Can you sell a rental property through a 1031 Exchange and use the money to buy your next home? Not if the property you are buying will be used entirely as your primary residence. But if the purchase includes both a home and a separate investment portion, the investment portion may be eligible for the 1031 Exchange while personal cash is used to purchase the residence. David Moore and Tom Moore, CEO and President of Equity Advantage, look at one example of how that distinction affected one investor’s options when trying to do a 1031 Exchange from rental property into a $500,000 mixed-use property that had both a home and 10 acres being leased out.
Why a Primary Residence Cannot Be the Replacement Property
Whether a property can qualify as replacement property in a 1031 Exchange depends on how it will be used. A 1031 Exchange applies to real estate held for investment, while a primary residence is held for personal use.
That distinction is fairly straightforward when the entire property has one use. However, things become more complicated when the same purchase includes both. That was the situation the investor faced. They owned a rental property with about $180,000 in equity and had another $150,000 in equity in their current home. They were considering a mixed-use property with a home and 10 acres that were currently leased, and the investor planned to live in the home while the acreage continued to be leased. Because the purchase included both a personal residence and an investment portion, those two portions needed to be considered separately.
The Exchange Is Based on the Current Property’s Sale Price, Not Just Its Equity
The investor was selling a rental property with about $180,000 in equity and considering a 1031 Exchange into the mixed-use property. But the amount of equity in the rental did not, by itself, show how much of the new purchase could be treated as replacement property.
Before they could determine how the Exchange would fit into the new purchase, they needed to know what the rental property would sell for, not just how much equity it had.
David used a simple example: if the rental was debt-free and sold for $180,000, then $180,000 from that sale would need to be applied to the investment portion of the new property. If the leased acreage was worth at least $180,000, the Exchange funds could potentially be allocated to that portion, while the investor’s other funds would go toward the home.
The Investment Portion Must Be Valued Separately
If the leased acreage is valued at least $180,000, the investor would not be treating the entire $500,000 purchase as replacement property. The acreage could represent the investment portion, while the home remains the personal portion.
The 1031 Exchange funds could go toward the leased acreage, while the investor’s other funds would go toward purchasing the residence portion. In other words, the Exchange cannot simply be used to buy the home the investor plans to live in.
Plan Around How the Property Will Be Used
When a purchase includes both a home the investor will live in and a separate investment portion, the 1031 Exchange can apply only to the investment portion, not the entire property. Looking at how each portion will be used, what each portion is worth, and where the money for each portion will come from can give you a much clearer picture of what may be possible before you move forward.
If you are considering a 1031 Exchange as part of a property purchase that includes both personal and investment portions, contact Equity Advantage to discuss your situation and structure the purchase around your goals.
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.
FAQ’s About 1031 Exchanges and Mixed-Use Properties
Can you do a 1031 Exchange into a primary home?
Not directly. An investment property cannot be exchanged into a home that will be used entirely as your primary residence. However, if a replacement property includes both a separately identifiable investment portion—such as rental or commercial property—and a primary residence, the investment portion may qualify for a 1031 Exchange if it is valued and structured separately from the residence.
Does the amount of equity in my investment property determine how much I need to replace?
No. Equity alone does not provide enough information. The investment property’s sale price also needs to be considered, along with the rest of the Exchange structure, when determining how the Exchange could fit into the purchase.
Can leased acreage be part of a 1031 Exchange when the property also includes a home?
Potentially. If the acreage is the investment portion of the property and is valued appropriately, it could receive an allocation from the 1031 Exchange while other funds are used for the residence.
