This is pretty rare for most investors, but we think it’s worth planting a flag here. If you or your business work with appliances, inventory, and other non-real estate assets, pay particular attention.
Consider the following scenario:
- You identify a $2 million Widget factory and warehouse.
- These come with another $350K in machines necessary to create the Widgets.
- You have $1.4 million in 1031 exchange proceeds from your prior sale.
- Your lender will finance up to $1 million for the purchase of real estate.
You have $2.4 million in potential purchase funds and only $2.35 million worth of real estate and equipment. Let’s also say that your lender will only allocate loan proceeds to pay for the factory and warehouse.
Now you have a problem.
Per IRS rules, those Widget machines are NOT like-kind to real property. You can’t trade $350K of real estate for $350K of equipment and defer taxes. If you use 1031 proceeds to pay for the Widget machines, you’ll recognize personal property boot.
We would suggest that you pay for the machines with outside cash. If you could not do that, maybe the lender could be flexible.
As a last resort, you would divert 1031 proceeds and deal with the ensuing taxes.