Hi, I own a rental property...single family residence. I have owned since 2003. I understand when I use an exchange company to facilitate sale/exchange, when property is sold the first mortgage is paid. I have an equity line on the property I attained to make repairs/upgrades to enhance the sale proceeds. Can the exchange facilitator also pay off the equity line on sale? So the net proceeds, to apply toward new exchanged property loan, will be the result of paying off first and equity line..and still be fully considered a 1031 exchange with no tax consequence from paying off both loans? All cash from equity line was used in the rental. Thanks for answering. I appreciate the time. dan
@Dan Cox , It's actually the title company or closing attorney who will make those payoffs as part of the regular closing. Any loan secured by the property will be paid off and the net cash after that and all closing costs have been paid is transferred to the exchange facilitator.
So your two reinvestment targets to defer all tax in the 1031 will be to purchase at least as much as your net sale (contract price less closing costs and commissions) and use all of the net cash ( net sale minus the mortgage pay offs) in the next purchase. As long as you do those two things you'll defer all tax.
Thanks Dave. I have another. I am trying to get an equity line on my rental to repair/upgrade to sell/exchange. The local bank will do but I have a first and a second...the local utility company loaned the money under their program..for a new HVAC three years ago..paying monthly. The local bank asked if they would subordinate..they said no. The local bank is asking their underwriting if they could pay off second utility loan with the new equity line...in effect the 50K equity loan..which I qualify..would have an initial 6K draw..I don’t see why they wouldn’t..we will see. If they will not, could I use my own funds...which I don’t want to..but could I use my own funds...pay of 6K utility loan...the local bank gives the equity line...I make repairs/upgrades...sell/exchange..and take 6K from net proceeds and be responsible for just that about of boot? The exchange would still be ok..under the parameters you previously explained? If so what would be taxable gain on the 6K boot? Thanks again for your time and experienced advice Dave. dan
@Dan Cox , I don't think you'll need to worry about boot at all. If the bank writes it all it's just another secured loan against the property that is 6K greater because they paid off another loan. When you sell that new loan gets paid off and you still have to purchase at least as much as you sold and use all of the net proceeds in the purchase. So you may have a little less cash to use to purchase the new property in the exchange. But that doesn't necessarily create boot.
You could take 6K from those proceeds and pay boot only on that $6k. So figure 15% fed and whatever state..
Or with your accountants blessing and good record keeping keep track of you paying off the equity line and then repaying yourself from the new equity line. When you sell, again your only responsibility is to purchase at least as much as you sold and to use all of the net proceeds. You're really not helping yourself. You paid off a loan and repaid yourself when you took out the new loan. I don't see why you'd need to take boot there either.
Thanks again Dave. Sorry to carry on..to hopefully simplify...if only way I can get the equity line to make repairs..about 25K needed..is to pay of the current utility loan which is 6K....if Iuse my own funds to pay off the 6K thereby allowing me to attain the new equity line...when I sell/exchange..the first and equity line will be paid...if I take 6K from the proceeds to reimburse what I had to use from personal funds..that will be considered boot? Correct?..and I would owe Fed and State Capital gains...which would be 15 Fed and 10 CA for 25% or about 1500 dollars? Any other way to accomplish what trying to do...without using own funds to make things work? Thanks again Dave. dan
@Dan Cox , S'all good. This is what I do for folks - 1031s! Yep, If you take proceeds from the sale to reimburse yourself it's taxable boot. If you tap the new equity line for $6K to pay yourself back it's not boot. Just be careful about doing that too closely to your sale. Keep good records that it's repaying actual expenses.
Another option would be to record a note for $6K on the property in 3rd position. If a note is attached to the property it must be paid off at closing. But that note can't be to you. So have friend loan you $6K and attach a note to that property.
Great advice Dave..so glad I found you. dan
Hi Dave..I attained the equity line. The bank paid off the 6K HVAC note.
The issue now. I have two rentals. The basic plan when I go..one for each son.
I want to help oldest son now attain a home.
He hopes to live in certain areas.
Once current tenant is out..then I have to decide what best to do..to accomplish the goal.
sell as is..at least entertain offers..maybe state subject to 1031.
use equity line, repair/upgrade..only to extent minimally recoup costs..sell..again subject to 1031.
if exchange cannot be worked out..can’t find/close on property in areas wanted...re rent attaining top dollar..increase rent attained could pay for equity line....currently about 300 under...and wait until sons situation/needs change.
do as above but after re renting attain a cash out refi, put money into an account and give/gift to son when finds a home..he does have some monies to use...would be first time home buyer.
last and really wouldn’t want to do...sell as is and or upgrade to extent would recoup and sell..pay the gains....my cpa says capital gain would be about 30K.
I owe 78K..value as is about 260..with 25K improvements, value perhaps 300..310K.
What would you do..what would be best/better choice.
It will be easy to sell, attaining a home for exchange, based on demand, in a desired area, may be the issue..the 45/180 day rules.
Thanks again for your help/time Dave.
@Dan Cox , all of those are viable. The two keys I see are that you want to help your son. But whether or not you buy a property for him depends on your ability to complete a 1031 to defer that $30K tax bill (does that include depreciation recapture? That might make the bill more).
Working the opposite direction backwards theres two ways you can give your son the most bang for your buck:
1. By keeping the property until you die. In which case he inherits at the step up in basis and all the deferred tax goes away.
2. By selling and doing a 1031 exchange into a property he would like to have.
Option 1 takes longer and he can only benefit with you giving him income while you're alive. You've got to die for him to get the benefit - not my favorite course of action.
Option 2 benefits him immediately which would be way more fun for you and him. But you've got to be able to complete a 1031.
Can't give you a best scenario. But here's a couple of thoughts.
You could always start the 1031 and if you can't find a good replacement let the exchange die. You do lose the $30K but you can then hoard cash until he finds something that works.
I don't know if this was part of your thinking or not. But rather than 1031ing into another pure investment property, you could 1031 into a really nice home that your son would like to have as a primary residence. You have to treat the property as an investment so he would have to be your tenant for a year or two. You'd have to have a lease and collect and report rents. But you can also gift back that rent using the annual exclusion.
Finding a good primary residence is far easier in most markets than finding the best investment property that has compelling return numbers.
Food for thought. But I think you're seeing the right big picture.
@Dan Cox if I am following your conversation with the ever-so-helpful Dave Foster, it sounds like you think it will be harder to find the replacement than sell your existing.
In that case, why not just wait until you DO find that replacement make an offer with maybe a little bit of an extended closing option, and THEN put yours up for sale?
Thanks so much. Dave again and Dan. Your thoughts/inputs are greatly appreciated. dan
Hi again Dave...If I can exchange and son moves in and pays reasonable rent..close to going rents...and lives in for two years, can I gift to him without tax consequence for me? How about for him?
If he is in the home, paying rent and wants to move elsewhere..options? do another exchange if couldn’t gift...or if does move and I could gift to him, is he responsible for the past and present gain?
Thanks for explaining the rules/options as you have opportunity Dave..and Dan if you like.
I appreciate all help.
@Dan Cox , I'll defer to our esteemed accountant colleagues here on the gift situation. I believe you can gift but they'll know the best way and potential fallout. From my perspective it's important that you not do it immediately so you can establish your investment intent to complete the 1031 so that in an audit your exchange wouldn't get blown up.
If he moves then that's exactly right - you do another 1031 exchange. There's a bunch of landlords out there who would kill to be able to follow a great tenant. Nothing wrong with that.
Thanks Dave..how would I contact some of the accountants on site you mentioned..for the tax question. Once again I appreciate your valued help/time. dan
Hi Dave..sorry to trouble you again...how can I contact some of the accounts on this site you mentioned that might be able to answer the tax question above in our emailing s. Thanks Dave. dan
Accountants that is.
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