1031 exchange to new construction?

Question

Can I do a 1031 exchange to a new construction. To be more specific, sell my place (that I have lived in less than 6 months) and then get a new construction loan if i can build it in less than 180 days?

Dave Foster · Answer

@Wade Stahle You could not do a 1031 in that example but not for why you think.

The 1031 is not available on your primary residence.  it is for investment property.  So you cannot sell a property you are living in and 1031 the sale into a new investment property.  And you sure can't 1031 into a property you are planning to live in.

However, If you were selling an investment property that you purchased with the intent to hold for productive us and wanted to sell it to buy a newly constructed investment property that has been build with funding provided by you within 180 days of the sale of your old property the answer is yes - with a caveat.

In order to do that the builder needs to stay in title to the lot and the construction needs to be treated as earnest money down payments that may loosely correlate to construction draws/amounts.  Then once construction is complete or enough complete to absorb the amount of your sale you close the sale of your old property and purchase the new property.  The proceeds of the sale are used to pay down the construction loan or fund the remaining amount.

This is really the inexpensive variation on a reverse construction exchange.  The reverse exchange provides infinitely more security and options for you.  But it is much more expensive.

Dave Foster · Answer

Brian Condron, The ownership can stay with the seller or go into and EAT (exchange accommodating titleholder) set up by the QI.  With new construction where in house financing is offered I've seen it the first way.  The builder remains on title and periodic earnest money payments are made until the buyer takes title.

More common in true improvement exchanges is the set up of the EAT by the QI.  There absolutely is a deed of trust and mortgage recorded against the property.  The loan is quirky only because te borrower is a non-recourse LLC but it is guaranteed by the client who does not have have title to the new property.  This does make it a portfolio type product.  So community banks and commercial lenders are your best source of lending.

In some cases, the lender actually takes a security position in the property being sold and the property being purchased which can make the loan doubly attractive.

Dave Foster · Answer

@Wade Stahle, Yep that's a problem.  Once you take title to the real estate you lose the opportunity to exchange into it.  About the only other potential option would be very sophisticated maneuver called a "lease hold" exchange. It's based on the legal doctrine that a lease of land of at least 30 years is considered a bundle of rights that rise to the ownership of the asset itself.  The process itself acts very similar to a reverse exchange after that point.  aside from a favorable private letter ruling several years ago there hasn't been much in the way of IRS activity.  Doesn't mean good or bad news just no news.  So brave souls still do them to their benefit so far.

Wade Stahle · Answer

Dave and Tim,

in this case the land is owner financed. So i own it but havent fully paid him yet. This is a confusing one!

Dave Foster · Answer

@Wade Stahle Sure depending on the flexibility of the lender and builder.  We've structured a bunch that way.

Wade Stahle · Answer

thanks Dave,

So if i did this with an investment property could I do it with an owner builder construction loan?

1031 exchange to new construction?

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