1031 exchange on a Lease Option

[Faraglioni]

Is it possible to do a 1031 exchange on a property that sits in the lease option and will be purchased in a couple of months?
thanks

[William L. Exeter]

Can you provide a few more details?  When would the actual closing/sale occur?  When would legal title to the property be conveyed?  

[Faraglioni]

I have a property that is in lease option and the lessee will be purchasing it from me on May 30th. Can I use the proceeds for 1031 exchange? Meaning, can I sell his property and buy a couple of rehabs?
Thanks

[John Hyre]

When you say "you have a property", I take that to mean you own it presently.  If you controlled via sandwich lease-option, for example, that would likely make a difference.

In the former case, you can likely do a 1031, though any "option money" received to date would probably be taxable, as it is outside of the 1031.

John Hyre

[jashome]

Hi all,

Actually, I'm new to posting on this site.  However, I have enjoyed reading the questions and responses regarding many matters of real estate, as well as other points of interest on this site.  Kudos to the brilliant individuals who created it!    

I had a question, also, on the 1031 Tax-Deferred Exchange Law on a Lease/Option property.  If, for example, I purchased a property on April 15 for $100,000, stated in the contract that I have 6 months to exercise my option, and was able to secure a buyer within 2 months after my initial lease/option (and exercised my option soon afterwards), and sold the property to the potential buyer for a decent profit, say, $40,000, how much of that is taxable?  Keep in mind, I used the $140,000 that was paid to me by the buyer, to pay the initial seller for exercising my option.  

Would I need to invest the entire $40,000 into another property, or could I keep it as pure profit?  What are the legal ramifications in doing this transaction?

Responses are welcomed, and appreciated.  Thank you for your help!

jas3030

[Bud Branstetter]

1031 exchanges are permitted for investment properties that you own.  If you have an option to buy then you do not own and cannot do a 1031 exchange.  You typically have to own it for a year and a day.

Now, if you rhad done or redid the option from the seller to your Roth IRA then you could assign the option to the buyer for the profit which would go into the Roth tax free.

[jashome]

Thank you, Bud, for your response to my 1031 question.  Of course, that leads to another question: is that $40,000 I received from the sale of the L/O property going to be taxable?  (Please review my previous post.)

Because I used the majority of the money the potential buyer gave me for the property, when I turned around and gave the original seller his payment (after I exercised my option to buy the property), what happens to the $40,000?

Please let me know.  Again, thank you for your previous response, and if you or anyone knowledgeable about this transaction has an answer, I'd truly appreciate hearing from you.  Thanks again!

[Dave T]

jashome,

In a nutshell, you are acquiring property primarily to resell for profit.  Your actual profit on the deal would be taxed as self-employment income at your ordinary income tax rate.  In the absence of a business entity, you would report your income on Schedule C and Schedule SE.

[jashome]

Thanks, Dave T.  That's what I needed to know.  (I'm glad I'm keeping good records!)  I'm working on a first sale now; when I complete it, I'll be able to hire either an excellent bookkeeper or a CPA/Tax Attorney.

Thanks again!    

[Bud Branstetter]

If you have a full time job and only make additional income a good CPA will likely have you report it as investment or option income thus saving you SE tax.  When it becomes your primary source then you will be self employed and should pay SE income on a short term investment.

[jashome]

EXCELLENT advice, Bud!  As a matter of fact, I do work a 9 - 5 job, so that's great to know that the taxes won't hit me so hard.  I will definitely take your advice under consideration.  Thanks again!

[chatterweb]

What about preconstruction (2nd home) and 1031 exchanges? I need more information about if a 1031 is permitted on preconstruction, and what like property it is exchanged for.

[Dave T]

chatterweb,

Neither your primary residence nor your second home are eligible to participate in a 1031 exchange.  

If you have further questions, it would be better to start a new thread with a subject title related to your question.