My first 1031 exchange - has anyone tried including rehab costs?

[Gordon Starr]

Hi BP!

I have been growing my portfolio of six houses and a duplex by around one house per year and I like to deal in cash with no mortgage. Problem is, I am a bit short on ready cash to continue growing. This forces me to sell (which I didn't really want to do). I have chosen a sell one, buy two strategy where I sell one of the more valuable houses and buy two houses that need rehab or a duplex needing rehab. Because I do most of my own rehabbing, my tax basis in these places is very low, so I am up against a serious tax burden when I sell.

I would love to hear from folks who have experience with the 1031 exchange. I have the sale set with my tenants buying that will net me 37k and want to purchase a duplex needing work for 24k. I could easily use up all the 37k (and maybe more) proceeds in the rehab of the duplex. Most of the info I have read does mention you can include rehab costs in the 1031 exchange. Sounds great, but reading about it and doing it are two different things.. Has anyone tried this? Thanks in advance for your input.

Gordon

[Dave Foster]

@Gordon Starr, the most straight up way to include rehab costs is to perform a variation of the 1031 called an improvement exchange.  Your QI takes title in a stand alone entity called the Exchange Accommodating Title Holder to the new house using proceeds borrowed from your exchange acct.  Then the exchange acct. further funds the improvements so that at the end of the period your new property is legitimately worth the cost of acquisition plus the improvements.  So you can successfully complete your exchange then.

The issue with an improvement exchange is the cost of them when dealing with a small acquisition.  While a regular exchange may cost you $700 or so, an improvement exchange can add 3-5K to that making it cost prohibitive.

Your plan to sell one appreciated and buy two fixers can help mitigate a little.  Throwing a third cheap acquisition into that mix can help further but of course then you'll have to fund the improvements outside the exchange.  

One other option to mitigate would be to purchase for all cash and fund the improvements out of pocket but immediately upon completion throw a mortgage on it and refund your improvement costs or use the improve the second one etc etc.