1031 exchange, mortgage boot, and capital gains tax

Tax, SDIRAs & Cost Segregation
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1031 exchange, mortgage boot, and capital gains tax

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Member since 2008 · 8 posts · 0 votes

I'm planning on selling one property for about $360,000. It currently has a mortgage of about $270,000, or about 75%.

The property I'm thinking of buying would be of lesser value and in a different state. Probably two properties totaling about $270,000. If I do a 1031 exchange, I know this won't completely satisfy the like-kind requirement, so I'd be taxed on part of it. I'm trying to figure out how I would calculate capital gains taxes on this.

I've been reading up about "mortgage boot" and it seems like if I were to end up with less debt, that that would be considered a gain. So could I reduce the capital gains tax by getting bigger loans? I'm aware that all cash proceeds from the original sale would have to go towards the new property in order to not have it be "cash boot."

The way I calculate things, if the deciding factor is the difference between the sale price of the old house and the total price of the new houses, that would be a $90,000 difference. But if it's the difference between the debt values, and I put 20% down instead of 25% down (20% down will just about use up what's left after realtor fees) then the difference between the old loan and the new loans would be about $55,000. Obviously I'd be better off in the second scenario. So which is the correct one?

Also, do I then just take that figure (the "gain") and multiply that by the percentage of my tax bracket (federal + state) to see what the capital gains tax would be?

And one more question: is capital gains tax like income tax? I mean, is it lumped in with income tax so that deductions will reduce it?

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    19y

    There are three requirements for completing a 100% tax-deferred 1031 exchange transaction. You must (1) trade equal or up in value based on the net sales price and the net purchase price; and (2) reinvest all of your net equity or cash proceeds that comes out of the sale closing; and (3) replace the same amount of debt.

    It sounds like you might be trading down in value. This would trigger boot, as you have pointed out. Boot would first be allocated to any depreciation recapture that you have and would be taxes at 25% flat rate for federal purposes and then what ever your state rate is, then the remaining boot amount would be allocated to your capital gain and taxed at a maximum rate of 15% for federal purposes and what ever your state rate is.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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    OP
    Member since 2008 · 8 posts · 0 votes
    19y

    Thanks for that clarification. None of the info I'd found before stated that all three of those were required. Now that I understand that all three of those requirements must be met, I'm definitely re-evaluating my plans.

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  • Lynn Z
    Member since 2008 · 689 posts · 23 votes
    19y

    I am involved in a 1031 exchange and made improvements to equalize the FMV of the two properties. It's tricky because all of this must be completed within the 180 day exchange period. Exchange expenses are deducted from the sales and purchase and that's pretty complicated too as to what IRS allows and disallows. For instance, security deposits should be paid outside of closing as that is not considered an exchange expense by the IRS apparently.

    There is conflicting information on whether or not the debt has to be equal and I've decided the FMV being equal on the replacement properties is the most important factor to remember. I did equalize the debt because my CPA believes it should be equal. When your letter was written stating the address of the property you planned to buy in the 1031 exchange (to the IRS within 45 days of sale of the relinquished property) my understanding is you state the price and add language that states "plus repairs".

    I'm not an accountant but I've done 3 of these. The legal papers must be in order from the beginning. Good Luck

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    19y
    Originally posted by "dal1":
    There is conflicting information on whether or not the debt has to be equal and I've decided the FMV being equal on the replacement properties is the most important factor to remember. I did equalize the debt because my CPA believes it should be equal. When your letter was written stating the address of the property you planned to buy in the 1031 exchange (to the IRS within 45 days of sale of the relinquished property) my understanding is you state the price and add language that states "plus repairs".

    [b]The majority of tax advisors believe that you MUST replace debt in order to have a qualified 1031 exchange transaction. This is NOT the case. You can replace debt with cash if you prefer. There is actually a specific example in Section 1.1031 of the Treasury Regulations that details this. You are right on the money in pointing out that the most important thing is that you trade equal or up in value. You must also reinvest 100% of your equity (cash proceeds) received by the Qualified Intermediary from the sale of your relinquished property. The amount of debt will fall into place if you follow these two rules.

    [/b]
    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
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