Can I do 1031 and also have a partner on a deal? Complicated

Question

This maybe a complicated question. I have a house I have owned for over one year and have my eye on a off market triplex. The same seller I purchased a 4 plex from a couple years ago. It is a run down property again and last time I got him to carry the loan for 20 years. This time I want to do a 1031 exchange with the house and trade into the triplex to avoid capital gains, and also have my son go in on this deal 50/50. I could cover the down payment with house proceeds and he can use his cash for extensive rehab costs. One expert told me I could possibly pull this off, but mentioned something about my son being "tenants in common." Does anyone know out there? I meet with the seller this Thursday to discuss options. Thanks for any input out there!

Cheers

Todd Powell

Cheers

Todd Powell

Dave Foster · Answer

@Todd Powell, if the house you are selling is in your name then you must take title to at least an equal amount of real estate also in your name.  So an LLC initially will not work.  The tax payer for the old property must be the tax payer for the new property.

This is where tenants in common comes into play.  tenants in common just means that you own a % of a bigger asset.  You own your house as a single tenant.  Say it's being sold for $200K.  You must take title to at least $200K of real estate to defer the tax in a 1031.  That could be another house for at least $200K - or it could be 50% of a property that is being purchased for $400K.  You son could take title to the remaining 50% and you would both be tenants in common.  That's both very common and absolutely allowed under 1031.

Once you complete your 1031 then you can work with your accountant to contribute the property into an LLC entity if you wish to own ongoing.

Todd Powell · Answer

@Dave Foster Using the same numbers in this scenario, can I sell the house for $200K and buy the new one for $300K and keep the same names (myself and wife), and keep that clean for the 1031, but later on handle the deal with cash with my son paying me back to make the 50/50 work by having him pay for all the repairs? In essence, we can internally make the numbers work for the even deal and keep the 1031 accurate for IRS? In other words, I close the deal cleaning with $200 price ($60,000 cash down equity as I owe $140K), and then my son pay the $60,000 in repairs. Or, if repairs exceed the equal $60K, I can match him dollar for dollar for whatever amount exceeds that?

I see your point and probably need to ask my accountant but wanted to clarify what your knowledge was here. I am guessing this "tenants in common" is a legal entity so our taxes all make sense? Sorry if I am confusing here, but this is a real deal possibly.

And, if I do a 1031 exchange, down the line this can be refinanced correct? I have done countless flips and buy and holds, but NEVER a 1031. Another way of doing this, is me just fixing the house and retailing it and then having to pay the taxes on the long term gain, which my cost basis is $150,000. I just wanted one time me to avoid paying taxes like I have many times before, and use the governments money to buy into the triplex.

Dave Foster · Answer

@Todd Powell,  Tenants in common isn't really an entity so much as it is just a way to own a  piece (or part of a piece) of real estate.  If you own the whole thing you are the sole tenant.  If you and your wife own it it is probably deeded as "Joint tenants".  If you and an unrelated party own it  then you are probably each deeded part of the property as "tenants in common".

I think you're heading down the right track for simplicity.  Sell as yourself (you and your wife) and buy as yourself.  Then after the purchase is complete form an entity like an LLC and you contribute the property in exchange for membership interest and your son contributes cash for improvements in exchange for membership interest.  Work out the capital accounts and membership interest with your accountant and you'll be good.

You can always refinance a property after a 1031 at any point in time.  That's what I think makes this strategy particularly elegant to use with a 1031.  You sell an appreciated asset and 1031 into an asset that needs value add.  Once you get it stabilized and improved you can then refi and pull out your cash as either a way to get profit out tax free or to reinvest in the next property.

Dave Foster · Answer

@Todd Powell, you're selling for $200K so you need to buy $200K in investment real estate.  If the triplex is for sale for $300K then you could take title to 2/3rds of it to satisfy the 1031 requirements and your son could take title to /3rd of.  So you're pretty close to making that work.

You can't go it 50-50 because 50% of the triplex is only $150K and you're selling for $200K so you have to take title to $200K of real estate in order to avoid all tax.  But you and your son can adjust the tenancy however you want after the 1031 is over as appropriate.  Just make sure and get your accountants blessing so you do it in such as way it doesn't trigger a recognition of gain.

Ann Zane · Answer

@Paul Moore and @Dave Foster- thank you so very much!  Both sets of insight are very helpful!

Paul Moore · Answer

Hi @Ann Zane.  Until we hear from the pros like @Dave Foster, I will try to weigh in on part of your question.  I think the owner's name on the relinquished property must be exactly the same on the new property. And I think it must be a TIC to make this work. I'm not sure how the lender will respond to that. The TIC structure may matter.

As far as consolidating your ownership under your LLC, I personally believe that should work at a later date.   Good luck on this!

Ann Zane · Answer

@Dave Foster  Hi Dave and Todd- reading this as I have a similar situation but am not 100% following.  Here is my situation.  My fiancé is doing a 1031 for $164K.  We are turning around and using that to purchase two homes with a partner that total $237K.  The partnership agreement is that we have 60% and the partner has 40%.  Right now our lender is coming up tight on the deadline getting everything finished with the loan under my fiancé's name.

My questions:

Do we need to take this as "tenants in common" with our partner, and if yes, will that cause an issue with the lender and the work he has done to-date?  Given all the issues we've already had I don't want to do something that would impact the lending process.

I have an LLC that I hold all my rental properties in.  Once married sometime in January (thank you Covid for that delay) we will want to add his properties, including these two, into that LLC.  Does that change what we need to do now in terms of how we close this deal?

Thank you in advance!

Ann Zane · Answer

@Todd Powell.  I forgot to tag you!  And I would love to hear what you did and how it turned out!

Todd Powell · Answer

@Dave Foster Thank you for breaking down the complexities of this for me. This is truly one bridge I have never crossed before and this will myself and @Jason Powell

In appreciation and Respectfully,

Todd Powell

Todd Powell · Answer

@Dave Foster thank you for your insightful input. Ironically, I think the said house would be worth around $200,000 in its condition. We paid $150,000 with owner carry with $10k down. I am guessing the triplex in its run down condition is worth around $300,000 so can I close just in my name, and put down the $60,000 of house equity and then have my son go in this deal and pay for $60,000 in rehab costs? Is this possible with the “tenants in common.”  It may take $80,000 of rehab to be honest, so can we each pay the extra $20k out of pocket or $10,000 each to keep it 50/50?

I hope this makes sense and again thank you for your professional opinion and this will help @Jason Powell and myslef moving forward. I am meeting with the seller this week and the last deal I purchased from him he did owner carry so I am trying to keep my options open. My goal is to just use my house equity for half of this new deal. Thank you !

Can I do 1031 and also have a partner on a deal? Complicated

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