Rental Investment vs. Flip

[John Mano]

I purchased a rental 4 years ago for $40k (no mortgage) and it's been rented for the first 3 yrs then last year I decided to fix and sell.  Spent $100k (no loan) on repairs and upgrades and I have an agreement of sales for $250k.  My questions are:

1.  does this qualify for the 1031 exchange?

2.  if yes and I buy a replacement property for $200k, what will be the basis for this property?

3,  since I will getting back about $50k, do I pay capital gains on that or will I have a loss because I would deduct the $100k I spent on repairs and upgrades?

Thank you for your feedback

[Dave Foster]

@John Mano,  There's a lot of different bits of information starting to creep in.  If you don't mind I'll just bullet point your questions.

1. Yes your sale would qualify for a 1031 exchange.  

2. In order to defer all tax you must do two things - First you must purchase at least as much as your net sale (250K ish).  Second you must use all of the proceeds from the sale in the purchase (again 250K ish since there's no loan). You use improvements etc as @Wayne Brooks said to establish your adjusted cost basis if you want to sell without a 1031 exchange. If you are doing a 1031 then those improvements as part of your basis get carried forward into the new property.

3. Your basis carries forward into the new property so if you purchase less than what you sell in a 1031, the IRS views that as a taking of profit.  Your basis is unaffected.

4. You can purchase less than what you sell or take cash out.  Either way, the IRS views that as taking profit.  You will owe tax on that amount.  you do not offset that against your improvements since those are going forward with the new property when you do an exchange.

This is what is called a partial exchange.  You will pay tax on the $50K but will shelter the tax on the $60K ish that is the remainder of your gain.

@Buddy Holmes is absolutely right, the 1031 cannot be a DIY process.  You must use a qualified intermediary to process the exchange along with your regular professionals.  In Buddy's case he reported his own 1031 using turbo tax to file the form 8824.  Your account can use your own capital improvement accounts and depreciation tables to do the same thing.  

And you'll want to pay close attention to all the tax implications of your exchange.  Pennsylvania does not recognize 1031 exchanges at the state level.  So you will not be deferring any state tax, only federal.