1031 Exchange question for my situation - Did the CPA misspeak?

Question

Can someone read this example and tell me one way or another what's possible. Just sat with another friend/CPA and what he mentioned I was not aware and I am not sure if it's accurate. Nothing against him, as only a small few ever come across 1031's.

1. If I have a rehab that is bought for 100k, 150k is put in, for an overall cost basis of 250k.

2. If I decide to list and it goes under contract for 450k, in theory, I have 200k in taxable sale proceeds. '

3. If I don't want or need the sales proceeds, can I not 1031 the 200k, start my period for a like kind exchange, and then convert back into a future buyer.

4. I would also then regain the 100k purchase price and the 150k rehab cost and (total 250k) which was my original cost basis back into my bank account without any limitations or taxable event

Correct?

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I know I could partial 1031 the 200k in gains listed above by 1031'ing say 150k....into a like kind exchnage, and then keep 50k of the sales proceeds....and pay taxes on that 50k.

My firend/CPA said that the only option he knew of was that you would have to 1031 the entire 450k....so you wouldn't keep back the 250k that was non-taxable. So he discouraged me to do a 1031. He lives in Malibu and I don't necessarily know anything about his tax background, his clients, or where his focus has been over the years.

If he is correct and I am misinformed, then this drastically changes my gameplan over the 4 projects I have this summer. All with the same goal of not wanting to take any of the sales proceeds and roll each sale in a 1031 for the entire amount over my cost basis (per property).

Happy Easter to those families that celebrate. Thanks for all your help. JP

Dave Foster · Answer

@JP Christopher, There may be a bigger issue lurking for you. Property that qualifies for 1031 treatment is property you purchased with the intent of holding for productive use. It sounds like you may have some properties you purchased to rehab and sell. If that was your intent then the 1031 will not work for you anyway. So start with that.The requirement to defer all tax is to purchase at least as much as your net sale (450) and use all of the proceeds from the sale in your purchase (200K). Although this 200K is your only profit, when you do a 1031 exchange the IRS says that any amount you purchase less than your net sale or any cash you take is profit first.So if you do a partial exchange what you take out is not your original basis according to the IRS. It is profit. they have nuclear weapons. So they win the argument :)

Dave Foster · Answer

Exactly right @Eric Ashby! Intent can be demonstrated in a variety of ways. Each individual situation determines what the client and their tax advisors are comfortable with. i even did an exchange for a BP member once who hled his property for 1 month. Turns out a bear moved in and the tenant moved out. And the client didn't want to fight a bear. The door camera pictures convinced his accountant :)

Eric Ashby · Answer

@Dave FosterThis is a great point. Also of note although I do not believe there is a specified hold period in the tax legislation some QIs will require a minimum hold (this helps prove that the intent was to utilize as a long term passive income investment opposed to active flip income). You need to explain the facts and circumstances with a QI and see what they think as they will ultimately need to sign off on the transaction.

Tanner Glenn · Answer

Another way to look at it is the first money reinvested is your basis from the sold property. You have to reinvest the entire basis before any gain can be deferred. I think you may have this backwards in your strategy. It sounds like you want the first money reinvested to be the taxable gain portion of the sales proceeds and you pocket the gain proceeds. The IRS won't let you treat it that way.

Eddie L. · Answer

***Not a CPA and no filing tax return experience for others***Yea definitely take a look at the article as it's helpful for the overall steps. Conceptually you can think of 1031 as you exchanging your now $450k value property for another $450k property in order to defer the taxes. If you think of it this way then you'll see that in order to full defer the entire gain from your sale, you'll need to use the entire $450k of cash received from the sold property to purchases the replacement propertie(s). I think the confusion is how much sale proceeds was your transaction. The amount of sale proceeds received in your example is $450k right? You received $450k of cash in your sale which implies your property's value was $450k at the time of sale. If then only use $200k out of the $450k to purchase a replacement property, then you see you just exchanged a $450k property for a $200k property and also received $250k of cash? $250k will be treated as "boot" but will be taxed to you up to the gain from the original sale so that would be the $200k. Effectively this ends up deferring $0 of the gain under 1031.

JP Christopher · Answer

Thanks to you both. I totally get it and just was looking at differently. I understand that if I want to proceed down this path, then I need to be prepared to exchange 100% of the total amount that is sold. And if for some reason I can't tie up that total amount, then I will need to treat the sale without an exchange and pay the tax accordingly. Thanks again. JP

JP Christopher · Answer

Sorry Eddie. I may have been confusing. All I am trying to do is not create a taxable event and defer the sales proceeds (that would be taxable) by carrying out a 1031 exchange. As I don't need the money and would rather re-invest. (that is what I meant by being a buyer again)So whatever I sell this house above what my basis is....I wanted to 1031 that specific amount. In my example, if purchase and rehab was 250k....and it sold for 450k....I wanted to 1031 the 200k sale proceeds. And take back the 250k purchase and rehab monies to use in other capacities. I understood the term "partial exchange" and also "boot" but I took it as....if I had 200k in sales proceeds in the example above, but only 1031 exchanged 150k amount...I would then be doing a partial exchange. The remaining 50k of the sales proceeds would be taxable and would be considered the "boot". If that is not correct and we are saying that the entire 450k has to be entered into a 1031 exchange.....then that was not my understanding. But I will take a look at the article. I have read a ton but not many get into the real weeds on things. Thanks again. Jp

Eddie L. · Answer

This BP article may be helpful as well.https://www.biggerpockets.com/...Technically, it is possible to carry out a partial 1031 exchange and purchase something of lower value, but taxes will have to be paid on the difference. For example, if the relinquished property is being sold for $1 million and the investor purchases a new property through the 1031 exchange for $900,000, they will need to pay the normal capital gains taxes on the $100,000 difference. This extra $100,000 is known as “boot.”

Eddie L. · Answer

Don't follow the example exactly. You sold a property with an adjusted basis of $250k for $450k. You have $450k of cash now. You can either full 1031 exchange the $450k or you can 1031 exchange a part of it. How much are you looking to partial? What does "convert back into a future buyer mean?