Can Seller 1031 into a new partnership with buyer of old property

Question

Hello,

I am wondering if a seller of an existing property, say a 4 plex, can do a 1031 into a 'new' property with the same person or entity that he sold the 'old' property to?

Think of it this way, I buy 4plex from 'Frank' for 300K, and he and I partner on a new different property(s) that cost 600K where he puts in the 300K from the sale and I come with 300 K cash or financing for my share. Would there be an issue if my share were a 'seller finance' on share of things?

Thanks, Dan Dietz

Ari Bauer · Answer

@Daniel Dietz

Perhaps you can have Frank put the 300k down and take out a 300k loan to purchase the property and then shortly thereafter cashout refinance it  at 75%ltv (450k).

This would allow you to return 150k to Frank.

By structuring the transaction this way, Frank will have access to the cash he wants while enabling him to defer taxes on the whole 300k.

I believe this would be a permitted transaction but I'm not an expert on 1031 so you should definitely double check with @Dave Foster.

Dave Foster · Answer

@Daniel Dietz, I think what you're describing is just fine as long as you can do it as a TIC with "Frank". He is selling a townhouse to you for $300K. This is not a related party transaction he is simply selling a property to you and starting a 1031 exchange. You guys get along and decide to go together on a new piece of property that is worth twice as much as the 4 plex he sold to you. He takes title to 50% of it as a TIC and you take title to it as 50% TIC. His cash provides the down payment and you provide the rest of the stroke either with cash or owner financing.

Looks fine.

Daniel Dietz · Answer

@Dave Foster or others too,

Back to the question of the 'partnership' part of things.....

I think this is not allowed, but thought I would check before I throw the idea out the window ;-)

Seller A wants to get rid of one of his individually held rentals so he can start to slow down. Lets say a 150K duplex. Seller A is ALSO a 33.33% owner of an LLC that buys and holds rentals, along with two non related parties.

Can that LLC which he is 1/3 owner of buy his existing individually owned property? He would then take those proceeds from selling his individually owned unit and 1031 that into a new project, such as a 300K 4 Plex?

I realize that on the 'back end of the exchange' Seller A cannot use the 1031 proceeds to buy into anything that he owns (assuming either individually or a share of either) but is seems like this would be 'on the front side of things'.

Thanks, Dan Dietz

Dave Foster · Answer

@Daniel Dietz I think you'll find that the 721 or upreit exchange usually involves either

1. the reit selling you a tenant in  common interest in properties it owns to complete your exchange.

2. You exchange into a property that is later contributed to the REIT for a membership/ownership/stock interest.

These are all pretty awkward for a reit to invest in with small investors.  The more zeros the more options of course.

What you really keep circling back to is partnership interests via a tenant in common ownership structure.  Easily doable with a 1031 and flexible and affordable.  Just has to be crafted one off for each situation.

Daniel Dietz · Answer

@Dave Foster or others..... I was doing some reading last night when I couldn't sleep. That can be dangerous with all the new ideas that pop up :-)

I came across 721 Exchanges when reading on 1031s. I DO understand how these can work moving up into 'Full Fledged REITs' as an 'end game' so to speak. I think.

What I am wondering is that it *sounds* to me like an owner who is wanting to exchange up can either put their physical property or the funds from the relinquished property into a 'temporary partnership'. (that is my paraphrase). It *seems* like this might be a work around as to the need for the *exact* same titling being needed on sold property and new property.

The thought in my mind is that what I think is the 'normal' way to do things if you want the new property to be a partnership is to use a TIC entity. It *seems* like there is more flexibility of how that new property is held with the 721 Exchange.

What I *dont* understated is if a 721 Exchange can be/is ever used on a 'tiny scale' (relative to REITS) of just 1 to maybe a few properties to add more flexibility going into the newly aquired property(s)?

Thanks, Dan Dietz

Daniel Dietz · Answer

@Ari Bauer I will have to look into that. I get the idea of what you are saying here and will talk to lender and lawyer for thoughts.

Thanks, Dan Dietz

Dave Foster · Answer

@Daniel Dietz, that's where the art of the cpa lies.  As far as I know there is no set convention on whether the first out is depreciation recapture or profit.  I've seen both.  My argument on mine has always been that I want to do the 1031 in order to carry forward my basis from the old property.  If I take money I'm wanting to take some profit as boot.

Daniel Dietz · Answer

@Dave Foster I wish you were wrong too ;-)

As far as the 'first out being taxed as profit".....

Let's say a property is being sold for 150K. It was bought for 120K, and 30K of depreciation has been taken. So the 'profit' is 50% depreciation recapture and 50% capital gains.

Say the seller does a 1031 and reinvests 120K and takes 30K "in boot". So I understand THAT is all profit. Is it then taxed as all 'recapture' since that is typically 'due at sale' (as in seller financing situations) or is is 'prorated' as part recapture and part capital gains? It seems that for some people those rates could be quite different.

Thanks again, Dan Dietz

Dave Foster · Answer

@Daniel Dietz, I've never been more sorry to be right :(.  The first dollars out as boot are taxable as profit not a proration.

Daniel Dietz · Answer

Hello All,

So if I am understanding you guys right @Mark Creason & @Dave Foster what you are saying is that if someone sells a 300K property that they have 150K of 'adjusted basis' in, and they want to take out 150K of 'boot', there is essentially no point in doing a 1031?

I think I *wrongly*  assumed that there would only be taxes on 1/2 of the departure & capital gains, since 'half' of the money was being reinvested.

Thanks, Dan Dietz

Can Seller 1031 into a new partnership with buyer of old property

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