Dividing Property For 1031 Exchange
Ask the Real Estate Lawyer: Real Estate Law Q&A
REM # LAW 686
By Ilyce R. Glink and Samuel J. Tamkin
Summary: A reader has inherited a large piece
of land, including a home and some rental property. Now the new owner has the
opportunity to sell the property at considerable gain. They want to make smart
decisions regarding taxes on the sale of the property. Sam and Ilyce discuss
the benefits of dividing the property in order to take advantage of a 1031 exchange.
Q: I inherited a 160-acre ranch in California. There is a house on it and a
separate building where I have two rental apartments.
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The ranch is basically bare land without horse, livestock, fruit trees or crops.
I had to move into the house last year when it was willed to me to take care
of the property and fix it up to sell. When the previous owner died the property
was appraised for a bit over $1 million. Now I have a buyer for twice that amount.
I would like to know if I can use a 1031 exchange to purchase a new rental
property and a ranch/ farm property where I could live as a caretaker/owner.
What do you think?
A: It sounds like you have a great investment on your hands. The critical question
that you will face is whether the farm has become your residence. Unfortunately,
you can’t utilize a 1031 tax-free exchange for your residence.
A 1031 exchange is a mechanism used by investors to sell one form of investment
property to buy another. When done properly, the investor is able to defer the
payment of federal income taxes until the replacement property is sold.
The key element to a 1031 exchange is that the property must be income producing
property – an investment property. The property can’t be your residence.
You should talk to a 1031 exchange specialist and find out if you can divide
the property and sell it as part of various transactions. One transaction would
be the sale of the home, one the sale of the land and, perhaps the final transaction
would be the sale of the rental building.
The rental building and the land could be part of the investment transaction
and the home could be considered your residence. While the sale of the property
might not have to be structured as wholly independent transactions, you might
want to find out how you can benefit from the provisions of the tax code.
It is not uncommon for homeowners to live in a multiunit building and then
sell it as an investment property. Some sellers even divide the transaction
to claim that the portion of the building they live in is their residence and
the balance of the property is an investment.
At the closing, a portion of the proceeds are allocated towards the residence
and a portion towards the investment property. The seller then proceeds to use
the proceeds allocated towards the investment portion of the property in a 1031
exchange. After the closing, the seller has to comply with some strict timing
rules to buy a replacement property.
Your case offers some unique circumstances that need to be addressed with someone
intimately familiar with 1031 exchanges and your own personal situation. You
will need to decide how to allocate the residential portion of the property
and the investment portion of the property. Is the value in the land or is the
value in the homes? Can you get the buyer to offer to buy the home separate
from buying the rental units and most of the land?
Of course, if you sell the land without using a 1031 exchange, you may pay
some tax to the federal government. As you seem to have owned it more than one
year, you will pay approximately fifteen percent in capital gains to the federal
One final thought: sometimes when you inherit property and then turn around
and sell it within a year or so, the new sales price is considered to be the
market value for purposes of considering the property’s value on the date
of inheritance. While this may increase the amount of the estate, it may allow
you to sell the entire property today without paying any tax whatsoever.
After looking at the date of the inheritance as well as your documentation,
a good estate attorney ought to be able to answer this question for you.
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