1031 Exchange: 2 Questions

[Michael Kiley]

I've decided to come out of my comfort zone in 2020 and exchange one of my SFH rentals for my first apartment building. The house is worth 85k and currently has no mortgage. 2 questions regarding 1031 Exchanges...

1. If there was a mortgage on the house when I sold it, would I be required to use less capital to purchase the apartment building? I'm aware that the purchase price needs to be the same or higher than the house I'm selling to defer 100% of the gain.

2. To get around the 45 days to locate the apartment after selling my house, is it possible to buy an apartment in my name, then sell my house, then use my LLC (house is held in LLC) to buy the apartment? (Hope this makes sense)

Thanks in advance!

[Dave Foster]

@Michael Kiley, Reinvestment requirements nailed by @Bill B.. Think of it like a two part rule.  Purchase at least as much as you sell.  And use all of the proceeds.  So the less the debt on the old property the more proceeds you have to use as a down payment.  The IRS does not care where the rest of the money comes from.  So if your proceeds are not enough for a down payment you an bring in other money from any source.  Just purchase at least as much as you sell and use all of the proceeds and you'll defer all tax.

What you are required to reinvest is not just the gain.  The mechanism of the 1031 exchange is that you leave your profit in the next purchase.  And you do that by carrying your basis forward in the new property.  Then you must purchase at least as much as you sell. This is what carries the profit forward also.  If you purchase less than you sold or if you take cash out the IRS says that you are taking profit so you can still do the exchange but you'll pay tax on the difference.

You cannot take title to your new property before closing the sale of your old property.  A reverse exchange let's you control your new property.  But the qualified intermediary for the 1031 must take title.  If you try to DIY and purchase it yourself either in the same name as your 1031 property or in a different entity you will be in violation of the Reverse exchange procedure.  But yes you could do a reverse exchange to avoid the 45 day crunch.   As @Bill B. said it's more expensive so your gain has to justify it.  For the average reverse exchange it takes around $40K - $50K of profit to justify the expense of the reverse.

Great plan to use the 1031 to ratchet up your portfolio!