Question about trading up

10 Replies

I think I have missed this aspect of 1031 exchanges. Can anyone clarify for me? Thanks - Here's my example. I have a mortgaged rental property SFH. The original sale price was $154,500. I currently owe about $130k and I plan to sell it fairly soon. I should clear about $215,000 when I sell it giving me $85000 left over. My plan was to use that money to purchase a duplex in another state for the full amount in cash, but now I'm reading about the new purchase property has to cost more than the house I sold? Is that how much I sold it for? How much I bought it for? More than the $85000? Trying to figure out how much I need to pay for the new property. Thanks!

If the property you are selling is $215k, the new property will need to be greater than that price. That is my understanding.

Also you may want to get some quotes on prices for how much the qualified intermediaries that hold the money, how much they cost.  I am in the process of selling a property now and was considering doing a 1031. But when I factored in the costs of doing so, and going into the next property with a really low cost basis, I elected to just pay my taxes now instead of deferring them down the road.

@Garrett Bailey , if you want to fully defer all tax through a 1031 exchange you would need to do two things in your example - Purchase at least 215K in real estate, and use all 85K to do that.  It doesn't need to be one property and you can take money out or buy less but you will pay tax on the difference.  

For what you're talking about doing you will be buying down so much that you would not shelter any of the gain so the 1031 would not be the right move.  But in thinking about using all 85K for a new property purchase you'll want to factor in 15 - 25K for taxes.  So that will put a dent in the war chest for sure.

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My understanding is that you must replace the full amount of the debt AND the equity based on your selling price. So if you sell a property for 200k, buying a duplex for $85,000 will not work. You will need to buy something that is more expensive than what you sell.

I'd recommend contacting a good 1031 intermediary and see if they can explain the process. Also recommend meeting with your Accountant and Attorney for your first 1031 just to be sure that everybody is on the same page.

Thank you for all the answers. I guess I don't really understand the point of doing a 1031 exchange then. If I have a house worth 225 and 85k equity, why would I want to sell that house and buy one for 225 or more with 85k in equity???

I can see some cases where it could be more beneficial with some of my properties that are worth a lot less. It just doesn't seem like the house I have the example for will be good for me to go the 1031 exchange route with. I appreciate all the responses and insights.

@Garrett Bailey , There can be many reasons for changing the real estate you own geographically or demographically or for a different type.  The 1031 allows you to do that without triggering a tax event.  If your goal is short term elimination of debt then the 1031 would not be as good a tool.  

In your specific example I can see value for the 1031 if you want to go to less expensive houses and are seeking to build a rental portfolio.   You are limited to purchasing one 225K house to exchange for the one you sell.  You could buy two 120K duplexes and use the 85k as downpayment on each one.  There's really quite a bit of flexibility.  But as mentioned, if you're wanting to eliminate debt then I would sell and pay that 20K tax bill now.Its a good conservative approach.

I agree.. Now that I'm letting go of my original mindset I'm starting to see some other options out there. Glad to finally have the right info to go forward.

Part of my limitation with getting a loan on two new properties is that I'm already at 4 loans. I own two properties outright. If I sell the one that'll take me to 3. But I've had trouble finding a loan for more than 4 properties.

Originally posted by @Garrett Bailey :

I agree.. Now that I'm letting go of my original mindset I'm starting to see some other options out there. Glad to finally have the right info to go forward.

Part of my limitation with getting a loan on two new properties is that I'm already at 4 loans. I own two properties outright. If I sell the one that'll take me to 3. But I've had trouble finding a loan for more than 4 properties.

That's the issue I had. The numbers with equity would allow me to sell and buy up but I had trouble on the new loan end. You need to know not guess. You have so many days to identify properties and so many to close. Mortgage brokers could guarantee anything in advance.
Side note: I was selling in one state and buying in an other. You have to know your state's claw back rules. Maryland allows it without a claw back as long as you show you kept the future properties and didn't sell. Some states tax the sale or the future sale with their claw back provisions.

Originally posted by @Garrett Bailey :

I think I have missed this aspect of 1031 exchanges. Can anyone clarify for me? Thanks - Here's my example. I have a mortgaged rental property SFH. The original sale price was $154,500. I currently owe about $130k and I plan to sell it fairly soon. I should clear about $215,000 when I sell it giving me $85000 left over. My plan was to use that money to purchase a duplex in another state for the full amount in cash, but now I'm reading about the new purchase property has to cost more than the house I sold? Is that how much I sold it for? How much I bought it for? More than the $85000? Trying to figure out how much I need to pay for the new property. Thanks!

Hi Garrett,

The $85,000 is only your net equity generated from the sale of your relinquished property.  It is not the value of your investment property that you own. 

Technically, you must reinvest your "net sale amount" in order to defer all of your tax consequences from the sale of your relinquished property.  The net sale amount is computed by taking your gross sale price of $215,000 and then subtracting your routine and permissible selling expenses, which generally include your broker's commission, owner's title insurance premium, escrow/closing attorney fees, recording fees, exchange fees, etc.  

You would not subtract items that are operating expenses such as prorated property taxes, HOA fees, prorated rents, security deposits paid to the buyer, nor lender related expenses/costs related to any loan payoffs. You can use proceeds generated from the sale of your relinquished property to pay for these items, but it will trigger a small amount of taxable boot.

Your net sale price will likely be in the range of $195,000 to $205,000 (ish) and that is the amount that you must reinvest.  This means that the replacement property that you buy must have a purchase price plus your routine and permissible purchase costs, which generally include your broker's commission, escrow/closing attorney fees, recording fees, exchange fees, etc.

You must also reinvest all of the net equity/cash proceeds generated from the sale of your relinquished property.