1031X from house flip to personal residence

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1031X from house flip to personal residence

Jordan NorthrupPro Member
Rental Property Investor · Stafford, VA · Member since 2017 · 66 posts · 23 votes

Good afternoon everyone,

I have a question that you may be able to help me with.  My mother-in-law has a property that she owns free and clear that needs to be rehab'd and then sold.  She'd like me to flip it for her.  After I rehab and sell the property, I'll have to pay her, pay the realtor, pay myself back for the rehab, pay capital gains tax, and then whatever is left over is mine.  In order to minimize my tax liability, I was thinking I could 1031X the profit into another property.  One thing that came to mind is that my wife and I are looking for a new home.  Could I take the profit from the flip and 1031 it into a single family home for my family...like using that to provide a portion of all of the down payment?

My mother-in-law's house could sell for around $580k based on the comps.  she'd ask around $400k for it, I'd sink $50k into the rehab, pay 6% for a realtor, etc.  For the 1031X to work, does the value of the new property have to exceed the value of the old property?  Or does the value of the new property have to exceed the PROFIT from the old property? 

Let me know if I'm looking at this the right way or not.  Thanks!

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jordan Northrup, the way you're describing it you would be purchasing the house from her in order to fix n flip.  This would not qualify for a 1031 because your intent in obtaining the property was primarily to resell.  Property that qualifies for 1031 treatment is property purchased with the intent of holding for productive use.  If you put a renter in there and sold in a year or so you've demonstrated the intent of holding and could then do a 1031.  But that takes time.

    But...

    1. If it's your MILs primary residence why not fix it and sell it now while she owns it?   She will get to exempt the first $250K of profit tax free.  My guess is that she doesn't have much more gain than that anyway.  So why not take it tax free and let her pay you a% on the sale for your effort and investment.

    2. If it was a rental for your MIL then she could 1031 into new properties.  You fix it.  She sells and 1031s and buys new property. And then creates an entity to own the properties and adds you as a member of that entity.  Or gifts you the interest in the entity or the properties.

    BTW - in order to defer all tax you must purchase at least as much as you sell. So it would be the $580 number minus realtor/closing etc.

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  • Jordan NorthrupPro Member
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    Rental Property Investor · Stafford, VA · Member since 2017 · 66 posts · 23 votes
    7y

    Hi Dave, thank you for that analysis.  I understand what you said in your first paragraph.  #1 sounds promising.  My MIL has no interest in being a landlord so #2 is out.

    This whole deal is really complicated.  Her husband died 1.5 years ago.  She said something about needing to sell the property before 2 years passed if she wanted to avoid taxes. I can't confirm or deny the truth of that.  It would also be difficult to renovate the property if she still owned it.  We'd have conflicting ideas and there would be coordination struggles.

    Since she offered seller financing, perhaps we could arrange the sale where she takes payment after I rehab and sell the property?  I'd have to pay capital gains on my profit (would she as well?) but I can't think of another way.

    I'd be open to renting the property instead of flipping it, but after the $400k acquisition and $50k rehab, I don't think the rents in the area would make it a cash flowing property.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jordan Northrup, An owner carry note would be fine but if you buy from her and sell it later she doesn't pay tax because she still gets the exemption.  but you would as you said.  If you held it for more than one year then it's a capital gain but otherwise it's ordinary income. which  can be quite a bit higher.

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