Does leasing out part of a property make it possible to do a 1031 Exchange into a Primary Home? David and Tom Moore, co-founders of Equity Advantage also known as The 1031 Exchange Bros., answer a question from an investor on Reddit who wants to buy a home with 10 acres leased to a farmer. There may be an exchange opportunity here, but you have to separate what you’re buying for investment from what you’re buying to live in.
How a 1031 Exchange into a Primary Home Could Apply to the Leased Portion
In this investor’s situation, they have about $180,000 in equity in a rental property and another $150,000 in their current home. They then want to buy a $500,000 property with a house and 10 acres that are already leased to a farmer. Can they exchange out of the rental and into that property?
Potentially, yes, but the exchange would apply only to the qualifying investment acreage. Having a farmer paying rent on the land doesn’t turn the house they plan to live in into investment property.
Although they’re purchasing the house and land together, they need to know how much they’re paying for each. Exchange proceeds could pay for the investment acreage, while personal cash would pay for the home.
The next question is how much of the $500,000 price is for the acreage. Since the exchange funds can only go toward the investment land, we need that amount to see whether the investor could put all of their rental sale proceeds into it.
Why We Need to Know the Rental’s Sale Price, Not Just Its Equity
There’s also another missing piece we need to know before we can feasibly say whether the Exchange might work or not. We know the investor has $180,000 in equity in the rental, but what is the rental property actually selling for?
The equity and the sale price aren’t necessarily the same number. For example, if there’s debt on the rental, the sale price could be higher than the equity. For a 1031 Exchange, we’re not just looking at the cash coming out of the sale.
To keep the example straightforward, let’s assume the rental is debt-free. It sells for $180,000, and that’s the cash coming out. Now we have a sale price to work with.
If the 10 acres are worth $180,000 or more, the investor could use the full $180,000 from the rental sale toward buying that land through a 1031 Exchange. They would use personal cash to pay for the home they plan to live in.
Under those assumptions, the investor could exchange the debt-free rental for the investment acreage as part of the larger home purchase.
Does the Investment Portion Have to Be Leased Out?
The existing farm lease is part of what prompted the investor to be interested in doing a 1031 Exchange with this property, but it begs the question: does the acreage actually have to be leased to qualify as investment property?
No. The land doesn’t have to actually produce rental income to be treated as an investment. It just needs to be a property that the investor intends to hold for investment or use in a trade or business.
So a lease isn’t what makes the entire purchase eligible, and the absence of a lease doesn’t automatically rule out the land. The land must be intended for investment or use in a trade or business, but a lease isn’t required.
A New Home and a Continued Investment
For this investor, buying a new home doesn’t necessarily mean leaving the rental property’s Exchange opportunity behind. The acreage may provide a way to continue holding investment real estate while purchasing a home with personal funds. The two goals can fit within one purchase, provided the investment portion’s value supports the exchange and the residence is funded separately.
If you are considering a home with investment acreage, contact Equity Advantage today to explore how a 1031 Exchange could fit into your purchase and clarify your options before you move forward.
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 Primary Homes
Can I do a 1031 Exchange into a Primary Home if part of the property is leased out?
The leased investment portion may qualify, but leasing out part of the property does not make the personal residence eligible. In the example above, the exchange could apply to the acreage, with personal cash covering the home.
Why isn’t the rental property’s equity enough to evaluate the exchange?
Equity alone doesn’t tell us the rental’s full sale price, which we need to compare with the value of the investment land being purchased. In this example, if the debt-free rental sells for $180,000, the investment acreage must be worth at least $180,000 to complete the full exchange into that land. The value of the home they’ll live in doesn’t count toward that amount.
Does the investment land have to be leased to a farmer?
A farm lease is not required for land to be considered investment property. The investor must intend to hold it for investment or use in a trade or business.
