1031 vs Self directed IRA

[Prithvi Sri]

I signed A contract to purchase a home about a year ago for 380 K. I’m going to take position in a months time. The house is now worth about 600 K. Looking at all the comps and history off the prices here in Phoenix metro area, I am almost certain that this price is not sustainable. So I want to sell it and cash in the profit. I also have a contract on a property in Peoria (replacement property) for around 580 K. I will be getting possession of the property in about six months. 

With this context, I have three choices to make:

1. Buy the property for 380 K and immediately sell it for 600 K pay the taxes on the profit and Collett a day. This offers no tax benefits and is probably the worst option so, I’m not considering this unless someone can show me it is.

2. Use the money I have in one of the IRAs to open up a self-directed IRA, have the self directed IRA purchase the property and immediately seller the property tax free, the. move the money back into the original IRA, close the self directed IRA.

3. Buy the property normally, do a 1031 exchange with the replacement property I am buying in Peoria and move forward the profits into the new property. 

Option #2 seems clean for me. I move all the profits into my IRA tax free and have no worry about the future legislation around 1031whether they keep it or not. The concern is, whether IRS agrees with the acquisition cost since I wrote the contract a year ago and the fair market value as of today is more like 600k.

Option #3 allows me to move the profit into another house, but still runs the risk of questioning by IRS whether the subject property is eligible for 1031 since I never rented it, even though my intent from day one is to rent (I have another property that I bought in the same neighborhood and rented it already to prove my intent is serious. I also don’t live in the state). 

I would really appreciate if someone can suggest which of these options I should pick and why. I’d also appreciate if you can highlight any tax implications that I’m failing to identify.

thank you in advance. 

[Bill Exeter]

#1 - I agree with Scott above.  This would be taxed at your ordinary income tax rate, so make sure you know what the final damages would be.  Other loss items on your tax return might be able to offset the gain.  

#2 - This is likely a prohibited transaction. I'm guessing the contract you signed one year ago was under your individual name, so assigning the contract from you personally to your Self-Directed IRA would be a self-dealing transaction (prohibited transaction). This would have worked had the initial contract been executed in the name of your Self-Directed IRA and signed by the IRA Custodian.

#3 - You must have the intent to hold the property for rental, investment or business use.  The initial intent for this property sounds like it is to buy and sell and not rent.  Buying the property and then immediately selling through a 1031 Exchange would likely be disqualified because your intent is to buy and sell and not buy and hold for investment purposes.  It does not matter that the replacement property would be held for rental (it might help), but the initial intent for the relinquished property is/was still held for sale.