I am new to the forum and looking for advice on my situation
I have a rental property I am about to sell and realize a large capital gain. The goal is to 1031 exchange this into another like-kind property.
Once I buy this new property, I am going to take a REFI against the newly purchased property to take out some cash. (Is that legally possible if I do it weeks later? All my research says that it Would be as the IRS paperwork shows the 1031 transaction complete.)
Using those funds, I want to buy my wife’s grandpa’s house.
a. The house has a fair market value of $300k but he just wants to sell it to us for what he owes, $150k. (He’s 84 and just wants to not have to worry about making a monthly mortgage payment, hence his desire to sell). I think we can consider this an arms-length transaction as I personally am not related to him, my wife is.
b. I believe my cost basis is established at the selling price, e.g $150k. If I was to sell it the “next day” for $300k, I would realize +$150k capital gains. How can we get that cost-basis higher?
i. I know if he dies and we inherit it, the inheritance clause allows the cost basis to equal the FMV, but he isn’t dying anytime soon. He’s a spunky little devil ;-)
ii. Can he sell me the house for $300k, but then “gift back” $150k? I know he has an annual $14,000 gift allotment each year, but he also has a $5 million lifetime gift exclusion as well. Can he “gift it all at once”? (not the $5 million, but the $150k)
It is these creative plays with the properties that I am looking to take advantage of and “think outside of the box”.
You are unnecessarily complicating this with the 1031 Exchange.
Forget 1031 Exchanging Into Grandpa’s Hell Hole, OPTION 1
a. Take over Grandpa’s existing loan payments.
b. Have Grandpa deed the house to you, “subject to” the existing loans.
c. Record the deed.
d. Get new insurance, add Grandpa as a beneficiary.
e. Establish the tax basis at $150k.
OR
Forget 1031 Exchanging Into Grandpa’s Hell Hole, OPTION 2.
a. Have Grandpa will the house to you.
b. Have Grandpa notarize a deed in your favor.
c. DO NOT RECORD THE DEED.
d. DO NOT GET NEW INSURANCE.
e. Take over Grandpa’s existing loan payments.
f. Record a Memorandum Of Agreement against the property to protect
against any new liens, or encumbrances; and/or protect against Grandpa
getting senile, and trying to give the house to his new girlfriend he met on
“I’m Seizure-Free.com.”
g. You hold the unrecorded deed.
h. You wait until Grandpa checks into “Motel Deep 6,” and then record the deed
per his will.
i. Establish the tax basis at $300, or whatever the FMV is when Grandpa assumes
ground temperature.
Neither option requires you to pay off Grandpa’s loan.
Just take over his payments.
Get the deed.
Don’t notify the bank.
Keep everything current, until Grandpa stops breathing, and then record the deed, per his will.
Both options effectively navigate around any probate problems, since there is a deed being delivered before Grandpa bites it.
****Grandpa decides NOT to give you the deed?
Then Grandpa needs a Will. Better yet, Grandpa needs Living Will and Trust. Or you’ll end up in Probate Court, and your tax basis will a mess.
You should pay for Grandpa’s Will, because Grandpa is handing you tens of thousands in equity, that took years to acquire; and because without a Will (and no deed), the property will go into probate, and the state will make a claim against all that equity, and again the ‘tax basis’ will be the least of your problems.
The 1031 is not for Grandpa’s Hell Hole (not sure why you called it that, but I like it). The 1031 is to avoid $100k in capital gains when I sell the rental property. I am selling the rental, realizing the substantial equity, and buying another rental (for cash) to generate monthly income.
Break, Break.
The reason for taking out the REFI on this new rental was that I could offset the rental income with an expense. If I just “take over” papa’s mortgage payments, I won’t be able to take advantage of that deduction.
And I’ll be sure to block his access to “I’m Seizure-Free.com” (BTW, that was hilarious)
Selling a reliably-performing rental house, to take cash, and put it into something similar is not the reason to do a 1031 Exchange.
1031’s are used to trade up, or trade down, but not trade even-Steven. 1031’s cost money and usually result in a drop in cash flow, not an increase. You’ll sacrifice at least 10% of your gross equity, if not your cash-flow after paying costs and fees.
Meantime, the legal limits on a 1031 Exchange are purposefully dysfunctional to discourage their use. That said, there’s no limit on the use of funds from a refinance. Not to mention that it’s also a tax deferred transaction.
And that’s why I would suggest that if you simply want to buy more cash-flowing rentals, than you should simply refinance the dead equity in the current house, and leverage yourself into more deals with that cash, and let the current cash-flow, pay the interest costs.
That said, it’s much more profitable to take $150,000 in refi money, or say $100,000 if you can’t pull that much cash out, and use that money as part of a down payment on a $1,000,000 income property. Now, you’ve gone from controlling a $300k deal, to controlling something 3x’s the size.
To give you some perspective, if things appreciate just 2% a year for five years, on your $300k house, you’ll make a whopping $30,000 in equity profits.
However, on a $1,000,000 property, over five years, you’ll make $100,000. Well, there’s your down payment back, along with five years of increasing cash-flow on top of it, and no unnecessary costs.
Of course, this assumes you buy a cash-flowing property, and the seller will also carry 10% back. Well, 10% seller carry-backs are as common as water in multifamily residential deals, or any other commercial deal, for that matter.
I’m just saying a 1031 Exchange to do what you’re wanting to do is expensive, not very efficient, and doesn’t have a point, other than to unload one rental for another one.
A more efficient alternative might be to trade your rental house with equity for a small apartment building, subject to.
I have done this. A guy bought 18 units in KCMO and managed it like a blind drunk. He got a good price, but the performance dropped substantially, and made it impossible for anyone to finance a purchase conventionally.
He wanted out. So, I proposed trading my free and clear rental house for all his equity, which happened to be close to what he bought the building for, and he was happy with that offer. Too happy probably, but I got into the deal without any costs, except for recording, and we then worked backwards on a 1031 Exchange.
He was effectively exchanging ‘down,’ and I was exchanging ‘up.’ Of course, I knew how to manage apartments, and he only knew (barely) how to manage a rental house. So, it was win/win. However, frankly I won more than he did, because my cash flow ended up being several times what I was getting off that rental house. I went from a single unit …to eighteen units …in one move. I had more than that, but I effectively added 17 more units to my portfolio.
You could do the same thing, if you decide that you really want to make a 1031 Exchange work for you the right way.