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Six
things you need to know about §1031 - Part 6
Equal-or-Up
Rule
Section
1031 allows you to roll the gain
from the sale of your Old Property to the purchase
of your New Property. To do this, you have to jump
through certain hoops: we've written previously
about how your property has to be held for investment
and that it can not be held for resale. We've talked
about the requirement to identify potential replacement
properties for your exchange and how you have to
complete a list of these potential properties within
45 days with the stipulation that what ever you
purchase must be on your 45 Day List. We also talked
about how your money must be held by an independent
third party called a qualified intermediary and
how you must make sure that the intermediary holds
your money in an account separate from their other
exchanges. And last month we talked about the requirement
that you need to take title to the new property
in the same name or entity that held title to your
Old Property.
This month we'll cover the final rule which requires
that to pay no tax you must do two things: you must
buy equal or up and you must reinvest all the cash.
This sounds very complicated, but let me make it
simple for you.
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| As
appeared in... |
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August 2004 |
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by
Gary Gorman, Founding Partner, The 1031
Exchange Experts |
| The
first part of the rule is that if you buy equal or up
you will pay no tax. If you sold your Old Property for
$100,000 and you are buying your New Property for $90,000
(i.e., you bought down by $10,000), does this mean that
your exchange is toast? No -- it just means that you
must pay tax on $10,000 because this is the amount by
which you failed to buy equal or up.
The
second part of the rule requires that you reinvest all
the cash. Let's say that you sold your Old Property
for $100,000 and that you paid the mortgage and closing
costs associated with this property in the amount of
$40,000, leaving $60,000 which went to your intermediary
(and was placed in a separate account, of course). This
$60,000 must be reinvested in your New Property in order
to avoid tax.
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| Let's
say that you pay $150,000 for your New Property. You've
met the equal or up rule because you sold for $100,000
and bought for $150,000. But if you get a mortgage for
$100,000 you only need $50,000 of the $60,000 that the
intermediary is holding, which will leave $10,000 of
funds that are not reinvested. Again, this $10,000 is
taxable because you failed to reinvest the entire proceeds
from the sale (the whole $10,000 is taxable even if
you put $15,000 cash down when you originally bought
the property and spent another $5,000 on remodeling
it a couple of years ago).
In both of these examples it's important to note that
the entire $10,000 is taxable. You can not offset any
of your costs against this amount. Note that in both
examples you could avoid paying tax on this amount by
buying a second property (assuming of course that you
listed it on your 45 day list), and in the second example
you could avoid the problem by changing the loan, or
simply paying it down at the closing.
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