrBobcat
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Re: 1031 Exchange Questions

Post by MrBobcat »

Sounds like the primary purpose of purchasing the condo was to house a family member, so it's going to be personal property not investment/business property so no 1031.
David_Cary
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Re: 1031 Exchange Questions

Post by David_Cary »

I would think if you acted on advice of professionals, you would be acting in good faith. The IRS may not agree and you aren't going to jail over something like this.

You can draw up a lease, have the family member pay you rent starting today. Gift the money back to the family member.

The fact is that you can have a house as primary and then turn it into a rental and then 1031 it.

1031 just delays the gain. The gain is still there so it isn't like you are getting out of the taxes unless you die holding it.

In fact, you may pay more taxes as you hit higher rates with more gains. Better to have a $400k gain in 2024 and then another in 2026 instead of a $800k gain in 2026. And this could happen in your scenario.

Why not just eat the capital gains now? Maybe some will be at 15% instead of 23.8% on the high end.
SubPar
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Re: 1031 Exchange Questions

Post by SubPar »

alexcr wrote: Wed Oct 30, 2024 11:28 am
123 wrote: Wed Oct 30, 2024 11:22 am It would seem that if a 1031 exchange were attempted at tax time the IRS could readily identify a problem based on the absence of rental income on the OP"s tax returns since the time of property acquisition.
The reason I'm a little confused is that Investopedia makes the requirements for qualifying sound less onerous: "To meet that safe harbor, in each of the two 12-month periods immediately AFTER the exchange: You must rent the dwelling unit to another person for a fair rental for 14 days or more."

Is this information incorrect? And if it is in fact accurate, I assume the requirements for the current property being sold are similar?

Because I can easily get a 14-day rental agreement in place for the current property prior to sale, and for the purchased property after.
That's a safe harbor for someone wanting to move into their replacement property after they've effectuated an exchange.

Based on details in your original post, you haven't treated the property as an investment property (or trade/business) since you've owned it. That disqualifies the ability to 1031 altogether.
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MrBobcat
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Re: 1031 Exchange Questions

Post by MrBobcat »

David_Cary wrote: Wed Oct 30, 2024 12:48 pm I would think if you acted on advice of professionals, you would be acting in good faith. The IRS may not agree and you aren't going to jail over something like this.

You can draw up a lease, have the family member pay you rent starting today. Gift the money back to the family member.

The fact is that you can have a house as primary and then turn it into a rental and then 1031 it.
They might have to do a bit of professional "shopping" to find one willing to sign there name as a tax preparer on something like this.
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