1031 Exchange Question

[Josh Walker]

I am looking for advice and ideas from those with experience with 1031 exchanges. I have a family member in the process of selling their business and was recently advised to consider a 1031 exchange for the portion of the sell of the business which includes the land and building. They have a good cpa and attorney, but I am more interested in strategies to invest the money with them. For discussion purposes let’s say the total to re-invest is $2M. I build new homes and deal in flips and holds. Any ideas of angles where We could both benefit in this situation? The recommendation of a good real estate cpa and attorney are already being utilized. Just wanting to get other ideas and maybe feedback from any of you who may have already lived through a similar situation. Thanks in advance!

[Dave Foster]

@Josh Walker, it can be difficult to mesh up the gears for a  construction model and an imminent 1031 especially since it's a family member and might be a related party which throws all kinds of obstacles up.

They could 1031 into raw land, lots, or infill/rehab properties that you could then partner up on.  But that will ultimately eliminate the 1031 advantage because as soon as you start selling the completed properties the gain will be recognized.  If the properties will be holds for investment after construction/rehab then you could partner and make it work. 

Perhaps the best way for the two of you to synergize in such a way that it can be sustained over a long period is to keep your two businesses separate initially.  Have them 1031 into a cash flowing asset and use the cash thrown off to invest with you in ongoing projects.  If they put the 1031 into something with predictable passive cash flow net of expenses then you have predictable income with which to leverage your construction business but at the same time they keep their 1031tax deferral intact.

A big key to this would be for them to invest in debt free instruments that qualify for 1031 treatment but minimize risk and concentrate the risk into the endeavor with you.  If they're carrying a loan right now they probably want  to eliminate that in the 1031.

There's a couple of ways to do that.

1. Simply not replace the mortgage in the purchase and take mortgage boot.  They pay tax on that amount but shelter the rest.

2. Since the FF&E (Furnishings fixtures and equipment) and good will cannot be exchanged they will owe tax on that allocation anyway.  But they can take that cash net of taxes and use it to replace the mortgage on the 1031 portion.

3. They can also simply bring in cash from their own reserves to replace any mortgage amount and allow them to complete their 1031 without debt.