Can a seller carry a second mortgage on the relinkquised property

1 Reply

Hello All, 

I am new to the concept of 1031s and have a basic questions. I would be the buyer in this case, not the seller.

If the seller has a property that say is sold for 250K which he purchased for 150K. He has taken 50K of depreciation, so I think his basis would be 100K. If no 1031 he would be on the hook for Recapture Tax on 50K, and Capital Gains on 100K, right?

If buyer can get a loan for 80% or 200K and the seller carries a 2nd for 50K, how would that affect a possible 1031? Do all the figure just 'get reduced' by 20% (the amount of the second)..... meaning use a purchase from of 120K, depreciation of 40K and capital gains of 80K? I hope that makes sense.

IF that is the case, and the seller does a 1031 with the rest of it, would that mean recapture tax and capital gains tax would only be due on the 20% he is carrying a note on and the rest could be deferred with a 1031?

Thanks, Dan Dietz

@Daniel Dietz you lay it out well.  That seller has a couple of options.  If they do a 1031 they must use all of the proceeds which include the note for $50K in the next purchase.  So....

1. They could take the note as boot and pay tax on the $50K and shelter the tax on the other $100K.  Whether that is treated as boot that is depreciation recap or boot that is taxable as gain is accountant by accountant.  I've seen both.

2. They could replace the note with cash while it is in the exchange account.  when they do this it leaves the exchange acct with enough cash to complete a full exchange.  And the note becomes an asset they have that is outside the exchange.  It has not gain in it so the only tax paid as that note is paid off is on the interest portion.

3. They could also sell the note on the open market while it is in the exchange account.  This would probably require a significant hair cut to make it attractive but would end up with the same scenario as #2 - the ability to complete a full exchange.

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