Renting to Yourself and 1031s

We all would like to have our cake and eat it too. For a real estate investor that might look like having a rental property and a primary residence all in one. Many folks would love to take advantage of the tax deferral for investment properties found in 1031 exchanges and then use the property as their primary residence.  And the idea of living in the property but still treating it as an investment by “renting to myself” comes up frequently.

Renting to yourself. is a tricky business that can land you in hot water very quickly.  If you simply move in and start paying yourself rent after a 1031 it’s very clear that your intent in purchasing that property was not to buy an investment property but to purchase your primary residence – 1031 disallowed.

You could set up an LLC to rent to yourself, but if that LLC is a disregarded entity (meaning that it doesn’t file its own tax return) the IRS will ignore the entity and say that you are the taxpayer for 1031 purposes. So, you would again be renting from yourself. And the whole intent issue once again rears its head.

If the LLC is a regarded entity with its own tax return and you are more than half member, then you are a related party to the LLC. You might be able to rent to yourself, but you better make it an arm’s length true rental. Collect the rent, declare the rent, etc.

Another issue, however, is that If you do that, then you are generating taxable income for the LLC from yourself.  So you’re paying tax for the privilege of paying yourself rent.  And at that point, you should be asking yourself “why?” Why not simply hold the property with an outside renter for a year or two and then convert you’re your primary residence by moving in. There is no statutory requirement that you keep the property as investment forever.  And there’s actually specific IRS code allowing you to convert a property into your primary residence AFTER demonstrating your intent to hold for investment purposes.

By that time, you would have satisfied your 1031 intent requirements and are simply changing the use. No rent needed at that time.

 

Multi-Member LLCs and 1031s?

When it comes to 1031s, it is all about whose name is on the original tax return. This goes for LLCs as well as individuals. Multi-member LLCs follow the same rules as everyone else. The name on the original tax return must be the name on the title of the replacement property. If an LLC is multi-member, they probably file taxes as a partnership. Each LLC can sell the property it owns and do a 1031 to buy a replacement property. If you find a replacement property that is big enough, then each LLC could sell and buy a % of the larger replacement as a tenant in common.

Example – each LLC owns a property that is worth $500,000. They could both sell and 1031 each into a 50% tenant in common interest of a property worth $1 million.

Once the LLCs have completed their exchanges, they could simply remain as tenants in common. Or could work with their accountants to dissolve one or both and leave the property in one LLC with the same membership interest allocation.

How Much Should You Be Paying for a 1031 Exchange? [New Research!]

Check out Dave’s recent article on the cost of 1031 Exchanges on the Bigger Pockets Blog here.

2 Things You Should Know About a Reverse Exchange

In simple terms, a reverse exchange is a 1031 exchange where the replacement property is purchased before the original investment property is sold. But they aren’t quite as simple as a 1031 exchange. It should be said before anything else, find a qualified intermediary (QI) before beginning the process.

1.   Financing can be a hassle if you are in need of funds for the purchase until you sell. In a reverse, the QI takes title to the new property in the EAT (Exchange Accommodating Title holder). So the loan has to be made to the EAT but guaranteed by you.

2.   The Reverse is relatively expensive because a holding company must be created to hold the replacement property until the exchange is complete.

Because of its complexity, taking some time with your QI to get fully educated on the nuances of the reverse will be well worth your while. It is always wise to check with your tax expert before making any moves towards a 1031.