Personal Use Rules in a 1031 Exchange of Real Estate

Recently, we worked with a client who wanted to 1031 exchange into a replacement property that was ideal for their exchange but had a purchase contract which stipulated that the home may be purchased for primary or secondary use but not income. The client wanted to ensure that there was nothing indicated in the 1031 requirements that might cause trouble down the road. In this scenario, is the replacement property acceptable as long as the client maintains his primary residence and uses the "secondary" residence less than six months out of the year?

Personal Use Requirements

In short, no. Your personal use should be minimal and your primary use should be for rental purposes. There is a safe harbor for properties in a rental pool that permits up to either:

• 14 days a year; or

• Up to 10% of the time it is actually rented out.

This tests only the first two tax years after the exchange is completed. See: https://www.irs.gov/pub/irs-drop/rp-08-16.pdf

It is best to purchase a replacement property that will be held primarily for business rental purposes in order to comply with the requirements of Section 1031.

• Start Your 1031 Exchange: If you have questions about personal use property in 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

What is “One Property” Under the 1031 Three Property Rule?

As a general guideline in any 1031 exchange, you want to identify three or fewer properties to exchange into. But what determines "one property" under this rule? Are two contiguous parcels considered separate? Will two contiguous properties take up two slots under the three property rule?

Identifying 2 Contiguous Parcels

If you identify two parcels which are contiguous, does that count as one property or two? In other words, can you still determine two other properties as part of a 1031 exchange?

Answer

Two contiguous parcels will probably be considered to be one parcel for 1031 identification purposes, if sold by one seller under one PA and conveyed under one deed at the same closing.

• Start Your 1031 Exchange: If you have questions about contiguous parcels in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

Can a Married Couple Purchase their Replacement Property with a Family Member as Tenants-in-Common?

Sometimes a couple will be doing a 1031 exchange where the relinquished property was owned by them as husband and wife, but they want to purchase the new replacement property with another family member as co-owners or tenants-in-common. In this article, we'll explain some key requirements to keep in mind while doing such an exchange.

1. Size Matters

In order to defer all of the gains, the ownership interest in the replacement property received by our exchanging husband and wife must be or equal or greater value than the net value of the sold relinquished property. So if a co-owning relative takes too large of a percentage ownership portion of the replacement property, our exchangors may not receive sufficient value to defer all of their gains.

2. Follow the Money

All of the exchange funds from the sale of the husband and wife’s sold relinquished property must be used exclusively for the purchase of their ownership interest in the replacement property, and may not be used to purchase the co-owning relative’s ownership interest. Each co-owner should contribute and pay for their proportionate share of the new replacement property with their own money.

3. Be Careful ~ Partnership Interests are Excluded from 1031

Once you own the new property, you may be tempted to file a partnership tax return (Form 1065) for the co-ownership of the property (like a joint venture). However, that would be inconsistent with the requirements for a 1031 exchange. Avoiding classification as a partnership for federal income tax purposes will be important for our exchangors to preserve their 1031 exchange. Generally, one cannot exchange into a partnership interest, even if partnership’s only asset is the subject real estate [subject to a narrow exception for partnerships with a valid 761(a) election in place; and rare situations where receipt of 100% of a partnership, results in consolidating ownership in one taxpayer such that it is equivalent to an acquisition of a "disregarded entity"].

• Start Your Exchange: If you have questions about replacement property rules, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

How Much Personal Use is Allowed after 1031 Exchanging into Rental Pool Replacement Property?

How much personal use, and business use (for repairing and maintaining) is allowed after 1031 exchanging into a rental pool replacement property?

Maintaining vs. Improving

Any day that you spend working substantially full-time repairing and maintaining (not improving) your property is NOT counted as a day of personal use. Do not count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.

Additional Resources

Here are some additional resources on this topic:

• First, check out this article on how much you can use the Replacement Property for personal use, if it is put into a rental pool.

• Internal Revenue Bulletin: 2008-10 

• Finally, please take a look at IRS Publication 527 for examples of time you are staying at the Replacement Property for business purposes.

Be sure to talk with your CPA or tax accountant about your specific situation.

• Start Your 1031 Exchange: If you have questions about personal use when it comes to replacement property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchange Tips for Competing for Replacement Property

What if you're punching above your weight class on the purchase of your replacement property in a 1031 exchange? In other words, what if you're acquiring a replacement property that's much bigger than you can afford on your own. Can you bring in partners to help purchase the property?

Partnership Interest

If you're doing a 1031 exchange you want to avoid acquiring the replacement property in a partnership because partnership interests are excluded from 1031 treatment. But that doesn't mean that you can't bring in other co-owners or purchasers with you that will acquire the property as tenants-in-common.

Tenancy-in-Common

One of the facets of a tenancy-in-common is that each purchaser will receive a proportionate share of the property in portion to the amount of cash that they contribute. So if you need $10 million as the down payment on a replacement property and you're able to put up $5 million of that down payment, you'd be eligible and should be allocated an undivided 50% tenant in common interest in the property. If any other co-purchasers want to come in with you and help with the down payment, they too would receive a portion of the common interest allocated to them based on how much of the down payment they pony up.

• Start Your Exchange: If you have questions about replacement property in a like-kind exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved