Can I do a 1031 exchange to help my son buy a house?
I want to do a 1031 and give the proceeds to my son so he can buy his second home. We want to do an equity sharing arrangement and he will pay me rent for my portion at the market rate. Will this arrangement be acceptable as a 1031 exchange?
IRC section 1031(a)(1) requires that a taxpayer buy a replacement property that is "held for investment or business."
An equity share arrangement with a child (or other related party under IRC section 267) can be a 1031 replacement property provided the child pays a market rent for the interest (e.g., if market rent for the house is $1,000 and 1031 investor/parent owns 30% interest in the property through the equity share, then child must pay $300 each month). Absent a rental arrangement, the child's possession of the property (even as a second home) is considered the 1031 taxpayer's personal use of that property, thus voiding the "held for investment" requirement.
The rent should be paid for at least 2 fiscal years starting on date of acquisition.
The arrangement is typically done with child’s principal residence, but also can be done with second home.
The child and parent should have an equity sharing agreement that clearly delineates responsibility for property taxes, insurance, maintenance, etc. The loan payment may be a separate animal. The non-loan payment expenses are divided by the ownership percentage allocation; the loan payment (principal and interest) may be allocated under a different percentage, depending on the agreement between investor/parent and occupant/child.
A more thorough discussion is beyond the scope of this note. Bottom line, it can be done. There are a lot of factors to consider, an attorney should prepare co-ownership agreement and lease. Additionally a CPA or attorney with 1031 experience should review the proposed transactions to make sure that (1) the 1031 "math" works to avoid taxable gain; and (2) the co-ownership arrangement does not run afoul of the IRC section 280A rules.
If the 1031 investor/parent wants to co-invest with a child into a jointly-held rental or investment property, the rules are somewhat different. In all cases, counsel should be sought.
G. Scott Haislet, CPA, Esq. is a tax adviser, estate planner and real estate attorney.
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