1031 Exchange. Net profit or capital gains?

Question

When purchasing the “replacement” property, do we need to purchase a property equal to or more than, the Capital Gains or the Net proceeds?

Sell “relinquish” property: $287k

Loan balance:  $115k

Commission, fees: $15k

Purchase price: $103k

Any info would be much appreciated. Selling in Hawaii. Purchasing a property in Utah. 🤙🏾

Bill B. · Answer

Anything less than $272k is profit taking. “Boot”   ($287k sales price minus any “sales costs”)

Jeremy Keone · Answer

@Dave Foster

Thank you! That makes sense now. No where that I looked, was it clear like you just stated.

Mahalo. 🤙🏾

Dave Foster · Answer

Hey @Jeremy Keone

In order to defer all tax you must do two things:

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

2. Use all of the net proceeds in your purchase (net sales price minus any mortgage payoff)

You can take cash out and you can purchase less than you sell but you will pay tax on the difference.

In your case your net sale is $272 (contract minus closing costs)

Your net cash is $157K (272 - 115).

To defer all tax you must purchase $272K of real estate and use all $157K to do that.  Since you're purchasing for $240 you'll pay tax on the $32K ish difference (you may have some closing costs on the purchase as well.  But t is the purchase price that matters not the number of properties so you could purchase two properties if you wanted to defer all tax.

Wayne Brooks · Answer

Yep.  Realize in addition to buying an equal priced property ($272, net of selling costs) you must also reinvest All the cash proceeds from the sale.

But, since you are buying a property about $30k less, I believe you can keep $30k cash, since you will be taxed on that amount anyway....without being taxed for the $30k lower replacement And $30k of retained cash.

@Dave Foster will know.

Dave Foster · Answer

@Jeremy Keone, I wish I could be as succinct as the last answer :) . There's no definitive list.  But some general guidelines.  Your accountant is the final decision maker before it goes to the tax return.  So it can depend on how they've treated things on your tax return sometimes.  And sometimes it ends up being an arm wrestle with your accountant.  It has to be placed on the settlement statement so it can truly be a cost of the sale.  And it needs to be something that generally wouldn't just be an expense.  So all those things you mention would normally be costs of the sale.  the termite inspection as long as it is on the settlement statement and not paid outside of closing.  Here's some more general guidance - https://www.biggerpockets.com/blog/closing-costs-1031-exchanges/

All of those expenses determine your net sales price.  The net sales price is your reinvestment target.  But your net sales price is before your loan is paid off.  The loan payoff determines the cash you have to use to purchase at least as much as your net sale.

So if you sell a property for $330K with $30K in closing costs and an outstanding loan of $100K then your net sale would be $300K and your net cash would be $200K.  In order to defer all tax you would need to purchase at least $300K of property and use all $200K to do that.

You can take cash out or purchase less than what you sell.  But you pay tax on the difference.

Jeremy Keone · Answer

@Dave Foster

Question?

What constitutes “closing costs”?

Ex. Termite inspection? Deed preparation? Credits to buyer? Escrow fees? Wire device? Exchange support? Notary fees? Recording fees? Releases. Conveyance Tax? Etc?

But more importantly.

“Pay off of existing loan”???

Any information would be greatly appreciate

Thank you.

Jeremy Keone · Answer

@Bill Brandt

Thank you for the info. So it has nothing to do with any balances owed against the relinquished property?

The next condo we’re buying is $240k. So what happens to the difference. Do I just pay taxes on that difference?

Jeremy Keone · Answer

@Jeremy Keone

Or is it off of the sales price of the relinquish property?  $287k?

1031 Exchange. Net profit or capital gains?

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