Can I use a 1031 Exchange to sell my rental property and use the proceeds to buy another rental property for cash without incurring capital gains tax?
The answer is it depends!
There is a two part rule for successfully deferring all tax on a 1031 exchange. First you must purchase at least as much as you sell (your net sales price before mortgage payoff). Second you must use all of your proceeds (after mortgage pay off) in the next purchase.
So if you are replacing the property you sell with one that is more expensive and you are using all of the cash in your exchange account plus cash from the outside so you own the replacement property for cash then yes you can do that.
If you are buying a property that is less expensive than what you sold and you only want to use the cash after loan payoff so that you don't replace the debt then no you cannot do that. The IRS will always take the stance that whether you buy less than what you sold or you take cash directly out of the exchange, you are taking profit. It is called boot and is taxable.
You can still do this. It is called a partial exchange. But make sure that there is enough profit and tax liability left to make it worth doing the 1031.
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