How to take advantage of 1031 for unfinished basement?

Question

My father recently sold an investment rental and is looking to reinvest the money under 1031. It happens to be that my wife and I recently bought a single family house (primary residence) in California with a ~1,000 sqft unfinished basement. The property is zoned for mixed use (i.e. converting the basement to make the property a duplex or creating an ADU are both eligible under zoning guidelines). My father and I are wondering the most effective way to transfer or sell the unfinished basement to him, so he can reinvest his capital to finish the basement and rent the property. Any ideas or suggestions on how to best take advantage of 1031 in this case?

Dave Foster · Answer

@Udit S., There are quite a few issues here. Related party issues - you would have to sell your basement to him. But the improvements would have to be done before he takes title to it.

He's got issues buying from a related party to complete his 1031. The IRS is suspicious of buying from related parties.

But really it's the sale of a basement. I spose you could convert it into a duplex. But you'd better be sure that a ground floor/basement duplex is a good candidate to then split legally. Lots of legal fees and logistical questions.

Bill B. · Answer

As long as you don’t own the home you might have a chance. You are a prohibited party to your father in a 1031. (He also couldn’t own the home obviously.)

I THINK your wife could sell a property to him if you’re not on the property. But you’ll need a 1031 expert to weigh in on if the funds can be used for improvements (I don’t think so) so she might have to sell the home to him rather than he just fixes it up. Otherwise you’d probably have to separate it in to 2 units liek an apartment or condo and sell him the basement if your local code allows? @Dave Foster ?

Wayne Brooks · Answer

@Udit Sekhri The main issue issue is that he’d have to Buy a property....and you can’t sell just your basement. Trying to make it a duplex wouldn’t help either...it would have to be a separately deeded property, in order to sell it.

Christopher Phillips · Answer

You're still going to have a problem because it's immediate family. It's not impossible, but the IRS generally frowns on such transactions.

Christopher Phillips · Answer

Okay. You said he already sold it…

Bill B. · Answer

I THINK your wife could sell to him, if she owned it exclusively. I don’t think father in laws are prohibited. But that’s defiantly something to be checked on.

The improvement 1031’s are also a different beast. That involves your father buying a property through a QI (with separate money) and paying for the improvements on that new to him property. And then doing the exchange to get his funds back from the QI which has to set up an account/company to own it in until the exchange. Again. There we at least a few VERY helpful QI’s on BP reach out to them. Click on the magnifying glass in the upper right if no one has chimed in with a day or two.

Udit S. · Answer

Thanks @Bill Brandt. We do own the property. So if we were able to make the property into a duplex and one of the units to my father, he still wouldn’t be able to use 1031 to purchase the property? I believe there is a way to take advantage of 1031 via improvement exchange. Unclear about the details / how it works.

Udit S. · Answer

@Christopher Phillips - He has not received the funds. We are in the planning stages on to how best handle the sale, timing, and reinvestment strategy. Any advice would be welcome!

Christopher Phillips · Answer

@Udit Sekhri

If your father already received the funds from the investment sale then he can't do a 1031.

How to take advantage of 1031 for unfinished basement?

How to take advantage of 1031 for unfinished basement?

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