Another Partial 1031 exchange question

[Terri Donovan]

I cannot find the answer to my question. Hoping someone here will help me figure out tax consequences of this scenario: 

Purchase price 150K

Improvements 118K

Depreciation 77K

Sale Price 450K  

    So my gain is 450 - (268 -77) = 259, right? 

I want to buy a 205K replacement property.  Will that allow me to defer ANY of my taxes? 

[Dave Foster]

@Terri Donovan, Both @Frank Maratta and @Noreen Duong just about have it nailed.  In order to defer all tax you do need to purchase at least as much as you sell.  The IRS doesn't care how much your gain is if you're doing a 1031.  They simply say that any amount you purchase less than you sell or any amount of cash you take out is first going to be profit.

But here's where your depreciation matters.  And you are correct - your adjusted cost basis is your purchase price + capital improvements - depreciation.  And your gain is the difference between the adjusted cost basis and your net sale.  So you'r gain would be $259K.  

If you purchase at least $450K you defer all tax.  If you purchase $400K you pay tax on the $50K difference but shelter the remaining $209 in the 1031.  If you purchase $205K as you propose you are buying $245K less than what you sold.  So  you would pay tax on the $245K   In that instance you would only shelter the remaining $14K.

With an average exchange fee you'd probably still be saving a few hundred bucks.  But may not be worth your while.  One answer might be to purchase a second property to get closer to that $450K mark.  You can allocate your cash proceeds in any way you want towards your purchases.  So there may be some strategic possibility thinking available there.