1031 exchange + 121 and a Big Boot

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1031 exchange + 121 and a Big Boot

Howei Yeh
Investor · Cleveland · Member since 2017 · 4 posts · 1 vote

In this case study, I am seeking to downsize a rental through a 1031 exchange combined with a 121 exclusion and take a big boot.   

For context, the house will sell for about $1.6 million and was purchased for $600k. I currently have a $400k mortgage on the house. Closing costs on the sale, around $100k (numbers are simplified). 

My plan is to roll forward $1.5 million in a 1031 exchange, and I was playing around with splitting it into 3 buckets.
A. $500k - exchanged into a new rental 
B. $500k - "121 exclusion" boot
C. $500k - additional boot

I understand that A is tax-deferred and B is tax-excluded. My question is how do I conceptualize the taxability of C., the last $500k? I am not sure if it will be fully subject to capital gains tax. 

I thought that this A, B, C, blended solution would save on tax expenses and I would owe less tax than if I just simply liquidated the property without a 1031 exchange. Feel free to poke holes into my logic.

Why such a big boot? I would like to diversify my investments.

Although this is my first post, please don't pull any punches :).

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Howei Yeh, it will be fully taxable.  Because it comes to you as cash.  The requirements to fully defer all tax are that you purchase at least as much as your net sale (1.5) and you use all of the proceeds in the purchase or purchases (1.1 mil).

    What you are proposing is to take $1mil in boot from the sale.  Ordinarily it would all be taxable but because you qualify for the 121 exemption that $500K will be tax free leaving the remaining $500K as the only boot you'll pay tax on.

    Why not use the $600K to purchase one property for $500K cash and one property for $500K using $100K down.  Immediately after the 1031 is complete refinance the free and clear property and take the $400k and diversify to your hearts content with no tax liability at all and a bonus property to go with it.  

    If you take cash it is taxable.  But a refi isn't.

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  • Howei Yeh
    OP
    Investor · Cleveland · Member since 2017 · 4 posts · 1 vote
    5y

    Thank you, Dave. A refi is a good idea. A follow-up question, for bucket B (Tax-excluded boot), can the exchanger get the cash at the close of the sale of the relinquished property, or first wait until the end of the exchange?

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Howei Yeh, There's no statutory way to handle it so you want to be careful with the QI you're using.  We would want to give it to you at the closing of the sale so you get it as quickly as possible.  It is reported as tax free and reconciled at the end of the year by your accountant either way so there's no reason for the QI to hold on to it except for their benefit.

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