1031 For Rehab Costs?

I am considering the benefits of a 1031 exchange, and realize there are a lot of details I am ignorant of.

I purchase properties that are structurally sound but need a lot of rehab- generally I wind up spending half or two thirds as much on the rehab as the property initially cost.

Is there any way to include rehab costs in a 1031 exchange? Essentially I will be spending my basis in the property I am selling on new properties, and my profit on rehab costs. If I have to pay taxes on the money I need for the rehabs, there is little point in doing the 1031 exchange in the first place.

Thanks for any insight!

Chris

Yes, you can have rehab costs covered under your exchange umbrella. Essentially you structure a construction exchange

First settle on your relinquished property and have your Qualified intermediary escrow the exchange proceeds

Next, your QI takes title to the replacement property using your exchange funds for the purchase. Your QI orders the rehab and pays contractors from your exchange escrow account.

Lastly, after all the rehab is done, the QI reconveys title to you and the exchange is closed.

Because the QI has title to the property, and has more risk of liability exposure, your exchange fees will be a lot higher than a typical forward exchange.

If Bill Exeter still participates in these forums, perhaps he can fill in some of the details, or, you could go to his website for more information.

[ Edited by NewKidInTown3 on Date 12/31/2007 ]

Thank you, Newkid. Complex, but not impossible. The additional cost of using contractors for everything could exceed the tax burden, as I usually do most of the work myself, but perhaps the property could be transferred to me partially completed after the contractors have done what I need them for.

I can see this is going to take some thought, and more information. I was planning on using Bill Exeter if i went through with an exchange, as his advice and information here has always been very astute and well informed. Haven't heard from him here in a while, but your advice of looking for his website is good.

Chris

Try http://www.exeter1031.com

If you are doing your own labor, your QI might still be able to purchase the materials you need under your exchange umbrella. Would probably have to be a direct purchase to avoid constructive receipt of exchange funds.

[ Edited by NewKidInTown3 on Date 01/01/2008 ]

Very professional looking site- I passed my questions on to Bill.

Thanks again...

Chris

What I am trying to say is that using contractors rather than cheap labor (including my own) may cost me more than just paying the capital gains taxes on my profit and hiring cheap labor or doing it myself.

All this may be moot in any case, as Mr. Exeter informs me that an LLC is personal property, and cannot be exchanged for real property. Since the profits will be coming from the sale of an interest in an LLC which holds title to the property rather than the property itself, I do not think I will be able to arrange my affairs to take advantage of a 1031 exchange in any case.

While I intend to discuss with him the options available to me, if anyone here has any ideas about how to get around this issue please let me know...

Chris

Well, we didn't know your proposed relinquished "property" is an LLC. Is the property the only asset owned by the LLC? If so, then why not sell the property and keep the LLC for your replacement property?

Notwithstanding, what was Mr. Exeter's answer with regards to your 1031-rehab question?

Mr. Exeter's answer was essentially the same as yours- it can be done as a construction exchange, as long as whatever construction I want done with the exchange money is completed within the 180 day window. Cost $5-6K. Cannot hire myself for the work.

Three parcels of property are "all" that is owned by the LLC (over 2600 acres); however as I only own just over 11% of the LLC, and will only be selling half of that, selling the property and recycling the LLC is not an option.

I do understand the difficulty of providing an accurate or complete answer with incomplete information, and certainly don't fault you for that. As always, Newkid, your advice and information are spot on and very much appreciated.

Chris