Selling rental to children for 1031 exchange

[Derwin Villanueva]

Aloha BP'rs,

My wife and I have our son and his family in our rental, which he wants to stay in, and we want to do a 1031 exchange into higher performing assets. The home here on O'ahu has a FMV of about $900k~, a $405k mortgage @5.3%. They had the rent covered up until our oldest son that shared rent, his brother, passed away in August. They have never owned a home. He wants to stay in the house and we, of course as doting parents, do not want to sell to him at the market rate. We are thinking to sell it to them at $650k.

What ideas/considerations do any of you with your collective base recommend to make this happen? Are there better alternatives to conduct the 1031?

[Dave Foster]

@Derwin Villanueva, As far as the 1031 goes its fairly well accepted that you can sell to a related party as long as you both keep your properties for at least two years.  However the IRS will still be on the lookout for basis shifting.  And selling to them for a discount might feel an awful lot like that.  I'd like some CPA folks to chime in here.  

I get that you're wanting to help your children.  And the partial gifting ideas from everyone are great.  You could also simply hang on to that property and rent it to them at just enough to cover the mortgage.  Then when you pass it could go to them but at a stepped up basis so the tax and depreciation recapture over all the years would disappear for them.  That's truly a magnificent gift.

In any event if your accountants weren't worried about the gift/basis shifting issue then you would be selling an asset for $650K and after paying off the note in the sale you would have around $250K in cash.  So you're requirements then for the 1031 would be to purchase at least $650K of real estate using the $250K in cash (plus whatever cash/mortgage you chose).