1031 exchange to get out of little-to-no equity property?

Question

Hello,

I have a 2/2 condo in a large 340-unit condo conversion property in Savannah, GA that I am dying to get rid of.  Originally purchased in 2006 (at the tippy top top of market as I was getting out of school) as primary residence, and it has been a rental since 2009.  Paid $168K.  It is now maybe worth $130-140K.  I owe $124K on it.  Property has always rented well (use a property manager) but due to crazy POA fees I am still losing about $100 a month in cash flow.  Have grown very tired of watching property values go nowhere with this property while here in Charlotte (where I live) values are going nuts (not to mention I want a local rental so I can manage myself).

My plan was always to sell this and 1031 into a rental in Charlotte, but would have never guessed in a million years the property wouldnt be worth what I paid for it more than 10 years later.  Ready to get rid of it.  Current tenant's lease is up end of June.

My question is: even with little to no equity, could I 1031 into a new property in the $100K range here in Charlotte area?  Would have no trouble getting approved for financing, but curious what that deal might look like and what sort of things I would need to pay attention to.  Would very much appreciate some suggestions here.

Thanks,

Coley

Dave Foster · Answer

@C Coley Mitchell, The first thing you need to do before thinking about scenarios is to get a clear picture of what your adjusted cost basis is from your accountant.  The adj. cost basis is the acquistion price less depreciation plus capital improvements.  without knowing your improvements total though you can ball park your depreciation somewhere around 50 -60K.  So your basis in that property is going to be somewhere around $110K. Now you can decide if your scenario  works with a 1031.

If you sell for 130 and your basis is 110 then you'll have gain of 20K.  It will all be depreciation recapture;

If you sell for 130 and do a 1031 and buy a property for 100 then you have potential taxable boot of 30K.  Since your total gain is only 20K then you would end up paying all the tax you would have without the 1031.  So no need to do the 1031.

your adjusted cost basis will tell you what to do.

Dave Foster · Answer

Absolutely correct @Natalie Kolodij, it's the amount of reinvestment not the numbers of properties.  So if the total of the two replacement properties equaled or exceeded the net sale of @C Coley Mitchells relinquished property he would also have no tax.

Natalie Kolodij · Answer

@Dave Foster

If he wanted cheaper property (s) he could potential purchase 2 though correct?

Coley Mitchell · Answer

Ok - thanks @Dave Foster!

Dave Foster · Answer

@C Coley Mitchell Good analysis.  Yes, if you want to defer all tax you must purchase at least as much as your net sale.  You could buy less.  you would pay tax on the difference but defer the remaining.

Coley Mitchell · Answer

Thank you for all replies.  I dont think I did best job of wording my question.  My primary concern is not "profit" as others have mentioned, but "taxable gain."  I have been depreciating property since 2007, for about $67K total.  Have spent around $7K on capital improvements (HVAC, paint, carpet).

According to @Dave Foster's advice, looks like cost basis is around $94K.   If I can sell property for $140K, my gain will be $46K.

Sounds like if I went 1031 route I would have to find a more expensive property to purchase ($140K+)?

Aaron Sigmon · Answer

Even if you had a gain and had to use a 1031, it would be difficult to do it with a decent property in Charlotte.  Any deal worth doing wouldn't be available by the time you closed on the place you are selling.  You would basically be jumping into another property that is over priced or complete crap.

I've considered taking some of my high equity properties in Charlotte and doing a 1031 for something like a beach house.  Those seem to sit on the market for awhile and would probably be available after closing on the property being sold.

Ralph C. · Answer

I do not see enough of a gain for the tax deferred exchange here.

Have you consulted with your tax cpa for all options and best route?

Drew Reynolds · Answer

@Dave Foster is absolutely correct.  @Ann Bellamy it's important to recognize that "profit" and "taxable gain" can be two very different things.  There are plenty of scenarios where investors have lost equity on the investment and are still stuck with capital gains/depreciation recapture taxes.

@C Coley Mitchell - to address your question directly, the 1031 exchange is not the limitation.  You always have that option.  Question one is does it make sense to do an exchange?  Determining your potential tax liability will help with that.  Question two is how you are going to buy something with little to no equity.  That's a question for your lender as to how high of an LTV they will provide.

Ann Bellamy · Answer

If you lost money on it, then I'm assuming you have no capital gain.  And protecting a gain from taxes is why you do a 1031.  No gain = no taxes = no reason for a 1031.

Did I miss something?  Someone correct my thinking here.......

1031 exchange to get out of little-to-no equity property?

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