What would 1031 exchange look like in our scenario

Question

We have an investement property, which we plan to sell and buy propertie/s in 1031 exchange. Have questions around those. Please help.

Let's say we we bought the proporty for $600K, sell the property for $1M , say a morgage of $400K was pending at the time of selling, say $80K is closing cost, say we spend $50K for rennovation before selling.

1. What would be the total reinvestement amount expected under 1031 exchange?

2. Does the new investment have to be a single property or can we invest in 2 new properties where the total value comes close to #1?

3. Since we have mortgage on the selling property, are we required to get a morgage for new property as well or we can do all money down ?

4. If we are unable to reinvest all required amount for 1031 exchange, what portion of the gains get taxed ?

Thank you! As always appreciate your help.

Dave Foster · Answer

@Ana Vhan,

1. like @Bill Brandt said you must purchase at least as much as your net sale ($920K) and use all of your proceeds ($520K) in your purchase or purchases. The $50K that you put into renovations right before the sale will go into the basis of the 1031. So you can't get paid back for it without paying tax on it. UNLESS... You borrow money to improve the property secured by that property. Then the $50K has to be paid back as part of the closing.

2. You can purchase one or multiple replacements. And you can allocate your proceeds any way you want. It's very common for our clients in your situation to buy one property for $400K cash. And then use the other $120K to purchase a $600k property with a mortgage. That way you purchase at least as much as you sold. You use all the cash to do it. So, no tax. But now you also have a free and clear property with equity concentrated. So if you ever wanted to you could do a cash out refi on it and use that tax free cash to buy another property.

3, You do not have to replace the mortgage with a new mortgage. But you do have to purchase at least as much as your net sale and use all of your proceeds. If you have funds of your own then that is fine.

4. Any amount you purchase less than you sold. Or any amount of cash you take out would be taxable first.

Hope that helps!

Bill B. · Answer

Amount you paid and the amount owed don’t matter for the replacement requirements.they only determine the amount of taxes you’re saving and the amount of cash you must reinvest n

Your replacement needs to be $1M minus the $80k in closing costs, $920k or more.

You must reinvest the $520k in “cash” you have left after paying off mortgage and $80k in closing costs or you will owe taxes on cash retained even if you buy more than $920k in property

You can invest in any number of properties but it’s much easier if you list 3 or less replacement properties. If you spend less than $920k you’ll pay taxes on the shortage.

If you have $400k in cash you can use that instead of a new $400k mortgage.

Any amount under $920k in your example would be taxable.

What would 1031 exchange look like in our scenario

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