Tax implications on a 1031 exchange

[Annie Le]

Hello everybody,

I am trying to figure out the tax implications, if any, for a client who is doing a 1031 exchange. I don't believe she should have any tax implications but would like a 2nd opinion.

Original rental property bought for $255K

Mortgage remaining: $166K

Sold this rental property for $380K

So in essence, her net profit is $125k

Bought a rental property through the 1031 exchange for $127k

So based on the above, she should be okay BUT here is what I'm not sure about:

When she sold her property for $380K, $166K was used to pay her mortgage and $214K went into her account with the Qualified Intermediary.

The purchase of the rental property as mentioned was $127K and with closing costs, fees, etc the total came out to $150K which they subtracted from the $214k in her account.

So she is left with $64K. The Qualified Intermediary withheld taxes for her at 10% and gave her proceeds of roughly $57K.

So the question is, does she have to report the proceeds that she is receiving? And if so, is she going to pay taxes on this amount? It would seem that she shouldn't have to since she technically did an even exchange.

Any input would be appreciated....thanks in advance!

[Bill Exeter]

Hi Annie,

I have bad news for you.

She did not do an even exchange.  She traded WAY down in value, so based upon the numbers that you provided the 1031 Exchange will provide NO tax-deferral at all.

In order for her to defer all of her taxes she must acquire replacement property that is equal to or greater in value based on the NET SALE PRICE (not her gain or profit). 

So, if she sold for $380,000, and her selling expenses were about $20,000, then her net sale price is $360,000, and she would have to acquire one or more properties valued at $360,000 or more. 

She has traded down by well over $250,000, which is more than her taxable gain, so she will recognize all of her taxable gain and pay all of her taxes.  Her qualified intermediary should have pointed that out to her.