All Forum Posts by: Sean Ross

@Michael Cai,

Is your $450K owned free and clear? 

With borrowing rates as high as they are, it could be difficult to maximize income by 1031 exchanging into a rental that is both (a) financed, and (b) in an urban area where prices may still be close to 2023 peaks. 

Have you considered 1031 exchanging into any other types of cash-flowing assets if your goal is to a max out cash flow?

Amen, @Anna Catron.  The limitations around targeting your own property (or a relative's property) in 1031 exchanges are clumsy.  They're written to avoid basis switching and also reflect the IRS' general discomfort with non-arms-length dealings, but they end up limiting a lot of very valuable improvements. 

It is technically possible to 1031x into land that you already own and improve it.  The structure is most commonly called a "ground leasehold improvement exchange" and it's the very deepest end of the 1031 pool.  In all our years doing this work, we've only seen it successfully completed a handful of times because of how many hurdles you have to jump over and through.  

Remember @Costin I. that for any liquidating distribution of a partnership, such as the LLC, the distributions should be done pro rata.  Unless your two properties are exactly the same value, deeding one house to each of you is not going to result in a pro rata distribution.  If it isn't pro rata, then you end up with a partial sale from one partner to the other, which creates tax consequences. 

@Costin I.

If by partnership you mean a legal partnership (LLC or LP or otherwise), then that legal entity would need to either dissolve (or deed out your 50% to you) prior to sale before you could sell your own 50%.

In order to do any 1031 exchange, the same tax filer has to complete both legs of the exchange. This means that if a multi-member LLC is on title to a property and sells that property, only that same LLC can engage in a 1031 exchange.

If you and your partner want to maintain flexibility, you should set up your ownership as two Tenant In Common owners with an undivided 50% ownership each in the properties. Each of you will report 50% of the property on your individual tax returns. (Alternatively, you could set up a single member LLC to own your 50% of the properties). Under this structure, you could sell and 1031 exchange your 50% without implicating your partner at all -- they could exchange with you, exchange without you, or cash out.

If you were both two members in an LLC, which is very common, and you wanted to go separate ways, which is also common, then you would probably want to go through a "drop and swap" process. This looks like:

- dissolve your LLC
- file a final tax return for the LLC
- distribute out the LLC's assets pro rata to each member (this is a tax-free distribution)
- each member takes title to an undivided interest in the properties in a TIC structure
- then you can sell 

We deal with this sort of thing literally every single day of the year.  Frankly, there are plenty of other small details that matter here.  There are also a few other possible strategies to deal with it.  I'll send you a connection request and you can message me directly as you think through this. 

@Carolina S.

I want to back up what @Jack Seiden wrote.  A lot of money put into primary residences isn't recouped $ for $ upon sale.  Now there are some improvements (kitchen remodel, bathroom remodel, upgrading windows) where that flips on its head, but it's still something to really plan through. 

If you cashed out, didn't 1031, paid the tax, and then did your renovations...the opportunity cost seems very high. You're getting a triple whammy of (1) paying a huge tax premium for not 1031 exchanging, (2) trapping even more equity into a position where it's not actively working for you, and (3) possibly engaging in renovations that aren't cost effective. 

Maybe that's worth it!  But only from a psychic standpoint.  It's very unlikely to be worth it from a pure numbers standpoint. 

We have lots of 1031 clients that are struggling with the idea of high interest rates right now. You're not alone. Maybe it's worth finding a cash-flowing asset that you can invest into that doesn't require a new mortgage on your part -- something syndicated or a NNN TIC property where you're just buying into a portion of the property and its existing debt load. That way you can preserve your cash flow and look to reposition when rates are better or prices are lower?

@Ashley Tarver,

Thanks for the question.

When you sell a property that you are occupying as a primary residence, unfortunately you are no longer eligible to perform a 1031 exchange.  It sounds like this used to be a second home or rental property for you - is that true?

Normally in a spot like this, we would recommend to a client that you sell your primary residence and claim your capital gains exemption under Section 121, but you have two strikes against you: (1) you have not lived in this property long enough to qualify for that, and (2) I'm hoping you already claimed an exemption on the sale of your other primary residence a few months ago, and you can't claim Section 121 exemptions within 2 years of each other. 

If you have previously treated this property as an investment property, one option you have is to move out of this property, move into a different property you own (or into a rental), and then do a 1031 exchange. You would want to work closely with your CPA or a good 1031 company to nail down the timing of it all. 

Do you have a lot of capital gains in this property?

How quickly are you looking to sell?

(as an aside, it is generally possible to 1031 out of a single family rental and then into a multi-family that is part investment property and part primary residence... It isn't always 100% tax efficient to do this, depending on circumstance)

 @Manny Vasquez is correct that she would have to move all of the proceeds into the new property in the case of a 1031 exchange.  I want to also point out that simply moving the proceeds over isn't enough to defer all of the taxes -- the new investment property must also be worth at least as much as the property she sells (after closing costs). 

@Muhammad Ali Raza,

Thanks for posting the question.  My guess is that you can't use a 1031 exchange to do what you want here.  I hate to bring you bad news.  But it sounds like you personally own both properties. 

If Rental #2 is a property that you do not already own, then the answer is almost certainly yes, you can sell Rental #1 and use a 1031 exchange to move the gain into Rental #2. 

If Rental #2 is a property that you already own, then almost certainly no. It is extremely difficult -- bordering on practically impossible -- to use a 1031 exchange to move gains from the sale of one of your existing properties into a property that you already own. 

Of course, nothing is stopping you from selling Rental #1, paying taxes, and then taking your leftover after-tax profit and moving that into Rental #2. 

@Steve K.,

I wish there were a super clean delineation that I could make for you here. In some respects, it depends on the track record of the investor rather than you timeline of any individual investment. And evaluating the track record is a call that's made first by the taxpayer or their CPA, and ultimately by an IRS auditor (should one get involved). 

it is very true that the IRS cares about intent with respect to capital gains in real estate -- I've certainly seen cases where the statutory timelines were less important and the identified intent of the investor.

with respect to determining whether you qualify as a developer or an investor, it's much more of a "forest" than the "trees"...so holding any given investment for 14 months prior to a flip is certainly no guarantee of receiving long-term capital gains treatment.

I hope this helps. 

@Lee Singleton,

I want to kick this off by saying that I've personally followed Perch Wealth's newsletters for at least the past two years.  Good stuff. 

To add on a thought to your post, one which you've already implied.  I simply want to make it a little more explicit:

For those investors who may be confused, 1031 Exchanges and DSTs are not competing products or strategies. It's not like you either have to choose DST or 1031 exchange.

Delaware Statutory Trusts are a vehicle for investors, while 1031 exchanges are more of a private toll road that helps navigate investors around the IRS (and DSTs are one possible vehicle that can access this private toll road).  

Many 1031 exchanges start and/or end with a DST (as either relinquished or replacement property).