In doing a 1031, what price must I pay for the new property to have no tax due?
A: When completing an exchange transaction, many a taxpayer's preference is to have no tax consequences. While there is a complicated set of cash and mortgage boot offset rules that you can review, http://www.invtitle.com/node/1529, we offer a more pragmatic approach to defining what is necessary.
Essentially, for total tax deferral, you need to replace 100% of any debt and equity in the property you are selling-- into the property you are buying.
For example, if you own a $1 million property that is debt-free, you will need to spend at least $1 million of the proceeds for the replacement property. If you are selling the same $1 million property but it is encumbered by a $600,000 mortgage, you must re-invest both the $400,000 of proceeds you will net from the sale, plus the $600,000 in debt into the new property. (You can also replace/offset the $600,000 of debt with additional cash if you have the ability.)
The replacement of equity and debt into a new property is why Congress allows you to defer the tax on the gain of your sale. Your financial picture before and after the exchange has not significantly changed: you are not cashing out any of your equity or being relieved of any debt without replacing it or offsetting it with new cash out of pocket. Therefore, you are allowed to continue to roll your equity forward without having to recognize gain.
So generally speaking, here are some guidelines: · The value of the replacement property must be equal to or greater than the value of the relinquished property.
· The equity in your replacement property must equal or exceed the equity in your relinquished property.
· The debt on your replacement property must be equal to or greater than the debt on your relinquished property (unless replaced with new cash).
· All of the net proceeds from the sale of the relinquished property must be used to acquire the replacement property.
Or simply stated, as long as you buy replacement property that is the same price or greater (than the relinquished) and use all the cash, your transaction should be "tax-free".