1031 tax question for partial exchange

[Ben Lin]

Hi BP,

I sold my property in CA for 755k and bought a property in Houston for 400k. Now, after months of trying I could not find another property to buy. So now I have a boot of 355k because I didn’t find anything else worth buying. Please note I used all the cash from my LA sale (366k after paying off the mortgage) and added my own money to buy the Houston property in cash. 

My question is do I pay taxes on that 355k boot although it was in the form of a mortgage? And if I do pay taxes do I get to deduct my original expenses from the LA sale? Such as renovation costs, money I paid for it, etc? If this is the case then I don’t owe capital gain taxes because I paid more to purchase and renovate the LA property than what I didn’t spend in the 1031 exchange? How does this work? Or do I just pay taxes on the 355k I didn’t spend without being able to deduct expenses?

My CPA is not 100 percent sure as well. If you have had the same experience please share. Any advice would be great! 

Thanks.

[Dave Foster]

@Galen Ikonomov, Sorry to say but you are wrong as well. Don't be so harsh on that CPA :). 1031 is a narrow deep niche that only nerds like me delve in.   And the reinvestment targets are very counterintuitive. 

@Ben Lin, The two part reinvestment requirement is that in order to defer all tax you must purchase at least as much as your net sale (contract price minus closing costs and commissions).  And you must use all of the net proceeds from the sale (the net sale minus mortgage paid off).  The reason for this two part requirement is that the IRS is willing to leave their tax with you.  But you are not allowed to benefit from the transaction without them getting some of their tax.

The IRS doesn't care how much gain you are deferring.  They simply say that the first dollar you benefit from (either by taking cash or by purchasing less than you sold - lowering your liabilities) is a dollar of profit.  

What Galen is saying is that you are taking your original basis out first which is not taxable.  That's understandable.  But the IRS says, NO - the first dollar you take out or any amount you reduce your debt by is gonna be profit first.  And since they make the rules, the IRS wins every time!

Sorry to say but yes, you will pay tax on all $355K (if there was that much profit in total). If your profit was only $300K. then you'll pay tax on the $300K and the other $55k would be considered a return of your basis.