1031 Exchange Example Question

4 Replies

Hello BP,

Question regarding exchanges in following example.

Selling Price: $1,200,000

Purchase Price: $200,000 (Fully Depreciated)

Exchange Properties:

2 different properties purchased for $400,000. What is the tax liability? Thank you in advanced for your input.


 not sure if the $400k is total, or each....

Anyway...whatever amount  you buy for less than than your $1.2 M (less actual selling costs/commission)...you’ll report your $200k in depreciation recapture as ordinary income, and the balance of the shortfall will be cap gains.

@Dave Foster . Right?

@Toshiki Hoshino ,

Simple calculation is sale price less basis. Your gain is 1.2mm, and if you conduct an exchange, you want to purchase for that much or more to defer tax liabilities. Using your numbers, you will be left with $800k boot (1.2mm-400k).

A few considerations:

- purchase additional like-kind property. Like-kind has a very broad definition of any real property used for investment. This could be as exotic as mineral rights, or passive investments such as Delaware Statutory Trusts.

- if only looking to purchase $400k or replacement property, maybe not conduct an exchange to have the flexibility of buying on your own timeline versus the strict rules of the tax code.

@Toshiki Hoshino , @Wayne Brooks and @Kyle Kadish pretty much nailed it.  In order to defer all tax in a 1031 you must purchase at least as much as your net sale (contract  price minus closing costs so 1.2 - ??).  You must also use all of your net proceeds in the purchase or purchases (net sale minus whatever mortgage was paid off).

Any amount you purchase less than you sell is considered profit. So to your example - you sold for 1.2 ish and bought 400K ish so you would have a gain of $800K.  But there are a couple of considerations that change this slightly.

1. When you say the property is completely depreciated that doesn't take the value completely to 0.  The land value is not depreciated.  So you still have a basis some something that would reduce that $800K gain.

2. The gain is made up of profit and depreciation recapture.  If you've owned the property for more than a year the two rates will be different.  So it will be up to your accountant whether the $400K of deferred gain is treated as depreciation recapture or profit.  I've seen it go both ways.  My preference in this case would be to treat the gain I'm deferring as depreciation recapture since I was wanting to transfer the basis from my old property to my new property.  And since the depreciation would be recaptured at a higher rate.

You'll have some tax savings in your scenario.  But you'll also have a pretty healthy tax hit on that $800K of gain.

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