1031 Exchange when I have no proceeds at settlement due to big refi in the past

[Account Closed]

Here is my situation:

I bought an investment property and improved it.  All-in for $200k cash.  I refinanced it and have a mortgage on the property for $450k.  I'm planning on selling it now and it should sell for about $500k or less.  Assuming $50k in closing costs, I should have $0 in proceeds from sale or even bring money to the table to pay off mortgage.

Net Sales Price will be $450k ($500k less $50k closing costs)

Cost basis is $200k (assume its already adjusted for depreciation for simplicity)

Capital Gain is $250k 

Am I right to not include the refinance proceeds in the above scenario when calculating capital gains?   If so, I want to do a 1031 exchange to avoid capital gains tax.  Would that be possible?  If so, how does the refinance play into that?  Also, the fact that I won't get proceeds from settlement.  

I feel like I'm missing something here.

[Dave Foster]

@Account Closed, To completely defer all tax you must purchase at least as much as your net sale ($450K) and use all of the proceeds ($0 in this case) in the next purchase.  Your refi eliminated your equity.  But that refi does not count as profit.  Profit is the difference between your adjusted cost basis and the net sales price.

Unfortunately this isn't a completely uncommon scenario.  It can happen when you have aggressively refinanced to squeeze out equity.  And it happens in the tailspin of a falling market where the value has dropped below the mortgage.  I've had clients bring money to the table in order to sell their property and start a 1031 (not nearly as much fun as having taken out a refi :).

You'll need to have some other cash to use as a down payment now. Or there is a Delaware Statutory Trust product called a Zero coupon DST. That doesn't pay monthly but absorbs 100% of your debt and uses all cash flow to pay off the institutional debt on the property. These can be a real benefit in the right circumstance to absorb that debt.