Q:

Subject: 1031 Exchange Question

 Dear Sir:

    I wish to sell my house  in Los Angeles, which is an investment property now, and in which i have not lived for over 3 years, for about a million dollars in a few months, and then within 180 days i wish to have closed escrow on a 600,000 dollar property, planning in time to knock down the shabby building on it, but borrowing a million dollars to build 8 units where that shabby property was within the 180 day period of the sale of my original property. 

 

Question 1.  It I have bought the new cheaper property, and received the construction loan to build on the site where that shabby property is, within the 180 days of selling my original home, will this quality as a 1031 exchange?  Or is such a project not covered by the 1031 program since it would take more than 180 days to build the 8 units, or for any other reason?

 

Question 2.  I bought my original home long time ago for 275,000, and i invested 100,000 dollars in renovating it.  But now I owe 540,000 on this property since i refinanced it in the interim.   If i sell this original house for a million dollars, satisfying all relevant 1031 exchange requirements,  are these following steps  the steps which would occur in this transaction?  First, the 540,000 loan is paid back, and then my net return now  due to me after the sale of my original home, which should probably be a million dollars minus the 540,000  ( and also minus  real estate commissions), is put into the new building or real estate project, plus a new loan is obtained for whatever additional moneys are needed to get into the new building or real estate project, keeping in mind that the new project would need to exceed the one million dollar value of the original building?

 

I thank you in advance for your answers to these 2 questions, and any helpful further thoughts which you may have on my planned project.  I will also keep you in mind for all my 1031 exchange needs, including conveyances, and facilitations.

Sincerely,

A:

You really need to be working on this kind of plan with your own personal professional tax advisor who can look at your actual figures.  In fact, we always advise people contemplating a 1031 exchange to have their tax advisors do the calculations on the tax effect of a full cash sale in order to see if an exchange makes economic sense.

With the brief description that you gave, it will probably be worthwhile to look into an exchange. One of the issues that you need to discuss with your personal tax advisor is the adjusted cost basis of the original property.  If you did take out equity via a mortgage, and did not use that money to make capital improvements, it is very likely that the current loan balance is much higher than the cost basis, especially after reducing the basis for depreciation.

In regard to the rules for reinvesting the exchange proceeds, it isn't required that the new property be completely finished within the 180 days.  You just have to spend, via cash and debt, an amount equal to or higher than the net proceeds within the 180 days.  With unfinished construction projects, you need to be very careful in regard to prepaying the contractor because there have been plenty of cases where the contractor disappears without finishing the job.   

Good luck.

Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 6/10/2006 12:51:00 PM Send this post: