1031 Exchange 'Nuts & Bolts'

[John Alosio]

Greeting BP community,

I have a question about the 1031 exchange

I understand the main concept but I am having trouble wrapping my head around the mechanics.

My situation: I currently own a duplex that I have lived in for over 2 years. I am looking to sell and flip it into another owner occupied Multi. When I sell, I am exempt for 50% of the capital gains. I’m looking to 1031 the other 50% into a larger house hack.

Question: When 1031ing these investment gains into the new property, I understand that all of these funds must go into the purchase of the house. What exactly does that mean? The full amount has to go into the down payment? Can I use it towards the closing costs / cost of procuring the 1031?

So I have a lot of numbers floating around in my head.

Lets say I sell the house for a combined gain of $100k.

$50k tax exempt - $50k 1031 exchanging

Lets say the new prospective 4-plex costs $500k ($375k investment - $125k owner occupied)

Now I have to figure out the minimum down payment I need to satisfy the $50k threshold.

My head is spinning just typing this up. I hope my question is making sense. Any help would be much appreciated.

Thank you all in advance.

[Dave Foster]

@John Alosio I think we just connected so I'll forward a paper to you that will sort it all out easily for you.  The brain seizure is that you're combining several things that don't really combine well.

You've got the Primary/investment distinction down.  You will get to take the $50K of profit (50% of the gain) tax free.  And you can do a 1031 on the other 50%.. But here's where it's getting a little confusing for you.

In order to defer all tax you must purchase at least as much as your net sale.  and you must use all of the net proceeds in the next purchase or purchases. (remember these actual numbers are just 50% of the net sale of the entire duplex and 50% of the proceeds).  And yes you can use your proceeds for both down payment and qualified closing costs.

Your actual gain is sort of irrelevant on the 1031 side.  The IRS simply says that to do the 1031 you must purchase as much as your net sale and use all of your net proceeds.  Any amount you purchase less than your net sale or any amount of cash you touch (only on the investment side 50%) they say is profit.  

So if you just stay focused on this two part rule it sorts itself out pretty quickly for you.  

Unfortunately the one number that's missing from your list is the net sales price is your net sale price.  So let me just plug in a number - $300K.  You sell your old duplex for $300K.  That means that the investment portion of the sale (the net sale number for 1031) is $150K.  And you walked with $50K in cash (the net proceeds on the 1031 side.

All you must do to defer all tax is purchase at least $150K in investment real estate using $50K of cash.   So your example of a 4 plex where the investment portion is $375K is perfectly fine.  Your down payment and closing costs on this will certainly exceed the 1031 cash.   Perfect exchange!!!

End of story - $50K goes into your pocket with no tax and no requirements.  $50K purchases a $500K 4 plex through a 1031 exchange.  that you will be using 1/4th of as a primary residence .  The holy grail of investing - Kudos!!!!