Buying Duplex, Selling 1 Unit

[Puri Indah]

Hello BP'ers,

I have a few questions and hoping you could give me some of the answers, if not all:

Scenario:Selling a rental property for $1,200,000 and thinking of 1031 exchange it to a duplex at $2,500,000.


Questions:

1. How do I apply the capital gain of the sold property: Do I have to apply to both units, or just one?

2. How do I assign prices for each unit? Is it up to me to assign Unit A for $2,000,000 and Unit B for $500,000?

3. If at some point I decide to sell Unit A and could only get $1,000,000 for the sale, does it mean I can claim a loss of $1,000,000?

4. Using Scenario 3 above, what would be the downside of assigning a very low price to unit B?

Thank you in advance for your help!

Puri

[Dave Foster]

@Puri Indah, You and your accountant will work out a reasonable allocation of starting basis in that property.  If the units are roughly the same size, quality, amenities, etc then its probably reasonable to say that each 1/2 of the duplex is half of the purchase price.  So that's where you start - with a duplex that you are buying each half for 1,250,000.  

Now for the 1031 side of things - You're selling another investment property for 1,200,000 and buying a duplex ( or two 1/2s of a duplex - actually considered to be two properties) for $2,500,000  That's perfect for the 1031.  What actually happens in a 1031 exchange is that your basis in the old property transfers to the new property.  So let's just say you had $200K of gain in the old property.  That would mean that your basis in the old property (ignoring capital improvements and depreciation for a second) is $1,000,000.  That basis transfers to the new property.  and since you're buying $1,300,000 K more than you sold your new basis in the investment side would be $2,300,000.

You and your accountant would make the allocation of the $1,000,000 basis to each unit.  Again, if equal each unit would have a new basis of $1,150,000.  

So then there's the sales side of things - if you ever sold one of the units for $ 1mil as you said then you would have a loss of $150K from the starting basis of $1,150,000

I think the most important factor in your questions is that you can't just arbitrarily assign value to each side.  There must be a reasonable allocation.  Otherwise it would be awfully easy to assign a very high basis and then sell that side so you don't make profit while holding onto the other side with an artificially low basis.  The IRS calls this a form of basis shifting - a no no.