where to investment 1031 money

[John Fong]

I'm selling my investment property and want to do a 1031. I'm thinking about where to invest that money into, and was wondering if the following is possible? Anything to pay attention to in each of the following scenario?

1. use the 1031 money to buy 2 investment properties with a combined values >= the sales price

2. use the 1031 money to improve one of my existing investment properties (e.g. building an ADU / remodeling)

Thanks

[Bradley Buxton]

@John Fong

Why are you selling and how can you make the money work for you better? Buying 2 investment properties would likely bring in more revenue and equity than renovating an ADU.

Talking with an experienced QI like @Dave Foster can help you with the rules. 

[Dan H.]

It is my #2 is not allowed but I defer to the experts @Dave Foster or @Bill Exeter. 

Good luck

[Bill Exeter]

Hi Dan, 

Thank you so much for the shout out. 

Hi JF, 

You can certainly sell one (1) relinquished property and acquire two (2) separate replacement properties as long as the total purchase amount is equal to or greater than the net sale price of your relinquished property.  It also diversifies your holdings, cash flow, risks, etc.  

Generally, you must acquire property that you do not already own.  Most people will tell you that your second choice can't be done, but the IRS has issued two (2) Private Letter Rulings on point where they did allow the taxpayer to build on property they already owned through a 1031 Exchange.  However, there is no way to do this without risk.  PLRs can't be cited as precedent, so you could do exactly the same thing as the other taxpayers in those PLRs and the IRS can still disqualify the 1031 Exchange and the more your transaction deviates from the PLRs the more risk you take on.  ADUs can be extremely difficult to structure since they are usually on the same parcel/parcel number.  

[Dave Foster]

Spot on @Dan H. @John Fong, you cannot exchange into improvements on property you own without an incredible amount of time, money and risk. The IRS doesn't like the process. For something like an ADU it's surely going to be cost prohibitive.

If you want to buy a cheaper property with your 1031 that has the ability to put an ADU on the lot. Then a reverse exchange would work well for you. Your QI for the 1031 takes title to the property before you. And then we can hold it for up to 180 days while you get the ADU in place. And you finally take title to the property at the purchase price reflecting both the existing structure and the ADU. These are also more expensive and complicated. But much less risky. This might also be a good option for you.

[Bill Exeter]

I would not say the IRS doesn't like the process.  The IRS has issued three (3) Private Letter Rulings that specifically allowed these types of transactions, but you are certainly right about the time, money, risk and cost prohibitive in many cases.