All Forum Posts by: Sean Ross

@Rob Rayborn,

Thanks for the post and question.  And here's a very premature toast to a happy retirement. 

You're looking for increased cash flow, so managing more doors and/or strategically utilizing leverage can make a certain sense there...but as you mention financing costs aren't as rosy as they were 2-3 years ago. 

If you go the 1031 route, here are some rules when trying to combine multiple sales:

1. Deferring All Taxes - if you want to defer all taxes, make sure that the total value of what you buy is greater than $580K (or whatever your final combined net sales value ends up at) and that you use all of your sale proceeds as down payment on your replacement property(ies).  I don't think these will be hard given what you've written.

2. Timing Your Sales - From a technical / IRS standpoint, it's easiest (and cheapest) to have all three of your sales close before your purchase, and to have all four of those transactions occur within the same 180-day calendar block. However, there are ways to structure your 1031 to accommodate virtually any timeline you can think of -- sell one, buy one, sell the other two...buy, then sell all three over time, etc.  The only catch here is that each scenario comes with its own rules and potential additional costs.

@Gabe Capoferri,

Communicate to them directly that you understand 1031 and want to make this easier and more flexible for them. Tell them that you'll work with their timeline. 

Outside of that, you're left working with normal buyer/seller relations. 

@Daniel Shuler

It is possible to include owner carry financing as part of a 1031 exchange. It's likely best to jump on the phone with an expert to discuss this, but I'll leave a quick description below:

Owner financing is a tricky issue for tax purposes. The IRS considers it a loan, just like any other, that represents potential interest income to the lender (in this case, you). Seller financing won't have any impact on the potential capital gains that you would face by selling a property, either -- you're still selling a property for the same appreciated amount. It doesn't matter if you also happen to be the lender and the seller.

There are a lot of possible issues with seller financing while doing a 1031. It's possible! But you want to be careful. A direct attempt at seller financing will result in taxes being recognized for the value of the carryback note (making the exchange less efficient). The carryback note is not considered a valid asset to receive in an exchange. For example, if you sell a $500K property with $150K in seller financing...well, the $150K will be excluded from the exchange and capital gains taxes will be recognized as payments are made. Even worse, all of the depreciation recapture taxes allocable to the $150K will be recognized and due in the year of sale.

(There are even some who believe that the seller providing a loan to the buyer will disqualify the exchange entirely, but that's not been our experience.)

The most straightforward solution is to have the seller provide a cash loan to the buyer outside of closing. This way the buyer can come to closing with all of the necessary funds to allow for a normal 1031.

If the seller is not liquid enough to provide a loan, they could attempt to find another financing option for the buyer. If this doesn't work, then the seller can have the carryback note made payable to their 1031 Qualified Intermediary. The Intermediary can then sell the note to any party, including the seller or a seller's family/friends. Any proceeds from the sale of the note can be added to the 1031 exchange account to allow for more tax deferral.

The issues get a little deeper, but the key takeaway is that careful planning is very, very important. A lot of my company's clients are trying to do this in 2024, with mixed results.

Happy to answer any questions you have.

When we're getting into the weeds here, @Keith Consiglio, the real question we're untimely asking is "If a state or federal auditor looked at what I did, would this cause any headaches for me?"

If the IRS, for example, looked at a closing where you put $150K down ($100K from a 1031 exchange account and $50K from outside personal funds) on a mixed-use duplex where the value is split 50/50, then they could very easily argue that $25K of your exchange funds went to acquire non-like-kind personal property. This wouldn't kill your exchange, but it would result in taxes owed on the $25K plus interest and possibly a penalty. 

This is why I like treating each part -- investment and primary residence -- as a distinct purchase even if there's only one closing and one contract.  You want separate settlement figures showing exactly where the funds came from and how they were used so that the regulators can't hose you. 

@Tyler Brobst, you've got a few hurdles from a 1031 standpoint.  

If you've already filed your 2023 tax return, how did you list this property?  Was it all a primary residence, or did you list a portion of it as an investment asset (with depreciation taken and rental income declared)?

Yes, @Keith Consiglio, you can do this.  In any of these potential scenarios, use this checklist:

- Is the investment/rental portion of the new property at least as valuable as what you previously sold in the 1031 (raw land, in your case)?

 - Is all of the equity from your land sale being transferred (through a Qualified Intermediary) to only the investment/rental portion of the new property?  See my note below about separate settlement statements. 

- Is the investment/rental portion of the property owned by the same taxpayer (person or entity) that sold the land?

If you can check these boxes, you're going to be starting off in great shape.  There are more 1031 rules to follow (always), but these are key. 

Now, this next part is technical but important: When you work with a QI, you also want to make sure that the personal residence portion is specifically excluded out of your Exchange Agreement and the Assignment of Contract to the QI, and there should be separate settlement statements for each side of the transaction. A good QI will make sure all of this happens for you by coaching everyone involved; you don't need to become an expert or a middle man. 

Identifying the use of the land is very important, @Caroline Gerardo, as you've mentioned. 

In that vein, and I'm speaking to any general reader who may come across this post later, land held simply for potential appreciation is considered a valid investment asset for 1031 exchange purposes.  Real property does not have to generate revenue or even have the foreseeable prospect of generating revenue in order to qualify under Section 1031. 

Similarly, land held for potential future development -- even if only vague potential -- can qualify under Section 1031. 

The IRS doesn't always like it, but the tax courts have made this very clear. 

On the owner-occupied loan - For 1031 purposes, the IRS doesn't care about the percentage down payment (although, if he wants to defer all taxes from the land, then all of the equity from the sale does need to go as down payment on the investment half of the duplex). And while grabbing an owner-occupied loan is typically a non-starter in a standard 1031 transaction, this is a mixed use property that does include a personal residence portion. He could go out of his way to try to separately finance each half, but I've never seen any guidance suggesting that is necessary. Lots of properties are acquired with an owner-occupied loan in a 1031 exchange, especially primary homes that have will have an ADU for rent or that contain a large office space for the homeowner/taxpayer. The rental/business portions of these properties are valid from a 1031 standpoint, independent of financing. These properties can be mortgaged through traditional means -- and tax deferral will be incumbent on following the other 1031 rules.

 @Keith Consiglio, a few quick points for you:

1. Yes, you can 1031 from land into a duplex

2. Yes, you can occupy one half of the duplex after a 1031 and still get the tax deferral - provided that the investment half of duplex by itself is worth at least as much as the land you sold AND all of the proceeds from your land sale are designated for down payment on the investment half only.  

3. You should be OK on financing. The IRS doesn't have a lot of hard rules about the type of loans (or source of loans) with a 1031 exchange.  Loans are almost always used as proof of correct "investment intent" under an audit scenario.  They don't want people buying property and using a primary or second home mortgage when the use is investment or business - that's loan fraud and tax fraud at the same time.  But since this is mixed use and a single structure, they'll default to other ways to demonstrate correct intent (rental income,  depreciation, length of hold, etc.)  Just make sure that you're following all the other rules. 

4. If you go this route, you'll want to be very detailed if and when you sell the duplex later down the road.  There can be a lot of advantages to having a mixed use property from a tax standpoint, but there are also lots of tripwires. 

My company has done 1031s for 31 years, we work in all 50 states, and we're very good at what we do.  If you want a free consult, we're available.  If you already have another company, I'm happy to be a second opinion.

 Just a quick note @Caroline Gerardo that raw land can qualify for 1031 treatment.  Any land held for potential appreciation, for farm usage, for its raw materials,  or for potential future development can qualify. And, in those circumstances, it's considered like-kind to any other business or investment real estate. 

Hello @Laura Yazdi,

This is anecdotal, but we're seeing our 1031 clients flee from the higher-tax and higher-regulation parts of the country to places like TX, NC, GA, FL, AZ, etc.  Lots of West Coast capital going elsewhere.  We hear lots of complaints about landlord laws, delinquent tenants, and homeless encampments causing trouble/damage. 

Maybe there is wisdom in the crowd. Again, just anecdotal. 

Here are some things to consider about 1031 exchanging in and out of California specifically:

1. California Clawback Provision - California Franchise Tax Board has rules about investors who sell and 1031 out of state.  In short, they're going to require you to file a new form each year to update them on the investment.  If you ever recognize capital gains down the road in another state, they want their cut.  Failure to file the form (#3840) will result in retroactive tax recognition in California. 

2. California tax burden - Due to the clawback provision, you don't get a full break from the higher income taxes in California if you sell in another state later after a 1031 exchange.  You'll still likely get some lower taxes, since some of the gain will be accrued in another state, but you still need a good tax accountant here.

3. CFTB review of 1031 exchanges - California Franchise Tax Board is even more diligent than the IRS when it comes to scrutinizing 1031 exchanges.  No matter how you 1031 in CA (inside or out), you really need to dot your "i"s and cross your "t"s. 

We do tons of work in CA. If you don't already have a preferred 1031 intermediary to work with, we'd be happy to give you a free consult whenever you're closer to making a decision.  If you do already have one, I'm happy to be a second opinion.