1031 Exchange and equity

[Michael Dahl]

I am in the process of selling my duplex and I would like to do a 1031 exchange, but also take out some equity that is in the deal. 

I originally put in approximately $50k as the down payment when I first bought the property and I will hopefully make another $75K when selling the property. Am I able to take out the original $50k and then roll over the $75k into a 1031 exchange without any tax implications?

[Daniel Osman]

@Michael Dahl 

In a 1031 exchange, to fully defer capital gains taxes, you must reinvest all net proceeds from the sale of your relinquished property into a like-kind replacement property. Any cash you take out from the transaction is considered "boot" and will be subject to capital gains tax.

It's a common misconception that you only need to reinvest the profit from the sale. In reality, you must reinvest all net sale proceeds to fully defer taxes. The IRS views this as a continuation of your investment, not a tax break. The concept is "continuity of investment," meaning you can roll your gains forward, but you can't take any money off the table while still fully deferring taxes.

In your case, if you withdraw the original 50k down payment, it will be treated as boot, and you will have to pay taxes on that amount. To avoid any tax implications, you would need to reinvest the entire 125k (50k original down payment + 75k gain) into the replacement property.

If you're in Minnesota, be aware that in addition to federal taxes, you may face a high state tax on any boot. You're usually better off completing the 1031 exchange to defer taxes and then refinancing the replacement property afterward. Refinancing does not create a taxable event since it's debt. The best part? Your tenants should be paying off that debt each month.