1031 into two properties, one new mortgage

[Lyndsay Dentel]

Hello, I am trying to make sure I have this correct. We are planning on talking with an intermediary next week but I'd love to pick your brain. Newbie to the 1031 world. 

Current property purchased: 400k, 300k mortgage. 

Estimated sale: 600k net proceeds 200k plus initial investment of 100k. Total proceeds 300k

Idea: Purchase another propety for 400k with 100k down, to have another mortgage for 300k. Purchase 2nd property with 200k cash. Wait, then refinance the 2nd property with mortgage after other closes.

Questions:

1. Is my initial investment of 100k taxable as well? My research says yes.

2. Can I split it up with one mortgage and one cash? I'm concerned about two mortgage loans at one time, and would prefer to do one and cash the rest. The requirement is to have the same loan right? So I'd only technically need 300k loan.

3. If I can do the split and purchase one with cash, when can I refinance and pull money out to buy another?

Any help would be appreciated.  If you have an intermediary in Portland, OR you prefer, please send them my way.

[Dave Foster]

@Lyndsay Dentel, Yes this is an awesome way to allocate your 1031.  In order to defer all tax you must purchase at least as much as your net sale (600K ish) and use all of your net proceeds in the purchase or purchases (300K ish).  You do not have to carry the same debt at all.  You can bring in cash from your own reserves.  But most people do not have that so they end up replacing the debt.  Purchasing at least as much as you sell and using all of the cash are the requirements.  Debt simply fills in what you need to meet those benchmarks.

You can purchase more than one property. And you can allocate your proceeds in any way you want. So what your talking about is something I've led several clients through at this time in the market. I call it a form of defensive investing. First of all you've got one cash property that is now safe from debt risk. If the market goes south your worst case is adjust rent to pay the taxes and insurance. That property is down turn safe. But the other property is able to enjoy the benefits of arbitrage on the interest and leverage. So your blended NOI is higher.

And, as you identified, if you want to you can do a refi and simply hang on to the cash free of the 1031 timelines and wait for a bargain to show up on your doorstep!

Your original capital is not taxable.  But if you take money out of the 1031 or if you purchase less than what you sell the IRS simply says that you are taking profit first.  So what you would call a return of your original capital they call taking profit.  And they generally win the argument :). 

But as long as you purchase at least as much as your sale and use all the cash you won't have to worry about it.  Use the refi to pay you back your original capital if you want.

Great Plan!!