Have multiple properties you’re looking to sell and wondering how to reduce your taxes? Or, are you selling one property and purchasing multiple properties? This article will explain how you do a 1031 exchange with multiple properties.
Relinquish One Property and Buy Multiple Replacements
The most common situation when multiple properties are involved in a 1031 exchange involves selling one valuable property and buying multiple rental properties. This is usually done in areas with high appreciation over the past 10-20 years. Areas where this method is popular include states such as California, Hawaii, New York, and Massachusetts.
Consider this scenario:
Investor A owns an investment property in Seattle and has rented it consistently over the past 10 years. While the cash flow is still positive, the property has appreciated to nearly 5X the original purchase price. Investor A is approaching retirement age, and looking for higher income. Instead of paying taxes when selling the property, they do a 1031 exchange and buy multiple properties in a cheaper area. Another option is a Delaware Statutory Trust, where an investor owns a portion of a much larger commercial property.
What are the benefits of relinquishing one property and buying multiple replacement properties?
There are many benefits to selling one valuable property and purchasing multiple. The first is that you are reducing risk. If the neighborhood or metro area the property is in goes south, you are relying on a single building for income. During the great recession many investors who held properties in one area were hard-hit by the downturn.
The second benefit to a 1031 exchange with multiple properties is cash flow. Moving your real estate holdings to an area with lower property values means you’ll have higher cash flow. For example, say you’ve owned a rental property in Boston for 15 years and it’s now worth $4 million. Other areas of the country tend to cash flow higher, so you could sell the Boston property and buy 10 duplexes in Cleveland and increase your cash flow.
The third benefit is that you are able to avoid potential housing bubbles in an area. Many real estate markets such as Seattle have seen property values decrease from bubble levels. A 1031 exchange into multiple properties allows you to move out of a “bubble” area and into a steadier market.
Many investors are concerned with the risk of owning multiple properties in the same metro area or in the same neighborhood. If there is a major employer that moves from the region or industry an area relies on goes south, your property values will be affected. Also, if you own multiple properties spread out over a metro area or multiple states, this can be difficult to manage.
Relinquish Multiple Properties and Buy One Replacement
Consider this scenario:
Investor B lives in Los Angeles and owns single family homes throughout LA, Orange County, and San Diego. They’ve decided the rentals are hard to manage, since they have separate maintenance teams for each location. Also, driving to check in on each property takes hours in Los Angeles traffic. Through the 1031 exchange process she would be able to relinquish (sell) all of the properties within a 45-day period and move the value into a single replacement property.
What are the benefits of selling multiple properties into a 1031 exchange?
There are many benefits to relinquishing multiple properties and buying one replacement property. The first is a reduction in maintenance and logistics for these properties. In Investor B’s scenario, they have to drive all over the Los Angeles metro in order to check in on their single family homes. By consolidating into one large property, you can reduce time spent on check-in’s and increase cash flow by potentially hiring a single management company.
The second benefit is the ability to move to a different type of commercial real estate. In Investor B’s scenario, they could sell multiple single family homes and purchase a warehouse or commercial retail building. If an investor purchases a NNN property, they eliminate maintenance concerns and likely earn a higher monthly cash flow.
What are the rules for a multiple property 1031 exchange?
The rules for a regular 1031 exchange are tough, but multiple properties are the next level of complexity. We recommend talking to a 1031 exchange qualified intermediary for guidance. We reviewed the 7 best 1031 exchange companies in the United States. Below are the rules to consider for a 1031 exchange with multiple properties.
- The 180-day completion and 45-day identification timelines begin when the first of multiple properties are sold
- The replacement property must be equal or greater value than the relinquished properties. This can be challenging when coordinating multiple sales within a tight deadline.
- You can identify more than 3 replacement properties, but the value cannot exceed 200% of the property being sold. This can be especially challenging for a multiple property sale.
These rules can be challenging to follow when coordinating multiple sales. Commercial properties have a longer sales process than single family homes, due diligence alone can take 180 days! Following the timelines can be nearly impossible in some scenarios.
Fortunately, there are some alternative solutions when doing a 1031 exchange with multiple properties
- Do a separate 1031 exchange for each property you sell. This can be expensive but ensures that you don’t sell a property below market value to meet the 180-day timeline
- Sell multiple properties and buy into a Delaware Statutory Trust (DST). A DST is a fractional ownership in a commercial property. This can be an effective solution to ensuring the replacement property is equal value to your relinquished properties.
- Stall when selling your old properties while you find and negotiate the replacement property. Then you can close on both within a short time frame.
- Do a reverse 1031 exchange so the replacement property can be purchased by an Exchange Accommodation Titleholder (EAT) before the sale of original properties.
If your situation is complex with multiple properties, we highly suggest speaking to a 1031 qualified intermediary. They will be able to assess your situation and recommend a plan that keeps you out of the IRS’ doghouse!