All Forum Posts by: Sean Ross

@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).

@Lucas Vreeken, 

Great to meet you and thanks for joining the community.  Thank you also for your service. 

Investing in a REIT is normally pretty straightforward -- although some "REIT" investments are really mutual funds or ETFs that themselves own some REIT shares or track REITs. I don't want to get too deep right off the bat, but suffice it to say that you can find a way if you're interested.

I do want to highlight that REITs are not eligible for 1031 treatment. You can't 1031 into or out of a REIT. (You can indirectly 1031 into a REIT through a 721 conversion, but I don't think that's really relevant to what you're talking about). If you want to preserve the ability to 1031 exchange down the road, maybe look into different assets outside of REITs.

What's most important to you in the short and long term?  that will help the community here filter through some ideas for you. 

@Ralph McDaniel I should emphasize that even if you don't pay capital gains taxes from flipping homes, you will still recognize taxable income from the profit you generate.  It's just that you will pay ordinary income rates rather than long-term capital gain rates.

@Ralph McDaniel,

The IRS applies the Long-Term Capital Gains rate to investments that are held for more than 12 months.  If you hold your property for less than 12 months, it is considered Short Term.  (You can read more on the IRS website here - https://www.irs.gov/taxtopics/tc409#:~:text=Generally%2C%20if%20you%20hold%20the,or%20loss%20is%20short%2Dterm.)

Gains from capital assets that you hold for less than one year (short-term) are almost always taxed at your ordinary income rate. This can be between 10% and 37% generally at the federal level (state taxes also apply).

Gains from capital assets held longer than one year are taxed at LT gain rates, which range from 0% to 20% federally (state taxes also apply). 

If you "flip" homes repeatedly as a business, the IRS might designate you a "developer" rather than an investor, in which case your properties will not be considered capital assets. Instead they will be considered inventory. Inventory is not eligible for capital gains treatment.