Another 1031 Exchange Question...........
Can one pay off any accounts or debts "associated" with the rehab such as credit cards for which supplies or materials were purchased before a 1031 exchange without being taxed?
Keep in mind that 1031 exchanges are used for long term investments---not a quick rehab that you fix up and sell.
But if there were rehab costs involved (then maybe to a rental for a year or two), that rehab cost is added to the basis of the property.
So in short--yes you will not be taxed on rehab expenses in this senario.
As always--seek competent professionals as my comments are as a layman and not as an attorney or accountant.
Let's say that you bought a property which you rehabbed. You charged your rehab cost to credit cards. Now you want to use this property in a 1031 exchange and use some of the exchange proceeds to clear your credit card debt.
Sorry, but this is called constructive receipt of some of the exchange proceeds. The amount of constructive receipt is taxable.
Remember that only property held for investment or for use in your business can participate in a 1031 exchange. Normally, the property you buy to rehab and resale for profit does not qualify for an exchange.
Maybe I am asking the incorrect question: I have rehabbed a property and when I sell I was going to purchase properties for long term investments.
1.
I have put $5K on credit cards due to the rehab so I was wondering if I could payoff the credit card without being taxed I have all receipts.
2.
I am attempting to avoid capital gains tax so that is why I am purchasing other properties. Also I will have had the property over 1 year.
Any thoughts?
I have been involved in a similar 1031 over the last 35 days and had a little sit down with my accountant to better understand the 1031 exchange. I suggest you have a little sit with your accountant cause it is invaluable info if you have a competant chap on your side.
But here's what I found:
You need to purchase property(ies) for same or greater value than what you have sold. And if you had any loan on property that is sold then you must aquire similar amount in loan(s) on purchases. Any "boot" or $$$ that you take from the proceeds will be taxed even if it was towards rehab expenses.
Try to look at it from IRS point of view, not of rehabber point of view. They don't care if you rehabbed, they just want to see that the exact amounts were exchanged - sales price amount and loan amount exchanged....which you must show of equal or greater purchase investment of similar/like-kind property.
If you take any boot, you will be taxed on that boot. Any proceeds that you transfer will not be taxed at this time.
Hope that helps,
good luck,
noel
[addsig]
noel,
Apparently, your accountant is only talking about simultaneous exchanges, so I suspect he/she may not be really familiar with all the exchange variations.
Instead, talk with an experienced exchange professional about doing a deferred exchange involving a qualified intermediary. In a deferred exchange, when you "sell" your relinquished property, the settlement agent forwards the net sale proceeds to your qualified intermediary. In a fully tax deferred exchange, the intermediary applies all the funds held in your exchange escrow account to the replacement property acquisition.
Because the settlement agent is only depositing the NET sale proceeds with your intermediary, any mortgage loan that you may have had on the relinquished property is paid off. The mortgage loan is paid off so your buyer can receive clear and marketable title. There is no mortgage left, and therefore no mortgage boot to worry about.
To summarize, in a tax deferred exchange, if the purchase price of the replacement property is greater than or equal to the sale price of the relinquished property AND if all of the exchange proceeds are applied to the replacement property acquisition, then the amount of financing required to complete the replacement property purchase is independent of the mortgage balance on your relinquished property.
In short, in a deferred exchange all the profit from the relinquished property sale is tax deferred as long as no net cash boot is received.
Quote:I have rehabbed a property and when I sell I was going to purchase properties for long term investments.It is not clear from your post whether you purchased this property to rehab and resell for profit, or for some other investment purpose. Perhaps you could clarify this point.
Quote:I have put $5K on credit cards due to the rehab so I was wondering if I could payoff the credit card without being taxed I have all receipts. The cost of your rehab is added to the cost basis of the property. If you take any money out of an otherwise qualified exchange to pay off your credit card debt, the money will be taxed as a capital gain.
Quote:I am attempting to avoid capital gains tax so that is why I am purchasing other properties. Also I will have had the property over 1 year.Again, the 1031 tax deferred exchange rules only apply to property you use for the production of income (such as long term rental use), hold for future appreciation, or use in your business.
A rehab property that you fix to flip does not meet the qualified investment use criteria to participate in a 1031 exchange. Even if it takes more than one year to complete the rehab before you flip it, it does not qualify for exchange treatment.
Tell us more about your initial exit strategy for the property and what you have been doing with it over the past year, and we can be somewhat more definitive about whether an exchange is possible.
Even if an exchange is possible, taking money out of the exchange proceeds to pay off your credit card debt will make that amount taxable as cash boot.
There is a lot of good advice here. To specifically address the question of whether your credit card debt can be paid off with your 1031 exchange proceeds, the answer is typically no. The use of the 1031 exchange proceeds to pay off personal debt - even if it was used to rehab - would be constructive receipt and create a taxable event. The credit card debt simply results in an additional capital investment in the property and increases your cost basis.
[addsig]
SInce the home is in my name and I have had almost a year I think I am going to refinance and then sell. That way I will have a chunk of cash to do other deals with while the home is on the market.
There are two ways to approach refinancing to pull cash out and one way that you want to avoid. The most conservative way is to sell, do a 1031 exchange and complete your acquisition and then refinance a few months later to pull cash out for other purposes. The next best would be to refinance and then wait as long as possible (personally, at least six months) before you sell and do an exchange. You absolutely do not want to refinance immediately prior to the 1031 exchange or the IRS could collapse the transaction as a step transaction and tax the funds pulled out as boot.
[addsig]
I only want the cash to purchase more properties so I may just refinance, purchase more units with those monies and then sell within the alotted time period. I do not want to hold onto the initial or refinanced property.
The 1031 Exchange was a concern when I sold the property and a way to reinvest in more properties if I did not refinance.
The only disadvantage to that is if you refi & invest the proceeds without doing a 1031, then you'll need to come up with cash to pay taxes on the initial property when sold.
fmmp,
If you want to cash out your equity to purchase more investment real estate and don't intend to keep the property, why bother with a refinance at all?
Why not just do the 1031 exchange to acquire your replacement investment property? You can acquire more than one replacement property under the exchange umbrella as long as the total value of your replacement property exceeds the sale price of your relinquished property.
Alternative to 1031? I am just thinking loudly, don't know if anybody tried this before...Lets say you flip the property, make for ex. $25,000 and pay your taxes which would be around $5,000 for the short term, I think ( 20%). Then you donate the rest of the money to the nonprofit organization and get the tax write off for yourself for the whole amount you donated. You will receive the tax refund for the amount of $5,000 and if you are an Officer of the nonprofit organization, you still have a handle on the rest of the money you donated. And who knows, you may even decide to work with HUD, they have "specials" for designated nonprofits. Now, does this sound crazy or what?
Yep, sounds pretty crazy.
Sell property for $25K quick profit, pay taxes at ordinary income tax rate (say 25%), and have $18750 left over after taxes.
Now you want me to donate $18750 to a charitable non-profit to get a charitable contribution deduction which (in the 25% tax bracket) reduces my income tax liability by $4687.50.
So, you would have me give away $18750 just to get a charitable contribution deduction which results in a tax benefit a little less than the short term capital gains tax I paid.
Assuming, I can even use a charitable deduction this large because I have not done a good enough job sheltering my income otherwise, how do I come out ahead on this strategy?[ Edited by NewKidinTown2 on Date 10/30/2004 ]