1031 On Lease Option Sales
I have held a rental for several years, and am preparing to sell it Lease Option, but need to avoid taxes on the considerable gain.
When must I initiate 1031?
I wonder if I do it after receiving the "down payment" or "Option Fee" will I have violated the timing rules? Will I be forced to put the fee in the hands of the intermediary to protect it from taxes?
How does this work with Lease Option?
I am showing this house now, so I need answers soon.
Thanks
Dan
As I see it, there are a couple of ways to go about this.
1. Assuming your tenant buyer absolutely will exercise the option to purchase, open an exchange escrow account with your qualified intermediary before entering into the option agreement. Have the tenant buyer pay the option consideration directly to your qualified intermediary to deposit into your exchange escrow account. When the time comes for your tenant buyer to purchase, have the settlement agent disburse the proceeds of the sale to your qualified intermediary to deposit into your exchange escrow account. Your 180 day exchange window starts on the day settlement closes on your relinquished property.
2. In the event your tenant buyer does not exercise the option to buy, wait until the tenant buyer gives you a 60 day notice of intent to exercise. Upon receiving notice, open an exchange escrow account with your qualified intermediary and proceed to settlement on your relinquished property. Have all sale proceeds disbursed to your qualified intermediary and start your 180 day exchange clock on the day of settlement. Any option consideration you have already received will be taxable boot, but this amount should really be minimal.
Thank you for taking the time to reply.
I am still searching for a qualified intermediary here in Richmond.
I havn't heared back from my tax lady on her opinion about what 1031 will save me over just selling & paying. A previous rental had little gain, so it was cheaper to pay taxes than an intermediary.
Thanks.
I contact my qualified intermediary usually within a week or so of closing. This is coordinated with the escrow handling the closing so that any funds that are due me are sent to the intermediary.
NewKiddInTown is right on the money. The most important point is to have the QI assigned into the transaction BEFORE you convey title to the buyer.
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Using this example where the lease/optionee previously paid an option fee.
We reflect the option fee on our books as "Deposit Payables: Option Fees". Do you think it would be possible to pay this option fee out of your account to the intermediary on behalf of the buyer towards the purchase price and thereby avoid having this previously received option fee counted as taxable boot?
Would you rather make $12K quickly and easily or pass on the deal entirely because the tax bite chews up a large chunk of your profit?
Hi HiloGuy,
The build-to-suit 1031 exchange (also known as an improvement or construction 1031 exchange) is not an all or nothing proposition, which is a great thing. So, in your example, if you are in the middle of a build-to-suit 1031 exchange transaction, have reached the end of your 180 calendar day exchange period and are only about 90% complete with the construction, you must make sure that the acquisition/transfer of the property from the qualified intermediary - including the transfer of legal title from the qualified intermediary - is completed NO LATER than the end of the 180th calendar day. I am assuming that in your example 90% completed means that 90% of your remaining 1031 exchange funds have been disbursed AND that the corresponding 90% of the construction has been actually COMPLETED. If this is true, then the 90% that has been completed would qualify for 1031 exchange treatment and the 10% that has not been completed would not qualify.
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