1031 Exchange into a different classification?

Question

Hey BP geniuses!   This is likely a simple answer, but I just don't know it yet.  I'm wondering if the 1031 exchange gods and/or goddesses of the universe allow us to sell a SFH (with a garage apartment, but zoned R1) and 1031 our profits into a multifamily (either less than 4 units, or greater than 4 units).   Please enlighten me!

Janet Davis · Answer

Randy, you can set up a 1031 exchange for any type of business or investment use property.  So if the SFH is a rental and not something you use personally, then you can exchange it for a multifamily property.

Dave Foster · Answer

@Peter Morgan and @Randy Stark, I'll go along with the hijacking :). Peter, what you have when you own a property like yours is a split or mixed use property.  You want to actually think of it as two different properties - one is an investment property that is eligible for 1031 treatment.  The other is your primary residence which you may be able to sell and take the first $250K of profit ($500K if married) tax free.  If you've lived in that property for 2 out of the 5 years prior to sale and haven't claimed that exemption within the last two years then you would qualify.

So think about that - You get some money tax free and the rest you 1031 into new investment property and the profit on that is indefinitely tax deferred!!!

So just some of the options

1. Sell the duplex and use the 1031 to purchase a property that is double the amount that you sold.  In order to defer all tax you must purchase at least as much as you sell.  So if you bought twice as much you use one unit for investment to satisfy the 1031.  And the other unit you can again move into.  All the while pocketing the cash from the primary residence side tax free and doing anything you want with it.

2. Sell and do the 1031 to purchase another investment property or two.  Use the primary residence money - tax free to purchase a new SF primary residence

3. sell and do the 1031 to purchase a really nice single family residence as an investment.  Use a bit of your tax free cash to go on an extended vacation working from your RV or rent a place for a year or so.  Once you've used the SFR long enough to establish your investment intent you then pull your RV up to the driveway, move in and convert it into your new primary residence.  Again all of the tax free portion from your primary is for you to use however you want.  And converting a property from investment to your primary does not create a taxable event.

House hacking like this is the holy grail of good things for you.

Bill Exeter · Answer

Hi @Randy Stark,

Yes, you can sell any type of real estate and exchange into any type of real estate as long as the real property is held for some type of rental, investment or business use.  Like-kind simply means you must exchange real estate for real estate.  It does not mean SFR for SFR or MF for MF.  It is a very broad definition.

The Qualified Intermediary does not need to be in the state where the investor or the properties are located.  It is merely a personal preference.

@Zachary Beach,

California has always taken the position that if you sell California real estate and 1031 Exchange into replacement property located outside of California you will owe California state tax when/if you sell the property and cash out/pay the tax.  A relatively new reporting requirement was enacted effective January 1, 2013 that requires an investor that has completed a 1031 Exchange into out of state property to report the status of that property (or any subsequent property that they 1031 Exchange into) to the California Franchise Tax Board.  However, as long as you keep deferring the tax through a 1031 Exchange or other tax strategy, or you hold the property until you pass and your heirs receive a step-up in cost basis, California will never get their tax.

@Ross Asher,

Yes, you can sell one relinquished property and 1031 Exchange into multiple replacement properties.  You can also sell multiple relinquished properties and 1031 Exchange into one replacement property.  The 1031 Exchange is a great way to diversify, consolidate or reposition your real estate portfolio without incurring taxes.

@Peter Morgan,

Yes, the duplex is considered split use.  The taxable gain would be allocated between the primary residence and rental property portions generally via square footage.  The taxable gain allocated to the primary residence would be tax free up to $250,000 if you are single or $500,000 if you are married and have owned and lived in the property as your primary residence for at least 2 out of the last 5 years.  The taxable gain allocated to the rental property potion would qualify for 1031 Exchange treatment.

Randy Stark · Answer

Hey @Peter Morgan , I don't consider that hijacking :)

It's fun to learn and explore all of the ins and outs of this 1031 thing.

In your situation with the owner occupied duplex, would you also have the opportunity to take advantage of the primary residence tax exemption, rather than delaying taxes with a 1031?  I believe if you sell a primary residence in which you have lived 2 of the past 5 years (and owned for at least 2 years),  you are not taxed on the gains.  But you may still be on the hook for half of the duplex (so half of the gains?)....and whatever depreciation you have claimed on the rental side since owning it.    Any CPAs who want to chime in on that?

Dave Foster · Answer

@Randy Stark, Your potential move is fine.  Any type of investment real estate for any other type.  That's one of the strategic superpowers of the 1031 - your ability to shift type and location to meet your investing goals.  And since 1031 is a federal statute it is practiced the same in all states.  And so many exchanges start in one state and end in another these days that any good QI with a good national footprint should be able to serve you fine.  State by state nuances like the claw back in CA and PA not recognizing 1031 at the state level are all things you can hope your QI knows but your accountant filing taxes in that state is going to be instrumental as well.

Sean Ross · Answer

@Janet Davis is 100% correct. @Randy Stark you can 1031X from any property held "for investment or use in a trade or business" into any other property held "for investment or use in a trade or business". Does not matter if it is Single Family, Multi Family, residential, commercial, etc.

The IRS is very liberal with their definition of "like-kind"

Just make sure you keep an eye on the other major 1031 rules:

• Reinvest into a property of equal/greater value and equity
• Keep the same taxpayer on both ends of the 1031X
• Identify within 45 days of your sale
• Close within 180 days of your sale
• Use a qualified intermediary

Zachary Beach · Answer

@Dave Foster would you mind sharing what you mean by the claw back in California? Is that true for 1031 exchange in state or only if you are  goings to a different state? What kind of tax/ penalty would there be? Thanks

Sean Ross · Answer

@Ross Asher, Dave and Bill have you covered here.  Yes, you can trade out of one property, multiple, or fractional and trade into one property, multiple, or fractional.

(Great name, by the way)

Peter Morgan · Answer

@Randy Stark

Thank you!!

Peter Morgan · Answer

@Randy Stark

Sorry to hijack the thread and I just have a vice-versa question, let’s say if I own a duplex multifamily home with one unit rented and another one unit owner occupied , is it possible to do a 1031 exchange and buy a SFH while still optimally reaping the tax saving benefits?

1031 Exchange into a different classification?

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