1031 exchange on loss?

Question

Does anyone understand the rules of a 1031 exchange?

Is it true the acquired property's purchase price must be higher than the net sales of the exchanged property?

If a property swap occurs of differently valued properties, is there any tax benefit to original owner of the higher value property?

Example

Adam has a rental valued at $75K
Brian has a rental valued at $100K

They swap properties plus $25K cash.

Adam gets a 1031 exchange due to higher value of new property.

Is there any benefit to Brian who now has a lower value property?

Pete T. · Answer

it doesn't really work that way. The 1031 has to do w/ selling one of your properties and using the proceeds to buy another. If it was a loss it would not make sense to do so, as the whole idea is to defer taxes. @Jon Holdman might be able to add more to that.

Bill Exeter · Answer

There are two different types of structures being addressed here. The first one is what we refer to as a "two party swap." Adam and Brian each want the other's property, so they record deeds to each other simultaneously and complete a two party swap. Adam pays Brian $25K in order to equalize the equity values. This qualifies as a 1031 Exchange provided all of the other requirements are met. Adam has disposed of a $75K investment property and simultaneously received a $100K investment property, so Adam has traded equal or up in value based on his net sale price. Brian has disposed of a $100K investment property and simultaneously received a $75K investment property plus $25K in cash. Brian has traded down in value by $25K and received the $25K in cash in order to compensate him for the difference in values. The $25K is taxable as cash boot received. The benefit to Brian would depend on his cost basis. If his taxable gain was more than $25K then it would provide some benefit (deferral). Alternatively, Brian could have set-up a 1031 Exchange with a Qualified Intermediary and the $25K could have been paid to the Qualified Intermediary and then used toward the purchase of a second replacement property.

Bill Exeter · Answer

You can trade down in value. Its referred to as a partial 1031 Exchange. However, if you trade too far down in value, then you would not defer any taxes. So, in your example above, if you traded down from $500K to $75K, he would likely recognize all of his taxable gain. The easy formula to look at is to calculate your total taxable gain (capital gain and depreciation recapture). If you trade down by more than your total taxable gain, you will recognize all of your taxable gain and receive no benefit from doing a 1031 Exchange.

Martin Scherer · Answer

What you are saying is correct Bill but you are not quoting what I said. I am talking about moving your equity into another property with the express purpose of deferring taxes.The OP was talking about was there a specific benefit such as a tax benefit to the larger property from exchanging down and I said "no" there is no benefit.Of course you can do exchanges with legs and multiple parties but that is not what the poster was asking nor what I was answering.

Bill Exeter · Answer

I thought I would jump in here again to clarify a few things. There are a number of posts/comments that are not exactly correct. First, there are two types of exchanges, and it is important to clarify them. One strategy is referred to as "equity exchanging," which does not involve a tax-deferred strategy/component, and the other strategy is a 1031 Exchange, which is all about deferring the payment of the taxes. An equity exchange may or may not involve a tax-deferred exchange component and a tax-deferred exchange may or may not involve an equity exchange. There are groups that specialize in equity exchanges such as the National Council of Exchangors (NCE) or the Society of Exchange Counselors (SEC).@Martin Scherer Exchanges can be about trading properties. Equity exchanging is all about trading properties (not deferring the taxes). They may be structured as two party swaps or they may involve numerous parties or "legs" to the transaction.

Martin Scherer · Answer

No there is no benefit, exchanges are not about trading properties in the sense you are trying to do. An exchange is taking your equity from one your properties and moving the equity into another property to defer paying the taxes to a later date. There are VERY specific rules regarding this and it should be researched very carefully. If you miss a date or choose an exchange property incorrectly you can end up paying the tax and pay for an expensive escrow.

Jeni L. · Answer

I hold, buy, and sell rentals. I've got some interest in some low value properties I have for sale, and I'm negotiating a contract on a much higher value property. I can 1031 exchange up. Just wondering if there's any tax benefit to the seller of a high value property to take a low value package as a part of the deal. It might help offset his taxes. We're dealing in 7 vs 6 figures here.

Pete T. · Answer

what are you trying to do? 1031 is not typically (never that I have heard of) used for 2 people to "trade" properties. I would search 1031 or talk to some of the people that specialize in that here.

Jeni L. · Answer

That was my understanding. Thank you. I was also under the impression that you could defer the taxes on the net sale while being taxed on the difference. That could maybe make a difference for someone. Let's say Adam has his $75K rental. Charlie has a $500K multi-family rental. Adam trades cash plus property to Charlie. Adam gets a 1031 exchange. Can Charlie defer a small portion of the taxes by participating in the exchange?