Is this transaction 1031 eligible?

[Eric Stiegel]

I am considering selling a rental property that I have owned for 10 years and immediately (within 30-60 days) buying a much more expensive rental property. Wondering if a 1031 exchange is possible and if it would be beneficial to me

CURRENT PROPERTY

Bought the current property for $212K ($50K down and 162K mortgage)

Made $53K of improvements

Claimed a total of $63K of depreciation on schedule E over the years

Adjusted Basis is $202K

I plan on selling for $280K

Less approx. selling costs of $18K leaves me with $262K from the sale (mortgage is paid off)

Therefore, my capital gain is $60K

I calculated Capital Gains tax due of approximately $18K

NEW PROPERTY

I am planning on buying a new rental property for approximately $550K

Use $150K of the $262K as a down payment on the new property and taking out a $400K mortgage for the difference

Use the remaining $112K for my daughter’s college fund.

I plan on keeping this rental property for 3-4 years and then either sell it or convert it over to my primary residence when I retire (I should be much lower income tax bracket then).

I realize, if the capital gain is allowed to be deferred, tax on the deferral will be due when I sell or make the conversion to my personal residence.

So my question is:

Does it make financial sense to pay the $18K tax now or do a 1031 exchange? Am I even eligible for a 1031 exchange due to keeping the $112K?

Thanks in advance

Eric

[Dave Foster]

@James Thomas Nakashian LOL . for that you get two votes :) . Both you and @Bill B. saw what I missed.  I was just looking at structure and didn't see the daughters college fund.  Good catch.

@Eric Stiegel, in order to completely defer all tax in a 1031 you must do two things - you must purchase at least as much as your net sale and you must use all of the proceeds from the sale in the next purchase.  The IRS is willing to leave it's tax in but they require that you leave all of your profit in. And the problem is that when you do a 1031 they interpret the first dollar you touch or the amount you buy less than you sell as profit.  So taking the $112K for your daughters fund is seen by you as a return of your original capital.  The IRS says, "Nope that's profit".  And that's a tough bunch to win an argument with.

So in your example you would not benefit from a 1031 since you would be taking out more casb than your profit.  So there would be no tax savings.

But depending on when your daughter will be heading to college you may want to think about putting all of the cash into that new property. The lower mortgage helps your NOI and you can use the extra NOI to slowly seed the college fund while still getting to defer the $18K of tax.

Or you could complete the 1031 and then refinance when your daughter is ready for school.  Or right now if you're dead set on a segregated college fund.  The refi is not taxable.

Or you could even use the $112K to buy a second property and dedicate that asset and cash flow as your daughters fund.

Lots of possibilities still to make it work.  But if you don't want a taxable event you must purchase at least the net sale and use all of the cash to do so.