Is a partial 1031 exchange possible?

Question

Is it acceptable to plan on doing a 1031 exchange with only part of the profit from a real estate sale? Can I take a potion of the profit and reinvest it tax-free while using the remainder for another purpose (and then paying tax on that remainder)?

In other words, is a 1031 exchange an all-or-nothing proposition?

In other words, is a 1031 exchange an all-or-nothing proposition?

Dave Foster · Answer

@Christopher Throop, That's exactly what you can do. The requirements for full tax deferral are that you purchase at least as much as your net sale, and that you use all of the proceeds in the next purchase or purchases. If you buy less than what you sold or if you take some of the cash out you can but will pay tax on that difference. Pay close attention to your total gain so that you don't inadvertently take out so much that you lose any tax benefit.

One other option to continue with full tax deferral would be to complete a full exchange and then immediately do a refi to tap the cash you need.

Robert Hetsler · Answer

@Dave Foster   Is absolutely correct. The only thing that I would add to his response is to keep in mind in that in a 1031 exchange, the capital gain calculation is reversed such that the IRS looks at every dollar taken out first as gain plus ( Federal and State level)  along with any pro rata share of depreciation recapture and then basis.  Alternatively, when a 1031 is not an issue you think about it as receiving your basis first in your gain only after and so I believe that's what David was saying at the bottom of his post but I just wanted to strengthen it up a little bit.  Bottom line is that he is correct that you must be careful that you don't take so much out that you loose all the benefit of the tax deferral. Best of luck to you

Christopher Throop · Answer

@Ahmed Mahmoud  I haven't yet spoken to any QIs, but its on my short list of things to do.  Let me know if you find a good one.  I'll do the same.

Christopher Throop · Answer

@Dave Foster, @Robert Hetsler

Thank you both for your answers.  That's what I was hoping to hear!

Pradeep Narayanashetty · Answer

@Dave Foster: Thank you for the clear answers to my questions. Appreciate it. I've read your other responses as well, but these were very specific to my case. I'll share any learnings from this current proceeds back to the community.Cheers,Pradeep

Dave Foster · Answer

@Pradeep Narayanashetty  You've got a lot of options.

1. Any type of investment real estate can be exchanged for any other type of investment real estate.  So going from condo to MF is absolutely fine.

2. In order to defer all tax you must do two things - first you must purchase at least as much as your net sale (contract price minus closing costs but before mortgage pay off).   Second you must use all of your net proceeds (the cash after mortgage is paid off).  In your case you are anticipating taking $20K in cash so you're going to pay tax on that amount.  In that event you would need to  purchase at least $205K ish in new property and use all $70K remaining cash to do so if you want to avoid further tax.

The refi route would save you the tax on the $20K but you'd have finance costs.  It may be a wash.  You can also leave the 20 in until the last minute and decide at the time of purchase whether to use it or take it.  the decision does not have to be made at sale.

3. Since your net sale is $225K ish or with the boot $205K ish then that is all you must purchase.  If you wanted to put your partner on deed as a tenant in common for the remaining % of the property that would be fine.  As long as you actually take title to as much real estate as you sold.

Pradeep Narayanashetty · Answer

I wanted to jump in here with my story which is similar and get some follow up questions/tips answered (Apologies if this is breaking any forum etiquette).

Property was bought 2 years ago at $125k and I spent $20k to fix it up and rented out for a year.

I am currently in the process of selling it at $225k (With estimated $90k available at closing after deducting closing costs, pay off remaining loan, agent costs etc.). I've requested for a 1031 exchange option and also mentioned that I might do a partial exchange (For some liquidity). The $90k will be split into $70k towards exchange and $20k cash out (I'm open to ideas on doing this differently - I've seen suggestions of going full $90k towards exchange and then refi).So, here are my questions:

• Can I switch from condo sale to multiplex purchase as a part of the exchange?
• Should the future property be greater than or equal to $225k even if I do a $70k towards 1031 exchange.
• If the future property exceeds $500k, can I add a friend (who is going to be my business partner) as a partner on the property ownership and still qualify for the exchange? I plan to do the loan entirely on me and he is not going to be on the loan.

Thanks,Pradeep

Dave Foster · Answer

@Lawrence Francis, Yep his lack of planning became your emergency - bummer.  It's probably still worth looking at the scenario where you do the 1031 and use the cash down to buy replacement whether hard asset or a fractional and take the note as boot.  If your accountant structures it right you should still be able to defer over several tax periods.

One thing definitely - stick your buyer with a healthy pre-payment penalty since he's the one who's forced you into a gain recognition situation.

Lawrence Francis · Answer

I think I'm just going to be forced to pay the  taxes.  The idea of doing a fractional interest is kind of extreme, even  for me.  I suppose I could take a security interest in another property  to avoid getting all that cash in one tax filing period.  But the  problem is that we have a really strong offer from someone doing a 1031  exchange and we have to match the % of financing / free & clear that  he exhibited in his previous transaction.  If we could have been  involved in the planning of his previous transaction maybe we could have  tried to induce him to take a line of credit or heloc to drive down the  % of free and clear (which translates into cash for us).  But I guess  that ship has sailed.

Lawrence Francis · Answer

I think I'm just going to be forced to pay the  taxes.  The idea of doing a fractional interest is kind of extreme, even  for me.  I suppose I could take a security interest in another property  to avoid getting all that cash in one tax filing period.  But the  problem is that we have a really strong offer from someone doing a 1031  exchange and we have to match the % of financing / free & clear that  he exhibited in his previous transaction.  If we could have been  involved in the planning of his previous transaction maybe we could have  tried to induce him to take a line of credit or heloc to drive down the  % of free and clear (which translates into cash for us).  But I guess  that ship has sailed.

Is a partial 1031 exchange possible?

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