Is a 1031 my next move?

[Ricky Brown]

I just wanted to get a general consensus on what my next move should be. I have a rental property (still financed as a primary residential) that is on the market for sale. From research, I see that 1031 is a way to defer capital gains tax. I understand that I must do this before the home is sold. Is the 45 day timeline accurate and does the proceeding property have to be in my name due to the fact I may not qualify for a new mortgage?  (going to school and currently not working). In other words, will my gains be deferred by being a investor through a 1031 exchange.

[Christian Bors]

@David Krulac is an expert on 1031's maybe he can help.

IRS pub 523 allows you claim 250k or 500k (if married) on gains made on a house if you lived in the property for 2 out of the last 5 years.  So if you have only been renting it for 3 years, sell the property and pay nothing!

[Ricky Brown]

I'm sorry @Christian Bors but I don't quite understand. Are you saying that I'm excluded from capital gains tax because I've held the property for more than 2 years?

[David Krulac]

@Ricky Brown

For IRS Code 1031 you have to identify the acquired property(s) within 45 days (calendar days) from when you sell the relinquished properties.  The proceeds money must NOT be available to you and held by a qualified intermediary.  Then you must settle on the acquired property within 180 days total included the 45 day id period.  Section 1031 is only for investment properties.

Section 121 is for your personal residence and you have to have lived in the house for 2 of the last 5 years, then the $250,000/$500,000 exemption is available. 

The real expert is @Bill Exeter

[Dave Foster]

@Ricky Brown, @David Krulac is absolutely right about the time lines.  And yes, they can cause you some angst trying to comply.  But as I read your post I think there's two more requirements for a successful 1031 that will potentially cause you some trouble.

1. In order to completely defer all tax you must purchase at least as much as you sell (this is the net sales price or the contract price minus closing costs and commissions but before mortgage payoff).  And you must use all of your proceeds in the next purchase.  So while there is no mortgage requirement it is usual for the investor to replace the paid off mortgage in order to reach your reinvestment target.  So if you'll have trouble qualifying for any borrowed money you'll have trouble completing your 1031.

You can do a partial exchange where you purchase less than what you sell and still keep your 1031 intact.  But the IRS says that if you take money out of a 1031 exchange or if you purchase less than what you well you will pay tax on the difference between what you sell and what you buy.

2. In the same vein the tax payer for the relinquished property must be the same as the tax payer for the replacement property.  So again, if the way you hold title to the property now may cause you issues then you'll have the same issues when you go to purchase if you want to do a 1031.

[Ricky Brown]

Thanks @Dave Foster. You have been a lot of help along with input of others. In my case, the balance on the relinquished property is 85k selling for 175k. Does that means that I will have to acquire the new property of 175k-10k(fees)=165k? If I'm understanding you correctly, this is simply an upgrade. My goal was to simply purchase a property equal to the profit and diminish debt completely. That stipulation is modern day financial slavery in my opinion.

[Mark Creason]

Ricky,

If you may have issues qualifying, I would suggest an asset based lending program or an owner carry situation.

Mark

[Bill Exeter]

Hi @Ricky Brown,

Yes, you would have to acquire a replacement property that is equal to or greater than the net sale price of your relinquished property. You would take the gross sale price and subtract routine selling expenses such as broker's commission, closing agent fees (escrow, title or closing attorney), recording fees, etc. Do not subtract any costs related to the loan payoff or any operating expenses such as prorated property taxes, HOA fees, etc. The $165,000 amount that you mention is probably pretty darn close.

It is not financial slavery.  The government realized that if an investor wanted to remain fully invested it would be very difficult to do so if you had to pay your taxes.  The 1031 Exchange allows you to defer the payment of your taxes as long as you remain fully invested (e.g., $165,000).  You own an asset that is worth $175,000 so you must reinvest at that level less your selling expenses, otherwise you would not remain fully invested and are trading down or "uninvesting" and there fore would qualify for either a reduce or no tax-deferred benefit depending on how far you trade down in value.