1031 Exchange Equity

[Rory Egelus]

Hi, I'm somewhat new to the game, and have a pretty simple question...I think.  I have a rental property I have significant appreciation on that I'd like to sell and 1031 into a different rental property.  I've read up on all the rules and regs and understand the timeline and values I need to meet, both in price and debt, regarding a 1031 exchange.  Anyway, I'm curious if I can pull out my initial investment in this property when I close?  For example, say I bought for $150k, $50k of which was my own money and I used financing for the $100k.  If I sell for $250k, with a gain of $100k, I'd like to use this $100k gain as my "downpayment" with the bank to purchase my next property ($300k) while the bank would finance $200k, thus, returning my $50k investment back to me, ideally.  Is this possible?  Or, do I need to keep all equity ($150k) in the new deal?

[Dave Foster]

@Rory Egelus, Sorry but the only way that works is if you pay tax on the 50K you take back.   Yes, it is correct that you will never pay tax on your initial investment because that becomes part of your starting basis.  But when you do a 1031 exchange the rules change and you are agreeing to do two things reinvestment wise (in order to defer all tax) - 

First you must purchase at least as much your net sale (that is your contract price minus costs of closing).  In your case that would be $250Kish - say 25K = net sale of $225,.

Second you agree to use all of your proceeds in the next purchase. In your case thats going to be the net sale of $225K - the loan of $100Kish or $150K.  That money must go into your exchange acct.  If you touch any of it you pay tax on it.  Any cash you take out the IRS declares it is first profit and not your original capital.

In other words the irs is allowing you to defer the tax but you are agreeing to leave your money in the deal.  

When it's a 1031 what you call your original investment the IRS calls profit you are pulling out.  Guess who wins that argument??!

The answer is to leave the money in and take less loan.  Then refinance after the purchase or take out a loc against the equity.

Or you could buy another property.  Your 1031 does not have to be one for one as long as you purchase at least as much as you sell and as long as you use all of your proceeds you'll defer all tax no matter how many properties you buy.