1031 Exchange for value of property less purchase price?

Question

I have a property that is worth about $465,000. I bought it in 2003 for $250,00 with the proceeds of my deceased mother's property that I sold. I thought I could 1031 it for the current value minus the amount I bought it for, or that that would be the only amount that I would need to have sheltered from capital gains. Am I thinking incorrectly about this? Probably, because that's what my CPA said. I'm thinking about buying a property for only $215,000. Would I be able to protect that amount using the 1031 Exchange and not worry about the other amount since it's not affected by capital gains?

Dave Foster · Answer

@Tambi Harwood, In the scenario you describe you would not be saving any taxes by doing a 1031.

In order to defer all tax in a 1031 you must purchase at least as much as you sell ($450K ish) and use all of the cash proceeds (approx $250K ish) in the next purchase or purchases.

In return for leaving the tax in the game the IRS expects you to leave your gain in the deal. But they consider gain differently than you are. You're accountant is thinking that you can pull . out your original capital first and leave the profit in to go forward.

But the IRS says that you always pull profit out first when doing a 1031 exchange. So, you can purchase less than you sold. And you can take cash out. But it is considered to be profit. You pay tax on the difference while sheltering any remaining profit in the 1031.

If you sold for $450K and purchased for $400K you would pay tax on the $50K difference but shelter the remaining profit in the 1031. You scenario has you purchasing around $250K less than you sold. Since your entire profit is around $200K you'll pay tax on all of your profit and there would be no incentive to do a 1031.

You could always purchase multiple properties. it's not the number of properties that matters, it is the valuation. As long as you purchase at least as much as you sell you'll defer all tax.

1031 Exchange for value of property less purchase price?

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