The questions here were received from interested 1031 exchangers visiting my website. I have chosen to leave the questions intact with their ambiguity, shorthand writing and misspellings so as not to act on the assumption as to what when unclear the questioner meant.
Partial Exchanges and Boot – Asset Class, Part 3
When you take out some of the cash from an exchange, the result is a partial exchange. Cash is the driver in these kinds of deals, and the investor can always increase the debt with cash if so desired.
The timelines are inscribed in granite — and then after the horrific events of 9/11, the IRS issued a nationwide exception extending the 45 day identification rule and the settlement deadline for the entire United States. Since then, the IRS has expanded its exceptions for major natural disasters. Don’t dawdle.
Here’s what’s important with a partial exchange – when you’re taking out the cash, you pay taxes on everything above the adjusted base.
There’s 25% on any depreciation, and then depending on income, you’ll pay another 15% to 20% on that money – plus 3.8% for the Affordable Care Act!
Other income taxes to the local jurisdiction can also apply. That ends up being a lot of money!
It only took me 19 years to learn that when you take out 40% of the cash or more the tax to be paid is closer to what the tax would be on the whole!!
When they’re trying to research these kinds of questions, many investors wistfully think that they can take out the original capital and roll over the profits into another deal. Some also wistfully think that because the loan is paid off at settlement there is no need to replace the loan, just 1031 the cash!! However, you can’t do either – the IRS is emphatic about that.
The government looks at your HUD sheet to see cash received and loan payoff amounts. Capital improvements also apply to the adjusted gross, and you can deduct the fees of a qualified intermediary for a partial exchange as you can with a complete exchange.
Question 1:
If I take a note back on the property with a six (6) percent interest rate as partial down payment, but put the note in an escrow account not controlled by me, is the note considered a taxable gain?
Answer:
In this situation, you’re going to owe taxes on the partial down payment unless you place the note with a qualified intermediary and sell the note and reinvest the funds within the time frame requirements. However, just placing the note in the escrow account has “0” bearing on the taxes due.
Question 2:
I AM A REAL ESTATE BROKER AND I HAVE A CUSTOMER SELLING A RENTAL HOUSE AND SHE WANTS TO KNOW HER TAX LIABILITY I SHE ACQUIRE A HOUSE AT A LOWER VALUE THAN THE ONE SHE IS SELLING AND SHE WANTS TO KNOW WHAT PERCENTAGE APPLIES, THANKS
Answer:
When you want to do a complete 1031 exchange, the rule is that you have to put the money intoa property with an equal or greater value than your initial property.
If the second property is a lower value, you have to take the difference and pay 25% on depreciation, as well as federal capital gains tax and state income tax. Send her to a knowledgeable CPA.
About Marilee: Role of Marilee Hill, Registered Representative (RR)
Marilee Hill is a FINRA certified professional with 20 years of experience in real estate. She has a lot of skill and experience in dealing with 1031 exchanges and helping clients to think about the risks they’re taking on as well as the potential reward.
Marilee Hill understands the technical side of a 1031 deal, which is pretty complicated in many situations. She also understands the people side of the business, and dedicates herself to helping clients through some pretty thorny scenarios.
Ask Marilee Hill about your next 1031 exchange strategy to get a great professional in your corner.
