Can use 1031 to offset just part of the gains?

3 Replies

I’m finally selling our first rental property. It was originally our family home but we had to rent it out for 10 years until we had enough equity to make it worth selling.

 I’m finally selling our first rental property. It was originally our family home but we had to rent it out for 10 years until we had enough equity to make it worth selling.

Now it looks like we will have $75,000 profit. We cannot afford to invest 100% of that in another property so that means we’re not eligible to use a 1031 exchange, right?

@Chris Laughary , It doesn't necessarily exclude the 1031 entirely.  You can do a partial exchange.  the requirements to fully defer all tax are that you purchase at least as much as your net sale and you use all of the proceeds.  If you can't do that and need to take cash out or reduce your debt you can.  

The IRS will interpret the difference as taxable gain. So you pay tax on the difference.  But it will not affect the rest of your exchange.

Thank You 

That’s great news!

So, I could use $20k of the $75k capital gains as a down payment to finance the purchase of a $100k rental unit in my personal name, and the 1031 portion would be the $20k, right?

@Chris Laughary , not quite.  If your gain is $75K then park that in the back of your mind for a minute.  

The two requirements valuation wise in order to defer all tax in the 1031 are that you purchase at least as much as your net sale and that you use all of the proceeds in the next purchase.  

In a partial exchange you either take cash out or you take out less mortgage.  So assume for a minute that your net sale was $200K with a loan of $125K.  Your reinvestment requirements would be to purchase at least $200K in real estate and use all $75K in the next purchase.  

If you only wanted to buy for $100K then you would have to pay tax on the difference.  Since your entire gain is $75K and you're buying down by $100K there is no advantage to doing the 1031.

Say you were willing to buy for $200K but only wanted to put $40K down.  You are taking $35K in cash which would be considered to be boot.  You would pay tax on the $35K but would still shelter the other $40K of profit.

You don't have to just reinvest your profit.  If you want to do a 1031 you must purchase at least as much as you sell and use all the cash.

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