1031 Situation - Posted by Randy

Posted by David Krulac on July 18, 2011 at 19:15:17:

BAD NEWS: Anytime that you acquire something of less value during an exchange it is called boot and will be taxed.

GOOD NEWS: The current long term tax rate is 15% until Jan 1, 2013.

1031 Situation - Posted by Randy

Posted by Randy on July 18, 2011 at 12:31:22:

I have a 1013 Exchange question ? what are the tax
consequences when you exchange into a lower value building,
after doing a few exchanges?

Here is an example:

Building #1

Purchase price: $50,000
Sales price: $120,000

Taxable gain: $70,000 (for simplicity let?s assume purchase
price = basis.)

But instead of paying the tax on the gain, we do an exchange

Building #2

Purchase price: $240,000
Sales price: $210,000

Basis: $50,000 + 140,000 mortgage = $190,000.

Building #3

Purchase price: $210,000

After exchanging into Building #3, is there any tax due?
True, #3 is of lesser value than #2, but it is of greater
value then #1.

Re: 1031 Situation - Posted by Dave T

Posted by Dave T on July 21, 2011 at 21:38:29:


Let’s go through your serial exchanges.

You bought property 1 for $50K and used that property in your first 1031 exchange. The value of the relinquished property was $120K and the value of the replacement property was $240K.

The amount of financing is not a factor in basis determination. In this case, your cost basis in the replacement property is the adjusted basis in the relinquished property ($50K in your example) plus the amount you had to bring to the settlement table to complete the replacement property acquisision, or $120K.

The cost basis in property 2, the replacement property in the first exchange, is $170K.

You sold property 2 for $210K, so your taxable profit on the would be $40K in the absence of an exchange.

However, you did use property 2 as the relinquished property in a second exchange and acquired property 3 as the replacement property. The value of the replacement property was equal to the value of the relinquished property at the time of the exhcnage, so your adjusted basis in property 2 became your cost basis for property 3, or $170K.

At the end of the last exchange, it would appear that all your exchanges are fully tax deferred provided you reinvested all the exchange proceeds from the sale of each relinquished property into the acquisition of the replacement property.

Note, that I use the work “provided”. From the numbers you gave, it appears that you took money out of the exchange proceeds in the first exchange. You say that property 1 was sold for $120. You say that property 2 was purchased for $240K and has a $140K mortgage.

Here is the problem I see here. There is too mich money on the table. You sold the property for $120K and financed property 2 for $140K. If the exchange proceeds of $120K are added to $140K in new financing, the total is $260K. This is $20K more than you needed to purchase the replacement property.

It appears that you took $20K away from the settlement table in the first exchange. If this is the case, you have taxable cash boot of $20K from the first exchange.

Since the value of the relinquished property in the second exchange is equal to the value of the replacement property, the exchange appears to be fully tax deferred from the information you gave in the example.