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1031 Reverse Exchange

Ask the Real Estate Lawyer: Real Estate Law Q&A

REM #LAW 706

By Ilyce R. Glink and Samuel J. Tamkin

Summary: A reader wants to use money from the sale of an investment property to purchase an office condo. Sam and Ilyce explain what a normal 1031 exchange is and the details involved in a 1031 reverse exchange.

Q: I have a 1031 reverse exchange question. I’m buying an office condo and need money for the down payment.
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I’m selling two condos in another state but don’t have buyers for them yet. I do have a home equity line on my personal residence.

Can I use the money from my personal residence to put the down payment money down for the office condo I am purchasing using a1031 reverse exchange or should I take the money from a savings account I have? The equity line is at prime plus one percent.

A: You seem to be a savvy real estate investor. As a bit of a background, a normal 1031 exchange is used by a real estate investor who wants to sell an investment property he or she owns but does not want to pay any taxes.

To avoid the payment of taxes, he or she sets up a 1031 exchange with one of the many companies that provides this service. The 1031 exchange company has paperwork that you fill out and tells you how and where the money should go from the sale of an investment property.

In essence, the 1031 exchange company parks the money until you can find and close on a replacement property. You must adhere to a certain timetable for finding a suitable replacement investment property (45 days) and must close on that replacement property within 180 days from date of sale of the existing investment property.

A successful 1031 exchange allows you to defer the payment of any taxes on the sale of the old property until you sell the newly acquired property. When it comes time to sell the newly acquired property, you can do another 1031 exchange and continue to defer accumulated capitals taxes.

But let’s say you find a new replacement property but do not have a buyer for your existing investment properties. Then, you need to switch gears. A reverse exchange allows you to buy a replacement property and sell your old property sometime after your purchase.

A 1031 reverse exchange tends to be more complicated and, therefore, more expensive than a standard 1031 exchange. The escrow company actually takes title to the property and holds it for you until you have sold the existing investment property. Once the existing investment property is sold, you can transfer the title of the new investment property back to you using an ordinary 1031 exchange.

If it sounds like a complicated transaction, rest assured it sometimes is.

If you’re familiar with the process of a 1031 reverse exchange, then the only issue to be concerned with is making sure you satisfy the requirements that the IRS has for a reverse exchange and the standard 1031 exchange to come.

Whether you use funds from equity lines of credit or your own funds to buy the new properties will depend on how you hold title to the properties. If the properties are held in your personal name, it won’t matter where the funds come from and you can choose either to use cash in your checking account or a home equity line of credit.

However, if the properties are held in a corporate entity, like a limited liability corporation (LLC) or some other sort of corporation, you will need to check with your accountant and your 1031 exchange company to make sure any funds coming from your own account won’t give you a tax headache later on.

Borrowing at prime plus one percent means that if the prime rate you are borrowing at is seven percent, the interest rate on your loan will be eight percent. If you’re comfortable with that rate and you feel like you need to keep the cash in hand from savings, then by all means use the equity line.

f the rate and its costs are too great for you to bear, you may want to use personal funds. At this point it probably will only depend on your desire to take on the risk of the loan.

Good luck with the exchanges and make sure you keep a good paper trail of all the funds and costs that you incur to maximize your deductions down the road.

Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your Home Faster and For More Money In Any Market. If you have questions for them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022 or contact them through Ilyce’s website www.thinkglink.com