1031 Exchange to a fix and hold?

Question

Hi All,

I bought a single family house investment property in Murfreesburo, Tennessee in 2006 after I graduated college with 100% financing and no money down. Pretty sweet deal considering the lack of experience I had at the time and money.

Anyways, fortunately, I've keep it all these years as an investment property, and I'm looking to 1031 exchange out of it today since the market is fairly good in Murfreesboro.  Currently, I owe about 125M on it, and I believe I could sell it for ~175M, so not crazy gains, but at least a decent chunk that i could invest elsewhere and make a better return.  Also, my tenants in there have a lease till 10/31/17.  I have a couple of questions:

1) Does the total dollar amount of the "like-kind" property or properties have to be equal to or greater than what I sell the Tennessee property for?  For example, if I found two Kansas City single family houses that added up were greater than how much I sold my Tennessee place for, does that work?

2) Can I use that equity to buy a wholesale property with a hard money loan, fix up, refinance into a long-term loan, and hold as an investment property in Denver (my current city)?  I'm currently in the process of looking for a fix and flip, but from what I've read here, is that you can't fix and flip with a 1031 property, but if I fix and hold as a rental, would that suffice?

3) And finally, if I just wanted to cash out and wanted to know how much I could get post all taxes, what would that amount be or is there a good calculator online to estimate?  I like to compare and contrast things.

All this is great information.

Thanks for the help!

Dave Foster · Answer

@Jeff White, You have to actually purchase real estate to count that towards your reinvestment requirements.  Improvements made after the purchase cannot go against your initial 1031 requirements.  It's the actual purchase price not the ARV after remodel that counts.

In your example you're selling for $175 ish and buying for $250.  So you're purchasing more than you sold.  That works.  You're also using all of your net cash (the $30 - $50K) to fund that purchase.  That's perfect.

You can't borrow $290K initially because that would result in cash back to you on the 1031 settlement statement.  The IRS would view that as taking profit.  So you would want to close on the property and then immediately take out a separate loan for the improvements - just like you said.  Immediately after you purchase your replacement property you can indebt it any way you choose to access cash for improvements or other investing or anything else.  When you do it before your purchase the IRS calls it taking profit - taxable.  If you do it after the purchase you are borrowing against equity - not taxable.

Dave Foster · Answer

@Jeff White and @Natalie Kolodij, don't get hung up on "debt".  The wording of the statute is somewhat confusing and there are a lot of people that think that debt must be replaced and exact debt must be carried on the new property.  But that isn't the case.

Think of the reinvestment criteria as a two part rule.  In order to defer all tax you must purchase at least as much as your net sale (contract minus closing costs but before mortgage payoff) and you must use all of your net cash (net sale minus mortgage pay off) in the next purchase or purchases.

Because most people don't have access to outside cash they end up replacing debt.  But that is not a statutory requirement as long as the valuation criteria and use of net cash is met.  Nor is proportional debt a requirement at all.  You could take your proceeds and purchase one property for $75K cash and get another $175K property with 100% hard money financing.  You purchased at least as much as you sold and you used all of your cash - perfect 1031.

Specific answers

1.  Sort of answered above but here's one more caveat.  Above is only if you want to defer all tax.  If you buy less than what you sell or if you take some cash you can do so without jeopardizing the remainder of your exchange but you would pay tax on the difference.

2.  A fix n flip would defeat the purpose of the 1031 which is to defer tax on investments you intend to hold.  If your primary intent is to purchase a property to resell immediately then you'll end up paying all the tax anyway.  But if you find that property and fix it and rent it and then evaluate in a while you establish your intent being not primarily to resell but to hold.  And that would then make you eligible for another 1031.  I shudder every time I see this phrase (pun intended) but look up the BRRR strategy.  Coupled with 1031s instead of "R"efis at strategic points and this can be a very powerful strategy.

Also, the source of the loan does not matter.  But you can't use the cost of improvements to property once you already own to satisfy your reinvestment requirements.  So the property or properties unfixed must equal or exceed the $175 you're selling for.  You can set up a second loan with your private lender for improvements.

3. Your accountant should have that info at their fingertips.  If not or if you don't have one then buy an hour of Natalie's time

Jeff White · Answer

@Dave Foster Thanks so much Dave for answering my questions!  That makes sense now.

Jeff White · Answer

@Dave Foster  Thanks so much for thorough response  I really appreciate it.  I'm learning so much, and I look forward gaining more information on this subject, no reason to not reinvest it elsewhere.

Can you clarify what you mean by not counting the cost of improvements in a fix and hold scenario? For example, lets say I find a house for 250M purchase price that needs 40M in work for an ARV of 350M when done, and I want to buy the house using hard money loan at 10%, can I finance the 250K as a downpayment using my net cash from the Tennessee property (lets say 30M after closing costs and realtor fees), and then get a seperate loan on the 40M in improvements?  Or do I have to come up with the 40M on my own?  I just want to understand what i can and can not do.

@Matt M.  I haven't told my CPA yet, but I will when I finish my taxes, so I can properly plan out this year.  Good stuff, I will look Tracy up.  Thanks for the recommendation.

Matt M. · Answer

Have you spoken to you CPA about it? He/she will give you most of the advice. You also probably want to talk to a 1031 intermediary about your options. I've used ipx1031 here in town. Tracy Wilson really knows his stuff and he's a CPA.

Your October 2017 timing is good for the buy side as things start to slow down. Odds are you won't find a flip in this market, but you could pickup a buy and hold here in town on or off market. I'm finding about 3-4 off market holds a month here in town.

Jeff White · Answer

Thanks for the info Natalie, I will definitely do more research.

Natalie Kolodij · Answer

Your gain/loss isn't based on what you owe on the house

It's going to be your sale price - (your purchase price + any improvements made)= gain/loss

You're also going to have depreciation recapture at 25%

Also though regarding a 1031.

1) Yes you can 1031 into more than 1 property to hit the equal/greater requirements

2) You have to match debts on the properties, I'm not sure that you could do a hard money loan up front vs. a traditional loan- @dave

@Dave Foster would know

3)  You should likely talk to an accountant or do some research into how the gain/loss on a sale of a rental is calculated and how 1250 tax comes into play

1031 Exchange to a fix and hold?

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