Can you 1031 into a cheaper property?

[Julia Taylor]

I talked to a 1031 exchange firm but left the conversation feeling more confused. Can I 1031 into a cheaper property?

We bought a SFH for $400K. We put an additional $65K into it. Realtor expects we can get $550-$575K for the sale. We do have a mortgage on the property, not sure if that matters in this equation.

We are looking to purchase a cheaper property (say, $300K), and put all the proceeds from the sale into it. 

Can you do a 1031 with this type of sale?

[Bill B.]

The mortgage doesn’t matter.

If you paid $400k plus $65k, that’s your cost basis $465k (plus some closing costs) if you sell for $550k you’ll only get $510k give or take after commissions and closing costs. That means you have a gain of $45k. 

I’d say just pay the 15% give or take taxes assuming you’ve owned it a a rental for more than a year. (Obviously your primary would not be eligible for a 1031 but would be 100% tax free.) if you owned it less than a year you’d owe regular taxes and I’d suggest holding on for a year if possible. 

Either way: in your situation there is no reason to do a 1031 and the QI should have told you that. If you sold for $550k and netted $510k, anything you buy less than that is taxable. Imagine your $300k replacement property. If you had $400k in gains, you’d pay taxes on the first $210k ($510k net minus $300k replacement) . But you only have $45k in gains so you’d pay the same taxes on $45k. 

If you plan to buy less than $465k (you cost basis.) there will be zero tax savings. (Other than possible a little depreciation capture avoided.) as mentioned. @Dave Foster is the expert. But I fear even he can’t help you in this case.