Assuming a mortgage

[Matthew Teifke]

I recently assumed a mortgage with build in equity. I'm planning to turn around and sell this property and I'm curious as to what my cost basis would be for taxing purposes. 

Just to make this simple. I paid $30 k to get the mortgage current and assumed the mortgage amount of $120,000. This property should sell for $220k on the open market.   Can you help me understand what my tax implication would be. I understand a 1031 may be a good option here as well. Looking forward to your thoughts and advice. Have a great day! 

[Clayton Mobley]

@Matthew Teifke according to the IRS, your cost basis in a property on which you have assumed an existing mortgage is equal to the amount of equity you put in, plus the amount of the mortgage. In this case it would be your $30k plus the $120k mortgage balance, giving you a basis of $150k. Of course, if you put in any money for considerable improvements prior to selling, then you can include that in your basis as well. You can also include any settlement costs that you incurred when you purchased the property, as well as any property taxes you paid that were owed by the seller as long as you were not reimbursed for that expense. 

Here's a link to the IRS publication that outlines this: https://www.irs.gov/publications/p551/ar02.html#en...

A 1031 is almost always a great option if you're looking to sell an investment property. Remember that you need to be able to demonstrate that your purchased it with the intent to hold it for the long term, so if you recently purchased it you may need to hold on for a while. There's no hard and fast rule about how long you need to hold a property, but most people feel comfortable with a year or more. Of course, sometimes life happens and you need to sell sooner rather than later, but it can raise eyebrows at the IRS, especially if you do it more than once. A 1031 is not for flippers, for example.

Also, remember that when you execute a 1031, you have to transfer the full value of the relinquished property (the one you currently own) into the replacement prop. So, if you sell for $220k, regardless of basis, you need to buy a prop (or props) with a value equal to or greater than that. There tends to be a lot of confusion about the transfer of equity and debt in a 1031, so here are the rules for deferring taxation completely:

1. You MUST transfer any and all profit you turn from the sale. So if you sell for $220k with a basis of $150k, you need to put at least $70k of equity into the new deal. You cannot take out a $220k loan and take the $70k profit as cash.

2. However, you do not have to necessarily have the same amount of debt in the new prop as you do in the current one, you can have less. If you want to put the $70k profit plus $150k of your own equity into the new prop and have zero debt, you can. You can also take on more debt (and/or put in more equity) to purchase a pricer property. What you CAN'T do is take on more debt and put in less equity, $70k of equity is your minimum in your scenario. 

Basically the IRS considers both cash in your pocket and debt reduction to be 'boot'. So if you reduce your debt burden, you need to be out a greater amount of cash. If you increase your debt burden, fine, but you'll then be buying a property worth more than your current one. You can substitute equity for debt, but not take on more debt to substitute for equity. Any amount of cash you end up with after the transaction is taxable, so abide by these rules to get the most out of your capital.

There are plenty of other 1031 details that are important to understand, so definitely ask questions and find a reputable qualified intermediary before you pull the trigger.

Best of luck!

Clayton