Stuck Overpaying because of 1031 Exchange

[Bryan Feik]

Hello everyone, Ive been listening to the Podcast and reading the forum for a while but am finally making my first post.Im an active investor in the Denver metro area trying to grow my portfolio in the difficult Colorado market. Any advice you guys can provide regarding my 1031 drama is much appreciated, Ill try to keep this short..

I recently came across an off market deal for two duplexes. I sold a single family home in June, transferred all gains into a 1031 intermediary, and closed on the first duplex without issue (I used half the gains from the sale as a down payment).The second duplex was never formally under contract as the seller agreed to make some costly repairs so that purchase was delayed. ONE DAY before the 45 day identification deadline the seller advised they can’t sell the second property in the same calendar year because of capital gains on both.

I scrambled and identified two additional properties before the 45 day deadline. Plan B was to purchase a great 5-plex in Colorado Springs but that building sold to another buyer and the sale has closed.Plan C is still on the market but overpriced by at least 10 – 15 percent (it probably wont even appraise which may help my cause). Normally I would not even consider this particular property at the inflated price but Im faced with either overpaying or having a large tax consequence.I rented out the single family house (that I sold) for 10 years so the depreciation recapture would be significant.

Plan D was to possibly transfer the remaining funds from the 1031 to be applied to the loan of the first duplex I purchased (purchase price is larger than the sales price of the single family). My 1031 intermediary advised that will not work as those funds must be listed on the settlement statement. Im wondering if anyone has experienced otherwise and if there is any wiggle room there? If not, Im faced with donating money to Uncle Sam or the seller. Any advice or words of wisdom would be much appreciated…

[Dave Foster]

@Bryan Feik, Ouch.  That's doubly a bummer because the first purchase would have covered everything.  At this point there is no wiggle room as far as the first purchase goes.  It's done.  The good news is that the only tax you'll incur will be on the cash left.

But no reason not to play the string out on that second property.  You've now got several months still to complete the purchase.  That's a lot of time for that seller to come back to reality if it's overpriced.  And you can be a gentle waiting presence constantly reminding him that he has a willing buyer whenever he makes the price attractive.  If he sells it in the meantime then it wasn't over priced (at least for retail) it just wasn't a bargain. There's a tipping point in negotiations like this sometimes.  A moment of panic where the seller freaks mildly and will grab at the what they perceive to be a lifeline and undersell because they over estimate the amount they have to drop to get a buyer. 

In a hot market like Denver even buying one replacement property can be daunting in a 1031.  One thing I recommend in situations like yours is to use all the funds if possible in the first purchase.  That way  your 1031 is covered with the first purchase.  Then refi to get the extra cash back out.  Or put a line of credit on it if possible so you've got cash available but not time constraints putting pressure on you.