Re: IRS 1031 Run Out-Ouch! - Posted by John J
Posted by John J on January 22, 2001 at 09:18:09:
Remember Shaun, that the 1031 does not give you a tax credit or a tax deduction. You are only postponing the tax payments and the only savings are the return on the amount that you would otherwise pay in taxes. A simplified example: Suppose your replacement property is worth $100,000 and you could get a commercial mortgage - but not within the 1031 timeframe - for the $65,000 at 10%, then you would be paying about $6,500 in interest the first year. If a hard money loan - within the allowable time frame - costs you 15%, you’d be paying about $9,750. So it will cost you an extra $3,250 in the first year to do the 1031. Suppose that $30K out of the $35K (or $40K incl. closing costs) that comes out of the 1031 escrow account is subject to capital gains taxes if your time runs out. You’ll be paying 20% of this, which is $6,000, in federal taxes (you’ll pay it now vs. later). If you can get a 20% return on your money, it will be worth $1,200 to you in the first year to be able to postpone these tax payments. Don’t end up paying $3,250 to save $1,200. Of course, there are many other factors to consider, such as new vs. carry-over depreciation schedule, state income taxes, depreciation recapture, compounding, and your actual figures being different.
I have let the 1031 eligibility run out in the past without feeling bad if I could not find a great deal on a replacement property within the 45 days. I find this a rather short time for folks like myself who primarily buy at trustee sales or from other distressed situations. On the other hand, I have seen numerous people rush into a transaction at unfavorable terms because they absolutely had to do a 1031 exchange. I always love it when I get a buyer who is set on doing a 1031 and I learn during the negotiations that the 45 days has run out and mine was the only property they had identified as a replacement. My objective now is to get the best deal on a property and I only include the tax consequences in the detailed analysis of the transaction and therefore it can still be a deciding factor. Hope this helps.