Invariably, when we give a seminar on 1031 exchanges, a question on mixed-use 1031 exchanges is raised.
What is mixed-use?
If you had a farm and lived in the farmhouse but farmed the surrounding land, you would have a mixed-use property. The farmhouse would be your personal residence, and the surrounding farmland would be a property that you used in your trade or business (in this case, farming) or was being held as an investment and could be used in a mixed-use 1031 Exchange transaction.
In this scenario, you (the Taxpayer) could sell the property and use sections 121 and 1031 of the Internal Revenue Code (IRC). How does that work, you ask? Under section 121 of the Internal Revenue Code(IRC), a taxpayer can sell their personal residence, and if they lived in the personal residence for two of the last five years, up to $250,000 of profit per person or up to $500,000 per married couple, can be received TAX-FREE.
That, of course, is presuming that the personal residence (in this case, the farmhouse) went up that much in increased equity. The remaining portion of the sales price could be allocated to the farmland, which would qualify for a Section 1031 exchange.
A Mixed-use 1031 Exchange Example:
Mr. and Mrs. McDonald (the taxpayers) purchased a farm for $300,000 in 2001. It has a farmhouse on it and 50 acres of farmland. The farmhouse is valued at $200,000, and the land is valued at $100,000 (that, of course, equals $300,000).
In 2023 they agree to sell the farmhouse and the 50 acres for $1,100,000. If they can justify the value of the farmhouse at $700,000, they could receive the profit on the farmhouse TAX-FREE (sales price of farmhouse $700,000 less original purchase price of $200,000 equals a TAX-FREE PROFIT of $500,000 under IRC Section 121).
The farmland, originally purchased for $100,000, is now worth $400,000, so there was a profit of $300,000 on the land.
The taxpayer could transact an IRC Section 1031 exchange on the $400,000 of land and purchase another real estate investment for $400,000 or more. If taxpayers did that, they would defer any and all taxes due on the sale of the farmland (that, of course, is covered under IRC Section 1031) in this mixed-use 1031 exchange.
It’s a convoluted example–but WOW–what a way to save money, pay no tax on the personal residence profit, and defer paying tax on all of the other profit.
At Affiliated 1031, we always recommend that the taxpayer consults with their tax and/or legal counsel on all matters dealing with the Internal Revenue Service.
To learn more about how 1031 Exchanges can help investors defer capital gains taxes visit our page Understanding 1031 Exchanges. Or call us today at 877.873.1031. We look forward to working with you.
