Parents have 500k in equity for 1031 - what options?

[James Piercy]

Hello Everyone,

I am looking for advice on a potentail 1031 situation.  My parents purchased a home 18 years ago for $160k. It is now worth around $850k, although they refinanced it once so there is a loan out for around $300k.  Both of my parents are tired and want to get out of this property since they don't want to live in it.  

1031s are new to me but since they require you to purchase a home at the same value or greater it has created some issues for my parents.  I was pushing them to purchase a multifamily for around $800k and collect the cash flow but they don't want that stress.  The title of the property is in parent's names.  

My dad is considering purchasing two homes around $400k one as a rental and one that I could live in/manage.  The question here is since their is a loan for $300k and both of my parents are retired (the only income they have is 1 rental, pension and 401k), I don't believe they could qualify to carry a loan onto new properties.  Is this correct?  Is there a way that I can sign on to the mortgage and have my parents 1031 the first property for two properties and keep one under them and give me rights to the other?  Or will both properties need to stay in their name indefinitely since they are on the first title?

What I am really trying to get at is, how can I help my parents capitalize on this $500k of equity and also in return set up a property (residence/investment) for myself to have full rights to?  My parents don't want to the burden of dealing with rentals in retirement and also don't want to pay $200k+ in taxes to sell.  They would like to use that money to help me further my real estate career.  Thanks for reading!

[Dave Foster]

@James Piercy, I don't think you want your parents taking out more debt.  I don't think they do either.  But I think the rules of 1031 actually give them a little wiggle room.  First let's ball park their gain at $690K and depreciation recapture at $100K.  That makes their total gain around $790K made up of depreciation recapture at probably 25% and capital gain at 15%.  If they don't do a 1031 they're looking at a tax hit of maybe $260K ish using hand grenade math.

Now segue into the requirements for a successful exchange.  In order to defer all tax they must purchase at least as much as they sell and they must use all of their proceeds in the next purchase.  But they do not have to if they're willing to pay some tax.

So option 1 would be to sell the house for $850K and take $150K in cash boot. Use the remaining cash to purchase a passive investment 1031 compatible vehicle like a TIC or NNN lease and pay tax on the mortgage buy down. Because they didn't replace the mortgage they can use the extra cash they took to pay the tax. End of story. They paid tax on $450K but sheltered the other $340K of profit, eliminated their mortgage and ended up with passive income for the rest of their lives.

Option 2 would be To sell for $850k and generate $550K in cash. Again use around $400K cash to buy a passive instrument that pays monthly probably 7-8% annually and use the other $150K ish to purchase $400K of zero coupon TIC or DST. Zero coupons are 1031 compatible products that do not pay monthly income but are assumption of debt for a value add project that let's the 1031 investor park debt in exchange for a payout later rather than mail box money today. The zero coupon has to be non-recourse so there is no personal assumption of debt. And it is not tied to the other investment at all. So the $400K bringing in 7-8% is at no risk at all either.

In this scenario your parents don't generate any more money monthly than in scenario one but they do not pay any tax.  And in the zero coupon debt they have an investment with a lump payout in a few years.

These are just two that come off the top of my head from what actual clients have done recently.  There's probably some other scenarios that would work as well.