All Forum Posts by: Sean Ross

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. 

Hello @Gabriel Zepeda,

As @Andrew Abeyta correctly mentioned, there is not a direct and clean way to use 1031 exchanges to pay off debt on your existing portfolio.  1031s are great for lots of things, and they're really important to serious investors; however, they are not very useful as a tool for deleveraging. 

Rather than taking out some boot from your sale to pay off debt, you could take a detailed look at your financing math after buying a new property and then strategically refinance to replace expensive debt with cheaper debt, but this is not very easy in today's rate environment. 

If you do decide to have a "partial" 1031 exchange and use some of your 1031 sale proceeds to pay off debt on other assets, you'll just want to make sure that the improvement in cash flow offsets the tax liability that you incur from your partial exchange AND the lower rents from potentially buying a less valuable property with your partial 1031 exchange. 

Otherwise, you're looking at trying to buy the best cash-flowing property with your 1031 exchange so that you can use the monthly income stream to pay off your total debt a little bit faster.  

Hello @Nancy Chawla,

You will still need a 1031 exchange for the half of the home that has not been treated as your primary residence.  It doesn't matter whether you qualify for Section 121 treatment on the other half, which I hope that you do. The tax exemption for Section 121 will not apply to the investment/rental portion. 

Here's how the 1031 rules break down for the rented-out $500K portion of your two-family home:

1. Unless you specifically took out a mortgage that is only applicable to the primary residence portion of the home, then the mortgage will be split pro rata between the two halves (so $150K each, in this case). 

2. When you sell, the $150K will be paid off at closing, only leaving $350K to be used in the exchange (I am ignoring closing costs in this breakdown). 

3. If you don't want to take out debt on the 1031 replacement property, then you can supplement $150K from the proceeds of the personal residence half -- or from any other source that you like. This way you can bring $500K of total down payment on the new property. 

Technical point: While you will technically incur "mortgage boot" by not replacing the debt in your new property, using another cash source to replace your debt gives you a "boot offset"; meaning you won't incur tax on the mortgage boot by doing this. 

Now, 1031/121 splits are common.  But, they're fraught with little nuances that depend on your circumstances. If you are not already working with a Qualified Intermediary on this, I'd be happy to give you a free consult to walk you through the details of your case.  If you are already using one, I'd be happy to act as a second opinion for you. 

Appreciate the good vibes, @Wyatt Wolff !

What kind of loans do you provide?  We can discuss further in a private feed if you'd prefer so we can keep this post discussion focused on Michelle's questions.

Yes, you absolutely can trade out of a condo and into a SFH or MFH, @Michelle Pepe. 

Where to Start With Your 1031:
1. Fact finding about 1031s, like you're doing now
2. Start looking for your replacement options early
3. Go under contract to sell
4. Pick a QI to work with; they should hold your hand through the rest.  

For first-timers, what normally causes the most heartburn is the rule that you have to formally identify what you want to buy within 45 days of your sale. 

I'll send you a PM; we have a lot of resources and guides for realtors specifically.  Also, one of my best officers is in NC, she's a Certified Exchange Specialist, and I'm sure she'd be happy to be a resource for you/your clients moving forward. 

(As an aside, I like the colorful phrase "death trap of taxes")

Exactly.  The mortgage has nothing to do with your basis or gains calculations. 

@Andrew C.,

When you 1031, you carry your adjusted tax basis from the old into the new.  If you trade into a more valuable property, as you did here, the increase in value is added to your old basis.  

I don't know what your depreciation was, but let's imagine that your old basis before the 1031 was $150K.  That's carried over.  The increase from $300K to $500K in property value (+$200K) is added to your old basis, giving you a starting basis of around $350K on this hypothetical scenario.  

If you sell now without a 1031, they'll take that new sale price and compare it to your new adjusted basis; the difference is your total gain,  split between long term gain and recaptured depreciation. 

If you 1031 again, you'll carry the updated adjusted basis into the new property. 

How the new property gets depreciated after a 1031 depends on whether you elected to keep your old schedule after your Exchange.  So you'll need to look closely at that to accurately determine your new basis.

Work with a good tax accountant on this.   Let me know if you need some good options here; we work with quality accountants all around the country.