capital gains question

7 Replies

I'll be selling my first investment property soon and will be buying another property and do a 1099 exchange, my question is if I'm going to have about $180k after the sale then I assume I have to buy a property at $180k or higher to avoid paying any capital gains tax..can I buy the property with hard money or does it have to be cash? And if it can be bought with hard money, can the $180k include rehab costs?? Example: sales price $150k + $30k rehab = $180k total loan and use a 1099 exchange? Or is that double dipping??

Hey Richard,

A 1031 Exchange allows you to take all of the equity built up from your current (down-leg) investment property and put it toward your new (up-leg) investment property. You are NOT required to use all of the equity. Any amount of equity money that is not contributed toward the new property is considered "boot", and will be taxed at the capital gains rate you qualify under. (anywhere from 15-35% depending on the length of ownership).


With your situation here, here is an example of how it could be done:

1.) Get your current property under contract specifying a 1031 Exchange (You're in TX, I'm from CA so your local MLS forms may or may not have that option like ours do, so you may need to ask around).

2.) You will have 45 days from the opening of your escrow to identify 3 valid potential up-leg properties, and 180 days to close escrow on one of them. Otherwise, your sale is no longer deemed a 1031 and you will be taxed as a standard sale.

3.) Say you found a house for $180k:
You can use all $180k as payment and pay ZERO cap gains

You can use $150k and pay cap gains on $30k | Use $100k get taxed on $80k.

etc.

You can include rehab costs but it gets tricky here. Renovations must be completed within that 180-day timeframe, and the property must remain with the 1031 intermediary until completion. For the full renovations aspect, I'll let a CPA on here hop on and take over, I'm not 100% on it myself yet.

Best of luck.

@Richard Lima

The $180k number is irrelevant. What matters is the total sale price, including mortgage payoff. So, if you sold the property for $300k, including a $120k mortgage, you would need to exchange it for a property (or multiple properties) worth at least $300k and take a loan of at least $120k.

A lot more rules exist, as @Wyatt Franta described, so don't try it on your own. Get help.

And critically important: you cannot sell the existing property and then start an exchange. You need to first hire some "qualified intermediary" (a company specializing in facilitating 1031 exchanges), and the sales proceeds will be held in escrow by that company. If you sell the property and touch the money - game over, you lost.

For more help, talk to those intermediaries. Two of them are @Dave Foster and @Bill Exeter .

@Richard Lima

You are making a great decision. It makes a lot of sense to do a 1031 exchange if you are selling an investment property with a gain and still continue to be in real estate.

Make sure you reach out to a 1031 intermediary BEFORE selling the property. He/she should be able to walk you through the process.

Regards what you need to buy back to defer 100% of the tax. You must atleast use the cost basis and the gain of the investment you are selling.

@Richard Lima , If you owned the property free and clear then your reinvestment target to avoid all tax and depreciation recapture will be the amount of your net proceeds (the !80K ish). If there was a loan paid off you must add that to the proceeds and make your purchase at least that much to avoid all tax.

The reason is that any amount of cash you take or any amount you purchase less than you sell the IRS determines is taking profit (either cash direct or with borrowing less).  

So the two part rule is to purchase at least as much as your net sale and use all of the proceeds in the purchase.  Or use all the cash and purchase at least as much as the cash plus the mortgage pay off.  It's the same number.  As long as you do those two things you'll defer all tax.  The IRS doesn't care if you bring your own cash to supplement or if you take conventional mortgage or hard money. 

The answer to your other question is "maybe". 1031 proceeds can only be used for the purchase of property. You cannot exchange for improvements on property you already own. So buying the property and then improving it after with 1031 money will not work. But you can do a process called a reverse improvement exchange. The difference is that your intermediary takes title to the new property and holds it until the improvements are complete and you complete the purchase of the new property for $180K ($150K + $30K improvements). The reverse exchange is more complicated and expensive but if you're saving more than $30K in profit there's going to be some net savings.


@Wyatt Franta , Just noticed one small changed needed in your excellent post.  And it's actually to your advantage.  The identification period and exchange period do not start until the closing of escrow.  So @Richard Lima would actually have 45 days more from the closing of his sale to identify his potential replacements and 180 days from that day of closing to complete his exchange.