1031 Question On Lease-option
I've got a rental that I want to offer as a rent to own. Lease + $5k for the option to purchase in 1 or 2 years.
In order to take advantage of 1031 tax breaks, must the option be paid to my 3rd party and held until the deed changes hands? Can I accept the option payment, or will that invalidate the exchange?
Many thanks in advance!
My information comes from a recent conversation with Starker Exchange. The option consideration is not considered to be part of the purchase price and does not need to be held by the qualified 3rd party.
Only the proceeds when/if the option holder decides to purchase the property.
It might be wise to have that the option holder must give 90 days or longer notice to purchase which would give you time to make plans to reinvest the 1031 money.
I'm going to throw in a little negative here, just food for thought.
By definition, to qualify for a 1031, you must have held the property as a rental for a miminum of one year with no intent to sell it. So while many investors do 1031s on their L/Os, technically, they do not qualify under that condition. Why? because by offering an option to purchase, you have an intent to sell.
Chances are that it will never be an issue. However, if the IRS wanted, I'd wager that all those L/Os put in 1031s could be recomputed as not qualifying. Then you'd have back taxes, penalities, etc. to worry about. Definitely worth your tax professional to sign off on (and be responsible for) in the event there of.
Roger
I only partially agree with rajwarrior.
You certainly must have the INTENT to HOLD the property for rental or investment. However, if you have HELD the property for rental or investment for many years and then decide to sell using a rent to own it would most definitely qualify for 1031 exchange treatment. If you acquire property and then immediately enter into a rent to own contract for a two year period I would agree that there is a risk that the IRS could disallow the transaction.
It all depends on the entire set of facts.
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Bill Exeter[ Edited by wexeter on Date 08/26/2004 ]
I'm not a 1031 expert--in fact I have never even done one. From the info I have I believe that the requirement for a 1031 is an intent to HOLD the property. I don't think they care if you intend to sell it right away or not. If you have a 2yr option on a lease, then I think you've showed that you've intended on holding that property at least 2 years?
Maybe I'm pushing the envelope but that's my nature
Hi MyFrogger,
The do care if you intend to sell it right away. You can not have the intent to hold it and also intend to sell it. That is impossible and contradictory. You must have the INTENT to HOLD it. If your actions demonstrate otherwise you run a huge risk of having your 1031 exchange disallowed during an audit.
[addsig]