Real estate investors are always looking for ways to put more money to work. If you have cash in a Self-Directed IRA and you’re also completing a 1031 Exchange, it may seem logical to combine the two and buy your next property with both sources of funds.
In some situations, that approach can work well. In others, it can create problems for your Exchange if you are expecting your IRA to replace part of the investment needed for full tax deferral.
Tom Moore, President of Equity Advantage, frequently helps investors understand how different ownership structures affect a transaction. Whether a 1031 Exchange and a Self-Directed IRA can be used together often comes down to how the property is being acquired and who owns each portion of the investment.
Your Self-Directed IRA Cannot Replace Exchange Equity
Let’s say you own an investment property individually and sell it for $500,000 as part of a 1031 Exchange. After paying off any loans, you may have a few hundred thousand dollars in equity available to reinvest.
Many investors assume they can buy another $500,000 property and use money from a Self-Directed IRA to make up the difference. The goal is often to bring IRA funds into the purchase so they can avoid taking on additional debt.
That is not how a 1031 Exchange works.
Tom explains that if you sell an individually owned property for $500,000 and want full tax deferral, you generally need to reinvest all of your Exchange equity into replacement property of equal or greater value. You cannot use IRA funds to replace part of that investment and still expect the Exchange to be fully deferred.
A Larger Property Purchase May Allow a 1031 Exchange and Self-Directed IRA to Work Together
If you want to use funds from a Self-Directed IRA, purchasing a larger replacement property may create opportunities that are not available when buying a replacement property of equal value.
For example, instead of buying another $500,000 property, you might purchase a $1 million property. In that situation, the Exchange proceeds from the sale of the original property could still be fully reinvested through the 1031 Exchange, while the IRA contributes the additional capital needed to acquire the other half of the property.
Planning a 1031 Exchange and Self-Directed IRA Strategy
Many investors see available IRA funds and Exchange proceeds and assume they can freely combine them however they choose. However, an individually owned property being sold through a 1031 Exchange still must satisfy the requirements for full tax deferral, even if a Self-Directed IRA is involved in the replacement property purchase.
While making 1-for-1 Exchanges with IRA funds is not feasible, investors do still have some flexibility to combine a 1031 Exchange and a Self-Directed IRA if they aim for larger replacement properties and plan the transaction carefully.
If you are planning a 1031 Exchange and want to understand how a Self-Directed IRA may fit into your investment strategy, contact Equity Advantage to learn how different ownership structures may help you put your available capital to work more effectively.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
FAQs About 1031 Exchanges and Self-Directed IRAs
Can a Self-Directed IRA replace Exchange equity in a 1031 Exchange?
No. If you want full tax deferral in a 1031 Exchange, you generally must reinvest all of your Exchange equity into replacement property of equal or greater value. Funds from a Self-Directed IRA cannot be used to replace part of that required investment.
Can a 1031 Exchange and a Self-Directed IRA be used together?
In some situations, yes. A larger replacement property may create opportunities to use both Exchange proceeds and Self-Directed IRA funds in the same acquisition. In that scenario, the Exchange proceeds are still being reinvested through the 1031 Exchange while the IRA contributes additional capital toward the purchase.
Why does a larger replacement property make a difference?
When you buy a replacement property of equal value, you generally need to reinvest all of your Exchange equity to achieve full tax deferral. A larger replacement property creates additional room for IRA funds because the Exchange proceeds are still being fully reinvested, while the IRA contributes additional capital needed to acquire the larger property.
