1031 Exchange and Renovations

[Joseph M.]

If I sell an investment property can I use those funds to refinance another property to do renovations?

For example: I sell a $200,000 condo with no mortgage debt on it. Then I refinance a property that I already own to do a renovation on it. I live in this property, but at some point plan to sell it and make a profit. Would that satisfy 1031 exchange requirements?

[Sam Shueh]

1031 tax deferred is for investment property. Upon selling it you exchange to a like property to defer the long term capital gain.

[Dave Foster]

@Joseph M., Then 1031 exchange can only be used to purchase investment real estate.  You cannot use it for improvements on property you already own. And you cannot use it to purchase a primary residence.

You can however use it to buy an investment property and later convert that into your primary residence to get a prorated amount of the gain tax free.

You can also use it purchase and improve an investment property as long as the improvements are complete prior to you taking title to it.  This is commonly called a reverse exchange or a construction or improvement exchange.  Your QI forms a holding entity and takes title to the new property while you improve it.   Once it's complete you take title and complete your exchange.

[Michael Plaks]

@Joseph M.

@Dave Foster is correct.

Also, keep in mind that you cannot sell and then do a 1031 exchange. You have to engage a 1031 intermediary like Dave before you sell the property. If you touched the money - the game is over, and you lost.

[Mark Fitzpatrick]

Quote from @Dave Foster:

@Joseph M., Then 1031 exchange can only be used to purchase investment real estate.  You cannot use it for improvements on property you already own. And you cannot use it to purchase a primary residence.

You can however use it to buy an investment property and later convert that into your primary residence to get a prorated amount of the gain tax free.

You can also use it purchase and improve an investment property as long as the improvements are complete prior to you taking title to it.  This is commonly called a reverse exchange or a construction or improvement exchange.  Your QI forms a holding entity and takes title to the new property while you improve it.   Once it's complete you take title and complete your exchange.

Can I put about 30% down on the new investment property using the 1031 exchange then take out a heloc loan of 80% LTV and use that money to make repairs? My accountant said as long as I keep all receipts for proof the money was used for renovations then it would be fine.

I'm also wondering can I put 20% down and put the remaining funds into a new bank account that is separate from my personal accounts. Then use those funds strictly to make renovations keeping all receipts. 

[Dave Foster]

@Mark Fitzpatrick, The 1031 can only be used for the purchase of real estate.  And you cannot exchange into improvements to property you own.  Your idea of purchasing and then refinancing with a heloc is perfectly fine.  But you can't just leave money from your 1031 somewhere to use for the improvements.  Here are your options

1. Have the improvements done before you take title so they can be added to the purchase price.

2. Take money from the 1031 exchange to do the improvements and pay tax on that amount.

3. Use 1031 funds to purchase the property with extra down payment.  And then immediately refinance it to get the funds to improve it.

4. Do what is called a "reverse exchange".  In a reverse the QI take titles to the new property before you do.  We can then hold the property for 180 days while you complete your improvements.  Then you take title to the new property counting both the purchase price and the improvements.

I'll shoot a colleague request to you if you have follow up questions for off line.

[Mark Fitzpatrick]

Quote from @Dave Foster:

@Mark Fitzpatrick, The 1031 can only be used for the purchase of real estate.  And you cannot exchange into improvements to property you own.  Your idea of purchasing and then refinancing with a heloc is perfectly fine.  But you can't just leave money from your 1031 somewhere to use for the improvements.  Here are your options

1. Have the improvements done before you take title so they can be added to the purchase price.

2. Take money from the 1031 exchange to do the improvements and pay tax on that amount.

3. Use 1031 funds to purchase the property with extra down payment.  And then immediately refinance it to get the funds to improve it.

4. Do what is called a "reverse exchange".  In a reverse the QI take titles to the new property before you do.  We can then hold the property for 180 days while you complete your improvements.  Then you take title to the new property counting both the purchase price and the improvements.

I'll shoot a colleague request to you if you have follow up questions for off line.

 Well said! Thanks