Selling a 1031 exchanged property with increased debt

[Andrew C.]

I have never sold a property that I've previously 1031'd into. I am confused on how to think about my potential tax liability and I've had different opinions from professionals. 

The scenario is that I bought a house for $200k ($150k mortgage). I sold it for $300k. Rather than realizing the $100k gain plus any depreciation recapture, I bought a property for $500k through a 1031 exchange. It was a $350k mortgage and $150k in transferred equity. 

If I sell the house for what I bought it for net of costs, I would think that there would be $100k in gain + recapture. However, I have been told that my cost basis is $200k (ignoring recapture) and the gain would be measured by the selling price $500k. However, that increased selling price is essentially due to taking on an extra $200k in mortgage.  I have been told that's just the way it is, despite seeming unfair on its face considering the increase is due to increased debt.  Is this correct? Any insight is appreciated. 

[Sean Ross]

@Andrew C.,

When you 1031, you carry your adjusted tax basis from the old into the new.  If you trade into a more valuable property, as you did here, the increase in value is added to your old basis.  

I don't know what your depreciation was, but let's imagine that your old basis before the 1031 was $150K.  That's carried over.  The increase from $300K to $500K in property value (+$200K) is added to your old basis, giving you a starting basis of around $350K on this hypothetical scenario.  

If you sell now without a 1031, they'll take that new sale price and compare it to your new adjusted basis; the difference is your total gain,  split between long term gain and recaptured depreciation. 

If you 1031 again, you'll carry the updated adjusted basis into the new property. 

How the new property gets depreciated after a 1031 depends on whether you elected to keep your old schedule after your Exchange.  So you'll need to look closely at that to accurately determine your new basis.

Work with a good tax accountant on this.   Let me know if you need some good options here; we work with quality accountants all around the country.