1031 Rules - purchase price or profit?

Question

I've never done a 1031 personally. Would absolutely get someone qualified involved. That said, I have a client with a condo she bought for $100k and is now selling for $190k. In order to comply with 1031 rules, does she have to purchase a new property for $190k, or does she have to purchase only for the profit she made, which would be $90k.

Numbers and scenario are for the sake of simplification. I know there is a tight timeframe in which to choose a new property, specific dates to close, etc.

Dave Foster · Answer

@?James Jasunas and @?natalie Kolodji thanks for the shouts out.  @Mindy Jensen, if she wants to defer all tax she needs to do two things reinvestment wise.  First she must purchase at least as much as her net sale (the contract price minus normal costs of closing).  Second she must use all her net proceeds (net sale minus mortgage payoff) in the replacement purchases.

Using your numbers, if the contract is $190 and there are $10K in closing costs then her net sale is $180K. A mortgage of $90K would leave her with proceeds of $90K.  So in order to defer all tax she must purchase at least $180K in real estate using all $90K to do so.

She can purchase less than what she sells or she can take cash but what ever she buys down or whatever she takes in Cash is consider to be profit first.  so she would pay tax on that amount but shelter the remainder.

One answer is exactly what you suggested - purchase more than one property using the cash proceeds as down payments.  She can allocate that cash in any way she wants as long as she purchases at least as much as she sells and uses all the proceeds - to defer all tax.

Topher Vanous · Answer

A big thanks to Dave Foster and Bill Exeter for taking the time to clarify my question!!

Bill Exeter · Answer

Hi @Topher Vanous,

Replacement property acquired as part of a 1031 Exchange transaction must be property that you intend to hold for rental, investment or business use. Properties acquired for personal use such as your primary residence, personal vacation property or personal second home would not qualify for 1031 Exchange treatment.

You can acquire replacement property that is held for rental, investment or business use, hold that property for a sufficient period of time in order to demonstrate that you did in fact have the intent to hold for investment purposes, and then later convert the property into your primary residence or second home.

The critical component here is that you must be able to demonstrate that you did in fact have the intent to hold for rental, investment or business use should you be audited.

Dave Foster · Answer

@Topher Vanous, 1031 is only for property you intend to hold for productive use in investment.  However it is a very common and statutorily approved process to "change your intent" after a period of time and convert an investment property into your primary residence.  So you can do it but you've got to be patient and first complete the 1031 into an investment property and later on convert it to your primary residence.  There is a safe harbor for a two year holding period before moving in.  Some folks feel comfortable at more than a year.

Bill Exeter · Answer

Hi @Mindy Jensen,

Technically, it is the Net Sale Price.  She would take her Gross Sale Price of $190,000 and subtract her "routine selling expenses" (not all closing costs) such as real estate agent's commission, documentary transfer tax, recording fees, escrow fees, title insurance charges, exchange fees, etc., but not any lender related pay-off expenses or operating expenses such as prorated property taxes, prorated rents, HOA fees, etc., which would give her the Net Sale Price.

The Net Sale Price is the amount that she needs to reinvest in one or more replacement properties in order to defer all of her tax consequences.  So, as long as the total of her replacement properties that she acquires are equal to or greater than the Net Sale Price, she will be good to go.  She must also reinvest all of the equity (cash) generated by the sale of her relinquished property.

Natalie Kolodij · Answer

Purchase Price I believe - So new condo would need to cost $190k plus.

@Dave Foster can confirm

Jay Jasunas · Answer

@Mindy Jensen

I am going through a 1031 currently and using Dave Foster at ERG here in Lakewood, CO. He seems super knowledgeable on the topic.

As a general rule, you must replace the property with the same or higher amount, so $190k or higher. Profits do not come into the 1031 equation.

Jeff D. · Answer

I believe in needs to be a investment property

Topher Vanous · Answer

Can you do a 1031 exchange into a personal property, that you as owner/occupant intend to live in, or is it only for tenant occupied type properties?

Mindy Jensen · Answer

Thanks so much @Dave Foster !

1031 Rules - purchase price or profit?

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