Finance example of 1031 echange

[Frank Schaefer]

I've done a search on this and couldn't find the answer. Sorry if I'm covering old territory.

I understand the 1031 exchange pretty well. I have a very specific question. 

Do I have to fund the downpayment of the purchase property with cash on hand? Or does my equity roll over of the 1031 satisfy this?

Example:

Property to sell: $690000

Less selling costs (simplified): $41,400

Net sales: $648,400

Less current mortgage: $160,000

Net profit: $483,600

New property purchase price: $648,400

QUESTION: Does my net profit from sale of old property of $483,600 count as a down payment? Therefore I don't have to come out of pocket 20% of the purchase price ($129,700) of new asset?

OR, do I have to pay the 20% out of pocket for the new asset?

Thanks in advance for input. I really did try to read up on everything before asking. Maybe I'm just making this more difficult than it really is.

[Dave Foster]

@Frank Schaefer, Think of it this way - In order to defer all tax in a 1031 you must do two things.

1. Purchase at least as much as your net sale ($648,400)

2. Use all of your net cash in that purchase or purchases ($483,600)

You can purchase less than you sell. And you can take cash out from the sale.  But in both instances you'll pay tax only on the difference while sheltering the rest in your 1031.

As long as you do the two things above  you'll defer all tax. In your example it's pretty straight forward - The net cash should be more than ample to fund your down payment.  But what if you wanted to purchase more than one property.  You could split up that cash in any way you want.  Purchase two properties for $200K cash each and use the other $83600 as a down payment on a $450K property.  

In the above example did you purchase more than you sold - yes.  Did you use all of your net cash - yes.  So tax and depreciation recapture totally deferred and at the end of the day you now have two properties free and clear so no leverage risk.  But you also are still harnessing the power of leverage in the third property.  This is a very nifty late market strategy that also leaves you ready to take advantage of buying opportunities using refis on the cash properties if and when you want.

One note - be careful about using the term "net profit" to describe the cash that your sale throws off.  that number is not your real profit and doesn't in any way represent what your tax is going to be.  You could generate a lot of cash in a sale and have no profit if you've paid the mortgage down aggressively.  Conversely (and worse) it's possible to sell a property with little net cash but have a large tax bill if you've refinanced it several times