Partial 1031 Exchange And Tax Consequences

Partial 1031 Exchange And Tax Consequences

How To Keep Some Cash While Doing A 1031 Exchange?

Though a 1031 exchange lets investors defer 100% of their capital gain taxes, some opt for a partial 1031 exchange. There could be innumerable reasons for which you need to take out cash from your sale proceeds. A medical emergency, financial crunch, marriage, and vacation are a few to name. A partial 1031 exchange could be the right decision under such circumstances.

Partial 1031 exchange occurs when an investor chooses to defer some capital gain tax, not all.

In a partial 1031 exchange, the investor decides to defer some capital gain taxes, and also recognize some gain by either

1- taking out some cash from the proceeds or

2- through debt reduction on their replacement property. Both events can result in a boot, which refers to ‘anything received in addition to’ the replacement property. It could be cash boot or mortgage boot. Any personal property received in the exchange is also considered boot.

An investor can receive cash proceeds in different ways.

  • The investor can ask the closing officer to transfer a part of the proceeds from their relinquished property directly to their account.
  • After the exchange, if there are properties that have been identified but not purchased, then it can result in a boot as well.

How to do a fully tax-deferred exchange?

If an investor to do a fully tax-deferred exchange and not a partial 1031 exchange, they must fulfill the following two requirements among all –

  • Reinvest the entire sale proceeds in one or more replacement properties.
  • Buy one or more replacement properties with equal or greater debt. [An exception to this requirement is that the investor can offset a reduction in debt by adding cash to the replacement property.] 

When shouldn’t you do a partial 1031 exchange?

Undoubtedly, a partial 1031 exchange gives investors cash and asset at the same time. However, not every time doing a partial 1031 exchange turns out to be beneficial. For example, if the boot is more than your capital gain, you should refrain from doing an exchange. After all, what’s the point of doing a 1031 exchange if you’re supposed to pay hefty taxes?

You might need a 1031 exchange properties list of your own.

One of the most challenging tasks is to identify a replacement property. Sometimes, even after successfully identifying a property, investors fail to acquire it. This could happen either because the seller refuses to hand over the property on the specified date or the property you choose is bought by someone else, or it turns out to be a primary residence. In any of these situations, you won’t be able to complete your 1031 exchange. Therefore, having a 1031 exchange properties list, it gets easier to figure out which properties qualify as 1031 exchange commercial properties and which don’t. Plus, you will have a clear idea if your chosen property is available or not. You can obtain your 1031 exchange properties list from a local broker or a real estate firm that facilitates 1031 exchanges.

“Our tax-deferred 1031 exchange programs can save millions in taxes, increase investor equity, and compound annual cash flow distributions and returns”