1031 Exchange with mortgage

Member since 2024 · 2 posts · 1 vote

We have a two family home. We live on one floor and the other half is rented. The property is being sold for $1 million with a mortgage of about $300k. We're planning on doing a 1031/121 combo. The rental half is essentially half the property, so worth $500k. I need help understanding how the mortgage will be handled. If rental portion is half, then mortgage would be $150k.

1. Would that $150k come out of the $500k proceeds involved in the exchange?
2. If the answer to the above question is yes, then I'd have $350k to use in the exchange. So if I buy a replacement property worth $500k, can I use proceeds from the personal residence half to cover the other $150k? Or would that result in a taxable event because my mortgage would go from 150k to 0?

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Sean RossPro Member

1031 Exchange Qualified Intermediary · Denver, CO · Member since 2017 · 176 posts · 97 votes

Hello @Nancy Chawla,

You will still need a 1031 exchange for the half of the home that has not been treated as your primary residence. It doesn't matter whether you qualify for Section 121 treatment on the other half, which I hope that you do. The tax exemption for Section 121 will not apply to the investment/rental portion.

Here's how the 1031 rules break down for the rented-out $500K portion of your two-family home:

1. Unless you specifically took out a mortgage that is only applicable to the primary residence portion of the home, then the mortgage will be split pro rata between the two halves (so $150K each, in this case).

2. When you sell, the $150K will be paid off at closing, only leaving $350K to be used in the exchange (I am ignoring closing costs in this breakdown).

3. If you don't want to take out debt on the 1031 replacement property, then you can supplement $150K from the proceeds of the personal residence half -- or from any other source that you like. This way you can bring $500K of total down payment on the new property.

Technical point: While you will technically incur "mortgage boot" by not replacing the debt in your new property, using another cash source to replace your debt gives you a "boot offset"; meaning you won't incur tax on the mortgage boot by doing this.

Now, 1031/121 splits are common. But, they're fraught with little nuances that depend on your circumstances. If you are not already working with a Qualified Intermediary on this, I'd be happy to give you a free consult to walk you through the details of your case. If you are already using one, I'd be happy to act as a second opinion for you.

[email protected]888-899-1031

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David Wolkoff
Member since 2021 · 7 posts · 4 votes
2y
Check with a tax professional, but if you have lived in the home for 2 of the previous 5 years, you may not owe any capital gains tax, and so a 1031 is irrelevant.
If you didn't you may want to wait.
If you do go ahead, read about 'mortgage boot'.
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Sean RossPro Member
1031 Exchange Qualified Intermediary · Denver, CO · Member since 2017 · 176 posts · 97 votes
2y
Hello @Nancy Chawla,
You will still need a 1031 exchange for the half of the home that has not been treated as your primary residence. It doesn't matter whether you qualify for Section 121 treatment on the other half, which I hope that you do. The tax exemption for Section 121 will not apply to the investment/rental portion.
Here's how the 1031 rules break down for the rented-out $500K portion of your two-family home:
1. Unless you specifically took out a mortgage that is only applicable to the primary residence portion of the home, then the mortgage will be split pro rata between the two halves (so $150K each, in this case).
2. When you sell, the $150K will be paid off at closing, only leaving $350K to be used in the exchange (I am ignoring closing costs in this breakdown).
3. If you don't want to take out debt on the 1031 replacement property, then you can supplement $150K from the proceeds of the personal residence half -- or from any other source that you like. This way you can bring $500K of total down payment on the new property.
Technical point: While you will technically incur "mortgage boot" by not replacing the debt in your new property, using another cash source to replace your debt gives you a "boot offset"; meaning you won't incur tax on the mortgage boot by doing this.
Now, 1031/121 splits are common. But, they're fraught with little nuances that depend on your circumstances. If you are not already working with a Qualified Intermediary on this, I'd be happy to give you a free consult to walk you through the details of your case. If you are already using one, I'd be happy to act as a second opinion for you.
[email protected]888-899-1031
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Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
2y
I think they ignored your question…

Yes. You could use the proceeds from your primary home portion of the sale to buy the exchanged property all cash. Keeping any exchange cash is taxable, adding more cash is not.
.
Do you have a new place to live? The place you purchase with your 1031 has to be 100% rental if you’re buying a $500k replacement.
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Mohammed Rahman
Real Estate Broker · New York, NY · Member since 2020 · 2k+ posts · 1k+ votes
2y
Very helpful question that I'm curious to follow - my suggestion would be to work with a local tax professional + 1031 qualified intermediary to better assess your personal situation.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
2y
@Nancy Chawla, In a mixed use property like this your accountant has already split up the property into the investment allocation and the primary residence portion. Since that allocation is 50-50 it becomes a simple matter that closing costs are paid. And the mortgage is paid off. And then the net proceeds are divided 50-50.
This would generate $350K that goes into your 1031 with the requirement to use that $350K to purchase at least $500K of real estate. The other $350K is allocated to the profit from the primary residence sale. This would all be tax free.
The requirement to complete your 1031 exchange as mentioned above is to use all of the net proceeds $350K) to purchase at least $500K of investment real estate. You can take out a loan for the remainder. Or you can use your own proceeds (including the tax free cash from the sale of the primary residence side).
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