Navigating Non-Conforming and Unpermitted Renovations in a 1031 Exchange Deal

Navigating non-conforming and unpermitted renovations in a 1031 Exchange deal can be complex, especially for investors looking to maximize the tax deferral benefits. When it comes to properties with unpermitted or other non-conforming work, such as additions or renovations that don’t meet local building codes or AOAO regulations, these issues can have significant implications for the buyer and seller.

For Buyers

First, it’s crucial for buyers to be aware that unpermitted renovations may affect financing, insurance, and the overall value of the property. Some mortgage lenders often hesitate to approve loans for properties with unpermitted work, or at the very least, usually refuse to include unpermitted additions to a property in the valuation assessment for loan purposes. Similarly, insurance companies may either deny coverage or exclude the unpermitted portions from their policies, leaving the buyer vulnerable if something goes wrong in the future.

For Sellers

From a legal standpoint, unpermitted work must be disclosed to potential buyers of Hawaii property, and failing to do so can result in significant penalties or legal challenges later down the road. Sellers must be transparent about any non-conforming work, and buyers should carefully inspect all documentation related to permits and AOAO rules and regulations. If unpermitted and or non-conforming work is discovered, buyers can negotiate for either a price reduction or require the seller to bring the renovations up to code, if not previously disclosed and accounted for in the listing price. Alternatively, if the buyer accepts the property “as-is,” they must be prepared to handle potential future remediation, which could involve securing retroactive permits or even undoing some of the work if it doesn’t meet current standards.

Know the 1031 Exchange Facts

For investors using the 1031 Exchange mechanism, it’s important to ensure that any necessary corrections to the unpermitted work won’t derail the tight timeline required for deferring capital gains taxes. Missteps could result in the buyer losing their 1031 tax benefits.

Overall, while investing in a property with non-conforming or unpermitted renovations can offer attractive returns, it carries additional risks. Consulting with your real estate agents, real estate attorneys, inspectors, and financial advisors can help manage these risks while maintaining the 1031 Exchange benefits.​

Sample Property

If you are interested in in this type of property, here is an example of a property currently listed for sale in Kailua:  599 Keolu Dr. #B in Kukilakila (MLS 202423607). This property is a good example of a property with some unpermitted and non-conforming additions that have been properly disclosed by the seller and reflected in the listing price while also demonstrating quality monthly rental income/cash flow along with significant capital appreciation of the last five years. This property just might be the ideal 1031 exchange property for the right investor buyer. If you want to know more about this property, I would be happy to schedule a showing and provide you with any additional information your desire…..Just reach out to me and we can take a look and discuss the pros and cons of purchasing this type of property.

Investing Disclaimer: While the property in Kukilakila presents the possibility of positive rental income potential and associated appreciation, it’s important to remember that real estate investments are inherently subject to market fluctuations. Rental income can vary based on tenant demand, local economic conditions, property management, and government regulations.  Similarly, capital appreciation is influenced by broader market trends. No investment is ever guaranteed, and real estate is no exception. As with any financial endeavor, there are risks, and returns are not assured. Investors should always consider these uncertainties when planning their investment strategy to make informed decisions that align with their risk tolerance.