1031 Struggle-Need some Advice

[David Weskamp]

Hello BP Team,

I am struggling to work through a potential 1031 that I thought was a no brainier.  I have been hearing this 1031 term for 20 years and thought it was such a great tool. I'm not sure that a 1031 exchange is a tool that will fit most properties and is really that useful

I have been investing in Idaho and out of state (Arkansas). I recently put a single family residence under contract in Arkansas that was contingent on selling my duplex in Idaho. This is where the 1031 comes in> 

Here is my scenario: 

Idaho

I purchased a duplex in Idaho (2019) for $135,000 at 20% down ($27,000). I currently have this property under contract for $208,000 My goal was to to 1031 exchange the capital gains into a property in Arkansas

Arkansas

I have a single family (plus detached apt) under contract for $70,000. I have sent both my PSA for Idaho and Arkansas to the 1031 escrow title company and have informed my CPA of my plans. The closing dates for both properties is August 6th.

My CPA has informed that this exchange will not really defer the taxes. I was informed that I must trade up with Like Properties. My goal was to exchange and use the capital gains to purchase the AR property free and clear. So, It appears that I must purchase/exchange a property that is equal or higher than the one i am selling. So, forced to purchase a property that might require a loan instead of being able to purchase free and clear? How do i complete this exchange and defer the taxes?

I also tried to do a reverse 1031 with two other AR properties that I purchased less than 180 days ago, but since the properties were not held with a title company after closing and until the exchange was complete, I did not qualify. (which i understand). 

Hoping that some investors may have some advice on how to complete this exchange with deferring all of the capital gains (or at least most of the gains) Is this true, that you must trade up and your exchange property must be higher value. 

Thanks,

Dave Weskamp in Picabo, Idaho

[Dave Foster]

@David Weskamp, Don't let "like kind" distract you.  Any type of investment property can be exchanged for any other type of property to be used for investment.  So that's not an issue.

In order to defer all tax you must purchase at least as much as your net sale ($208K ish).  And you must use all of your net proceeds (maybe $108K ish) in the purchase or purchases.  You can purchase less than you sell and you can take cash.  But when you do the IRS says you are taking profit first and not your original capital.  So you pay tax on the difference.  You're buying so much less than your net sale that there is not tax savings left.

The answer would be to purchase 3 of those $70K properties.  You sell one for 208 and buy 3 for $210K.  That is a 1031 that would defer all tax.  And you can use your proceeds in anyway you want.  So purchase one property for $70K cash and use the other $38K as down payments on the other two.

A 1031 exchange is as much or more strategy and long term thinking as it is filling out the right forms.  But the reward at the end can be pretty nice when you defer all that tax indefinitely.