Partial 1031 Exchange

[Kelley Cock]

We are very novice investors. We turned a primary home into a rental 8 years ago because we wanted a bigger home and didn't want to sell during a downturn in the market. We would now like to sell our rental and reinvest in a home in the mountains that we would use as a STR and a vacation place for our family. Our basis is pretty low since the marKet was so low when we converted it to a rental so we will, of course be looking at paying a boat load of capital gains.

Ideally, we would like to keep some cash back In the exchange and have less invested and Less mortgaged in this property. I’m a little unclear on exactly what has to be satisfied on a partial exchange. Can we finance less AND purchase a property that costs less thus having cash and less money in the new home? Or can we only choose one rule to not satisfy...for example, only keep cash back or only purchase for less than our current home sells etc. I know we pay taxes on any of the difference. 

If there is a better way to think about ending up with less "in" on the investment property, we're certainly open to ideas. We are so used to having what feels like guaranteed money each month from our LTR that we are managing fear of the unknown on the STR side.

Thanks so much for any advice. Like I said, we are as novice as you can get  and I have really appreciated the insane amount of information in these forums. 

Kelley

[Dave Foster]

@Kelley Cock, In order to completely defer all tax you must do two things - 

1. Purchase at least as much as your net sale (contract price minus closing costs)

2. Use all of your net proceeds in the purchase of the new property (net sales price minus mortgage pay off)

You can purchase less than your net sale and you can take cash out But you pay tax on the difference.  This is what is knows as a partial exchange.  Just remember it's not a proration.  The first dollar you take in cash or the first dollar you purchase less than you sell is considered to be a dollar of profit and taxable.

In your example you could do exactly what you're thinking.  Decide how much cash you want to take out.  This cash will be taxable. then adjust the purchase price of the new property down by that much (you won't get dinged for both just the amount of the cash you take out). This gives you cash but wouldn't reduce debt.

Or you could purchase less you sold but use all of your cash.  You'll pay tax on the difference between what you sold and purchased.  You won't get any cash in your pocket.  But you'll reduce debt.

Or a 3rd option would be to complete a full 1031 exchange.  And then after the 1031 is complete do a refinance and pull cash out.  A cash out refi is not a taxable event.  And you'll have the cash you want with no taxable event because you did a full 1031.  And the mortgage is paid by the tenants.