Will A 1031 Help?
I have a rental property that is worth about $320K, my basis is about $200K. A guy wants to trade me a property that is worth about $120K + $200K in cash. Would I be able to do a 1031 exchange for this situation? If so, would my basis in the new property be zero?
Yes, absolutely. You would have a 1031 exchange where you would close on your first like-kind replacement property simultaneously and the $200K in cash would be deposited with your Qualified Intermediary waiting for the second acquisition.
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Hi NewKid,
You are right. In a direct exchange no QI is needed. The two parties would simply prepare deeds and record them simultaneously. This is what we call a two party swap.
However, in most cases, such as this one, the values are not equal and one party has to pay the other party in order to balance out the values. If you do a two party swap without a QI the cash payment is boot and would be taxable.
Instead, you could set-up the entire transaction as a 1031 exchange with a QI (Qualified Intermediary or Accommodator) and have the first property close simultaneously as the first like-kind replacement property in the 1031 exchange and the $200K in cash would be sent directly to the QI so that the investor could then identify and acquire another like-kind replacement property and defer the taxes on the $200K as well.
If the cash boot amount is a small amount, I usually recommend the two party swap and just pay taxes on the difference. But, $200K is a nice chunk, so using a QI and buying another property to defer all of the tax is most likely the best strategy, depending on the investors objectives.
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Hi Jason,
If you want to defer 100% of your income tax consequences, you have to meet three requirements:
1. Trade equal or up in value based on your net sales/purchase prices.
2. Reinvest 100% of net cash proceeds from sale into your like-kind replacement properties.
3. Replace the same amount of debt that was paid off on the close of your relinquished property with new debt on your like-kind replacement properties.
It sounds like you really need to trade down in value in order to simlify your life, so a 1031 exchange may not provide you any benefit. It would depend on the amount of your depreciation recapture (if any) and capital gain gain. If you trade down too much you would recognize all of your taxable events and not defer any taxes.
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