Will property qualify for 1031 exchange and can I take some $ out

Question

We bought a property in January with cash. We were planning on renting it and had a couple tenants fall through. Now spring has rolled around and we saw what local houses were selling for and decided since we didn't get it rented to fix it up a little more and sell it. Will it qualify for a 1031 exchange since we didn't end up getting it rented?

When we do get it sold we would like to take back out the amount we bought it for and the money we put into it (we do not have a mortgage on it we bought it in cash and did all the repairs with cash). Then just 1031 the remaining profit. Is this allowed?

Dave Foster · Answer

@Terri Dyer, in really rough numbers you've got $74K in gain. If you took $36K out of the 1031 you would pay tax on the $36K but shelter the tax on the remaining $38K. As @Wayne Brooks it would be ordinary income so that would still be a significant savings.

The other option as @Matt K. alluded to is a cash out refi. I would not recommend doing that prior to your sale. The IRS has consistently shown that it views cash outs immediately prior to a sale as a form of taking profit. However if you completed a full 1031 you could then do a cash out refi after the 1031 was complete.

Matt K. · Answer

Always have the option of a cash out refi, since it's a loan it's not taxable.

You'd have to plan around and be careful with a 1031 though ...

Dave Foster · Answer

Great question @Terri Dyer, the answer is it depends :)

Property that qualifies for 1031 treatment is property you purchased with the intent to hold for productive use as investment. There is an implication of holding but no statutory holding period. Most people feel comfortable with anything over a year. However there could always be individual circumstances that might make a shorter (or longer) holding period appropriate.

It sounds like you bought it with the intent to hold for productive use. What kinds of things can you point to that would back up that intent? Past practice, the rental applications, conversations with your cpa, etc etc.

I've got a feeling thought that even if you felt like your intent was solid that the 1031 still won't work for you this time.

The reason is that in order to defer all tax in a 1031 you must purchase at least as much as you sell. The IRS doesn't just let you park profit. You can purchase less than what you sell but you will pay tax on the difference just as if you pulled profit out of the deal.

I know, you put the money in the first time and it's not taxable. That's right. But when you purchase less than what you sell and take money out the IRS says that's not your original capital but profit. They win the argument.

So if you're wanting to buy down that much I don't think the 1031 would provide you any savings.

Terri Dyer · Answer

Thanks so much Dave. Yes I could prove our intent to rent with advertisements placed, applications taken, etc. We also keep our properties for rentals. We have only ever sold one of our properties after about 3 years of keeping it as a rental and we did 1031 it.

So I could pull out some money? But it would be taxed on that portion correct?

We bought the house for $36,000 put about $10,000 in it and will sell it for around $120,000. I would like to pull back out the $36,000.

Will property qualify for 1031 exchange and can I take some $ out

Will property qualify for 1031 exchange and can I take some $ out

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