New to 1031 Exchange

1031 Exchanges
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New to 1031 Exchange

Felipe Ocampo
Robotics Engineer · Germantown, MD · Member since 2015 · 98 posts · 24 votes

I am currently selling a rental property(just signed the offer) that I have had for about 6 years and just realized that the capital gains will probably be pretty steep so I may want to do a 1031 exchange. I originally bought the property for about $208,000, will sell it for about $235,000, and the depreciation has been about $7563 each year. I put about $6000 into capital improvements. I know I need to include closing costs, which I am assuming were around $7,000 for each transaction. That is almost $8,000 in capital gains assuming a 15% tax rate. I currently own about $147,000 on the mortgage. 

My questions are: 

1.How complicated is the 1031 exchange process and is it worth it in my case?

2. Do my numbers above look correct or am I missing something?

3. How quickly do I need to identify the replacement property/properties?

4. What are the typical costs to do a 1031 exchange?

5. Any other suggestions or recommendations? 

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
5y

@Felipe Ocampo, For the investor your 1031 exchange should be seamless and invisible.  You will be doing exactly what you always do with all your regular professionals - list and sell a property.  And search for find and purchase a replacement investment property.  The 1031 portion that indefinitely defers the tax on gain and depreciation recapture is paperwork performed by the qualified intermediary who is the extra required presence by the IRS to facilitate your exchange.  

The only significant challenge to a successful 1031 exchange is locating suitable replacements so that they can be identified  by the end of day 45 after your close.  In this sellers market the 45 day deadline is a looming barrier to you.  So the best recommendation I could give you is to start shopping for your replacement now!  

Although you have 45 days after your sale closes to identify your replacements, I wouldn't leave it to then.  Try to get under contract right now for your replacement.  Use your sales contract to demonstrate your seriousness with the seller.  Try to get a contingency for your purchase to close first.  Offer extra earnest money. Use every trick you can to get a contract now or as soon after your old property closes as you can.

Focused pro-active exchangers always fare better in a competitive market.  You provide the swift action and your QI serves as your trusty guide through the maze of regulation.  And you'll do just fine.

The 1031 Investor5137 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Felipe Ocampo, 

    The 1031 Exchange process is not really that complicated, but there are timing considerations that make it feel complicated.  A good Qualified Intermediary can walk you through the entire process, including the timing requirements for identifying your replacement property and completing your 1031 Exchange.  

    The tax amount looks a little low.  Federal capital gain tax is at 15%, depreciation recapture tax is at 25%, plus state taxes.  

    You have 45 calendar days after the close of your relinquished property to identify your potential replacement properties to your Qualified Intermediary and you have an additional 135 calendar days after your 45 days to complete your 1031 Exchange for a total of 180 calendar days.  

    1031 Exchange fees generally range from $750.00 to $1,200.00.  These generally cover the first relinquished property and the first replacement property.  I would compare the amount of actual taxes that you would be paying/saving and then decide if the process is worth it for you. 

    Successful 1031 Exchanges are all about planning ahead.  Laying out your goals and objectives.  Getting everything ready.  

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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    3Reply
  • Felipe Ocampo
    OP
    Robotics Engineer · Germantown, MD · Member since 2015 · 98 posts · 24 votes
    5y

    @Bill Exeter thanks so much for the response. You were right! I was assuming the recapture tax was also 15% like the capital gains tax, so the actual taxes that need to be paid are closer to $12,000, which makes the 1031 exchange even more appealing. Does your company help out with 1031 exchanges? If so, is that the $750 to $1200 fee you are talking about, or are there additional fees?

    0Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Felipe Ocampo, 

    You are most welcome.  Yes, Exeter administers 1031 Exchanges.  We charge $899.00 for one sale and one purchase.  There are no additional fees. 

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Felipe Ocampo, For the investor your 1031 exchange should be seamless and invisible.  You will be doing exactly what you always do with all your regular professionals - list and sell a property.  And search for find and purchase a replacement investment property.  The 1031 portion that indefinitely defers the tax on gain and depreciation recapture is paperwork performed by the qualified intermediary who is the extra required presence by the IRS to facilitate your exchange.  

    The only significant challenge to a successful 1031 exchange is locating suitable replacements so that they can be identified  by the end of day 45 after your close.  In this sellers market the 45 day deadline is a looming barrier to you.  So the best recommendation I could give you is to start shopping for your replacement now!  

    Although you have 45 days after your sale closes to identify your replacements, I wouldn't leave it to then.  Try to get under contract right now for your replacement.  Use your sales contract to demonstrate your seriousness with the seller.  Try to get a contingency for your purchase to close first.  Offer extra earnest money. Use every trick you can to get a contract now or as soon after your old property closes as you can.

    Focused pro-active exchangers always fare better in a competitive market.  You provide the swift action and your QI serves as your trusty guide through the maze of regulation.  And you'll do just fine.

    The 1031 Investor5137 Reviews
    WebsiteView Page
    4Reply
  • Bob NortonPro Member
    Accountant · Slidell, LA · Member since 2019 · 382 posts · 272 votes
    5y

    @Felipe Ocampo The critical step in the 1031 process is to contract with a Qualified Intermediary (QI), like @Bill Exeter or @Dave Foster before you close on your sale.  Otherwise, you don't have a 1031.  The QI sells the property on your behalf, holds the sales proceeds in escrow, and then purchases the new property on your behalf with those proceeds.  If you miss this step, then you do not have a 1031 exchange and will be paying taxes.

    1Reply
  • Felipe Ocampo
    OP
    Robotics Engineer · Germantown, MD · Member since 2015 · 98 posts · 24 votes
    5y

    @Dave Foster and @Bob Norton thank you very much for your responses. I am glad I was able to get started on this early. 

    1Reply
  • Ralph Pombo
    Member since 2020 · 101 posts · 34 votes
    5y

    I hope that it is okay to hijack this thread for a few follow up questions. If not, then I can take the discussion to a new thread. I have done 1031 exchange about 6 years ago, but never really understood the process completely. Actually, I have questions as to whether or not the real estate attorney did either. Here are a couple of concerns that I have. 
    1) How is the exchange value calculated? I am in the process of selling one home, but I am not sure what the replacement value needs to be. Is it the entire amount that the home sells for even if you are paying off loans?
    2) Do replacement purchases need to be financed or can they be a cash sale?
    3) If I do not replace for the full replacement value, does that ruin the entire exchange or can you exchange only part of the total amount? For an example, the replacement value is $500k but you only bought a property worth $400k.

    0Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    Great questions @Ralph Pombo.

    1. The requirement to defer all tax in a 1031 is two parts.  You must purchase at least as much as your net sale (contract price minus closing cost but not the mortgage pay off).  And you must use all of your net proceeds in the next purchase or purchases (the net sale amount minus mortgage pay off).  You can purchase less than you sell.  And you can take cash out but you pay tax on the difference or what cash you take out as if you were taking profit.

    2. It doesn't matter a bit whether you pay all cash or do a finance of the new properties - as long as you spend all of your cash in the purchases and the total is at least as much as your net sale (to defer all tax).  And another fun strategy point - You can allocate. those proceeds in any way you want.  So you could buy two or three replacement properties and pay cash for one and use maximum financing on the others.  That can be a great way to mitigate risk but still get the boost from some leverage.

    3. Any amount you purchase less than your net sale or any amount of cash you take out of the 1031 the IRS considers to be profit first.  So you pay tax on that amount but shelter any remaining gain in the 1031.  In your example you'd pay tax on the $100K difference.  But if there was say $200K of gain total you would shelter the tax on the other $100K of gain.

    The 1031 Investor5137 Reviews
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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    5y

    Hi @Ralph Pombo, 

    It is technically your “Net Sale Price” that matters in determining the minimum Purchase Price or purchase amount for your replacement property(ies).

    Your Net Sale Price is computed by taking your Gross Sale Price and subtracting your routine “permissible selling expenses.” The routine permissible selling expenses do not include everything on your closing or settlement statement. You would only subtract routine permissible selling expenses such as:

    Owner's title insurance premiums
    Escrow agent, settlement agent or closing attorney fees
    Real estate agent’s or broker's commissions
    Finder fees or referral fees
    1031 Exchange Qualified Intermediary fees
    Documentary transfer taxes
    Recording or filing fees
    Attorney fees and costs related to the disposition or acquisition
    Tax advisor fees related to the disposition or acquisition

    You would NOT subtract any non-permissible operating expenses or costs nor any lender or financing related costs such as:

    Financing or lender costs such as loan fees, loan points, appraisal fees, mortgage insurance premiums, lender's title insurance policy premiums, and other loan processing fees and costs
    Prorated Property taxes
    Prorated rents
    Insurance premium payments
    Security deposits
    Payoff of credit card balances
    Repairs and/or maintenance costs

    Your second question depends on your situation.  The important points are that you must acquire one or more properties that have an aggregate purchase amount of at least your Net Sale Price (trade equal or up in value) and you must reinvest all of your cash/equity that comes out of the sale of your relinquished property.  As long as you meet these two requirements, the difference can be out-of-pocket cash (new cash) or new debt. 

    You can certainly "trade down in value."  It will not hurt your 1031 Exchange, but you will pay taxes on the amount that is not reinvested.  Investors trade down for strategic reasons all the time.  

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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    2Reply
  • Ralph Pombo
    Member since 2020 · 101 posts · 34 votes
    5y

    @Bill Exeter - Thank you. That is very helpful.

    0Reply
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