Sold a property, 1031 or pay the tax and shop more given mkt soft

[Brannon Hamby]

 Just sold an out of state property and  shopping now to move those funds ($210K) locally (coastal South East market).

 I had planned to do 1031 but looking at average to below average deals.   With the market trending soft/correcting, should I just pay the tax and shop harder/longer or go with an average deal to take advantage of deferred taxes? 

[Dave Foster]

@Tony Kim, I think I can answer some of your question and still not hijack the OP's question.  If you want to we can also PM and go further.

To determine if a 1031 is worth it or not you first have to have an accurate read on your potential tax situation.  this is determined as the difference between your adjusted cost basis and the net selling price (contract after closing costs - not mortgage payoff).

You calculate your adjusted cost basis by taking the purchase price plus capitalized improvements minus depreciation taken (or that could have been taken).  

Your gain is the difference between this adjusted cost basis and the net selling price.  The adjusted cost basis is also what transfers over into the new properties in a 1031.

I have a capital gain calculator at www.the1031investor.com that you can play with to look at various scenarios and estimate your tax in a 1031/no 1031 scenario.

So for example purposes lets say you are selling a property for $400K that has an adjusted cost basis of $200K.  If  you sell and do not do a 1031 you pay tax on the $200K profit (combination of depreciation recap and cap gain probably).  If you do a 1031 and buy one replacement property for $400K then the basis of $200K transfers to that property so if you sold it the day after you buy it for exactly the same price you would pay tax on the $200K of profit that was created by the adjusted cost basis of $200K carrying forward to the new $400K property.

If you buy for more then the additional amount you purchase gets added to the basis.  So if you bought for $500K then your adjusted cost basis would be $300K ish.  

If you buy multiple properties this is where @Brannon Hamby has his opportunity.  Say he buys 4 $100K properties as replacements in a 1031.  His accountant allocates the basis of the old property into the new properties.  So each $100K property would have a basis of $50K and a potential profit of $50K if it was sold the next day for the same purchase price.

This is the calculation that your accountant makes when they fill out the form 8824 on your tax return in the year of your 1031.  It sets up the basis and depreciation schedules for the new properties using the basis (or proration of basis) from the old property.

So if he wants he can then spread out the sales of the 4 new properties and each time he sells one he pays tax only on the gain attributed to that property.  So if he sold one for exactly what he paid for it he would pay tax on the $50K gain attributed to that property not all $200K from the original sale.

That's why the minimal cost of a 1031 shouldn't stand in your way from taking advantage of it.  At your best case you find good replacements.  In an OK scenario you find replacements but end up selling one or two in the near future if they're not as good as you'd like but you still don't pay all of the tax.  In the worst case scenario you get to shop for 45 days and when you don't find good replacements you let the exchange die and pay the tax.  At a cost of $750 ish the 1031 is well worth the attempt.