There are consequences. Most real estate owners making a 1031 swap want to put aside an amount from the sale of their surrendered property. Perhapsthey need money to fund their business, tuition costs for their children’s college or even a personal debt. Then, we come to the next question: can you still retain a portion of the sold property’s proceeds and defer tax due through a 1031 exchange?
In a nutshell, Yes. There is no requirement to reinvest all of the proceeds of the sale of your renounced property. If you choose to keep a specific portion of it, you’re making an partial exchange. The portion of real estate sale proceeds that you choose to save is referred to as boot and is subject to depreciation and capital gains recapture tax. Note that boot can come in two main forms: cash boot as well as mortgage boot. We will be able to guide you through this when you schedule an appointment for a no-cost consultation.
What Is An Exchange Partial Work?
In order to complete a 1031 partial exchange, you must to follow all IRS established guidelines and rules that govern an exchange procedure. If you’ve chosen the price for the property you are replacing You can ask to receive a percentage of the proceeds from the sale upon the conclusion of the sale, or at anytime after that.
Typically, at the time that you have closed the deal on the relinquished property, the amount required to buy the replacement property is generally not known. An ideal solution is to have the escrow store the profits from the sale to escrow till the value for the new property has been established.
But, you’ll need to wait until the closing of your new property before receiving the extra funds from your intermediary. When the intermediary is able to release the funds that are not in the possession of you, then you become automatically responsible for tax payments on the funds received.
Let’s take a look at the example below to assist gain a better understanding of the boot as well as partial exchange. The property you sell has no mortgage, and you net $550,000. The new house is appraised at $400,000. Because $150,000 cannot be put into the replacement property it will be taxed it at the normal tax rate.
In the above instance The extra $150,000 is called boot. Since you were unable to acquire a replacement property of equivalent or greater value to your property that you have sold In this case, the IRS views the exchange as partial.
Pros Of A Partially 1031 Exchange
The main benefit of performing an exchange in part is the speedy access to money. If you are in urgent cash requirement, then the partial exchange 1031 is the ideal option. The surplus funds generated by the exchange are able to be used for any reason as they are tax-deductible.
Reduce leverage and debt. For instance the office property in Annapolis is priced at $600,000 with there is only $100,000 remaining to pay the mortgage. You could decide to buy the property for $500,000 free and clear, and then pay taxes on the $100,000 remaining boot. In this situation, DSTs DST could be a feasible alternative to your $100,000 in boot since you can invest in DST instead of a tax deductible partial exchange, you could get a tax-free complete exchange. DSTs are a fantastic place to invest your boot.
Cons Of An Exchange Partial To 1031
Taxes will be imposed on your boot.
Last Thoughts
In many instances we suggest an exchange of a portion of 1031 as a viable alternative to a traditional exchange. We suggest partial exchanges when the seller is faced with a financial need that needs some, but not all money from a sale. As an example, it’s not unusual to sell a house which is not a debtor it, and outside of their home, it might constitute close to 100 percent the assets they own. In addition when they sell it they do not want to have anything to have to do with tenants or active property management. This means the DST is their most lucrative tax-wise option. However, DSTs are not known for their liquidity or ability to loan against should someone require urgent cash or emergency funds. In these situations it is recommended to have some cash in reserve for rainy days regardless of whether you need to be taxed on it.
If you are considering any partial exchange or traditional 1031 exchange, you should seek out your tax advisor for further advice on your situation. Make sure you know the facts prior to proceeding.
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In case you’ve got any concerns regarding your exchange 1031 make a call now to discuss your options..
