Partial 1031 Exchange?

[Ronald Roetsel]

Is it possible to do a "partial" 1031 exchange? I need to sell my NY rental property (co-op) but unfortunately I cannot reinvest 100% of its value. I was wondering if buying e.g. some land (value approx 25-30% of sold property) would allow me to lower / defer taxes?

Also, would you be able to recommend a NY based CPA / tax expert familiar with RE who can review with me available options and deductions? 

Thank you,

R.

[Lauren Speidel]

@Ronald Roetsel - Yes, you absolutely can do a "partial" 1031 exchange. If you do not trade equal or up in value and instead trade down in value the, portion that you don't replace may be subject to tax and depreciation recapture liability. Ultimately, it would depend on the amount of your gain to see if a 1031 exchange financially makes sense. If you'd like, I'd be happy to refer a CPA in New York.

[Christopher Smith]

I did a partial related party 1031 in 2010 where I exchanged a property of Value X for a 50% interest in another property of Value 2X, this combined with a gifting of the other 50% interest. I felt very confident at the time that it would withstand full scrutiny if challenged, despite the fact that it was never ultimately challenged. Even had to check a special box on the return indicating that it was a "related party" 1031, and I thought that of itself might attract a little additional scrutiny, but now that we are past the 6 year statue of limitations, that's no longer really an issue either. 

[Dave Foster]

@Ronald Roetsel, As @Lauren Speidel indicated,  you can do a partial 1031 exchange.  The best way to approach it is to start with the requirements to fully defer all tax - you must purchase at least as much as your net sale and use all of the proceeds.  However in a partial exchange you either take cash out or purchase less than you sell.  You can do that but every dollar you take in cash or purchase less than what you sell is interpreted by the IRS as taking profit.  So the difference is taxable but you still shelter the rest of the gain in your 1031.

In your case you may be contemplating buying down so low that there will no longer be a tax saving.  If you sell a property for $250K with a gain of $50K you could sell, do a 1031 and buy a property for $240K.  You would pay tax on the $10K difference but would shelter the tax on the remaining $40K.  But if you wanted to only buy a property for $200K you'd be paying the tax on $50K which equals your gain so no reason to do the 1031.

[Ronald Roetsel]

Thank you all!

@Dave Foster how 1031 would work in the following scenario? Let's say, I sold a rental property for $250K. I bought it 10 years ago for $240K. Theoretically my gain was $10K plus $50K depreciation I claimed over those years. (exact numbers are irrelevant; I wanted to show a disproportion)

Would re-investing (1031 exchange) $100K of $250K make any sense in this case? 

What if... what if  spent those $100K on some rural land. Obviously I will not able able to rent it for - let's say - next 5+ years. Would there be any tax implications (penalties, interests) if after those 5+ years (of unsuccessful rental) I would build there my vacation home or a primary residence? 

Thanks again!,

R. 

[Dave Foster]

@Ronald Roetsel, At those numbers the 1031 would not save you any tax.  When doing a 1031 the IRS does not care how much gain you have.  In order to defer tax on all the gain you must purchase at least as much as you sell.  If you buy less than that you pay tax on the difference.

So if you sold for $250 and only bought $100K you are buying down $150K.  But you're total gain including depreciation recapture was $60K so you would end up having to pay the tax on all $60K - no benefit to the 1031.

The other question you're hinting at is what if you bought a tract of agricultural or hunting/fishing land that you intended to use for productive use (wilderness activities, rental, agricultural, livestock etc etc).  There is nothing to keep you from later down the road (as you said 2-5 years) deciding that it wasn't the greatest investment and building a house on it and converting it to  your primary residence or a vacation rental.  The key is buying it with the correct intent in the 1031.

By the way, 1031 exchange isn't just one for one.  You could use $100K to buy some land and use the remaining $150K to buy another property that provides cash flow.  It's the dollar amount you reinvest not the number of properties that matters.