Advice for selling multiple properties

1031 Exchanges
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Advice for selling multiple properties

Todd Krummel
Investor · Chicago, IL · Member since 2017 · 1 post · 0 votes

My brother and I own an LLC that purchased a 40 unit rental property (10 buildings, each with 4 units). The area we own them in is rapidly growing and we have decided to convert them into condos. If we were to sell all 40 units at that price, it would bring in substantial profits. Obviously, we would like to explore opportunities to roll the proceeds and minimize our tax consequences.

I have been looking into 1031 exchange options and have several questions about what may or may not be possible. The first hurdle I see is that selling 40 individual units would take time and may make it difficult (if not practically impossible), to meet the 45 and 180 day time limits set under 1031 rules. Is it possible to sell just 16 units (4 buildings) first, not worrying about doing a 1031 exchange? Selling 16 units would basically cover the initial purchase price of the 40 units. From there, could we continue renting out the remaining 24 units as we have been doing and possibly sell them down the road and look to do a 1031 exchange then? Technically, we would not have made a profit yet on selling the overall property as we would have just sold enough units to cover our initial investment (unless they revalue the whole property based on the sales comps). Alternatively, would it be possible to sell one building (4 units) at a time and do 10 separate 1031 exchanges (one for each building sold)? If anyone has experience with this type of complication, any advice would be appreciated.

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    9y

    Hi @Todd Krummel, 

    The first issue that you need to address with your legal and tax advisors is whether or not the property described above was held for rental, investment or business use or was rather held for conversion into condos and then sale. Properties that qualify for 1031 Exchange treatment must be held for rental, investment or business use. Properties acquired with the intent to rehab, develop or convert and then sell can be treated as inventory in a real estate business and would therefore not qualify for 1031 Exchange treatment. The critical component is your intent, and intent can be changed. The risk here is that your original intent was to acquire the properties for rental purposes, but the IRS could determine that your intent has changed into a condo conversion project and then held for sale rather than investment. I would have your tax advisor review this first to ensure that you would qualify for 1031 Exchange treatment.

    Second, your adjusted cost basis in the entire property would be allocated or prorated between the various units. The sale of the first 16 units would trigger a prorated amount of your profit or taxable gain. There is no way to allocate the first sale exclusively to your adjusted cost basis.

    However, I think it would likely make sense, provided that you qualify for 1031 Exchange treatment, to market each four unit building separately and structure separate 1031 Exchange transactions. This would make the implementation of each 1031 Exchange, especially meeting the 45 calendar day identification period, much easier.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    9y

    @Todd Krummel, There's a lot of your scenario that needs to be fleshed out but here's a couple of thoughts to some of your initial questions.

    You're absolutely right that trying to sell several properties at once to combine 1031 exchanges can cause you all kinds of 45/180 day angst.  Many times the solution to this is a reverse exchange where the new property is purchased first and held by the QI while you then go about selling the old properties.  This can significantly eliminate some of the issues with trying to coordinate several sales into one purchase.

    However, there's a couple more serious issues you may have.  First, your idea of selling a few to generate cash to pay back initial purchase is a good one.  But you will have a profit on each unit sold.  The basis of the property is allocated to each individual unit on a pro rata basis so Each unit will have a % of the original basis and will generate a % of the net profit.  So any sale is going to have some taxable gain.

    I'm also not sure whether the 1031 would even be available to you.  This speaks to a full condoed project or a  one building at a time scenario like you imagine at the end of your post.  A lot is going to depend on the actions necessary and structure of the condo project.  It is very conceivable that you could be interpreted as "creating inventory" that is substantially different from the real estate you have been holding for productive use.  Exactly like a developer who buys raw land and then subdivides improves and sells lots.  When you do this you are now selling inventory and that is not eligible for 1031. 

    There are some answers to this that your legal team and QI can flesh out. Land banking is one avenue but it must be approached very carefully and particularly as well.

    Answer to you question - Yes it can be done.  Your situation is not a simple one.

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