dilemma, reinvest with 1013 exchange or take a major loss?

Question

Hello All, firstly I would like to thank you for reading this and for any suggestions you may have...I am very close to selling my property in the Hudson Valley and I am very confused about what I should do afterward. I bought a two family brick property in Hudson NY in 2014 for 250 K (all cash deal) and I might be selling it soon for 600K, sounds good right? Not really because I found out that, after the real estate agency's 5% fee (30K),  I will have to pay around 30% in capital gain taxes which comes up to a whopping 96K. This is to say that my 4 year investment yielded net 224K, approx. 56k per year...I did a lot of improvement works on the house: new floors on two of the three floors, tore down a wall down, completely rehabbed the basement, added a bathroom, put in a new kitchen, replaced some appliances and many other cosmetic jobs which were costly but I did myself with the help of my father and the occasional local handyman. Of course I kept all the material receipts and paid my father and the handymen but I did not hire a contractor so I do not have proper invoices but only receipts...I probably spent around 60 to 80k for the rehab but even if I could fully deduct the expenses the capital gain would be still very stiff...A friend suggested I should reinvest right away and do a 1013 exchange to defer capital gains and another friend mentioned to reinvest through RealWealth Network. My questions are:

ABOUT 1013 exchange : I understand that I have to exchange a two family for a two family, but if I buy a two family and make one of the apartments my primary residence, will I still have to pay capital gain taxes if I sell in let's say in 5 years?

Once the sale will have gone through and after I will have paid the real estate fee, I will have roughly 570K to reinvest.

I understand that I have to identify one or more properties to swap with a total value of the sale of my property: are we talking about the gross yield  (600K) or the net yield (570 after after the real estate fee)?

If I buy let's say 2 two family properties for 200k each I will have 70k left. If I can't find a two family for 70k could I buy land?

If I cannot buy land and I am left with the 70k, I will have to pay what they call the boot, am I correct in thinking that I will have to pay  (let's say capital gain is 30%) capital gains on the 70k?

Could I sell 1 of the two two families in the future and pay capital gains on it or the 1013 exchange requires to sell both properties at once?

Could anybody please explain to my these 1013 rules below with examples in numbers keeping in mind that my numbers are:

purchased for 250 all cash deal

sold for 600 - 30k for real estate agent = 570K

Types of Replacement Properties to Identify:

• Three properties without regard to their fair market value.
• Any number of properties as long as their aggregate fair market value at the end of the identification period does not exceed 200% of the aggregate fair market value of the relinquished property as of the transfer date.
• If the three-property rule and the 200% rule is exceeded, the exchange will not fail if the taxpayer purchases 95% of the aggregate fair market value of all identified properties.

I do not understand exactly what "aggregate fair market value" means and especially the third point is a mystery...

if you made it so far ;) and understood I misinterpreted the BOOT, could you please explain it to me with a clear explain in numbers?

Again, thank you so much for reading this and apologies for the length of the post...

Natalie Kolodij · Answer

Hi @Evelyn Zanetti

I wanted to clarify a couple items for you.

• The gain will not be 600K- 250k- comission. You also mentioned doing a TON of work to the property. All of that increases the bases an will reduce gain. The calculation will be closer to 600k-250-(cost of all reno)- comission= taxable gain. + you will need to add back and depreciation and pay recapture tax on that.

• You do not need to exchange a two unit for a two unit. That is not what like kind refers to. It's the type of property per the IRS code. You can exchange for any thing that's a buy and hold real estate asset for the most part. This would actually be a great opportunity to sell the duplex...and buy a large apartment building since you have so much equity and they tend to produce better income .

I'm sure @Dave Foster can chime in with more information to help

with you with decisions on the 1031 element of it.

Wayne Brooks · Answer

@Evelyn Zanetti You need to talk to a Qualified Intermediary for 1031's, like @Dave Foster.

As pointed out, you had some misunderstandings of the requirements and tax liability, Dave could clear these up, along with other options/information in about 10 minutes.

Joshua Wright · Answer

Absolutely @Evelyn Zanetti Happy to help. Reach out if you need anything!

Evelyn Zanetti · Answer

thank you so much @Joshua Wright Sounds like a very interesting option! I am so glad I posted my dilemma on Bigger Pockets!

Dave Foster · Answer

@Evelyn Zanetti,  Glad that was helpful.  Since the 1031 exchange is a federal statute it applies nationally and any good QI with a national foot print can help you out - including me  (may the Bigger Pocket community standard gods forgive me) :)

Cash is king and you're in a great position.

Evelyn Zanetti · Answer

Wow, thank you, thank you, thank you @Natalie Kolodij @Caleb Heimsoth @Scott Wolf @Wayne Brooks@Bjorn Ahlblad and a very special thank you to @Dave Foster for answering in detail all my pesky questions.

To answer some of your questions @Natalie Kolodij:

I still have to calculate the exact amount of the renovation costs, but I am pretty sure it would be around 70K and some of has probably already been deducted from my taxes because I forgot to mention that I bought my property under a  sole proprietorship LLC

I could buy a multi family out of state but I would need to hire a management company

I part time occupied part of the two family but not as my primary home just as a vacation home

The 2 family was an investment property

For @Dave Foster:

is it better to hire a 1031exchange intermediary from the area where the property that will be sold is, or could I work with you even if you are based in Florida?

Also, I now understand, that the reason why I had a hard time grasping the total aggregate value is that I don't want to take any loans, I want to reinvest the exact amount of the net yield (570K) so I need to find one or more investment properties to reach that 570K

I am looking at one property in Hudson NY and i will be soon be talking to one of the representative from Real Wealth Network to try to identify properties out of state and see what would be the best option for me.

Dave Foster · Answer

@Evelyn Zanetti, I can help with some of that confusion - welcome to the wacky world of 1031 exchanges!

Boot is what the IRS calls profit that you take from the sale.  In order to completely defer all tax you need to buy at least as much as your net sale (the $570K number) and use all of the proceeds (also $570K right).  you can purchase less than what you sold and you can take cash out but the IRS considers either a way of taking profit and calls the difference boot and you pay tax on it.

The nuance with the identification list can be very confusing.  But first you need to know that "like kind" does not mean the specific type of real estate.  Any kind of investment real estate can be exchanged for any other kind of investment real estate.  You do not have to purchase a 2 family if you sell a 2 family.  You do have to purchase investment property.

From the day you sell you have 45 days to produce a list of potential replacement properties.  After day 45 the list is set in stone and cannot be modified in any way.  You're stuck with those properties on the list.  And the quote you used are the restrictions for your list.

1. If you name 3 or fewer properties on your list it doesn't matter how much their worth - sell your place for $570K and name 3 $5 mil apt buildings.  Thats fine but you've got to close on one of them.

2. If you have to name more than 3 properties then the total (aggregate) value of the list can be no more than 200% of what you sold.  So you can name 4 properties or more but their total value could be no more than $1,140,000 (200% of $570).

3. Unless you purchase at least 95% of the value of your list.

My recommendation is always to get the new property under contract during the 45 days after the sale or in the short period before the sale happens (you can go into contract for your replacement property prior to sale.  You just can't close on it.)

Without getting past the hand grenade stage I think it's probably safe to say that you've got a gain of at least $260K which would be some depreciation and some profit.  With federal and state capital gain and depreciation recapture you're looking at at least a $60K tax bill. Get an accountant like @Natalie Kolodij on board and she can tell you exactly.  Either way that's a pretty strong incentive to do the 1031 exchange.  Even if you want to invest in a platform like Real Wealth Network you'll still want to use the 1031 exchange so you can avoid that huge tax bill.

So, the 1031 can save you a bunch of money in tax.  You don't have to trade exact same type properties.  There's no penalty for starting a 1031 and not completing it. And there is a way that you could use the 1031 exchange to purchase a property that you live in part of and rent part of.  I think it looks like the right thing to do.

Bjorn Ahlblad · Answer

@Evelyn Zanetti done correctly buying and selling using 1031x can be a real blessing. Done wrong it is a transaction from hell. Please get a qualified CPA and or RE attorney before you proceed. As you can tell from the responses you need a professional to make this as smooth and uncomplicated as possible. As they say "don't try this at home"!

dilemma, reinvest with 1013 exchange or take a major loss?

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