1031 as means to consolidate assets?

Question

I've done a lot of reading and never seen this touched. Say I have four homes worth 100k each with 50k each in equity and 50k each in loans, giving me a total of 200k equity. Can I sell those four and exchange in to paying 200k cash for a nice new single home?

Bill Exeter · Answer

Hi @Casey S.,

Unfortunately, no.  You would be selling assets worth a total of $400,000 and then only reinvesting a total of $200,000, which means that you would be trading down by $200,000.  The amount that you trade down by would be applied toward your taxable gains and in this case would like trigger all of your taxable gain so the 1031 Exchange would not provide any benefit to you.

The government takes the position that you own $400,000 in assets and as long as you reinvest and remain fully invested at $400,000 you can defer all of your taxes, but when you either trade down or pull cash out you will begin to recognize and pay your taxes.

The consolidation strategy is very common.  The most common use is to sell a number of smaller assets and exchange into a larger asset that produces more cash flow, better efficiencies, etc.  It is also used by investors that have hit the maximum number of loans permitted for them.  They can sell off a number of properties and exchange into a larger asset in order to make room for more loans.  It is also a common practice when the investor has gotten tired of the property manager function and wants to trade multiple properties into one easier to manage property (or where they can hire a property manager).

Casey S. · Answer

Thanks a bunch! I'm just trying to get a mid time range game plan together. Currently have 23 middle of the road houses spread all over town. A lot of them are older though and can be a drain. The equity machine is running full bore and I'm thinking in 4-5 years Ill be ready to reduce my work load. (Heck this might motivate me to start on two of them now). I really like SFRs and have no desire to trade up to apartments. It sounds like condensing 2 properties back down in to 1 and only financing at 50% LTV will be the game plan. Luckily, my properties are in an area with extremely high demand for investor properties so selling them fast, turnkey, for a good price should be no problem. On the replacement side, I'll probably have to accept paying close to retail for upper middle class, newer homes, within a couple miles of my house. The numbers aren't as good but the demand for rentals is still high. The plan would be to keep a dozen of these and pass them to my heirs.

Dave Foster · Answer

@Casey S., Sorry to say but you absolutely cannot do that without incurring a significant tax event.  The two part rule for reinvestment requirement in a 1031 exchange is that you purchase at least as much as  you sell and you use all of the proceeds in the next purchase or purchases.  If you were to do what you describe you would be selling 400K of real estate and purchasing 200K.  The IRS interprets the first dollar you take in cash or reduced purchase (reduced debt) as a form of taking profit and you would pay tax on it until you had taken your full profit out.

Consolidation exchanges are common and can be a very powerful tool but the requirements must be understood thoroughly.  Again, in your example, you are selling 400K in real estate and generating 200K in proceeds.  You could consolidate into fewer or one properties but in order to defer all tax you would need to purchase at least 400K in real estate and use all $200K in proceeds to do that.  There is no specific requirement to replace debt with debt.  You can bring in outside cash from another source if you want.  But practically speaking most folks selling like that don't have outside cash so they replace the debt with debt.

One trick is that you can use the proceeds in any way that you want in your purchases.  You could purchase one property for $400K with $200K down.  You could purchase two properties worth $200K each and pay cash for one and finance the other one 100%.  The ratio doesn't matter and the number of properties doesn't matter.  The value does.

The key to a successful consolidation exchange is that all of your sales must happen within a time period that accommodates the 180 day exchange period for the first sale.  Have a good team around you including a QI experienced in these types of exchanges and they can be a great tool.

Account Closed · Answer

Absolutely, provided that the four homes qualify, and you have the required intent to use the new property as investment property.

It might be a bit tricky as far as timing goes.  It would be a good idea to secure the purchase before you start doing the sales.  And it would be even better if you could sell the 4 to the same buyer, to reduce cost and uncertainty.

But, in effect, your Replacement Property for each of the 4 Relinquished Properties would be a  1/4 interest in the new property.

Hope this helps.

Michael Lantrip

1031 as means to consolidate assets?

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