1031 Exchange and Improvements

9 Replies

I have a 1031 Exchange going. We put an offer in on an identified home. We have about $40,000 left over, meaning the home we made an offer on was less than the 1031 Exchange amount. The home, as-is, can work but it needs improvements and updating. The 1031 Exchange people say the sellers must do the improvements BEFORE closing. Because of the weather and contractors schedule, it doesn't look like it can be completed in time. We don't want to pay taxes on the excess.

Just wondering....how close do the 1031 people check the HUD-1? For example, can I bump up the sales price and get a check at closing to cover the improvements?

Can I bump up the sales price, contract with the contractors and they get paid from closing?

Any other ideas other than extending the closing date?

@Lee Hughes , if you get cash in any way it's taxable.  There's a relatively untested way to absorb some but I emphasize it's untested which a long way from either approved or disallowed.

The theory is that if the improvements are less than 10% of the value of the property you are buying and the improvements are things that would normally be associated with a structure (roof, A/C, flooring etc not furniture or a car in the garage).  Then you could have those invoices  placed directly on the settlement statement and paid to the contractors.  The risk is the work is not done.  But the accounting concept is that these would fall into the "deminimus" range (noise level) category and be fine.  Again, not tested and not approved.

Well not all QIs are created equal @Lee Hughes :) . But it shouldn't be a matter of hiding that from them.  They should be willing to let you do that at your own risk.  The QI should be concerned the the process structure is done appropriately.  The decision of what qualifies is your's and your tax and legal professionals.  I would just bring this idea up to them.  Hopefully they already know about it and will understand what needs to happen.  Or they might not know about it and I just helped educate a competitor :) . Or they say no and then you got an issue.

Any QI that has time to call vendors and check invoices has wayyyyy too much time on their hands.

We have $246,000 from proceeds of sale. If we didn't do the exchange, we figure the basis in the property sold is $85,000. So, we pay tax on the $161,000.  

If we use the 1031 Exchange, we have $246,000 less $196,000 (Sales Price of Replacement Property) = $50,000 taxable excess. 
Can any of the tax on that unused portion be reduced by the $85,000 basis in the original property?


@Lee Hughes Unfortunately not when you do a 1031 exchange.  And if you don't do the 1031 exchange your taxable situation is worse as you figured.  When you do a 1031 the IRS is allowing the tax to go forward and are expecting you to let all of the profit go forward.  But they calculate "profit" differently when you do a 1031.  They simply choose to say that any amount you purchase less than you sell or any amount of cash you take out is profit first.  You would naturally want that difference to be basis so you don't pay tax on it.  But they say it's profit first.  And since they have access to nuclear weapons they win the argument.

There is one other option however that would work.  And that would be to purchase a second property.  As long as you purchase at least as much as you sell and you use all of the proceeds in the purchases you will defer all tax.  So use the $50K to purchase a second property - either for cash or buy something larger using it as a down payment.  I've got a pending colleague request out to you for follow up questions.

one last thing...I promise.  You mentioned using the excess $50,000 to buy another property.   The property has to be one of the ones previously identified as replacement properties, doesn't it?