1031 advice would be appreciated!

[Brett Lee]

I have 2 houses on 1 lot in the Seattle area i am planning on sell and reinvest in another house. I am probably selling our houses for around $325k and the house i am planning to purchase is 280k. My understanding is the new house purchase needs to be more then what i sell hoyse for. However i saw that there is some sort of construction provision that allows a person to use some of equity on new house. Wondering if anyone has advice on whether this would work with 1031 exchange? Also any tax experts who specialize in 1031 exchanges would be appreciated!

[Dave Foster]

@Brett Lee, You're correct in your understanding that if you want to defer all tax you must purchase at least as much investment real estate as you sell.  And you cannot exchange into improvements on property you already own.  But there is a process called a reverse or improvement exchange that allows you to accomplish what you're thinking about.  

In an improvement exchange the QI (qualified intermediary who processes your 1031) takes title to the new property and holds it in a special purpose entity called the Exchange Accommodating Title  Holder (EAT).  While the EAT owns the property you are totally in control but you do not own it.  So you can improve the property until it is now worth what you need it to be in order to accommodate your 1031.  In your example you would sell your old property for $325K and the QI would purchase the new property for $280K in an EAT.  While the EAT holds it you would complete $45K of improvements so between the acquisition price and the improvements that property is now worth $325K.  Then you take title to complete your exchange.  You sold for 325 and you bought for 325.

The two issues usually with improvement exchanges are the financing - you have to provide the financing to purchase the property.  It can be cash or a portfolio bank or private loan.  Conventional lenders cannot do them.  And secondly they are relatively expensive.  While a straight exchange might cost you $750.  An improvement exchange can easily add $4k - $5K to that.

Another option would be for you to do a partial exchange.  You can buy less than you sell but you pay tax on the difference.   So if you had $80K profit in the current house and bought $45K less than you sold in a 1031, you would pay tax on the $45K difference but would shelter the remaining $35K of profit in the 1031.

Or you could buy a second property to eat up the difference.  You can allocate your proceeds in any way you want as down payments or whatever in the new purchases.

It's all a numbers game for you to play with.