Q: I own two investment properties with my dad in Sacramento. I live in Seattle and am thinking of purchasing a residence here, but have some questions on a 1031 Exchange:
1. The title & mortgage are held in both our names for the houses in Sacramento. Do both our names have to be on the new property's title/mortgage? What happens if my Dad dies or I get married and title has to change?
2. Do the full proceeds have to be used for the down payment of the new house, or can some be used for upgrades on the property?
3. Can both our properties be rolled into the 1031 exchange?
Thanks for any assistance. -- Scott, Seattle, WA
A: 1. If two people own a piece of investment real estate, such as a father and son, and one wants to engage in a tax deferred exchange, the other owner does not have to engage in the exchange. Each owner's tax consequences will be determined separately, based on whether they meet Section 1031's requirements for tax deferral. If one of the owners does not acquire qualifying replacement property, they would have to recognize gain or loss, as the case may be.
If both owners engage in an exchange, receiving "like kind" property, and one dies, what happens to their interest depends on two factors: how title to the property is held and whether they have an estate plan in place. If the property is held as joint tenants with rights of survivorship, which is common with married couples, the decedent's interest passes to the other joint tenant by operation of title. The surviving owner would then become the sole owner of the property. If title is held as tenants-in-common, and the decedent executed a will, then their interest in the property would pass in accordance with the terms of their will. The surviving owner's interest would not be directly affected.
2. If an owner of investment property wishes to defer the entire gain from the disposition of investment property, then the replacement property must cost at least as much as the net disposition amount of the original property and they must invest their entire equity from the original property in the replacement property. Unless both of these conditions are met, the owner of the original property will have received "boot," property that is not "like kind," which will trigger recognition of gain.
3. More than one property can be exchanged into a single replacement property.
Be aware that only property used in a trade or business or held for investment qualifies for tax deferral under Section 1031. Exchanging rental real estate for a principal residence or vacation home will not qualify for deferral of gain. Given the complexity of the rules concerning tax deferred exchanges, it is important to get competent advice before engaging in the exchange. This is certainly one area where an ounce of prevention is worth a pound of cure.