1031X minimum requirements

[Bill Ramsour]

I'm trying to understand the exact requirements on a 1031, but keep getting confused. I know... "talk to a pro for my specific needs"... and i will before taking action, but I'd like to understand my options before paying someone for info.

This house was my residence, then a few years ago i moved out and started renting it out. These numbers are appropriate to make math easy...

My situation:

- purchased for $160k.

- $15k in depreciation

- looking to sell it for around $250k

- i currently owe $120k on the mortgage.

- for simplicity, assuming about $20k in cost to sell (realtor, closing, etc.)

I think this means:

- my basis $145k (160-15)

- my net sale price is $230 (250-20)

- i walk away with $110 in cash (230-120)

- of that cash, $70k is "taxable gains", $15k is taxed as "depreciation recapture", and $25 is just mine.

So, i have a few questions:

1. Any mistakes in my baseline understanding above?

2. For the house(s) i purchase with the exchange, what is the minimum value of the purchase? $250? $230? $110? $85? It seems to me like it should be $110 or $85 because it it just feels odd that the IRS would require me to move into a situation where i have to get a new loan, or invest more cash.

3. How much cash do i have to put into the purchase? $110? $85? 20%?

4. Let's imagine it's a future date, and this new place has appreciated by $30k and been depreciated by $20k. If i sold, would i owe on $100k in gains and $35k in recapture? Or just the new $30k and $20k? What if instead of selling at that point, i moved in for 2+ years, then sold? All gains and recapture forgiven?

Thanks for your help!

Bill

[Dave Foster]

@Bill Ramsour, That's a pretty good analysis of your situation.  Let me tweak it and you'll understand #4 better.

Your gain is determined by the difference between your adjusted cost basis and your net sale (the sales price minus closing costs. Adjusted cost basis is determined by starting with your acquisition price +capital improvements - depreciation. This is subtracted from the the net sale and that is your gain.

And the gain is made of two components - gain and depreciation. You pay 15 or 20% on the gain. But you pay 25% on the depreciation recapture. 

In your case then the acquisition was $160K + improvments (???)  - $15K (depreciation) = $145K.

Net sales price - $230K - $145K adjusted cost basis = Total gain of $85K.  of this gain $70K is true capital gain and $15k is depreciation.  Your numbers are right on.  But here's why I took you through the adjusted cost basis calc.

The best way to understand the impact of the 1031 exchange is to think of it as the basis of the old property exchanging into the new property.  So if you sold your old property for a net sale of $230 and bought a new property for $230k your basis in the new property starts at $145K .  because that was the basis of the old property.  If you bought something for $300K your basis would be the $145K plus the additional $70K up purchase of additional depreciable basis so your new basis in a $300K purchase would be $215K.

In order to figure out the gain from a future sale of the next property take the starting basis, add additional purchased basis, add capital improvements, subtract additional depreciation taken.  Subtract that from the next net sale and voila!  There's your new gain situation.

In order to completely defer all tax you must do two things = First you must purchase at least as much as your net sale ($230K);  Second you must use all of the net proceeds from the sale in the next purchase or purchases ($110K).

You can purchase less than you sell.  And you can take cash out of the exchange.  But the IRS will classify the difference as a taking of profit.  So you would pay tax on the difference but shelter the rest of your profit in the 1031.

If you move back in for two years then new rules dominate.  First you must have owned the property for a minimum of 5 years.  Second you must have lived in it for 2 out of the previous 5 years.  Third you will still have to recapture all depreciation.  Fourth you will get to take a prorated amount of gain tax free.  The proration is between periods of qualified use (as primary residence) and non-qualified use (as investment).  So if you rented it for 3 and lived in it for 2 and then sold you would get 2/5ths of the gain tax free and have to recapture depreciation.