Invariably, when I give a seminar or speech on 1031 exchanges, a question on mixed-use 1031 exchanges is raised.
What is mixed-use?
Pretend my last name is McDonald. Further, pretend that I am a farmer. AND on my farm–E- I, E- I – O, –ENOUGH of the nursery rhyme–but if I had a farm and I lived in the farmhouse but farmed the surrounding land, I would have a mixed-use property. The farmhouse would be my personal residence and the surrounding farmland would be a property that I used in my trade or business (in this case, farming) or was being held as an investment.
I have a transaction in the office right now that is very similar to the above example but it deals with orange groves.
The Taxpayer could sell the property and use both 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 2 of the last 5 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) purchase 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 2019 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 which was 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 that would be due on the sale of the farmland (that, of course, is covered under IRC Section 1031).
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 Liberty 1031, we always recommend that the taxpayer consult with their tax and/or legal counsel on all matters dealing with the Internal Revenue Serice.
For more information on Section 1031 issues go to our website: www.liberty1031.com and visit our 1031 FAQ, Section 1031 Basics, and Section 1031 Case Studies. Or call us today at 866.903.1031. We look forward to working with you on future Section 1031 exchanges– Steve