1031 Exchange after refinance??

[Cassidy Burns]

Hi BP,

If you have an investment property that you did the BRRR strategy on but want to eventually do a 1031 Exchange, does the capital gains credit based off of the original purchase price or the new loan on the property?

Thanks!

[Jaron Walling]

I would assume it's based off the ARV of the property when you had it appraised.

[Cassidy Burns]

@Jaron Walling the appraisal off the initial purchase or the new appraisal from the new loan?

[Corby Goade]

Capital gains are based off of your "basis" in the property, regardless of funding, refi's etc. Your basis is the actual money you have in to the property to get it rent ready and maintain it, subtracted from the value of the property when you liquidate. If you are thinking of this, call the title company you closed with and meet with their 1031 specialist. If you don't have one already, get an accountant who knows REI well and go over the details with them. Those two pros will be able to give you some guidance on the best way to handle your next step. Good luck!

[Jaron Walling]

@Cassidy Burns Was the property a primary residence or purely investment? 

After researching more on this it looks like when a property is purchased, be sure to retain a copy of documents that can prove the cost basis. If you make improvements to a property (garage or another type of remodeling or addition) those items will also be added to your cost basis and affect your capital gain or loss. 

[Frank Jiang]

Your loan has nothing to do with the value of the property.  It is only dependent on the value of the property when you purchased it.  That value can be flexible depending on work done and improvements but a refi has no bearing on the value of that property.

[Dave Foster]

@Cassidy Burns, if you do a 1031 the amount of capital gain is sort of irrelevant.  If you want to defer all tax you must purchase at least as much as your net sale and use all of the proceeds.  If you purchase less than your sale or if you take cash out from the 1031 you will pay tax on it as profit.

However, If  you want to accurately calculate your tax position in a property you must calculate the adjusted cost basis.  

The purchase price + capital improvements - depreciation taken = your adjusted cost basis.   Loan amount or equity does not determine your gain.  Gain is determined by the difference between your adjusted cost basis and your net sale.  And your gain will consist of two potentially differently taxed amounts - depreciation recapture and profit.

Takeaway - BRRRR to your hearts content. It doesn't affect your tax.

[Micki Sluyter]

@Dave Foster if you only do the 1031 exchange for the adjusted cost basis does that eliminate the tax liability?  If I have a house for $250k but the adjusted cost basis is $150k and I buy an new property for $150k, what would the tax position be?

[Dave Foster]

@Micki Sluyter, The IRS has a funny (not so much) way of accounting for profit when you do a 1031 exchange.   In order to completely defer all tax you must purchase at least as much as you sell.  And difference the IRS says is a way of taking profit.

so if your adjusted cost basis in the example is $150K then your profit is $100K.  If you sell for $250K but buy for $150K the IRS says that the difference is profit ($100K).  So you'll end up paying tax on all your profit so no reason to do the 1031.

[Micki Sluyter]

@Dave Foster thank you for the info!