1031 Exchange- Complex question

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captbone
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Joined: Sun Feb 04, 2018 5:28 pm

1031 Exchange- Complex question

Post by captbone » Sun May 13, 2018 5:02 pm

Hello,

Looking for some insight.

Example for discussion: We own 5 house (1 primary home and 4 rentals)

We sell one rental and buy our dream house using a 1031 exchange. Dream house sits empty for a months while we redo it.

We then sell our primary home. We eventually move into our dream house and never sell it.

What is our tax burden? Primary home should be free and clear. The rental house we turned into our dream home??????? Any time limits we need to be aware of?

Thank you for your time.

Spedward
Posts: 146
Joined: Mon Jun 13, 2011 4:48 pm

Re: 1031 Exchange- Complex question

Post by Spedward » Sun May 13, 2018 5:08 pm

The dream house would not qualify as replacement property for 1031 exchange purposes. It would have to be 1231 property (property used in a trade or business).

Basically if you do this it would be treated as if you did not replace the property and would have to pay tax on the gain in full.

captbone
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Re: 1031 Exchange- Complex question

Post by captbone » Mon May 14, 2018 6:36 am

Thank you.

What if we gift (or sell very cheap) our primary home to one of our children?

niceguy7376
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Re: 1031 Exchange- Complex question

Post by niceguy7376 » Mon May 14, 2018 7:36 am

OP,
1031 exchange means exchanging one investment/rental property with another one.

So how would you get your dream house as part of 1031?

I dont know what/how your second question "What if we gift (or sell very cheap) our primary home to one of our children?" applies to your original post.

metrunt
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Re: 1031 Exchange- Complex question

Post by metrunt » Mon May 14, 2018 8:31 am

What's your goal here? It sounds like it is to free up some cash by selling a rental property in order to buy a new primary residence and keep your tax burden as low as possible. Is that correct?

Gifting your primary residence to your kids doesn't make any sense towards this goal.

You have a couple options.

You could sell the rental, do a 1031, and use your dream home as a rental for two years before converting it into your primary residence. There are rules around this. Talk to an experienced accountant.

You could move into your rental, make it your primary residence and sell your current home. You'd take a $500K exclusion to the sale of your current primary. Buy your new house with the proceeds, reno it, living in your rental for two years, making that your primary, then sell it and take another $500K exclusion.

grkmec
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Re: 1031 Exchange- Complex question

Post by grkmec » Mon May 14, 2018 10:20 am

I am no accountant (so could be completely wrong), but I think you could probably pull this off with the right amount of planning....

Say you live in Northeast and you have a rental property and a primary residence. Rental property has been depreciated to zero. You sell your rental property and buy your dream house in Florida via 1031 exchange (triggering no taxes on depreciation recapture or any long term capital gains you might have). Then you rent your dream house for a period of time to make it look you made a like for like exchange. Then say after a couple years, you sell primary residence and move into your Florida rental property.

Why won't this strategy work ?

curmudgeon
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Re: 1031 Exchange- Complex question

Post by curmudgeon » Mon May 14, 2018 10:22 am

metrunt wrote:
Mon May 14, 2018 8:31 am

You could move into your rental, make it your primary residence and sell your current home. You'd take a $500K exclusion to the sale of your current primary. Buy your new house with the proceeds, reno it, living in your rental for two years, making that your primary, then sell it and take another $500K exclusion.
These days the $500K exclusion has to be pro-rated across the years of rental/personal use for a converted rental. Not quite the sweet deal it was in the past.

ChrisC
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Re: 1031 Exchange- Complex question

Post by ChrisC » Mon May 14, 2018 10:44 am

grkmec wrote:
Mon May 14, 2018 10:20 am
I am no accountant (so could be completely wrong), but I think you could probably pull this off with the right amount of planning....

Say you live in Northeast and you have a rental property and a primary residence. Rental property has been depreciated to zero. You sell your rental property and buy your dream house in Florida via 1031 exchange (triggering no taxes on depreciation recapture or any long term capital gains you might have). Then you rent your dream house for a period of time to make it look you made a like for like exchange. Then say after a couple years, you sell primary residence and move into your Florida rental property.

Why won't this strategy work ?
It could work if the dream house/1031 replacement house is initially intended as investment property, and it's rented for at least two years, which appears to be a safe harbor period of time. But I think if one goes into this transaction with the pretext of not really treating the replacement property as an investment and it's obvious that this is pretextual (for example, charging below market rates, not handling the property as a rental, leaving the property vacant or treating it as a second home, etc), then it's possible for the IRS to disallow the exchange. I think there is IRS case law on these scenarios.

metrunt
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Re: 1031 Exchange- Complex question

Post by metrunt » Mon May 14, 2018 1:01 pm

curmudgeon wrote:
Mon May 14, 2018 10:22 am
These days the $500K exclusion has to be pro-rated across the years of rental/personal use for a converted rental. Not quite the sweet deal it was in the past.
Oh no! That was a nice feature.

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tadamsmar
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Re: 1031 Exchange- Complex question

Post by tadamsmar » Wed May 16, 2018 7:54 am

captbone wrote:
Sun May 13, 2018 5:02 pm
Hello,

Looking for some insight.

Example for discussion: We own 5 house (1 primary home and 4 rentals)

We sell one rental and buy our dream house using a 1031 exchange. Dream house sits empty for a months while we redo it.

We then sell our primary home. We eventually move into our dream house and never sell it.

What is our tax burden? Primary home should be free and clear. The rental house we turned into our dream home??????? Any time limits we need to be aware of?

Thank you for your time.
I looked into a 1031 when I was selling a farm, with a possible conversion of the purchased property to our primary residence. Consulted with lawyer and an accountant. But I don't recall all the details.

As ChrisC pointed out, it has to be a rental property for a grace period. You don't actually have to rent it, but you have to act like a normal landlord and advertise it for rent at market rates except when it is down for renovation for a reasonable amount of time. Usually not practical/credible to avoid renting it out while claiming to the IRS that it is a rental property.

You did not say how you are going to get the money to buy the dream home. If you sell some of your current rentals, then there is a 1031 time limit on reinvesting in the new property. I don't recall the time limit, but it seemed uncomfortably short in my circumstances. You can buy the dream home with loan and then sell your current rentals and retire the loan, but there will be fees and stipulations on this plan. You could try to get a contract to buy the dream home and then try to sell the current rental properties before closing, but that is tricky and the owner of the dream home might think you are too big a default risk, but you can also just qualify for a loan with your bank to give the seller some warm fuzzies. Anyway juggling the two or more closings to make the 1031 exchange go smoothly at a low cost can be tricky.

You mentioned selling your current residence cheap to a relative as if that would not be a gift. The delta between the sale price and market price is a gift for tax reporting purposes. Also the tax forms for the 1031 ask questions about your dealing with relatives, but perhaps the sale of your residence would not be part of the overall 1031 arrangement not sure.

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