1031 Exchanges

Comments(2)

• 
  DaveT28th February, 2003

  Quote:1. The Adjusted Sale Price would be $188,000. I would get proceds of 98,000 and my mortgage comp. would get 90,000. I have to buy at least 188000 worth of rentals to get my 98000 defered?
  
  2. So after the 180 days if I only closed on one property that was 100,000, how much of my money is tax defered?
  
  3. Say I do buy a house for 188000, and all the capital gain is defered, I rent it out for 1 year, live in it for 2 more and then sell it. All the original capital gain is now tax free right? blum1390,
  
  1. Yes, but I can't really say if that amount is $98K. You don't tell us what your adjusted cost basis is, so I can not really say how much capital gain is being deferred in a 1031 exchange. Your capital gain is the difference between your net sales price and your adjusted cost basis. This is the amount that is eligible to be deferred in a 1031 exchange. To have a completely tax free exchange, the replacement property should cost at least as much as the selling price of the relinquished property.
  
  2. After the exchange window is closed, if you have only purchased a $100K replacement property for your $188K relinquished property, then the difference between your adjusted cost basis in the relinquished property and $100K is your deferred capital gain. Anything over $100K is taxable.
  
  3. Essentially correct, but I would suggest using the replacement property for investment purposes for at least two years before converting it to your primary residence. Taxjunkie, in another post in this forum, encourages three years of investment use before conversion to personal use. After conversion and two years use as your primary residence, up to $250K of capital gain per taxpayer is tax free, but you would still be liable for the depreciation recapture tax.

• 
  28th February, 2003

  Quote:
  On 2003-02-26 01:15, blum1390 wrote:
  Today is the first time I read about 1031 exchanges and I wanted to get some facts straight. Any help would be greatly appreciated.
  1. I have a 4 unit I am considering selling I figured my capital gains taxe will be 21,000, that is why I am looking to defer it. Anyways the Adjusted Sale Price would be $188,000. I would get proceds of 98,000 and my mortgage comp. would get 90,000. So my 98,000 would be put into escrow at the Quailified Intermediary. Now I have 45 to pick up to 3 properties and 180 days to close. Question? I have to buy at least 188000 worth of rentals to get my 98000 defered?
  
  Yes. (However, to clarify ... it is not the sales price less mortgage amount, but rather the amount you are really seeking to defer is the the sale price less your basis (increased by commissions and selling expenses) . You can see my point if you have refinanced for more than your original purchase price). Also it is $188,000 worth of real estate (condos, houses, raw land, commercial property) that you need to purchase. To the extent that you do not purchase $188,000, the difference will be taxable gain.
  
  Which I would have to get mortgages for the rest of the money (or come up with it some other way). So after the 180 days if I only closed on one property that was 100,000, how much of my money is tax defered?
  
  $100,000 less your basis (plus commissions and closing costs). For example, if you originally purchased the property for $95,000 and put in $2,000 worth of improvements, your basis is $97,000. Now assume that your selling costs are $2,000. The amount you have to defer under Section 1031 is $1,000 (i.e., $100k less $99k).
  
  New question: Say I do buy a house for 188000, and all the money is capital gain is defered, I rent it out for 1 year, live in it for 2 more and then sell it. All the original capital gain is now tax free right? (I read on one of the 'Quailified Intermediary' sites that you could make it your primary residence after 1 year. Anyways thanks for any help you can give me. I haven't put up the 4 unit yet so I have a little time to think about it.
  
  
  Here is the problem with that fact situation. If you had originally planned to do the Section 1031 exchange and then planned on converting it to a primarily residence after 1 year, there is a risk the IRS would argue that the replacement property was investment property because you intended to convert it to your primary residence in the near future. This is the IRS using the "step transaction" doctrine in which they consider the exchange and the 1 year later conversion to primary residence a part of the same transaction (trust me on this one; this is usually hard to understand why this can be so for most laypersons). You may want to rent the property out for three years to be safe, as that is the general statute of limitations period on which the IRS could challenge the 1031 exchange.
  
  Now, to answer your question on the gain. Not all of the gain will be excluded from tax. The part that is depreciated (or should have been depreciated) while it was a rental will be "recaptured" on the sale, meaning that part of the capital gain will be converted to ordinary income but subject to tax at federal tax rates up to 28% rate. This will occur even if you do not claim any depreciation deductions on the house during the rental period because the depreciation law (Section 167 and 168 of the Internal Revenue Code in conjunction with the recapture provisions) say that the basis of the property is reduced by the "allowable" depreciation amount, not the "claimed" depreciation amount.
  
  If you get over those hurdles, assuming you have lived in and used the property as your primary residence meeting the 2 out of 5 year test in IRC Section 121, the gain (sales price less basis; here basis is the original basis from the 4-plex plus any cash you put in the deal, if any, to purchase the house on the 1031 exchange) will be tax-free up to $250,000 (or $500,000 if married).
  
  Hope that helps,
  
  Taxjunkie