Flip, refi, lease option, then 1031 exchange

[Cha Yang]

Hello BP,

I did some research and couldn't find if this has been tried before. I have my first flip under contract but I wanted to run this strategy (I thought of last night) by the BP community to see if anyone has tried it before, or if it is even possible. Here is the situation, I am flipping a property under my llc but I also want to take the equity out so I can pay back my investors and avoid a big tax bill. Then once I refi, I would do a lease option on the property for 3 years, then 1031 exchange if the tenant actually bought the property and pay off the refi. In my head it sounds like it would work, but I would like to know what others have tried.

Thanks,

David

[Dave Foster]

@Cha Yang, Break it down into steps and it's not so bad.  But at each step there's going to be pitfalls to look out for.

1.  Your first flip - You want to be very careful.  If you are buying the property with the primary intent to resell it then you make it ineligible for the 1031 exchange.  Using the terminology "flip" is misleading and could get you in trouble.  But what I read was that you were purchasing your first investment property and you will be renting it and holding on to it for a while.   So far so good.

2. Refi to pay back investors and eliminate tax bill - That's a great plan to pay back investors with refi money.  But it does not alleviate any tax burden.  Gain is not calculated on the amount of equity.  It is a calculation of the selling price of the property minus what you paid for it and what you spent in improvements plus the depreciation you have taken.  So just owing a lot of money doesn't decrease taxes.  And if you're going the 1031 route you will defer the taxes anyway when you sell and perform the 1031.

3.  Do a lease option - great strategy.  Not a lease purchase, that might trigger a sales event.  But a lease and an option (most would recommend two separate documents).  Now you are demonstrating your intent to hold the property for productive use and yet leaving the door open so the tenant could purchase down the road when and if they wanted to.

4.  sell and 1031.  When you sell the refi would be paid off and you would go forward into the 1031.  Your requirements to defer all tax would be that you purchase at least as much as you sell and that you use all of the net proceeds in the next purchase.  

When you break your strategy down this way it can be easily done.  Again at each step there's things to look out for.  So def talk to your accountant.  And since the end game is the 1031 you need to ongoing ear of your QI so you don't do something early that would disqualify you.