Partial 1031 exchange

[Matt Smith]

I am planning to do a partial 1031 exchange but I am confused.

- I thought the rules were that in order to do a 1031 exchange I need to buy a property of at least the SAME (or more) value of the net sale of the previous one. Is it true? If not, then I "just" have to pay taxes on the difference (net sale of the old home minus purchase price of the new home)

- Can I use the closing cost amount of the old and new home as part of the tax free money I can spend from the 1031 exchange or these closing cost are purely out of pocket amounts?

[Dave Foster]

Originally posted by @Matt Smith:

I am planning to do a partial 1031 exchange but I am confused.

- I thought the rules were that in order to do a 1031 exchange I need to buy a property of at least the SAME (or more) value of the net sale of the previous one. Is it true? If not, then I "just" have to pay taxes on the difference (net sale of the old home minus purchase price of the new home)

You've almost got it.  In order to defer all taxes you must purchase at least as much as your net sale (contract price less commissions and costs of closing) and you must use all of the net proceeds (net sales amount less debt pay off) in the next purchase or purchases.  But that is only to defer all tax.  If you purchase less than what you sell or if you take some cash out as what is called "boot' you will pay tax only on the difference.  This is where the partial exchange comes in.  If you sell a house for 200K and you have a 100K gain and want to only buy a 150K replacement property you will pay tax on the 50K buy down but still shelter the remaining 50K in gain through the 1031.

The other thing that's not quite right is your last statement above.  If you don't do a 1031 at all you will be taxed on the total amount of your gain which is not the same as the difference between net sale and purchase price.   There are other calculations that you have to factor in to get to your adjusted cost basis such as recapture of depreciation and adding capital improvements to the basis.

- Can I use the closing cost amount of the old and new home as part of the tax free money I can spend from the 1031 exchange or these closing cost are purely out of pocket amounts?

Yes closing costs like commissions, title insurance, closing doc preparation, 1031 fees are decuctible and reduce your net sale.  Any of the same on the purchase do the same.  

[Bill Exeter]

Originally posted by @Matt Smith:

I am planning to do a partial 1031 exchange but I am confused.

- I thought the rules were that in order to do a 1031 exchange I need to buy a property of at least the SAME (or more) value of the net sale of the previous one. Is it true? If not, then I "just" have to pay taxes on the difference (net sale of the old home minus purchase price of the new home)

- Can I use the closing cost amount of the old and new home as part of the tax free money I can spend from the 1031 exchange or these closing cost are purely out of pocket amounts?

Let me try to simplify it for you.

Yes, you need to trade equal or up in value and reinvest all of your cash if you want to defer all of your tax consequences.  However, you mentioned that you are thinking of doing a partial 1031 Exchange.  If you pull cash out and/or you trade down in value, you will pay tax on the amount of cash that you pull out or the amount that you trade down by.  It does not affect or hurt your 1031 Exchange, it just means that you will pay some taxes.

Routine selling expenses such as broker's commissions, title insurance costs, escrow fees, recording fees, exchange fees, and the like are permissible 1031 Exchange costs and can be paid out of the 1031 Exchange proceeds.