Renovating your property before a 1031

[Debbie C.]

I have a question about the 1031 exchange that I’m still confused over. Let’s say I bought a property for $200k and rented it out for many years and paid off the mortgage so it’s free and clear. Now I want to sell it and I first spend $50k doing improvement renovations before selling. Then I find someone that’ll purchase it for $500k through a 1031 and name myself a replacement property. The costs of selling (agent fees, etc.) let’s say are about $20k. It’s my understanding that my potentially taxable gain would be $230k in this case ($500k minus $200k + 50k renovation + 20k costs to sell). However, is it true that the replacement property must also be $500k (and not $230k) or above for me to avoid capital gains taxes? And if so, does that mean if I wanted to buy a replacement property with my sales proceeds in cash (avoiding any mortgages), I’d basically have to use all of the $500k I got from the sale….meaning I wouldn’t be able to pay back the money I spent on the renovation and the other miscellaneous costs involved in the sale. Is there any way at all to do renovations on the property you want to sell in a 1031 without putting yourself in more debt?

[Ashish Acharya]

Originally posted by @Debbie C.:

I have a question about the 1031 exchange that I’m still confused over. Let’s say I bought a property for $200k and rented it out for many years and paid off the mortgage so it’s free and clear. Now I want to sell it and I first spend $50k doing improvement renovations before selling. Then I find someone that’ll purchase it for $500k through a 1031 and name myself a replacement property. The costs of selling (agent fees, etc.) let’s say are about $20k. It’s my understanding that my potentially taxable gain would be $230k in this case ($500k minus $200k + 50k renovation + 20k costs to sell). However, is it true that the replacement property must also be $500k (and not $230k) or above for me to avoid capital gains taxes? And if so, does that mean if I wanted to buy a replacement property with my sales proceeds in cash (avoiding any mortgages), I’d basically have to use all of the $500k I got from the sale….meaning I wouldn’t be able to pay back the money I spent on the renovation and the other miscellaneous costs involved in the sale. Is there any way at all to do renovations on the property you want to sell in a 1031 without putting yourself in more debt?

 Just to clear up one point. You actually will not sale and buy another property with the cash. 1031 doesn’t work like that. 

The proceeds from the sale of the original property must be held by a qualified intermediary escrow agent (the proceeds may not be received by the property owner wishing to engage in the 1031 exchange).You might have to do some more digging on it. 

You have 3 options: 

1- Why don’t you just do 1031 without making any repairs? 

1- If not, replace with lower value property, you will get some cash ( boot), although taxable, you can pay your debt with that money. 

3- If tax deferral is main concern, then sell the house, Keep the basis and pay the debt. Invest the gain in the Opportunity zone funds to defer taxes. Might want to do more research on the opportunity zones.