Capital Gains tax

[AUDREY DESOUZA]

Selling an investment property, that I purchased for little to nothing and  selling for over a huge profit, after renting for 5 years... what is the best way to avoid huge capital gains tax.  Do I have to buy another property with the entire amount that I make?  Any advise would be appreciated.  I was intending on buying  a couple of single family houses, but would it make sense to purchase a multifamily building that is more expensive?

[Joel Owens]

Hey John Roust,

2. What you do not use in the 1031 will be boot and taxable. If you had 2 million to exchange and used 1,500,000 and took the 500,000 out then you would be taxed on the 500,000.

There is also depreciation recapture to contend with. Bottom line is if it's just long term capital gains tax it is not as bad if you do not 1031 but if you have built up considerable depreciation over the years it can be a killer. Yes eventually you leave in the stepped up basis and are no longer on the globe but at least your heirs aren't getting hit with all that deferred built up junk ( capital gains deferment & depreciation recapture ).

4. After the 45 day period is over you are then stuck with the selections. Prior to the 45 days you need to lock in your selections. A 1031 company sends a form you fill out with your 3 selections if that is the option you are choosing. You want time to send in your written form to the 1031 companies audit review department. They are confirming that you filled out everything correctly before locking the selections in. For instance if 45 days ended and they had received your selections but have not screened it yet then if you had errors you could not change them.

If you plan on closing multiple properties then plan way in advance. This is different then selecting three to close on one. You need to talk to a broker who specializes in the asset class you are trying to exchange into. When new clients call me we go through a process. I want to know what they are looking to exchange into, funds they are working with for 1031 money, liquidity and net worth and if willing to add more funds to buy something, & expectations on return and cap rate. They need to know what is possible and not possible. If a broker isn't asking you these items run from them very fast as they will likely stick you into any crappy property available instead of searching for the best fit.

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On having all of your money from the 1031 into the property you are exchanging into I have seen a few strategies used before. After awhile from the exchange you refinance out some of the 1031 equity you used as the down payment to re-invest into other properties.

I have also seen where a developer for instance will buy a Walgreens zero cash flow and the down payment only needs to be 2 million on a 6 million property. They exchange 3,500,000 in and then after closing do a re-advance and pull the money back out.  Pay down re-advance feature ‐ Large benefit of a zero cash flow investment is the pay down re‐advance feature when the buyer can access non‐taxable cash from the exchange.  

1031 strategies especially advanced ones can get complex. It is  important for the broker and the 1031 company to be in communication with the client all through the process so that everyone understands timelines and objectives. The 1031 avenues should be discussed with your 1031 company as they guide you on what is optimal and best fits your individual situation.

Another item is that if you do not close on anything and the exchange fails the 1031 company has to hold the funds for a certain period of time before releasing back to you. So not only do you pay taxes but insult to injury the money is trapped for awhile not getting a return on it. This is why it is important to have a plan in place EARLY. I am astounded by the people contacting me needing help at the 11th hour. I try to help and sometimes I can make it work for them but I can't walk on water. Short fuse timelines sometimes just do not work out.   

No legal advice given.