1031 exchange refresher

[Nancy Bachety]

Using Round numbers 

Selling condo without realtor for $444,000 bought it at $144,000, $44,000 improvements, no mortgage, lived in first 5 years, rental for last 29 years.

1) In order to have zero tax liability on gains, is the minimum purchase price of new investment property $300,000 - $44,000 = $254,000? 
2) Must I put every dollar from sale, using a proper 1031 exchanger of course,  toward purchase or can I put some toward down payment (finance the rest) and use remaining cash proceeds elsewhere (pay for other things)?

[Dave Foster]

@Nancy Bachety, The easiest way to calculate your reinvestment target is to take the amount of cash that goes into your exchange account and add to that the amount of mortgage that was paid off.  Since you have no mortgage your reinvestment target is the amount of cash that goes into your exchange account.  

Now that is of course if you want to defer all tax.  You can take cash and you can buy less than you sell.  But the IRS will interpret that as taking profit.  So if you wanted to purchase only $400K of real estate you would pay tax on the $44K difference but shelter the remaining profit in the 1031.  That's one answer for you - do a partial exchange.

Another option is to understand that you can allocate your proceeds in any way you want. And it's not the amount of properties you purchase - it's the dollar amount that determines your taxability.  So you could take the proceeds from this sale and purchase two $222K properties.  Or you could purchase one property for $350K of cash and use the remaining 94K as a down payment on one or more properties.

A lot of clients love this approach because it lets them get a property out of harms way for cash.  And it still lets them take advantage of the bump in return from leverage.  As an added bonus you've got a larger free and clear property that you can refinance later if you want.  A refinance is not a taxable event.  So you can get the full tax benefit of the 1031 and still access the cash you want for other purposes.