1031 exchange question

[Patrick Flanagan]

I’m in the equity zone on my 4 plex to do a 1031 exchange and use that equity to buy a smaller apartment building. 

I have a basic understanding of how the process works. My question is do I need to use all of the equity towards the down payment of the property, to avoid capital gains tax? 

Or could you set some of the money aside to do some renovations to the property?

thanks,

Pat

[Maxine Brown]

Hi BP Family.

Regarding your 1031 exchange. As per the IRS code you must use all the funds on your next purchase, either scale up or like same value. If you purchase less than your equity in the 1031 exchange. You will pay the taxes on the balance. Known as your "booth". However, whoever is handling your 1030 exchange should be explaining the tax ramifications of the tax codes. Hope that help with your question.

[David M.]

@Patrick Flanagan

@Dave Foster is our resident expert...

But yet, you need to buy something "as much as you sold" and "with at least as much of the cash proceeds" from your transaction.  Its an over/up type transaction, if that makes sense.  You can't buy down.  If you take any cash out of the transactions, its call the "boot" on which you pay tax.

I'm not sure what you mean by "equity zone."  I tend to admonish about automatically doing 1031 exchanges.  In some cases, its cheaper not to.  You just need to run all the numbers, and also take into account any Passive Activity Losses (PAL).

Make sure you use a Qualified Intermediary (QI) for the transaction.  You or your attorney cannot touch the funds from the transaction.

So, no, you can't set aside funds to my understanding.  It has to all go into the purchase via the QI.

Hope this helps.  Happy to chat.  good luck.

[Dave Foster]

thanks for that shout out @David M., @Patrick Flanagan, If you want to defer all tax you must do 2 things.  First you must purchase at least as much as your net sale (the contract price minus closing costs).  And second, you must use all of your net proceeds (the equity zone) in your purchase.  

There are 3 ways to use money for improvements

1. a reverse improvement exchange where we as the QI take title to the new property and hold it for up to 180 days while you improve the property. (expensive and complicated).

2. Complete your full exchange and immediately after do a cash-out refinance on the property And use that money (not taxable) to improve the property.

3. Use your own proceeds from anywhere to improve the property and then after it is improved do a cash-out refinance on the newly improved property to pay yourself back plus whatever you want.

[Jacob Sherman]

Quote from @Patrick Flanagan:

I’m in the equity zone on my 4 plex to do a 1031 exchange and use that equity to buy a smaller apartment building. 

I have a basic understanding of how the process works. My question is do I need to use all of the equity towards the down payment of the property, to avoid capital gains tax? 

Or could you set some of the money aside to do some renovations to the property?

thanks,

Pat

 This all has to be done ahead of time with the 1031 app . i would consult with your cpa

[Alex Keim]

This was basically covered by other responses but just to put some numbers on it my QI told me that if the improvements were less than $75k then it made more sense to just take a little bit of the cash as boot and pay the taxes on that small amount of cash. Over $75k it made sense to do the reverse improvement exchange that Dave mentioned. The extra cost from my QI was $7,000 for the reverse improvement exchange. 

[Bill B.]

Last note, in case others didn’t make it clear. The amount of equity doesn’t matter one bit. If you sell a property and net $100k after closing costs that you owned outright, you have to spend at least $100k on a 1031 exchange purchase to avoid all taxes. (You also have to use all $100k in “cash” on the purchase.) If you sell a property and net $1million after closing costs that you owe $900k on. You have to spend at least $1million on the exchange purchase (and the entire $100k “cash” you netted after paying off the debt.) to avoid all taxes. The amount of debt has nothing to do with how much you purchase. Only your minimum downpayment to avoid taxable “boot”.

[Basit Siddiqi]

You have to use sales price minus sales expenses to figure out what amount you need to buy.

You can potentially factor in your suspended passive losses to determine how much 'boot' you can receive.