A residential property that is not a primary residence and meets the 1031 exchange criteria can be exchanged into a commercial property. Outside of following the 1031 exchange rules, there really aren’t any special considerations. The investor is basically going from a smaller investment property to a larger one. In this article, we’ll look into the details of what’s involved when doing a 1031 exchange from a residential to commercial property.
Residential Vs. Primary Residence
We should distinguish between a residential property and a primary residence. A primary residence is not an investment property. It fails one of the primary 1031 exchange rules: the property must be held for productive use in a trade or business. A residential investment property is not one that the property owner lives in as their primary residence.
Residential Vs. Commercial Properties
Residential property is a smaller investment property compared to a commercial property. There are also some differences in tenants.
Residential properties are single-family homes and buildings with no more than four units. These include condos, duplexes, and up to quadplexes.
Residential property tenants are individuals or families who plan to use the unit as their primary residence. These properties are often hands-on management for the landlord.
Commercial properties consist of large residential buildings, such as apartment complexes and smaller buildings with more than four units. Industrial buildings, warehouses, and offices are also commercial properties.
Transitioning from Residential to Commercial Property
Going from a residential property, where a single person can often manage the property, to a commercial property means scaling up. Depending on the property’s size, it may no longer be possible for a single person to manage the property, which means additional help will need to be hired.
Commercial property tenants will include businesses rather than only individuals. The landlord will be working with individuals, of course, for apartment buildings. But for industrial spaces, offices, and warehouses, landlords will be working with business owners.
A business is generally a more reliable tenant than an individual. Especially if the business is established, some businesses are backed by larger businesses, adding more credibility.
1031 Residential to Commercial Property
From a 1031 exchange point of view, there isn’t anything special about going from a residential property to a commercial property. The two main rules to follow are that the properties be held for productive use in a trade or business rather than for personal use. And they must be like-kind properties.
Of course, you’ll want to work with your finance and tax team to ensure the properties do qualify for a 1031 exchange.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.