How would this scenario play out?

3 Replies

If I buy a property for $140,000 and 2 years later it sold in a 1031 exchange for $60,000 but I have a loan on it for $130,000 can I buy a property for $260,000 or $120,000? Or am I completely off?

@John LaVecchia If you do a 1031 Exchange you will need to pay off your mortgage at closing. What is left is sent to the QI to hold your funds. To complete a 100% tax deferred exchange you will need to replace all of the equity and all of the debt.

Therefore, if you purchase a property for $140k and sell the property for $200k (if I am following correctly the 60k is your gain?) you would pay off the $130k mortgage at closing and the rest of the funds (in this scenario $70k) would come to the QI. You would need to purchase a property that is 200k or more to have a 100% tax deferred Exchange.

If you chose to not replace all the debt and equity, you will be responsible for tax and depreciation recapture liability on the portion you do not replace. Let me know if you'd like to discuss your particular situation.

@John LaVecchia , if you bought a property for $140K and sold it for 60K you have a huge net loss so no need for a 1031.

However if you dropped a 2 at the beginning of that sales price then you are both happy and able to do a 1031 and shelter a bunch of taxes.

The two part rule for reinvestment is that you purchase at least as much as your net sale (contract price minus closing costs).  Ball park that at your $260K.  You need to purchase at least $260K in order to completely defer all tax.

Secondly you must use all of the net proceeds (net sales price minus mortgage  payoff).  In your case that is $130Kish.  In order to defer all tax you must use all $130Kish in the next purchase.

You can purchase less than what you sell and you can take cash out but the IRS says that's a way of taking profit so you would pay tax on the difference and shelter the rest of the gain, if any, in the 1031.

@Lauren Speidel and @Dave Foster In this scenario I was attempting to find a way to get out of a property that is found underwater in the case that the market drops dramatically, by taking advantage of the large loan to get into a bigger and better deal in the down market with the 1031 (not as focused on the tax benefits). Now knowing that I would have to pay off the mortgage at closing it does not sound like my plan would be possible. Thank you for clarifying the issue.

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