How to get rid off mortgage boot in a failed 1031 exchange

Question

Hi: To All 1031 Exchange Subject Matter Experts

So, last year I sold an investment property that carried a debt 800k. Since the sale of the property occurred towards the end of the year, in October, the 1031 Exchange was going to receive an Installement Sale treatment and in the event a Like Kind property was not purchased within 180 days the proceeds would have been taxed in 2018. So, I failed to find a replacement property and couple of days ago my CPA shares the news with me that because of the 800k mortgage debt I had on the property I am subject to pay capital gains taxes on the debt? It's hard to comprehend this but appearently there is this mortgage boot event that's causing the taxable event. So, my question to you RE experts in 1031 exchange is, are there any tax strategies to implement post 180 day exchange rule expiration to avoid this mortgage boot tax??

Thanks in sdvance.

Wayne Brooks · Answer

Huh? If you did Not do a 1031 at all, I don’t see where the concept of boot comes in.....you pay your regular cap gains and dereciation recapture just as if you never heard of a 1031, but only a year later, in your case, I believe.

Where is that Dave guy anyway?

Bob B. · Answer

@Dave Foster will be around shortly to help explain what your option is, if there is one.  You are in good hands..

George A. · Answer

Under the instalment sale rule if the 1031 exchange falls towards the end of the taxable year proceeds of the exchange can be taxed the following year. In my case 1031 exchange failed so the mortgage I was carrying on the relinquished property according to my CPA is causing capital gains tax in 2017 and then remaining profit that came out from the 1031 intermediary account will be taxed in 2018 tax year. It's crazy to think that I am getting taxed on the debt and I am hoping experts in the matter may have some resolution in this situation. Thanks

George A. · Answer

Thanks Dave. Appreciate your insightful response. George

Bob B. · Answer

@Dave Foster As usual, good news or bad news, Dave has the answer.

I'm on my boat right now enjoying my first adult beverage of the evening.  I've got plenty of umbrellas and you are welcome to join me anytime.

Dave Foster · Answer

One of these days I'm going to actually be on a boat having umbrella drinks with @Bob B. when he throws me under the bus :)  Thanks Bob!  Hey @?wayne Brooks.  I was napping!

Dave Foster · Answer

@George A.,  That is the weirdest thing I've heard in a while.  But the answer to your real question - Sorry - but this ones gonna sting!  The two part rule for reinvestment in a 1031 exchange is that you must use all of the proceeds in the next purchase or purchases and you must purchase at least as much as your net sale.

You can purchase less than you sell (reducing your mortgage - aka mortgage boot) and you can take cash out of a sale (cash boot).  But the IRS interprets this as taking profit first.  So you pay tax on the difference but shelter the remaining gain in the rest of your 1031 exchange.

But you're never going to pay more in tax than you had in gain and depreciation recapture.  Since you didn't find any replacement property you basically have a non-event.  Your 1031 never happened.  You did an installment sale in 2017 reporting no income so all gain was deferred to 2018 - that's better than a sharp stick in the eye.

And now in 2018 you will pay the tax on the full gain - both profit and depreciation recapture.  the mortgage is irrelevant.  I have no clue where that idea popped into the CPAs head.  Your property had an adjusted cost basis when it was sold and that basis nets against your net sale to determine the tax liability.

No replacement property = no 1031.  No 1031 =full taxability of your gain.  crossing the calendar year to recognize the gain in - 2018 = as good as it's going to get for you.  But it shouldn't have anything to do with your debt at all.

George A. · Answer

Thanks.

How to get rid off mortgage boot in a failed 1031 exchange

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