Another 1031 question - Posted by Carl

Posted by Jim on March 20, 2006 at 23:23:36:


Another 1031 question - Posted by Carl

Posted by Carl on March 16, 2006 at 06:43:00:

I’ve tried to make sense of the IRS 1031 code and it seems to say that you put into your 1031 all profit from the sale of your investment property. So…(assuming there are no improvements and no costs involved in buying or selling)…if you bought for 300K and sold for 500K it would seem that 200K goes into your 1031 and that it has nothing to do with how much you owe on the property. My accountant confirms this.

But, in speaking with a few 1031 agents, I think I’m hearing something different. They tell me that how much you owe on the property is involved in the mix. So, if you buy for 300K and have a 100K mortgage and sell for 500K, 400K goes into your 1031 (sales price of 500 minus mortgage of 100 equals 400) They say that you have to pay cap gains tax on every dollar you walk away with.

Could someone please let me know which is correct. If it’s the latter, I should get a second mortgage and pull some cash out before I sell, no?


Section 1031 Exchange Reference Manual - Posted by William L. Exeter

Posted by William L. Exeter on March 19, 2006 at 17:29:41:

I would be happy to email any one a PDF version of our Section 1031 Tax-Deferred Exchange Reference Manual. Just email me and let me know.

Bill Exeter

Re: Another 1031 question - Posted by William L. Exeter

Posted by William L. Exeter on March 19, 2006 at 17:17:45:

There are three (3) requirements that you must meet in order to defer 100% of your capital gain and depreciation recapture taxes.

(1) Exchange (trade) equal or up in value. The value is based on your net sales price, not your equity. If you sell property at a net sales price of $500K you must acquire like-kind replacmeent property(ies) worth $500K or more.

(2) You must reinvest all of your cash (net equity) that is generated by the sale in your replacement property(ies). The closing agent will wire transfer your net proceeds from the sale of your property to your Accommodator (Qualified Intermediary) and all of the cash must be reinvested in the property(ies) that you acquire. You can pull cash out, but it will always trigger a taxable event.

(3) You must replace the amount of debt paid off with new debt of equal or greater value on the properties that you acquire (provided you do not increase the debt amount too high and end up with cash out at the close of the transaction).

Let me know if you have any additional questions. I would be happy to chat with you.

Re: Another 1031 question - Posted by Chris in FL

Posted by Chris in FL on March 16, 2006 at 12:55:37:

Carl,Basics of a 1031 exchange is, you sell a property (I believe you need to have owned for at least one year), and, rather than paying capital gains on the profit, you exchange it into a like-kind property (investment property for investment property). Done correctly, you do not pay any tax - you defer your profit in the sold property into the purchased property. Your accountant is an I-D-I-O-T (or you misunderstood him). As you laid it out, the actual money in the 1031 exchange account will be sell price (500k), less liens (100k), or (400k) [plus, would be reduced by closing costs and exchange fees]. You definitely want to use a 1031 exchange intermediary. To pay no taxes, the property purchased must cost more and have a bigger mortgage than the property sold. Using your example, if you bought a new 800k property, you would have 400k down (from exchange), and get a 400k mortgage. You would pay no taxes, and your 200k profit on sold property (500k sell price less 300k purchase price) would reduce your basis in the new property (thus a 600k basis). In reality, these numbers would be adjusted by closing costs, exchange fees, and depreciation on the property being sold, plus maybe other factors. If you later sold the new property, say for 900k, without exchanging again, you would pay capital gains on the profit in the old property (200k) as well as on the new property (100k). I did two 1031’s this year, and I will say the details can be very complex (even if you know what you are doing). Also, IRS says you can not withdraw money from an investment property shortly before a 1031 exchange for the purpose of extracting tax-free money, or the entire exchange is void and becomes taxable. I can not stress this enough: get experienced professionals on your side (ask around your local REIA for an accountant that handles 1031’s every day)! Good luck!

Re: Another 1031 question - Posted by Jim

Posted by Jim on March 16, 2006 at 22:12:20:

Could you do the 1031 exchange first, and THEN borrow money against the NEW property in order to tap tax-free money (tax-deferred actually)?

Re: Another 1031 question - Posted by William L. Exeter

Posted by William L. Exeter on March 19, 2006 at 17:23:39:

The Treasury Regulations require that you have the INTENT to REINVEST and HOLD the property for rental, investment or use in a business. They do not specifically address these issues, such as pulling cash out through a refinance transaction before or after the 1031 exchange transaction. You will get a lot of opinions here. If you refinance and pull cash out before the 1031 exchange I would wait at least six (6) months before starting your 1031 exchange transaction. If you intend to refinance after you have completed your 1031 exchange transaction I would wait at least 2 or 3 months before you refinance. There is a private letter ruling where the gentleman refinanced his replacement property the week after his 1031 exchange. The PLR was not obtained for this issue, but the Treasury Department did not disallow it either. I would still take a more conservative approach and wait 2 or 3 months before you refinance. Its better not to invite trouble during an audit unless you must.

Bill Exeter