In a 1031 if I take out part of the proceeds what happens tax-wise?

Question

If I sell a property I own completely (worth 175k after realtor's fees) and want to keep 50k of the proceeds and 1031 the rest into 2 or 3 new properties how do the tax consequences play out? Do I pay 15% on, say, 58k (paying about 8k in taxes) so I end with 50k? Or is the amount of taxes paid based on how much I actually gained? I originally bought the house for 89k in 1996. I didn't know about mandatory depreciation and I've been renting it almost 10 years, so I only started depreciating it on taxes a few years ago. Would the taxes owed on the 58k (or whatever amount) I keep out from the sale be taxed differently based on the cost basis of the house (what I paid minus what's been depreciated)? Can someone help me make sense of this? To summarize:

- Sell house worth 185k, netting 175k. House was bought for 89k in 1996.

- Keep a net of 50k after whatever taxes are owed.

- Invest the remainder (~117k) into two or three other properties.

Thanks for any help/advice!

- Sell house worth 185k, netting 175k.  House was bought for 89k in 1996.

- Keep a net of 50k after whatever taxes are owed.

- Invest the remainder (~117k) into two or three other properties.

Thanks for any help/advice!

Joel Owens · Answer

Yes you will have boot and be taxed on that amount.

You also need to have a qualified QI hold your funds during the process.

Look up Bill Exeter 1031 on here.

Dave Foster · Answer

Account Closed, better late than never right ?? :)

It starts with the understanding that in exchange for letting you do a 1031 the IRS will be leaving it's tax in the new property.  You will be leaving all of the equity in the new property.  In order to fully defer all tax in a 1031 you must do two things - first you must purchase at least as much as your net sale (the contract price minus closing costs).  And second you must use all of the net proceeds (the net sale minus any mortgage payoff) in the next purchase or purchases.

You can purchase less than you sell and you can take cash out of the sale (as you say - a partial exchange).  But when you do the IRS interprets that as taking profit and wants their tax.  So you pay tax on the difference but can still shelter the remaining in the 1031.

So to your example you're correct you would have $75K in boot.  $75K will be taxable. The treatment of boot is really the question.  Did you take a capital gain or did you take back depreciation?  Because how your account defines it will determine the tax rate to apply.

The way a 1031 is accounted for is that the basis of the old property transfers to the the new property via the form 8824 filed by your accountant.  This transfer accounts for a carry over of the remainder of depreciable basis. And this is why many accountants will treat the boot as first a taking of profit and only after that has been exhausted do they start to recapture the depreciation.  I have seen it both ways.  But predominantly it is treated as gain first.

So I think what you're being told is probably accurate.  You'll pay capital gains on that $75K unless your entire profit is less than $75K in which case  then you'll dip into some depreciation recapture.  You don't exactly get a credit for this.  But it does change the adjusted cost basis calculation that will go into the new property.

Account Closed · Answer

@Bill Exeter, I'm late to this discussion but have similar questions. We were told that for our transaction the amount owed would be approximately $15-20k in capital gains taxes if we do not go the 1031 exchange route, and  instead choose to cash out the entire 225K. If we do a partial 1031, and for example purchase a property at 150K, and cash out the remaining 75K, as I understand it the depreciation recapture is taxed against that 75K but capital gains taxes are not due. Is  the amount of the depreciation recapture then "credited" when the time comes for the sale of the new property, and about what percentage of the entire 75K amount would then be due?  I realize that without all the numbers it's tough to do a calculation, but trying to get an idea of a ballpark figure to see if this is still worth it. Thanks!

Bill Exeter · Answer

@Christopher Andujar

Yes, the most important part is that you have the intent to reinvest, so I would make sure that you reinvest and then do the cash out refi a few months later to ensure that the two transactions are not "connected."

Christopher Andujar · Answer

@Bill Exeter yes i remember now. It also said something about if you do not want to be taxed on that amount you would reinvest it all and then use a cash-out refinance on the new property.

Is that correct?

Bill Exeter · Answer

@Paul Doherty

Hi Paul, if you pull $50K in cash out, it will be taxable.  The $50K cash boot is first applied toward any depreciation recapture that you might have, then toward capital gain taxes.  The cost basis is not prorated, so the entire amount of cash boot would be taxable.

Bill Exeter · Answer

Hi Christopher,

You can structure a partial 1031 Exchange and pull cash out.  The amount of cash that you pull out will be taxable, but it does not jeopardize the 1031 Exchange.  If you wish to defer all of your taxes, then you must reinvest everything.

Christopher Andujar · Answer

I believe i read that somewhere on the forums. May be wrong. I would speak with a QI.

Paul Doherty · Answer

Are you sure?

http://www.forbes.com/2010/01/26/capital-gains-tax...

"8. If you receive cash, it’s taxed.

You may have cash left over after the intermediary acquires the  replacement property. If so, the intermediary will pay it to you at the  end of the 180 days. That cash–known as “boot”–will be taxed as partial  sales proceeds from the sale of your property, generally as a capital  gain."

Christopher Andujar · Answer

It is to my understanding that when you do a 1031 EVERYTHING must go into the new properties you may not take any $ out.

In a 1031 if I take out part of the proceeds what happens tax-wise?

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