1031 Exchange - Debt, syndication, partnerships

[Cameron Snyder]

Hi all!  My husband and I are currently selling an investment property with the goal of a 1031 exchange and have some questions around the debt component.  

For simplicity's sake, if the property will sell for $1.5m and there is $500k of debt currently, we are trying to understand our options.  How do these numbers (mostly the debt amount) work If we want to put some of the profit into a syndication and some of the profit into a multifamily partnership (I understand that you need to purchase something of equal or greater value), ie - if we are just a small part of a down payment in a syndication and / or partnership deal, where the total purchase amount is greater than $1.5m and the debt is greater than $500k, are we ok?  

I'll also add that my husband and I are self-employed (last 1.5 years) so partnerships vs. loan vehicles are probably the better bet for us at this juncture.

Thank you!

[Dave Foster]

@Cameron Snyder, There's actually a couple different issues wrapped up in your question.  First the issue reinvestment and debt.

It is not true that you must replace your debt in a 1031 exchange.  The two requirements to defer all tax are that you purchase at least as much as your net sale (the contract price minus closing costs and commissions) and that you use all of the net proceeds (the net sale minus any mortgage pay off) in the purchase of your replacement properties.  In your example that probably represents a net sale of a little less than $1.5 mil and net cash of a little less than $ 1mil.  You can use your own cash reserves if you want to replace some or all of the debt and still defer all tax.  Most people do not have those reserves so they do take out more debt.  But not required.  You can also purchase less than what you sell (reducing debt) or take cash out of the exchange.  You will pay tax on the difference without jeopardizing the rest of your exchange.

This all becomes important as you look at your overall financial situation and lendability as self employed professionals.  If you're limited in borrowing capability you can always adjust your loan down to accommodate your abilities and pay a little tax but still shelter some gain.

The second issue is that of where you reinvest.  You can allocate your proceeds ($1 mil ish in any way you want in the purchase of replacement investment real estate.  So you could purchase two properties and pay for one in cash and take out the maximum leverage on the other.  Allocate those proceeds how you wish.

But the purchase must be actual investment real estate.  And here's where you have some issues with your plan to go into partnerships and syndications.   Most of what are called "syndications" now are being structured as limited partnerships to accommodate debt, management, and profit structure.  Unfortunately you cannot use 1031 proceeds to purchase an interest in an LP doing a syndication because that is not seen as purchasing the real estate itself.  Same general concept with a partnership.  If you're buying an interest in a registered partnership you are not buying real estate so no 1031.  If you can a "partner" buy a property together as tenants in common then you are buying actual real estate and that would qualify.

Syndication types that qualify for 1031 are those which you take title to actual property as a tenant in common (TIC) or you purchase a share of a Delaware Statutory Trust (dst) because the dst was specifically blessed by the IRS in 2004 to count as purchase of real estate itself.