1031 Exchange to build ADU on family owned property

[Kyle Knudsen]

Hello,

I’m looking for guidance on if a 1031 exchange is applicable in my situation.

I currently own a single family rental property that I’m planning on selling. The sale price will most likely be around $500,000 and the mortgage is currently about $200,000.

I plan on using the profits (let's just say $300,000) to build an ADU on property that my family owns in Central Oregon. The property is under a family trust. The ADU would then be used as a long-term rental.

Does this qualify as a “like-for-like” property exchange even though I’m technically not buying another property and does a 1031 apply?

Thanks!

[Dave Foster]

@Todd Anderson Thanks for that shout out.  @Kyle Knudsen, There's a couple reasons why this wont work unfortunately.

1. The 1031 must be a sale of investment property followed by the purchase of investment property.  Improvements on property you own do not qualify.

2. In order to defer all tax you must purchase at least as much as your net sale ($500K ish).  And you must use all of your proceeds ($300K ish).   If you buy less or take cash out you will pay tax on that amount.  In your scenario you'd have a potential tax event on that $200K difference.

Here's a creative way to access most of that money tax free however.  Do a 1031 exchange and buy two replacement properties - one for $250K cash and one for $250K using the remaining $50K of proceeds as your down payment.

Once this is done your 1031 is complete. You purchased $500K in real estate. And you used all $300K of proceeds in the purchases. Then you can immediately put a loan on. the free and clear property and pull that cash out to get close to what you need for the ADU. You deferred all tax in the 1031. And the refinance is not a taxable event.