Feeling 1031 Stupid
Two questions, one was recently asked by Francine but I still need a dunce cap, apparently.
One: I've just been told by the 1031 exchange company I intend to use that the ENTIRE sales price - not just what I earned off of it once the mort is paid off (30K) - has to be used to purchase the next property. So if I am selling for 60K, I have to buy for 60K and up. Correct?
Next dunce question, that was already pretty much asked but I'm still at a loss for some reason. Can I ever refi the new rental I just (theoretically) purchased with 1031 funds for 60K, to take cash out and purchase another rental with those funds?
In other words, is the 30K in equity I have in the new rental entirely tied up? The 1031 exchange company said I should probably not do a refi, that the IRS would frown on it.
Thanks for your patience.
-The Grey Dunce
I am relatively new to the 1031 thing also but I found out a lot asking around in these forums. The company is correct in saying that the replacement property must have equal or greater value than the relinquished property. The reason is because of what they call "Debt Boot" If you take money from the exchange to pay off your current mortgage, it is considered a gain. In order to defer all of the capital gains taxes, the you must end up with the same amount of debt UNLESS, you take money out of your pocket to pay down the debt.
Check out this little book that one company put together. It explains a lot.
http://www.irs1031exchanges.com/manual/book.shtml
Thank you - I'm going to look at it as soon as I finish this post!
I actually looked again at the other thread, at NewKid's suggestion to look at how much we would pay in capital gains as opposed to how much we would spend in closing costs/transaction fees/etc. I'll be talking to my accountant tommorrow to see how much the CGs would be.
Does anyone have a ballpark figure of the buyer's closing costs on an investment of 120K? It'd help me weigh the trouble involved with the 1031s.
Which, it seems the 1031s are GREAT if you have an apartment building or larger blocks of investment property. But for us small fries... not as great.
As for the closing costs, I think you should be able to get the Seller to pick up all of them. But if you don't I think the going rate is 2.5% for each realtor and 1% for the escrow co. 120K X 6% = 7200
I am in the process of selling two places and my realtor has me picking up the buyers closing on one of them. It depends on how much the seller wants to sell.
LadyGrey
Quote:I've just been told by the 1031 exchange company I intend to use that the ENTIRE sales price - not just what I earned off of it once the mort is paid off (30K) - has to be used to purchase the next property. So if I am selling for 60K, I have to buy for 60K and up. Correct?This is correct. Your replacement property must cost at least as much as the sale price you received for your relinquished property.
Dontaskwhy is correct that net debt relief received is taxable boot, but this ONLY applies when a simultaneous or direct exchange is involved. Direct exchanges (I give you my property, you give me yours, and we just assume each other's debt) are pretty rare these days.
The deferred exchange which requires a qualified intermediary, is more commonly employed. In a deferred exchange, you are selling your relinquished property and purchasing a new replacement property. Since you are paying off your old debt there is NO debt relief involved. So, in a deferred exchange, you only need to worry about trading equal or up in value.
As long as all of your net proceeds from the relinquished property sale are held by your qualified intermediary and reinvested in your replacement property acquisition, the exchange is intact and your capital gains are deferred.
Quote:Can I ever refi the new rental I just (theoretically) purchased with 1031 funds for 60K, to take cash out and purchase another rental with those funds?
In other words, is the 30K in equity I have in the new rental entirely tied up? The 1031 exchange company said I should probably not do a refi, that the IRS would frown on it.The exchange company is partially correct. The IRS may frown upon a cash out refi of your relinquished property just prior to an exchange. You can safely refinance your replacement property after the exchange has closed.
The problem you will encounter is finding a lender that will do a 100% LTV cash out refinance on an investment property. Let's say that you only find lenders that will go to 80% LTV. So for your $60K property, the maximum cash out refi loan you can get in this case is $48K. This still leaves $12K in equity in your replacement property but gives you another $18K to invest in another property.
If you know you want to acquire an additional investment property with some of the equity in your replacement property, you don't have to go through the extra costs of refinancing the replacement property. A better approach would be to acquire two properties as replacements for your relinquished property. You are allowed to identify up to three replacement properties for your exchange. To complete the exchange you are required to purchase one or more of your identified properties before the exchange window closes. You are not limited to just one replacement property for one relinquished property. As long as the total cost of your replacement properties is at least as great as the sale price of your relinquished property, you will be OK.
I just completed an exchange where I sold one property for $150K and purchased two replacement properties totalling $190K. The sale proceeds from the relinquished property settlement was $100K. I applied $50K of my exchange funds to each replacement property acquisition.
Thanks, NewKid, it all makes sense now. Takes a while for some of us. 8-)