1031 exchange - taxes and not matching debt

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1031 exchange - taxes and not matching debt

David Grootegoed
Member since 2018 · 2 posts · 0 votes
I’m under contract to sell a rental I have and I’m planning on do a 1031 exchange. I have a few questions that I’m hoping you guys can help me with. We are planning on taking some of the cash from the sale and paying the capital gains tax on it in order to pay off some personal debt. So my question is if we not only take some of the cash but also not meet the debt requirement. What are the ramifications? For example let’s say we only buy one property for $175,000 and put down 20%. That would leave us roughly $95,000 of cash that we would pay back the depreciation that we've already taken plus the capital gains on the remainder. In this scenario we are still $105,000 short of matching our current debt. Is there a fee or penalty or tax that we would have to pay due to the fact that we are short on the debt match? Thanks David
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y

@David Grootegoed, I'm not totally following your numbers but in order to fully defer all tax you must do two things - You must use all of the proceeds in the purchase or purchases.  And you must purchase at least as much as your net sale.

Any amount you purchase less than what you sell and the difference is taking profit in the IRS's eyes.  Because if you purchase less than you sell you will either put cash in your pocket or you will take less mortgage meaning you have less liabilities.

Anything you do that puts cash in your pocket is taking profit in the eyes of the IRS.  Anything you do that lessens your liabilities is a way of taking profit in the eyes of the IRS. 

I know, I know, we want to say that we're simply returning our original capital and not taking profit.  But the IRS says that the first dollar you take out or buy less is profit first.  And they have nuclear weapons!

The answer if you don't want to pay any tax is to purchase at least as much as you sell (could be more than one property).  And use all of the cash proceeds to do that.  You can allocate those proceeds anyway you want.  So put the minimum down on one property and take out maximum leverage.  Purchase the other property for cash.  Immediately after the 1031 is complete do a refinance and take the cash out.  Now it's not seen as taking profit but rather as accessing equity through a debt instrument.  So not taxable.

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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    7y

    Yes, there is what is called mortgage boot. If you acquire for anything less than you sold minus allowed selling expenses you will be subject to capital gain first.

    You need to review this with your accountant ASAP.

    [email protected]224-381-2660
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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    7y

    Yeah, it’s the same as keeping part of the cash...”boot”, you’ll pay tax on that portion too. On the other hand, if you kept no cash and put up another $105k cash to cover the difference in total price....no tax.

    Sounds like you are $200k short on the replacement property?

    @Dave Foster can plain it in better detail.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @David Grootegoed, I'm not totally following your numbers but in order to fully defer all tax you must do two things - You must use all of the proceeds in the purchase or purchases.  And you must purchase at least as much as your net sale.

    Any amount you purchase less than what you sell and the difference is taking profit in the IRS's eyes.  Because if you purchase less than you sell you will either put cash in your pocket or you will take less mortgage meaning you have less liabilities.

    Anything you do that puts cash in your pocket is taking profit in the eyes of the IRS.  Anything you do that lessens your liabilities is a way of taking profit in the eyes of the IRS. 

    I know, I know, we want to say that we're simply returning our original capital and not taking profit.  But the IRS says that the first dollar you take out or buy less is profit first.  And they have nuclear weapons!

    The answer if you don't want to pay any tax is to purchase at least as much as you sell (could be more than one property).  And use all of the cash proceeds to do that.  You can allocate those proceeds anyway you want.  So put the minimum down on one property and take out maximum leverage.  Purchase the other property for cash.  Immediately after the 1031 is complete do a refinance and take the cash out.  Now it's not seen as taking profit but rather as accessing equity through a debt instrument.  So not taxable.

    The 1031 Investor5137 Reviews
    WebsiteView Page
    3Reply
  • David Grootegoed
    OP
    Member since 2018 · 2 posts · 0 votes
    7y
    @Steven Hamilton II Got it. Thanks. So it seem that in the example I give I’d be better off not doing a 1031. Just taking the cash and pay the capital gain on it. Then purchase the small property that I want. Thanks again
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