recapture expenses from sales proceeds before 1031 exchange

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recapture expenses from sales proceeds before 1031 exchange

Randall D Cheney
Member since 2018 · 13 posts · 1 vote

We're going to sell some building lots that we have divided off of our farm, and do a 1031 exchange with the proceeds. We'd like to pull at least some of the development expenses out of the sales money before we reinvest, but have been told by our title company that that's not possible. Are there any 1031 loopholes that would allow us to do that? We know that we have to spend equal to or greater than the sales price in the new investment, and that the proceeds of multiple lots can be combined to make one purchase. We also know that the sale of each lot can be used for a separate, individual 1031 purchase. Would it be possible to 1031 the proceeds of all lots but one, and keep the proceeds of the last lot to help cover the development expenses, and then to avoid capital gains taxes on the money from the last lot, deduct all or some of the development costs from it? Any other ideas on how to cover our expenses and avoid taxes? We thought of paying cash for a property in the exchange and then doing a cash-out refi on the property to pay the development expenses, but we'd have to pay closing costs and interest etc. We could do that, but maybe there's a better way or a 1031 loophole that we don't know about. Thank you for your ideas!!

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    5y
    Originally posted by @Randall D Cheney:

    We're going to sell some building lots that we have divided off of our farm, and do a 1031 exchange with the proceeds. We'd like to pull at least some of the development expenses out of the sales money before we reinvest, but have been told by our title company that that's not possible. Are there any 1031 loopholes that would allow us to do that? We know that we have to spend equal to or greater than the sales price in the new investment, and that the proceeds of multiple lots can be combined to make one purchase. We also know that the sale of each lot can be used for a separate, individual 1031 purchase. Would it be possible to 1031 the proceeds of all lots but one, and keep the proceeds of the last lot to help cover the development expenses, and then to avoid capital gains taxes on the money from the last lot, deduct all or some of the development costs from it? Any other ideas on how to cover our expenses and avoid taxes? We thought of paying cash for a property in the exchange and then doing a cash-out refi on the property to pay the development expenses, but we'd have to pay closing costs and interest etc. We could do that, but maybe there's a better way or a 1031 loophole that we don't know about. Thank you for your ideas!!

    Yes, it’s possible to take take out partial cash from 1031 exchange and defer the taxes on the other proceeds/gain. However, you have to pay taxes on the cash you take out. I have see people put the cash in the escrow account and direcly pay the vendor to cover the expenses and not pay the taxes. 

    If the expenses are already paid, I am not sure if you can get the previous expenses refunded and pay them when closing.  

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
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    @Randall D Cheney, Those expenses would have to go on the settlement statement.  And as @Ashish Acharya, said it's cleaner if the checks go directly to the vendor.  If the checks go to you as reimbursement it is almost impossible to do that without paying tax on that amount.  Those expenses were already capitalized when the property was put into service.  So they became part of the basis.  And when you take money out of a 1031 exchange the IRS says you are always taking profit out first and not basis.

    Your accountant would have to be willing to uncapitalize those and then treat them as ordinary expenses which would probably involve an amended return to change the basis, the depreciation schedules, your net ordinary gain.  And once all of that high visibility stuff was done your'e going to have a 1031 settlement statement showing cash going to you - Yikes.  Not seeing this as a good option at all.

    But what you could do is to complete your purchase of the new property and then immediately refinance it and take the cash and pay yourselves back.  A cash out refi is not a taxable event.  You get the money you need, and the tenants are paying the mortgage - Now that's easy peasy!

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