Possible first time 1031 major blunder!!

[Keith Jackson]

Hi Everyone...first timer 1031-er here and thinking I may have grossly misunderstood the process recently.

I just opened one 1031 and used it to purchase one property and am considering another right away due to pending sale of rental property. My question is general and regards to my first 1031. I only found out about 1031 the week we were selling and may have made a big mistake. I sent all the proceeds to the 1031.  My plan was to really just offset the gain we made, but could not find any answers in the hasty timeframe I was on.

The properties were an inheritance for my wife and had a stated value combined of 290K. The sale price was higher at 395K, less lots of expenses which brought the net sale to 353K.  All 353K went to the 1031. I really only wanted to offset the gain between the 290K and the 395K. So I bought a property already for 105K and used 1031 to fund it. 

 I would like to obtain the remaining proceeds of about 248K but am now getting the impression that by committing all the proceeds to the 1031 as I did, that somehow appears that we are looking at a full taxable payment of 395K if we do not make a purchase of that amount...or at least to the $353K amount. 

I am hoping for a general answer to this, not to pin you down. I also hope to know this before I commit to another 1031 for this upcoming sale. Thanks!!

[Dave Foster]

@Jay Hinrichs, thanks for the shout out.  Unfortunately @Keith Jackson it doesn't sound like your QI either understood the law or that you asked the wrong questions.  

In order to defer all tax in a 1031 you must purchase at least as much as your net sale (contract price minus closing costs) and you must use all of your net proceeds (the net sale minus any mortgage payoff).  Any cash you take or any amount you purchase less than what you sell is considered to be first a taking of profit;  You can do it but it is called boot.  It is taxable.  But it doesn't affect the rest of your exchange.  This would be called a partial exchange.

So in your scenario we don't know anything about mortgage but we do know that your net sale was $353.  So in order to defer all tax you would need to purchase at least $353K of replacement real estate.  If you follow through on your plan to purchase only $105K then you would be purchasing $248K less than what you sold.  So that amount would indeed be taxable if there was that much total profit in the property.

If you're still in your 45 day identification window you could identify and purchase more property.  It is perfectly permissable to sell one and purchase several.

If you're past the 45 day period on this one you're kind of out of luck.  But you could explore taking the boot and explore putting it into one of the new qualified opportunity zones.  Over time that could alleviate a bunch of that tax.

And Jay's question about when your wife inherited is well asked.  If it wasn't long ago your gain might not be much at all and the 1031 wouldn't help you out that much anyway.

At this point there really isn't anything you can undo that would help you tax wise.  But going forward with that second sale you'll at least be forewarned so you'll know your reinvestment requirements and can act accordingly.