1031 Exchange complication

8 Replies

Hi, looking at doing a 1031 exchange; property being sold will net $545k; capital gain will be around $150k and I will end up with around $320k in cash. Let's say I find  one replacement property for $320k that I buy with cash; that means my cash has been spent but I have still have a requirement to spend the remaining $235k balance to ensure that my replacement properties exceed the value of the property I am selling. My question is what happens if I can't find a 2nd replacement property? The cash has been spent; the 1031 exchange company won't have any of my money left....I assume I will have some form of tax liability, but how is that calculated? 

Thanks in advance.

Rob

@Rob Saunders , The two requirements of the 1031 exchange in order to defer all tax are to purchase at least as much as your net sale ($545ish) and to use all of the net proceeds ($320ish) in the next purchase or purchases.  You can take cash out of the exchange or you can lessen the amount of debt.  But in each case the IRS views that as a taking of profit.  So you pay tax on the difference and shelter the rest of the profit if any in the exchange.

In your scenario you are using all the cash but buying less property thus lessening your overall debt same as if you took cash and paid it down on other debt.  It acts like profit.  So you would pay tax on the $225K.  Since your total gain was only $150K you would pay tax on that much.  But that means you're not sheltering anything in the 1031.

The reckoning isn't provided by your QI.  It is done by your accountant when they file the form 8824 at your next tax filing.  That's when it will be documented that you did not meet the reinvestment target and created a taxable event.

I see, simple once explained! Thanks.

You could also purchase something like a DST with the remainder to avoid paying taxes on any of it. You are typically looking at 5-6% interest earned on the money but it is completely passive and backed by some asset (multi family, storage, commercial, etc). 5-6% interest isn’t something to get too excited about but sure as heck beats paying Uncle Sam anything when you don’t have to. You do have to be an accredited investor so DSTs aren’t for just anyone.

Let me know if you want more info on one, I have docs on one right now I could show you.

Your debt is roughly 43%....you want your purchase(s) to average out to at least that as well.  You can go up but not down on debt.  You can combine an all cash purchase with a leveraged one. That’s where strategy comes into play in looking at the best way for you and your situation to utilize a 1031.  

Thanks Brandon, not that familiar with DST's but my question was more theoretical, I think I will find the properties as and when we proceed.

Karen, can you explain your comment; wouldn't it depend on your overall strategy? For example we are in a position where we have cash available and out of standard mortgages; any reason why you wouldn't make cash purchases in these situations?

Thanks,

Rob 

@Rob Saunders

Karen is saying that you want to purchase replacement property (or properties) valued at $545K or more.  Don't spend all your cash on one property.  

If you purchase two or more replacement properties for $545K total, then finance about $225K of your total acquisition cost, your exchange is fully tax deferred.  If you allocate the cash proceeds from the relinquished property sale to each replacement property purchase, you will pay cash for about 60% of the cost of each new replacement property and use new debt to finance the remainder of the acquisition cost for each property.  Do this for as many properties (and as many settlements) needed to fully defer your capital gain on the relinquished property, but complete settlement on all acquisitions within the 180-day exchange timeframe.

Ok, thanks for the explanation.....

Rob

@Rob Saunders , 1031 makes sense if your goal is to buy a bigger property to generate more revenues, and of course also to reap the side-benefit of deferring capital gains taxes.  Even if that were the case, in the current market, you would be buying high which is something I personally wouldn't want to do.  If, on the other hand, your goal is to simply dispose of your property and still would like to defer capital gains taxes, why not do a M453 sale?  The smartest thing to do, as a real estate investor is to sell high, park the money in a safer place (and may be even grow it), wait for the market to crash and then buy low.  If your goal is the latter, let me know, and I would be happy to share my personal experience with M453 sale.

Join the Largest Real Estate Investing Community

Basic membership is free, forever.