Using 1031 Exchange from Wholesaling to Buy Rentals?

Question

I have begun gaining some traction getting deals under contract and have started accumulating a small buyers list. I don't want to be wholesaling long term though. I want to be developing my rental portfolio for long term wealth building.

I do use the term wholesaling kind of loosely here, as I have purchased the properties using my own cash, and then are proceeding to sell them to other buyers. I haven't gotten one "wholesaled" yet.

Since I am using my own cash to purchase, and then sell, I am thinking that doing a 1031 exchange, and then purchasing rental units with the tax deferred money might be a good idea.

I am only somewhat familiar with how a 1031 exchange works, but know that it provides benefits for people who are trying to move one asset into a similar asset without having to pay capital gains tax.

Has anyone out there done this kind of thing before and have any insights? Can you think of any reasons why I shouldn't do this?

Dave Foster · Answer

@Melanie Hartmann and @Nathaniel Hovsepian, There is no statutory holding period that qualifies a property for a 1031 exchange.  It is your intent and how you can demonstrate that intent.

If you buy a property primarily to resell (sort of like you're doing or as a traditional fix n flip) then you cannot do a 1031.  Your intent must have been to hold for productive use.

Most folks feel comfortable at anything more than a year.  But there could always be situations where a hold time of less than (or more than) a year would be appropriate.

Things that demonstrate your intent are unsolicited offers to purchase it from you, actually putting a rentor in and treating it like a buy and hold, communicating with your professionals, listing it for rent, actual rent production, your past practice, etc etc.  Every case is different.  You just have to use the mirror test - look in a mirror and if you can say you were intending to hold the property with a straight face then you've got a good case.

The 1031 is incredibly powerful as @Frank Chin said.  And it's interesting Nathaniel that you're already well down the road to becoming a savvy 1031 investor.  Just put the brakes on some of those resales.  Use the Brrrr method on the first ones.  And before you know it you'll be building wealth from rental income, equity by acquisition, and making money off the deferred tax.

Melanie, keep looking dere be a whole heap of folks who've never paid a penny in capital gains tax.  Here's a BP blog we wrote on some of the exit strategies - https://www.biggerpockets.com/blog/1031-exchange-files-3-buy-hold-exit-strategies

Frank Chin · Answer

With 1031 exchanges, you'll have to hold it as a rental, and then take the entire proceeds, and 1031 it into something larger. You cannot touch the proceeds, must be done thru a QI, (Qualified Intermediary) There's a few on this site, like @Dave Foster

You can go on forever like this, 1031 into a replacement property, or several replacement properties. Then you can sell the replacement, 1031 into a third generation, 4th generation and so forth. If you 1031 into something smaller, you'll pay capital gains on the difference.

It's a long term game, and if you hold these things to your death, with the stepped up bases, there's no cap gains for your heirs. If you get tired of doing rentals in between, you can 1031 into DST's, in short, managed rentals that guarantees certain returns. See DST

Yes, there's a few rules you got to follow, but if you know them, or utilize a knowlegible QI, it ca be very financially rewarding.

Frank Chin · Answer

In order to qualify for a 1031, you must have held the property as a rental for a period of time, preferably at least 18 months, or about two years to be safe. Without going further, it does not seem that you met this requirement. Sounds more like you're doing a flip.

Melanie Hartmann · Answer

Much better to walk away from a bad deal than potentially being stuck with one. Ask me how I know. Hahaha!

I look forward to hearing about the next one you do purchase and how all the numbers shake out. I watched a webinar on buying multifamily houses and how to add value and utilize the 1031 exchange. It reignited the fire for sure! One day...

Nathaniel Hovsepian · Answer

Hey @Melanie Hartmann Buy and Holds is where it's at!

I haven't found one yet to BRRRR, but getting that cash flow coming in. Set out to get 2 rentals that cash flow $200 per month with an annual 10% ROI by April 3rd. I am closing on my first Jan 28th!

Nathaniel Hovsepian · Answer

@Dave Foster That Uncle Sam has got me comin and goin

Melanie Hartmann · Answer

Hey Nate! I don't know much about the 1031 exchange yet myself so very much looking forward to the insight provided by those more familiar.

I do know that capital gains tax is only deferred through a 1031 exchange so eventually it will have to be paid. What that looks like, when, and how I am not sure.

Nathaniel Hovsepian · Answer

@Melanie Hartmann we are going to get some solid rentals going and then about 5 years from now we will 1031 them into a huge apartment complex and retire! You in?

Nathaniel Hovsepian · Answer

@Melanie Hartmann the case study has been closed. We had to back out of the deal due to some repairs that the inspector uncovered that I did not notice. It had a foundation concern, and at the very top of the roof, that I couldn't see, the shingles were all jacked up and it was recommended to go ahead and replace the whole roof.

The seller was selling the property to me as is because we were pretty far under their "asking price". Oh well, on to the next one. I still plan on getting 2 by April 3rd!

Melanie Hartmann · Answer

This is very exciting! I can't wait to be in your shoes!! Keep us updated on the numbers and how things turn out. I'd love to learn from the case study if you decide to create one for this property.

Using 1031 Exchange from Wholesaling to Buy Rentals?

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