What are my options with this 1031???

Question

My husband and I intended to do a reverse 1031/investment exchange that has gotten a little too complicated. We've identified the replacement property, to make the numbers easy costing $300,000. We plan to live on it as well but not sure of the timing of building on the 9 acres. Ultimately a house and garage for us, rental cabins for the investment portion. I would guess not more than 1/3 for primary residence. Initially a garage with a living area that will house both rental and personal items. We think we will build rental cabins next and a house later but we might just keep living in the garage area for an extended period of time. Closing end of October/beginning of November. One question is valuation of investment versus residence (how does the caretaker quarters come in to play?) but first...

We plan to sell a relinquished property worth about $350,000 some time after the closing on the replacement property. We were going to do improvements in the 180 days to use try to up the full $350,000 some of which depends how much of the garage can be considered improvements and how much of the land as the investment was used up with the $300,000 purchase price. I now learn (maybe I'm using the wrong 1031 exchange company...) that the credit union I planned to use for the loan with 20% down is not likely to get involved in an exchange like this. I just reached out to my lender today. I am considering my options for the best tax strategy and don't have time to waste! We stand to "save" about $75,000 in taxes from both the deferred capital gains taxes and the avoiding the increase in healthcare tax etc with our income pushed $350,000 higher for the tax year.

I understand the easiest solution to my possible lender problem is to pay cash for the replacement property.  We have no mortgage on our primary residence or the relinquished property.  We have assets that we do not want to liquidate.  So we have wealth, but not cash.  What are other options?   My husband threw out home equity loan (house worth $400-450,000) to fund the replacement property, to be paid off upon sale of the relinquished property.  I have no idea how viable a strategy that could be.  We could probably get $120,00 in cash from our parents combined.  Perhaps just paying the taxes on the sale of the relinquished property is the best option. Any ideas?  Other information you need to be able to help me?  Who is the best professional to help me sort through all of this?

Thank you!

Dave Foster · Answer

@Jennifer Stanovich, It sounds like you've put a good plan together and understand the issues of separating the primary residence portion from the investment portion like @Lauren Speidel suggests.  But you're planning for that. That's not your issue. And the issue really isn't your QI although they should have talked to you about the kind of lender you would need before you were "surprised".  There are almost no conventional lenders who can accommodate reverse exchanges because of federal lending guidelines.  It is usually a portfolio lender or a private lender.  and surely they took you through the exercise to compare your taxable gain without a reverse and your savings by doing the process???

a Reverse with the QI purchasing the relinquished property could be done like @Michael Skoczylas suggested. Not a bad idea  But they can be tricky with opportunities for accidentally triggering taxable events on some of the sale that you can't eliminate.  And in your case it sets . you up so that you can't include the improvements on the property in the exchange.  And you've still got to find cash anyway for the acquisition and improvements.  So it really doesn't solve the root problem.

In your case I think your husband is right on the nose.  Do a quick heloc on your house to create liquidity to purchase and place enough construction on the investment portion to satisfy the exchange Remember your target is going to be $350K of reinvestment.  This will roughly equate to 1/3rd of the property plus another $150K of construction.

Or secure a private loan for a short term for acquisition and construction.  Folks get scared of these because their apr and points is so high compared to conventional financing.  But that extra cost is really very little if it's only for a 180 day period.  And if you used the $120K liquid that you have available you're only looking at a relatively small loan.

The other reason I'd recommend staying the course on your current structure is that once your relinquished property sells you can use it for  the construction.  So really you're only looking at a loan for acquisition.  Just remember that you're going to need to be very focused on getting construction done within 180 days of when the Qi takes title to that new property.

Michael Skoczylas · Answer

There are plenty of lenders that will work with Reverse Exchanges- but not all of them will. It may be easier to do a Reverse Exchange where the Relinquished Property is held by the EAT/QI - since the entity borrowing the money will never have a change of control nor will there be a transfer. Particularly since there is no debt on your Relinquished Property - doing a RL Hold Reverse Exchange is definitely a good option for you. Let me know if you have any other questions - or want to understand the mechanics of that RL Hold Reverse Exchange.

Lauren Speidel · Answer

@John Warren - Thanks for the mention.

@Jennifer Stanovich - In regards to using an exchange property for personal use, it is often frowned upon by the IRS. You should have the intent to hold the replacement property for rental use, appreciation, or use in a trade or business. If you are planning on living in a portion of it, then you should not use your exchange funds for the primary portion of the asset.

It is recommended that before you engage in a Reverse Exchange that you, your CPA, your lender, contractor, anyone that is assisting you with the 1031, including your QI, have a phone call to discuss the transaction. That way if any arm of the transaction has questions or concerns, the QI can address them at that time. With that being said, yes you can use out of pocket funds to fund the purchase and improvements. Of course you can take a home equity line out on your current property and pay it back with the funds from the sale of your relinquished. Those funds would be looked at as out of pocket funds. If you don't have the out of pocket funds, I would recommend reaching out to a hard money lender or local bank. The larger banks like Chase and Wells Fargo don't service their own loans so engaging in a transaction like this doesn't fit well with their structure.

Wayne Brooks · Answer

@Dave Foster ??

John Warren · Answer

@Jennifer Stanovich have you reached out to @Lauren Speidel? She has helped three of my clients close 1031 exchanges this year, and is very knowledgeable.

What are my options with this 1031???

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