Adrian_Thompson (Forum Supporter)
Adrian_Thompson (Forum Supporter) MegaDork
9/15/21 11:20 a.m.

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.

67LS1 Reader
9/15/21 11:31 a.m.

I've done a lot of 1031 exchanges over the years but never for raw land. I've even exchanged one property for two. 
One solution I can think of if the current owner of the raw land is willing to work with you is to have them perform the improvements prior to your purchase and raising the purchase price accordingly. Possibly during an iron clad lease-option period.

Adrian_Thompson (Forum Supporter)
Adrian_Thompson (Forum Supporter) MegaDork
9/15/21 11:32 a.m.

In reply to 67LS1 :

Hmm, something to consider there but the numbers aren't as round and simple as in my example.  thx

mr2s2000elise UberDork
9/15/21 11:43 a.m.

I think you speaking to a new accountant is a good idea.


 I am a JD LLM Taxation, thus I have done 1031 exchanges for about 12 years now all on my own. I keep deferring all capital gains, till my death.  Most recently I did two, one which is similar to yours.

I did a forward exchange, by selling a house in Santa Monica, and purchasing a 14 unit rental in Missoula, MT. By doing a forward exchange, I purchased the MT property first. Sold the SM property second, and use the funds to pay back back the MT loan. 

I have previously (4 years ago), did a construction/improvement  1031 exchange (we are allowed that in CA). Given I knew I had 6 months to use my sale equity in my construction, that gave me plenty of time to make all the improvements on the vacant land I needed to turn it into an AirBnB, and defer all capital gains by using the full 100% equity from previous sale, without paying a dime to uncle sam.

AngryCorvair (Forum Supporter)
AngryCorvair (Forum Supporter) MegaDork
9/15/21 12:12 p.m.

In reply to mr2s2000elise :

A bit OT, but does "deferring all capital gains" only apply to 1031 exchanges?

bgkast PowerDork
9/15/21 12:22 p.m.

My wife has successfully completed several. From what I recall before you sell the original property you need to identify several potential properties to reinvest in. There are also timelines you need to meet as you mentioned. I'll see if she can give a brain dump if it would be helpful.

Adrian_Thompson (Forum Supporter)
Adrian_Thompson (Forum Supporter) MegaDork
9/15/21 12:44 p.m.

In reply to bgkast :

That would be great.  

I agree we should have had somewhere in mind already, we did in fact have several, including the one we still want.  Unfortunalty there were issues and other people bidding meaning that the other possibilites all fell through while our sale was still going ahead.  

jgrewe HalfDork
9/15/21 4:02 p.m.

The issue I get from reading the plan is if you are going to use this new property personally as your new home or is it a "like" property that will be a new rental? If this is a new home for you a 1031 isn't going to work.

Adrian_Thompson (Forum Supporter)
Adrian_Thompson (Forum Supporter) MegaDork
9/15/21 7:13 p.m.

In reply to jgrewe :

No worries. Like for like. 

jgrewe HalfDork
9/15/21 9:53 p.m.

edit: re-read your first post and saw that you already closed on the property you were selling.

My post of reverse 1031's does nothing for you.

As you were...

bgkast PowerDork
9/16/21 1:32 a.m.

In reply to Adrian_Thompson (Forum Supporter) :

She ran through the thread it sounds like you have the basics. You have 45 days to identify property you are interested in swapping to, and 180 days to close. Due to the short timeline she said it's best to have an offer in the works during the 45 day period. She said rolling it into land plus improvements should be possible, but adds complexity, as you have found. Her suggestion was to reach out to a 1031 exchange company (you will have to identify which you want to use with the deal) and have them advise.  If you have already sold the property the clock is ticking...


fromeast2west Reader
9/17/21 12:36 a.m.

One of the key concepts of a 1031 is that you can't 'touch' the money from the sale.  The exchange agent steps in as an intermediary so you end up exchanging one property for another... which is why the funds need to be held by the exchange company.   If you have too much control over those funds then the IRS can say that you have functionally taken possession and the exchange fails. construction exchanges are more complex, but possible.  

Your best option is the one previously mentioned; have the seller make some improvements and charge you more.  It would work well, but it means the seller has to have enough cash on hand to make the improvements.  

If the exchange company you're working with handles construction exchanges then talk to them.  Your accountant may not be the best to talk to.

Source; was a 1031 exchange coordinator for a law firm in CA.  

Adrian_Thompson (Forum Supporter)
Adrian_Thompson (Forum Supporter) MegaDork
9/17/21 8:55 a.m.

Thanks guys. Yes we already have a 1031 coordinator and she was the one who alerted us that our original plan would not work. We had sought advice from an account previously but it looks like that advice was incomplete.  We closed on our old property two weeks ago so the 45 days is already down to 31 days. We have identified but not made an offer on the property we wish to purchase and are meeting the builder and architect in a couple of hours. 

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