1031 Exchange, 2 partner LLC, Into 2 Replacements, 1 Each Partner

[Douglas Andrew]

Hi All!  I have a question. My partner and I are seriously considering the sale of a multifamily investment property that is worth $8M, and has current mortgage of say $2.5M. I own 64% and he owns 36%.

The original mortgage was for $1.5M, but we did a refinance cash out (interest

only this time with the same mortgage payments as previous) and took $1M out last year.

For argument purposes, let's say net sales proceeds are $7.5M, and our equity

after mortgage close out is $5M. 

In this case, if we wanted to do separate projects, assuming the assignment of the 

equity and total value would be  ;

Me: (0.64 x $7.5M) = $4.80 assigned value and (.64 x $2.5M) = $1.60 assigned debt

Partner: (0.36 x $7.5M) = $2.7M assigned value and (0.34 x $2.5) = $0.85M ***. debt

In this case, or in any way to meet the separation or new projects objective, can we

do the following?

Me: Purchase a replacement property for $3.35M equity plus $1.6M debt

Partner: Buy into a DST for $1.65 equity plus $0.85M debt?

Thanks for any guidance you can offer!

Doug

Manhattan, NY

[Dave Foster]

@Douglas Andrew, The easiest way to treat this would be as two separate exchanges.  It sounds like you own the property as tenants in common.  In that event what you own is 64% of a property and he owns 36% of a piece of property.  At closing of the sale you could each separate and do your own exchanges.   That's easy enough.  

The problem comes in your valuations.  In order to defer all tax you need to do two things:

1. Purchase at least as much as your net sale (in your case that would be 4.8 mil and for your partner that would be 2.7 mil).

2. you must use all of the net proceeds in the next purchase or purchases (again for you that would be 3,2 mil and for your partner that would be 1.8 mil).  

The idea of replacing debt can work but you can always supplement with your own cash if you do not want to replace debt in a 1031.  so I like to work from the net sale/net proceeds side of the sheet.

This means that in order to defer all tax you must purchase at least 4.8 mil using 3.2 mil of proceeds.  

Your partner would need to purchase at least 2.7 mil in real estate using 1.8 mil in real estate.

Your scenario anticipates that you would take out the same amount of debt but purchase less than what you sold.  That will result in cash to you and would be taxable.  The same is true for your partner.  You could certainly purchase 3.35 mil in replacement real estate but would pay tax on the boot difference between 4.8 and 3.35.  Same thing for your partner on the difference between his sale % of 2.7 mil and the anticipated purchase of 1.65.

If the profit is large enough this might be justified.  But that's a lot of boot.  And your leverage is low enough that you should have no problem absorbing all of that into new properties or fractionals if you want to completely defer all tax.