1031 exchange when I want to buy new 10 weeks before selling?

Question

Hi BP, I need some help. I am looking to buy a new property as a primary residence and to house hack the property.

Here is the info on the new property: it’s a 3 bed, 2 Bath SFH listed for 240k. It also has 1bed 1 bath mother in law suite in the backyard that would rent for $1,000 a month once fixed up. It would take roughly 10 weeks and 60k to fix up the entire property.

I have about 30k that I could obtain once I sell my current home and an additional 10k saved up to put into the new home purchase. I was hoping to do a 1031 exchange to avoid capital gains tax and put it into the new property. However, my spouse is not willing to live in a work site for the 10 weeks during the renovation. (So I would need to buy the new property before I sell the current one).

Is there anyway I could purchase the new property now, do the renovations, then sell my current home after the renovations are done on the new home, put all of the gains towards my new property and not have to pay capital gains tax?

Any advice would be greatly appreciated!

Wayne Brooks · Answer

@Seth O.

Sounds like no reason to......

1) a 1031 is Not available for a primary residence, neither the one being sold nor the one being bought.

2) irs section 121....if it is your primary residence you are selling and you’ve lived in for at least 2 years, the profit is exempt (up to $250k filing single, $500k filing jointly) with no need to buy a replacement primary residence.  If you owned it as rental before being your primary, the gain is prorated and some is taxable.

Lynn McGeein · Answer

My daughter and son-in-law just did this -- purchased their new home, started renovations, then sold their old primary residence a month later once they reached the 2-year mark there, and now are using the whole amount, tax exempt due to 2-year rule -- to finish renovations.  They did, however, need the 20% down payment up front for the purchase, which they had in savings and borrowed from her 401k, which doesn't count toward debt-to-income ratio.  Both house payments were considered for the debt-to-income ratio, so loan approval was a razor-thin margin, hence the need for the 20% down, avoiding additional mortgage insurance.

Would your wife consider you fixing up the mother-in-law suite in the backyard first, then putting your primary on the market, moving into the suite once your home is sold, then the main house once it's complete?  Then she wouldn't have to live inside the work zone, just adjacent to it for a short period, and you'd then have the tax-free money from your old primary to complete your project, and a rent-ready apartment making money for you as soon as you move into the main house.  Doesn't work if you haven't been at your current primary for over 2 years, though.

Matt Devincenzo · Answer

@Seth O. just to clarify the 'waiting for the 2 year' requirement. The 2 year is owned and used as a primary. It sounds like @Lynn M. scenario was a good example of this, buy the new primary 1-2 months prior and start work while still living there and then sell after the 2 year mark. If you were buy say 4 months prior to that date and move out to start reno for 10 weeks then close 6 weeks later in order to hit the 2 year it doesn't sound like that wouldn't pass the sniff test, though you may successfully do it and not have the IRS question the time frame.

IRS guidelines for the ownership and use test are here so you can read them for yourself to see how they determine what qualifies.

Seth O. · Answer

@Matt Devincenzo thanks for the clarification! I appreciate it!

Seth O. · Answer

@David Roe thanks so much! I’m going to talk with a few lenders about getting the renovation loans as well!

David Roe · Answer

Do a construction loan on the new purchase;

Under a construction-to-permanent loan, you borrow money to pay for the construction costs of building your home. Once the house is complete and you move in, the loan is converted into a permanent mortgage.

Because this format is basically a two-in-one loan, you have only one set of closing costs to pay, reducing the number of fees you owe.

During the construction of your house, you pay interest only on the outstanding balance; you don’t have to worry about paying down the principal yet. Typically, you’ll have a variable interest rate during the construction phase, so the rate and your payment can fluctuate.

Once it becomes a permanent mortgage — with a loan term of 15 to 30 years — then you’ll make payments that cover both interest and the principal. At that time, you can opt for a fixed-rate or variable-rate mortgage.

Also check with your bank, USAA allowed us to purchase our new home before selling the old property, i was not able to use the equity but they still alowed us to close.  If you have the cash in a 401k pull it out as a loan, purchase the new place then when your old home sells pay it back.

Hard money lender can also help, do a hard money loan to purchase and do a BRRRR but instead of renting you live in it.

Ask the seller if you can do a Owner Finace deal or Option2  etc.....

MB keep your current home as a rental.... Why not?

Seth O. · Answer

@Lynn M. Love this idea! Thank you very much. We have not been in our current location for 2 years yet, but I think we could hold both until we are at the 2 year mark, and then sell.

The guest house would be much quicker to fix up, so that could be a great option, so that we can get our current home on the market quickly!

Seth O. · Answer

@Wayne Brooks that makes sense, thanks for your reply, very helpful!

Seth O. · Answer

Thanks for your response @Ryan Ingram. I’ll check him out!

Ryan Ingram · Answer

Hey Seth,

I think that is a great question. I wish I could help...but, I do know Phillip Weickert. He is another fellow Ohioan and he is a wizard at this stuff.

https://www.biggerpockets.com/users/FarmerPhil#0

1031 exchange when I want to buy new 10 weeks before selling?

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