OK, this place being the fountain of all knowledge, does anyone here know 1031 exchanges?
I think the information we got from our accountant before starting was either incomplete, incorrect and or we misunderstood part or all of it. We are reaching out to our accountant again, and also asking some other friends with far more experience than us and possibly finding a new accountant. But of course I'm coming here as well for advice, I mean how does one get out of bed in the morning without checking in with the GRM crew?
So the situation is as follows. All the numbers below are plucked from where the sun doesn't shine to make laying it out nice and simple and should not be taken as a sneak peak into our personal finances so don't make assumptions!
Let's say we bought an investment rental property for $100K (which easily equates to 100%, hence why it was chosen for my example). Four years later we sell it for $150K, or a nice simple 50% return. So if we don't re-invest in the time frame (45 days from closing to identify the new property(ies) then 180 days from closing until transaction is compete) then the IRS (and state) will rightly come for capitol gains. Let's say 20% of the profit or $10K of the $50K return. All nice and simple so far.
Initially we were looking at houses which would have cost more than the total of the prior sale, so we'd have used all the money and more in one single transaction. But after several issues and offers falling through etc. we've returned to buying land and building on it. This is where it appears to get tricky according to the call we've received from the company handling the 1031 exchange. Note. For legal tax reasons you have to use a registered company and not do it on your own cognition, again I have no issue with this. The thing is, if we were buying land for $150K we'd have no problem. We're not. For round numbers again, let's say we're getting the land for $100K and planned on using the remaining $50K for the start of construction with the builder/architect. This is where the issues come in. It now appears, even though you'd think it would make sense, we can't buy the property for say $100k, then spend $10k on septic installation, $10K on a well, $30K on clearing land and putting in the beginning of a driveway. The IRS would look at that and say 'you only spent $100K so you owe us capitol gains on the remaining $50K that was profit'. The fact we've spent that money on improving the land doesn't count. What they want you to do is 'buy' the whole building from a builder, say $400K that would have covered the land, the basic clearing and utilities mentioned above, then the house, say $100k + $50k + $300K. Bingo, that's one transaction, just don't forget you have to have the building complete in 180 days from closing or no matter what you're back to square one and have to pay capitol gains on the original $50k/50% profit no matter that you are actually well on your way to spending $400K and may already be $200-300K down that path. This is where it's getting really tricky, we could try and do that, but in reality the clock has started ticking (we closed 10 days ago, and are in the process of putting in an offer on land) and the chances of getting a house that hasn't been designed, on land we haven't had an offer accepted on yet, completed with a Northern Michigan winter around the corner in 180 days are about as likely as the next leader of Afghanistan being a transgender woman.
What to do.
Has anyone doe this before and got some legal work around they can offer. Obviously we're going to talk to the builder, but we haven't even made a 100% decision who to go with. We're going up to meet one builder / architecture team on Friday, and another on Saturday and will obviously bounce ideas off them.
We've wondered about setting up a trust / LLC that could buy it for the $100k, make the basic basic $50K improvements mentioned above (well, septic, clearing, rough in driveway etc.) then sell it to us for exactly $150K, but there's a conflict int hat we'd be buying it and selling it to ourselves and 'we' could again have made another 50% profit that the IRS will want cap gains from. We could get the builders (or other organization) to buy it for $100K, sell it to us the next day for $150K with the understanding that they will do those improvements before building starts. But then that organization may or may not have a $50K profit they owe tax on as they haven't made the improvements yet. Then we could get the builders to look at them buying it for us, doing those improvements and selling it too us within the 180 days, then employing them in a separate transaction to design and build the house.
As I say, we are looking into real professional advice that will hopefully be worth what we pay for it, but in the mean time I'm asking the brain trust if you have ideas as it always astounds me the information people on here have at their fingertips.
TIA chaps and chapettes.
