1031 With Debt Boot
We are getting different answers from tax accountant and 1031 exchange representative, and from my reading.
How can we determine what amount of cash should be brought to closing?
There was $20,000 debt on relinquished property (paid off at closing). Now buying into a TIC that has more debt. Then there were $10,000 in closing costs on the relinquished property. We are being told we need to bring $30,000 to closing to cover these costs. This does not seem correct to me. Can somebody please help me understand?
[ Edited by lazyme on Date 05/11/2006 ]
Is my question not clear? Or, could someone point me to a previous thread or link? Thanks.
Buying and selling $1,000,000. (for simplicity sake, but close to this)
Debt on old property was $16,000.
Buying into TIC so the debt on that is much more, even at our small % of ownership.
No financing taken out to purchase the TIC.
No cash taken out, want to come as close as possible to an even exchange, so that is why the question.
Seems the $16,000 in debt would offset the debt on the new property. The closing costs on both old and new and what is allowed on exchange is still a little fuzzy.
And, thank you for pointing out what you needed to help with my question
The ownership in the TIC (multi-million dollar property) is about 4%. The debt on that piece (pro-rated to reflect the percentage interest and debt) is way over the $16,000 on the property relinquished.
The adjusted basis is @$300,000 so most of it is gain.
Thank you for all your help. One more question, and I realize it is complicated as you mentioned, but what are some of the typical closing costs that are allowed as part of the 1031 exchange monies? If there is no easy answer, I understand.
lazyme,
From your original post, it appears that you are doing a foward exchange. In this case, you only need to meet two requirements for a fully tax deferred exchange All of the sale proceeds from the relinquished property must be reinvested in the replacement property acquisition, and,
The purchase price of the replacement property must be equal or exceed the sale price (less selling costs) of the relinquished property.Exchange funds can be used to pay those closing costs for your replacement property that are additions to basis, but can not be used to pay for prepaid escrows, hazard insurance, nor interim interest on your new financing.
There is no requirement to replace your debt on the relinquished property. However, since the replacement property must be at least as expensive as the sale price of the relinquished property, it is often difficult to complete the replacement property acquisition without bringing new (and more) financing to the settlement table.
To estimate the amount of cash you need to bring to the settlement table, first add the estimated closing costs to the purchase price of your replacement property. From that total, subtract the amount of the exchange funds deposited with your qualified intermediary. The diffference is the amount of cash and/or new financing you will need to bring to the settlement table.
I see where you got the $34,000. Sorry. However, I still have the question on the debt buying into a TIC that has debt enough (more) to cover relinquished property debt.
The relinquished property debt is irrelevant -- it was paid off from the proceeds of the relinquished property sale and is removed from further consideration as your complete your exchange.
For an estimating guide, the purchase price of your replacement property should be equal to the sale price of your relinquished property.
The purchase price of your replacement property, minus the funds deposited into your exchange escrow account is the minimum amount of cash and or new financing you need to bring to the settlement table. If you have settlement costs for your TIC property, add these to your cash at settlement requirements.
Additionally, in order to reinvest equal to or greater than, I would like to invest maybe $1,000 more rather than $20,000 more when all is said and done. Trying to arrive at that figure has become problematic.
And, the business sold is a C corporation if that makes any difference.
Now, after all this you tell us that you held back some information? The relinquished property is a business, maybe two businesses. Either or both may have capital assets that are not real estate (furnishings and/or equipment, for example).
This really adds more complexity to the 1031 exchange questions and the solution may have to deal with non-like kind property. Throw away most everything we have already discussed because a lot of the responses we have already given are not tailored to this specific situation.
The best you can do for the elderly person you are trying to assist is to have them go to a licensed tax professional and to a 1031exchange professional (not the TIC agent), even pay for the consultation(s) yourself if necessary. There is too much money involved to get it wrong, especially when you withhold material facts.
I just re-read your other thoughts. No, there are no capital assets included in the scenario presented. It is all real estate. Sold one business, investing in 3 businesses.
What was the business that was sold?
a camper park
Let me know if you need any further assistance. I would be happy to help you crunch the numbers.
[addsig]
The answer to your question is that there is no need to replace the debt portion on the relinquished property.
You may choose to use your own cash and acquire a free and clear replacement property if you so choose. Even if the replacement property is a TIC deal. Your investment can be all cash with no debt if you wish.
The site just posted an article on this:
http://www.thecreativeinvestor.com/Article1377-You_Can_Buy_Real_Estate_With_Your_IRA_or_401K_.html
Skydiver,
One problem with your strategy is double taxation.
lf you borrow from your 401k, you have to pay it back with interest. The money you use to pay back your loan is money you have already paid taxes on.
When you are eligible to make withdrawals, your withdrawals are taxed as ordinary income. So, you are taxed once again on the same money you used to pay back the loan.
You also run the risk of having your loan called early. What if you are caught in a corporate downsizing. Since you are no longer an employee of the company, the plan administrator will call your loan due and payable in full (probably with a 30 day deadline) or your loan will be deemed to be an early withdrawal.
Early withdrawals are taxed as ordinary income AND a 10% early withdrawal penalty is added on when you file your income tax return.