1031 Exchange complication

[Rob Saunders]

Hi, looking at doing a 1031 exchange; property being sold will net $545k; capital gain will be around $150k and I will end up with around $320k in cash. Let's say I find  one replacement property for $320k that I buy with cash; that means my cash has been spent but I have still have a requirement to spend the remaining $235k balance to ensure that my replacement properties exceed the value of the property I am selling. My question is what happens if I can't find a 2nd replacement property? The cash has been spent; the 1031 exchange company won't have any of my money left....I assume I will have some form of tax liability, but how is that calculated? 

Thanks in advance.

Rob

[Dave Foster]

@Rob Saunders, The two requirements of the 1031 exchange in order to defer all tax are to purchase at least as much as your net sale ($545ish) and to use all of the net proceeds ($320ish) in the next purchase or purchases.  You can take cash out of the exchange or you can lessen the amount of debt.  But in each case the IRS views that as a taking of profit.  So you pay tax on the difference and shelter the rest of the profit if any in the exchange.

In your scenario you are using all the cash but buying less property thus lessening your overall debt same as if you took cash and paid it down on other debt.  It acts like profit.  So you would pay tax on the $225K.  Since your total gain was only $150K you would pay tax on that much.  But that means you're not sheltering anything in the 1031.

The reckoning isn't provided by your QI.  It is done by your accountant when they file the form 8824 at your next tax filing.  That's when it will be documented that you did not meet the reinvestment target and created a taxable event.