Can you 1031 into a cheaper property?

Question

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?

Dave Foster · Answer

@Julia Taylor, I totally get the confusion.  And I appreciate @Alex Olson and @Bill Brandts shout outs.

If you want to defer all tax you must purchase at least as much as your net sale (contract price minus closing costs).  And you must use all of your proceeds from the sale in your purchase or purchases.

Where it gets confusing is that the IRS doesn't really care what your true gain is.  They simply say that if you purchase less than your net sale you pay tax on the difference.  If you take cash out you pay tax on the cash you take out.

In your example you're wanting to buy so much less than you sold that all of your profit would be taxable anyways like Bill said.

Where it all hits the road is that the amount you buy down you want to say is your original capital and that you're leaving the profit in the 1031.  But the IRS treats it exactly opposit.  when you do a 1031 the amount you take out is always considered profit first.

I hear the IRS is buying around 800,000 new handguns for their field agents.  Guess who's going to win that argument???!

Bill B. · Answer

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.

Alex Olson · Answer

@Julia Taylor In this case you would be selling for close to what you have into the property so you would not have any capital gains. However if you have capital gains and they are substantial, you would want to exchange for the same price or more than the property you sold. You can also buy 1, 2, or 3 properties with your 1031 exchange funds. Your tax accountant and a QI (@Dave Foster is the best at keeping it simple) would be able to help make sure you lined it up. Honestly, it is not complicated at all. Some people make it complicated because they throw all of your options at you. On your first exchange, keep it as simple as possible and make sure you are upgrading either location, newer construction, more passive, or simple to operate and you will be winning!

Basit Siddiqi · Answer

You can do a 1031 but you may recognize some gain from the sale.Also factor in if you have any 'suspended passive losses' to help offset some of that gain.Best of luck.

Tracey Lane · Answer

There's tons of great threads on here to learn from and yes, it feels very confusing at times. We almost did one a couple years ago and I remember there being a steep learning curve with it all. I'm sure someone knowledgdable will chime in but basically, no, it has to be equal or more than the property you're selling. And I believe you also have to carry a similar mortgage going in to the new property. Search through the forums here for more detailed info.

Can you 1031 into a cheaper property?

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