I should first give the disclaimer that I am not giving you advice just sharing my experience. I would recommend consulting with your attorney and/or accountant. Although I would have paid taxes on the gain of $22k if I didnt do the 1031 deferred tax exchange, I still had to purchase a property of equal or greater value. If I would have purchased a property for $64 K (my basis in the property I sold) I would have still ahd to pay cap gains tax on the profit. The IRS wont allow you to take out the profit (or gains) first. So my gross was $85.9K on the sold property and I purchased a “replacement” property for $82.5 K , therefore I will have to pay cap gains tax on teh difference of $3,400 even though i did the deferred exchange. And that is just what it is , deferred tax. Your basis in a property is the amount you purchase it for plus other expenses that the IRS allows (requires) you to add such as fees to obtain a mortgage, capital improvements, etc. This basis is transferred to the replacement property when you do the exchange. This is how the IRS makes sure they eventually will get their money. If I sell the duplex tomorrow for $100k . I will owe $100k-$64k (less cost of improvements i made to the duplex) in cap gains tax , unless I did another 1031 exchange. I had cash (usnecured loan) in the sold property so there was not a mortgage to pay off. I paid for the duplex with the proceeds so i owned it free and clear but still had to pay off unsecured loan for $64K. I refinanced the duplex for $80K which was a cash out because there was not mortgage to pay off. I took the $80k , paid off the $64K and had $16K to move on with. The qualified intermediary sent me a check for the balance of $85.9K - $82.5K.
I hope this helps you some , but again I would recommend hearing from others, reading information on the tax code, and talking to an attorney or accountant.
Posted by Natalie-VA on April 23, 2006 at 10:03:16:
Mark,
Please seek competant tax advice on this one. You cannot use a 1031 exchange for quick flips. You have to hold it for a certain amount of time for investment.
A better plan would be to rehab the house and rent it for at least one year before exchanging it.
I did my first flip and 1031 exchange recently. I bought a FSBO for $60k. Spent $4k on repairs. I put up a FSBO sign about 3 weeks after I closed and had a contract on it before I could finish painting for $89.9k w/ me paying $4k closing cost. So about $22k cap gain. I used Wachovia Exchange Services as qualified intermediary and found a 2-plex for $82.5K, so Ill have to pay 25% tax on the difference of $85.9K and $82.5K. I did a cash out loan on the duplex 2 weeks after the exchange for $80K . Now I have $64k ‘basis’ in the duplex and it is appraised at $105K.
Very interesting, so you had your 22K profit rolled into the 82.5K duplex with a new ~$60K mortgage?
Could you please explain what you mean by the “cash out loan”? You have ~$45K equity after appraisal, right? I am thinking you refinanced for $80,000 cash out but do not see how that could be right… and what do you mean by $64K ‘basis’ I am confused but very interested.