Value Requirements for a 1031 Exchange
October 24, 2016
We’ve walked through the process of a 1031 exchange. Now, it is important for the exchanger to be aware of the value requirements for a qualified compliant exchange. The exchanger must make sure the value of the property to be acquired is in line with what was relinquished. It is not necessary for exchange purposes for the values to be an exact match, but any funds remaining whether in the form of cash or debt from the property sold will be taxed. The excess proceeds, commonly known as “Boot,” are fully taxable back to the exchanger’s original cost basis. For some exchangers it may make sense to leave some money on the table for other investment classes or current needs. It is important that each exchanger consult with their financial or tax advisor prior to leaving any money on the table in an exchange.
To make a fully tax deferred exchange and have no Boot, the exchanger is required to acquire one or more properties of equal or greater value of what they sold. In addition, if the exchanger has debt on the relinquished property they should count on acquiring new debt equal or greater to what was on the previous property. It is more important to note however, that cash is Kind. If the exchanger does not wish to have a substantial debt obligation on the new asset, they can pay down the debt requirement in the exchange with an additional cash contribution. Unfortunately, for those who want to take some cash out of a deal, this flexibility on the debt requirement does not go the other way. Placing of additional debt on a property, while allowed, does not get the exchanger to the value component if they remove cash from the exchange.
Here is an example:
Property A is sold for $200,000. When old, the cash proceeds are $100,000 and $100,000 of debt is repaid. The exchanger places $100,000 of cash proceeds with the QI, identifies another property within the 45-day identification period worth $200,000. The exchanger then acquires the new property with a new loan of $100,000 within the 180-day exchange period. They have completed a successful exchange.
Property B is a similar property as A is sold for $200,000. When sold, the cash proceeds are $100,000 and $100,000 worth of debt repaid. The exchanger places the $100,000 of cash proceeds with the QI, identifies another property within the 45-day identification period worth $200,000. The exchanger then obtains a new loan of $100,000 and close on the replacement property within the 180-day exchange period. While the exchanger has acquired a property for $200,000, the same that was relinquished, the additional loan amount taken leaves $10,000 exposed for taxation should the excess funds not be used to acquire new investment property.
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Please note: 1031RPS.com and its associated personnel are not tax professionals, and they recommend investors consult with their tax advisor to ensure their 1031 Exchange is within the IRS guidelines established.