Pulling out initial down payment...taxed?

14 Replies

Hello beautiful people of BP,

So, I'm no CPA, but it would seem that if I do not apply my original down payment on a property towards the new purchase, it would not be taxable as it wasn't actually a gain. So if I originally bought a $100k property w/ 20% down, I should be able to pull out that $20k after the sale and not be taxed on it. 

Anyone know if that's kosher with our friends at the IRS?

Sorry Dustin.  Twould be nice but it doesn't work that way.

1. If you sell and do not do a 1031 then all the gain is recognized and taxable regardless of what you do with your original investment.  You're absolutely right that your original deposit will not be taxed but without a 1031 the gain will be.

2. If you do a 1031 exchange then the two part requirement comes into play.  You must purchase at least as much as your net sale and you must use all of the proceeds in the next purchase or purchases.  If you take cash out you may say that you are taking your original deposit but the IRS says that the first dollar out is a dollar of gain.

Originally posted by @Dave Foster :

Sorry Dustin.  Twould be nice but it doesn't work that way.

1. If you sell and do not do a 1031 then all the gain is recognized and taxable regardless of what you do with your original investment.  You're absolutely right that your original deposit will not be taxed but without a 1031 the gain will be.

2. If you do a 1031 exchange then the two part requirement comes into play.  You must purchase at least as much as your net sale and you must use all of the proceeds in the next purchase or purchases.  If you take cash out you may say that you are taking your original deposit but the IRS says that the first dollar out is a dollar of gain.

 Thanks Dave! I did not know that you had to apply all proceeds to the next purchase. I assumed you could withold whatever portion you wanted as long as you accept that you pay tax on that witheld amount. Good to know!

Wait a sec - @Dustin Beam , You are absolutely correct.  You can withhold whatever portion you want from a 1031 as long as you are willing to pay the tax on that amount.  

the problem is that you get into an argument with the IRS in your scenario.  You say you're pulling out your original investment which would not be taxable.  They say you are pulling out profit first.  It's the same dollar bill.  You say it's original deposit.  They say it's profit.

With a standing army and nuclear weapons guess who wins the argument :)

@Dustin Beam you are right about being able to withhold some and being taxed (the boot). Smarter play would be to apply all and do cash out refi AFTER.

Originally posted by @Dave Foster :

Wait a sec - @Dustin Beam, You are absolutely correct.  You can withhold whatever portion you want from a 1031 as long as you are willing to pay the tax on that amount.  

the problem is that you get into an argument with the IRS in your scenario.  You say you're pulling out your original investment which would not be taxable.  They say you are pulling out profit first.  It's the same dollar bill.  You say it's original deposit.  They say it's profit.

With a standing army and nuclear weapons guess who wins the argument :)

 Thanks for clarifying Dave. I read this sentence and took it the wrong way:

"You must purchase at least as much as your net sale and you must use all of the proceeds in the next purchase or purchases"

I understand what you mean now, though. 

I'm not often the smartest person in the room, but I know I'm not challenging the IRS unless I have to lol. A certain song by the Clash would be my theme song if I did. :)

Originally posted by @Matt K. :

@Dustin Beam you are right about being able to withhold some and being taxed (the boot). Smarter play would be to apply all and do cash out refi AFTER.

Hey Matt, that's actually what my plan is. But that amount is less than my original down payment, so I had the not so bright idea that I could pull it out ahead of time and skip the refi costs. Ah well

Originally posted by @Dustin Beam :
Originally posted by @Matt K.:

@Dustin Beam you are right about being able to withhold some and being taxed (the boot). Smarter play would be to apply all and do cash out refi AFTER.

Hey Matt, that's actually what my plan is. But that amount is less than my original down payment, so I had the not so bright idea that I could pull it out ahead of time and skip the refi costs. Ah well

 Refi costs will look like a bargain compared to the taxes haha....

@Dustin Beam

The amount/percentage of down payment is irrelevant to the IRS when calculating gain/losses.
The IRS looks at adjusted basis, which is roughly speaking, purchase price + closing costs + costs to get property ready for use + improvements - depreciation.
You would then factor in any gain by taking selling price less adjusted basis to calculate your gain.
As Dave suggested; a tool to defer the gain is doing a 1031 exchange.

In your case - what is your selling price and what is your adjusted basis?

Basit Siddiqi, CPA
917-280-8544
Originally posted by @Basit Siddiqi :

@Dustin Beam

The amount/percentage of down payment is irrelevant to the IRS when calculating gain/losses.
The IRS looks at adjusted basis, which is roughly speaking, purchase price + closing costs + costs to get property ready for use + improvements - depreciation.
You would then factor in any gain by taking selling price less adjusted basis to calculate your gain.
As Dave suggested; a tool to defer the gain is doing a 1031 exchange.

In your case - what is your selling price and what is your adjusted basis?

Hi Basit, I'm in the middle of a 1031 right now and intend to get some money out of the sale. I was just hoping that I could pull out my initial down payment instead of refinancing it out or paying taxes on it since its not a real gain. But the IRS doesn't see it that way haha!

I'll end up refinancing it to get that money back.

A related example, I'm doing a 1031 on a property worth say $1.5M.  In order to get ready for sale, I'm putting in money to renovate, say $80k.

After the sale, I must buy something worth between $1.5 to 3M per the 1031 rules.  But I would like to get back my $80k for other purposes.  

To do so, I can either:

1) Pull it out prior to  purchase of the replacement property but lose an amount taxed as pure profit (20% times 80k) or

2) Execute the next purchase, then refi pulling out 80k or more at the cost of refinancing.

Is that about correct?

Thanks in advance.

Originally posted by @Gary Wong :

A related example, I'm doing a 1031 on a property worth say $1.5M.  In order to get ready for sale, I'm putting in money to renovate, say $80k.

After the sale, I must buy something worth between $1.5 to 3M per the 1031 rules.  But I would like to get back my $80k for other purposes.  

To do so, I can either:

1) Pull it out prior to  purchase of the replacement property but lose an amount taxed as pure profit (20% times 80k) or

2) Execute the next purchase, then refi pulling out 80k or more at the cost of refinancing.

Is that about correct?

Thanks in advance.

 That's the way I understand it, Gary. 

For what its worth, my bank told me they are open to refinancing or to give me a line of credit. At first, I hated the line of credit version, but I've thought it through and think I actually kinda like it. I have access to it whenever I want, but will only pay interest on it if I need it. By refinancing it out, I pay interest on it for the life of the loan, plus refinance costs. Just something you might want to consider.

@Gary Wong , that's about it.  The 80 K will be subject to tax a boot and you'll pay fed and state on that.  In order to fully defer all tax you must buy at least as much as your net sale and use all the proceeds in the purchase.  

The refi after eliminates that.

Dave:  Are there any minimum time limits before doing the post exchange refi?  eg, if I do it simultaneous with closing, or even a few days after, that might smell like boot to the IRS.  Is there a seasoning period, such as three months, that is viewed as a safe time passage?

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