1031 Exchange into Mixed-Use Property?

[Tim Turner]

We will receive a net gain of $250,000 from the sale of a relinquished investment property and the funds will be held by a QI. We want to purchase a mixed-use replacement property for $750,000--a home with a detached apartment to rent out alongside a primary residence we'll move into as owners. The value of the replacement property is apportioned using a ratio of 66% residential to 33% investment—or $500,000 residential value to $250,000 investment value. Can we finance the purchase of the replacement property using the $250,000 in exchange funds as the down payment for the loan on the new property? Does this satisfy the requirement that the investment portion of the property (33% or $250,000) be paid for with exchange funds while the residential portion of the property (66% or $500,000) be paid for with only non-exchange funds—in this case, the funds borrowed from the lender? (I've set aside closing costs for the moment--let's say that the seller of the replacement property has agreed to pay all closing costs).

[Dave Foster]

@Tim Turner, In a mixed use situation like you are describing it is helpful to think of it as two different properties - one is your primary and one is investment.  You've done some great calculations to determine the % allotment.  And as long as the investment allocation meets your reinvestment target you will complete a successful 1031.  

But there's a couple potential issues here

1. The requirement to defer all tax is that you purchase at least as much replacement investment real estate as your net sale.  And that you use all of the proceeds from the sale to accomplish that.  

     a. This means that you can indeed use your proceeds as a down payment on the entire property as long as the investment allocation is at least equal to your net sale.

.    b. But I'm concerned because you use the word "gain" of $250K.  In your scenario the investment portion equals this number nicely.  But if your sale was actually for more then you may have a valuation problem.  Because the purchase requirement to meet to defer all tax is your net sale.  Not just the gain.  

So that could be a potential issue.  But your premise is solid and doable.