1031 Exchange, whether or not to Carry the note, how it works?

[Matthew Maggy]

I've got a situation and I could really use some advice and input (it's time sensitive and I'm waiting to hear back from my accountant and 1031 Exchange agent).

I'm selling my out of state condo for $70k, I paid $26k in 2010. I want to employ a BRRR strategy locally in Richmond with the proceeds. And I will be doing a 1031 Exchange.

A wrinkle came up where I could carry the note for half down at 7%, which would give me $35k to play with and $203/month cash flow (which is what I want from a property anyway). 

A) I'm trying to figure out how this jives with a 1031 Exchange. Do I just Exchange the amount above the note? Which part gets taxed first against the basis? 

B) I have less money to play with for BRRR (which means not as nice of a property). Am I killing my velocity of money? It would be nice to have the cash flow to pay for property related expenses while fixing it up.

C) I could also sell the note if I wanted (but this would incur the capital gains, correct? Minus the 1031 Exchange protection?)

D) Any other aspects that I'm missing and should consider?

 I have 24 hours to make this decision. Ha.

[Dave Foster]

@Matthew Maggy

Sell and carry a note and you will only pay tax on gain and interest as it comes in to you as cash. You will have to recapture all depreciation in the year you sell.  

You can do an exchange but you must purchase at least as much as you sell and use all of the proceeds in the next purchase.  If you try to buy down by 35K you would only be sheltering about 15K in profit and that probably doesn't make it worth the effort.

In your example you would need to buy at least 70K in real estate and use the 35K down and the 35 note in the next purchase.  This is probably a non-starter but if you have access to 35K in cash from somewhere ( savings, loan, equity from somewhere else) you can exchange that cash with the note in your exchange account during the exchange period.  After you do that you would have 70K in your exchange account and a note outside your exchange account for $35K that you just paid $35K for.  Now you can complete your exchange and as the note is paid off you only pay tax on the interest.

It's actually doable and a sound strategy.