Can I use a DSCR loan for my replacement property?

Any mortgage on the replacement offsets the debt you were relieved of

Reg. Section 1.1031(d)-2 treats liabilities on the property you give up as money received, and its examples let liabilities on the property you receive offset that relief. The regulation looks at the liability, not at how the lender decided to make it. A loan sized to the property's rent works the same as one sized to your tax returns.

The offset runs one way only. New debt offsets debt relief, but it does not offset cash you take out, which is why the down payment should come entirely from the exchange account. The mechanics are in using exchange funds as the down payment and replace the mortgage or add cash.

The LLC the lender wants on title must still be you for tax purposes

Lenders making rent-based loans often require the borrower to be an entity rather than an individual. Under Reg. Section 301.7701-3(b)(1), a domestic LLC with one owner is disregarded as separate from its owner unless it elects otherwise, so title in a new single-member LLC you own is title in your name for section 1031.

The same paragraph makes an LLC with two or more members a partnership by default. If the lender wants a co-guarantor added as a member, or you put a spouse into the LLC, the buyer of the replacement may no longer be the seller of the relinquished property. The rule and its exceptions are in the same-taxpayer rule and can an LLC do a 1031 exchange.

Agree the vesting with the lender and your intermediary before the loan application, not at the closing table.

It is business credit, so read the prepayment terms yourself

Regulation Z exempts credit 'primarily for a business, commercial or agricultural purpose' in 12 CFR 1026.3(a), and the official interpretation says credit to acquire, improve or maintain rental property that is not owner-occupied is deemed business purpose. If you expect to occupy the property for more than 14 days in the coming year, that rule does not apply.

The limits on prepayment penalties in 12 CFR 1026.43(g) apply to consumer credit secured by a dwelling, so they do not cap penalties on a business-purpose rental loan. Any limit comes from state law or the loan contract. A penalty matters to an exchanger because the next sale pays off this loan.

A hypothetical: $1,000,000 replacement with a rent-based loan

Hypothetical figures: you sell a rental for $900,000, a $400,000 mortgage is paid off, and $480,000 reaches your intermediary after $20,000 of closing costs. You buy a $1,000,000 rental through a new single-member LLC, with the $480,000 as down payment and a $520,000 rent-based loan.

Debt relief of $400,000 is more than offset by $520,000 of new debt, and all the exchange cash went into the property, so no boot arises from the financing. If the lender's $10,000 of origination charges had been paid from the exchange account, that would be a different story. Run your own numbers with your CPA.

Protect the timeline, and know when a DST replaces the loan

Start the loan application as soon as the property is under contract, and give the lender your day 180 in writing, because the appraisal, the rent analysis behind the coverage ratio and the entity documents all take time. Identify more than one property by day 45 if the loan is not yet approved, so a failed approval does not end the exchange.

A lender's appraisal or underwriting delay does not move day 180; see whether a lender delay extends the deadline. Pay origination fees, points and lender reserves with your own funds, for the reasons in loan fees and points paid from exchange funds.

If qualifying for a loan is the obstacle, an interest in a Delaware Statutory Trust carries the trust's own financing, and your share of it can count as replacement debt; see whether a DST loan counts as replacement debt.