Converting a 4 Suite Office Building into Commercial Condos

[Melissa Kirk]

I'm considering purchasing a commercial office building that has 4 suites.  My own business currently leases one of the spaces.  I would like to then convert it into a commercial condo. I know I would need to establish an association with declaration, condo docs and such, get city approval and have a surveyor involved.  Once everything is completely set up, I would be interested in selling two of the suites, while keeping the other two. One to continue my business out of, and the other to retain for cash flow. 

Here are the numbers:  Purchase price to be between $500,000-$530,000.  I would make the purchase with a 1031 exchange, putting approx. $220,000 down, financing 8% on 20 years, payment of $2,593.  The building currently produces $5,300 a month gross and is fully leased. 

Does anyone have experience doing this?  I'm curious how capital gains would work with having rolled in a previous gain and then selling two suites while keeping the other two.  

If it matters to the conversation: I'm planning to sell my STR in Wisconsin Dells soon and roll that gain into this commercial building. Thank you to anyone who takes the time to respond.

[Ty Coutts]

Hello, Melissa Kirk, here are my considerations. 

Legal and Regulatory Steps:

Establish an Association: You'll need to create a condominium association and draft the necessary declaration and bylaws (condo docs).

City Approval: Obtain the necessary approvals from the local government or zoning board. This can involve public hearings and meeting specific requirements.

Surveyor: Hire a surveyor to map the property and define the boundaries of each condo unit.

Legal Counsel: Work with a real estate attorney to ensure all legal requirements are met and the condo conversion is properly documented.

Financial and Operational Considerations:

Condo Fees: Determine the monthly condo fees for maintenance, repairs, and other communal expenses.

Insurance: Ensure proper insurance coverage for the condo association and individual units.

Reserve Fund: Establish a reserve fund for future repairs and maintenance.

Tax Considerations:

Initial Purchase with 1031 Exchange: 1031 Exchange Basics: By using a 1031 exchange, you defer capital gains taxes on the sale of your previous property by reinvesting the proceeds into a new like-kind property.

Down Payment and Financing: You're putting down $220,000 and financing the remainder at 8% over 20 years, resulting in a monthly payment of $2,593.
Converting to Condos and Selling Units:

Capital Gains Deferral: The 1031 exchange allows you to defer capital gains on the initial exchange. However, when you sell the individual condo units, capital gains tax will be triggered on the gains attributable to those sales.

Allocation of Basis: The original purchase price and any improvements made should be allocated among the individual condo units to determine the basis for each unit.
Gains Calculation: When selling a unit, the gain is calculated based on the difference between the allocated basis and the sale price of that unit.

Partial 1031 Exchange: You may be able to use another 1031 exchange to defer gains on the sale of individual units if you reinvest the proceeds into other like-kind properties. However, this requires careful planning and adherence to 1031 rules.
Holding and Renting Units:

Retained Units: For the units you retain (one for your business and one for rental income), you will continue to benefit from rental income and potential appreciation.

Depreciation: You can continue to depreciate the retained units, which provides additional tax benefits by offsetting rental income.

With these considerations, this approach allows you to leverage the benefits of a 1031 exchange while maximizing the potential of your investment in the commercial property. Hope this finds you well!

[Thai Chau]

On the surveying side, my company can help. We produce architectural as-built floor plans and packages, which you’ll need to kick start this entire process. You’ll then have the ability to produce LOD’s and a myriad of other drawings to get this approved by each jurisdiction and department.  Keep in mind this is not land surveying, to determine property lines and easements.

Wishing you the best of luck with this project.