Calling all 1031 Exchange experts - Off standard question

[Brandon Hartman]

As part of my partner and I's year two growth strategy, we will each be purchasing a duplex with an FHA loan that we plan to separately house hack for two years (me with my girlfriend, he with his current roommate). After occupying them for 2+ years we will then be looking to 1031 exchange them both to size up under our LLC. While living in them we will be pooling capital together, equal contribution, to perform a live-in rehab to both properties to force appreciation over the two years we occupy the properties.

Disclaimer:  I have a very beginners level understanding of all of the principles being discussed and will be covering all of this this with my CPA and attorney in the future, but I first wanted to educate myself with the help of the experts of BP in advance.

My question is, what is the best path to get these properties from our individual names and into the LLC when we 1031 the two properties to size up into the new property/properties? Could we each get an FHA loan under our LLC/Partnership and sign as a personal guarantor; he as a personal guarantor on his duplex and me on mine, so that for tax purposes when we go to exchange we aren't transferring the taxable owner and nullifying the opportunity to 1031 exchange it? Is that even possible/qualifying? If yes, I guess my next question would be will we be able to obtain a FHA loan under the LLC by signing as a single personal guarantor on the loan?

Thanks in advance for any and all help, and please let me know if I was unclear in any way (I know this is a bit of an oddball question).

[Dave Foster]

@Brandon Hartman

@Wayne Brooks is right.  Once you cut through the particulars your situation can actually be simpler and more advantageous than you are perceiving now.

When each of you buy your duplexes you will be using them for two purposes - primary residence and investment purposes.  For simplicity let's assume that all 4 units are of equal size so that each of you are living in 50% and renting 50% of each.

When you sell you will want to use two opportunities available to you.   First you will each use the sec 121 primary residence exclusion to exempt 50% of the gain tax free up to $250,000.  You can do this because you have lived in 50% of the property foe 2 of the previous 5 year period.  This money is yours to use however you want.

Secondly you will each want to do a 1031 exchange on the other 50% of the sale and defer that tax into a new investment property.  What you actually do is to do a 1031 exchange and take 50% of the profit as boot and then report the 121 exemption but that's just a tax reporting nuance.  The reality is that you will get 50% tax free and do a 1031 on the other half.

So what can you do at that point?  Again assuming for simplicity that each of your duplexes were identical and sold for the same amount say 200K then you would take 100K as the primary residence exemption and 1031 the other 100K  If you want to combine it with your partner then you would buy a property or properties worth at least $200K (your 100 and his 100).  You don't have to combine with your partner but you can.  Each of you has your own stand alone 1031.  

If the two of you do work together to 1031 both your duplexes into a new bigger investment property then each of you would be buying 50% of the property in your own names (title on your new property has to be the same as on your old property). You could leave this property in each of your names as tennants in common. Or you could contribute the property into a new LLC after the fact and allocate the membership interests appropriately. Once you do that then any future 1031 will need to be done by the LLC that now owns the property. So financing may become an issue.

The bottom line for you is that when you talk to your cpa and attorney you'll want to discuss combining a 1031 exchange with a sec 121 primary residence exclusion.  It'll be the best of both worlds for you.