When performing a 1031 exchange we are frequently asked the following question:
Can I receive some non-taxable cash from the sale of my property? After all I put cash down when I bought it, I paid down the principal on my mortgage and, I paid cash to improve it while I owned it, can’t I receive at least my down payment, principal reduction or capital improvements back in tax free cash?
The simplest answer to this question is NO. If cash is received from the disposition of property, gain will be recognized regardless of the amount of your down payment, regardless of the amount of your equity, and regardless of the improvements you have made to the property during your ownership. Internal Revenue Code Section 1031 allows for the non-recognition of gain when properties of “like-kind” are exchanged. Section 1031(b) labels other things of value received in an exchange as “boot.” “Boot” simply means everything of value other than “like-kind” property which you receive during an exchange. Since you are exchanging like-kind real property, any cash that you receive would be considered as “boot.” It would be taxable to the extent of gain “realized”.
While this provision seems “unfair” to certain people with whom we discuss this issue, it is an accurate statement of the law.
If structured correctly an exchange can provide the “exchanger” with limited amounts of cash on which the “exchanger” pays the tax while the remainder of the funds are used to acquire the “replacement” like-kind property. Care must be taken regarding the time and manner in which the “exchanger” is provided with the taxable cash or the entire exchange may fail.
Attorney Steve Hickox ESQ.
Contact us for further strategies to meet your present needs for cash while maximizing your non-recognition of gain 1-888-899-1031.
The regulations creating Qualified Intermediaries (companies like ours) have been around now for ten years. Word of the benefits of using IRC section 1031 as a capital preservation tool has spread far and wide. Yet, we still receive calls every week from investors as follows: “I have just sold a real estate investment and I want to do an exchange.”
The sad truth is that by that time it is too late to take advantage of the benefits of section 1031. Our company must be involved prior to the closing of the sale of the investment property, and we must receive the funds from the sale. If the investor receives the proceeds or if an “Exchange Agreement” is not in place with us at closing, then the benefits of section 1031 will not be available. Any attempt to take advantage of section 1031 after the fact will likely result in tax fraud which creates both civil and criminal penalties for the tax payer and anyone else who participates in the fraud. Don’t get caught in this situation.
On September 15, 2000 the IRS issued guidance and recognition for Reverse Exchanges.
Rev. Proc 2000-37.
Here is a summary:
If you’ve completed a 1031 exchange, you can use IRSForm8824.com to complete your Form 8824!
You enter information about your properties from your settlement statements and tax records and it will automatically produce a Form 8824 that is downloaded to your computer.
*Zero Balance check to help you make sure the input is correct.
*Allows you to verify you input BEFORE you purchase.
*Produces calculation worksheets.
*Data file is downloaded to your PC.
When you open the Form 8824 PDF the fields are automatically filled in! It is ready for review, printing and filing with the IRS. If you have a tax question–you can send it to one of our tax attorney/CPAs for an answer.
Since 1994, 1031x has assisted thousands of clients with their tax-deferred, like-kind real estate exchanges. Our clients have often requested assistance with completion of their required Form 8824–this website is the tool you need!
Like-kind has been broadly defined by the IRS to include ANY kind of real estate for ANY other kind of real estate. For instance an apartment building can be traded for a farm or, a mobile home park can be traded for a warehouse. In this regard real estate is a very special investment tool because very few other investments can be exchanged with this flexibility. From a broker’s stand point, this allows the broker to meet the client’s needs to change the shape of their real estate investment. The client may want an investment that is easier to manage. Or, the client may want an investment that provides better cash flow. Or, the client may want a property yet to be developed. Use of a 1031 exchange allows the broker to meet the changing investment needs of the client while at the same time the client has no present tax liability from the exchange. It’s a great tool for both the client and the broker.
Now here is a good rule of thumb for you and your clients to follow: IF NO TAX LIABILITY IS TO BE INCURRED THE CLIENT MUST TRADE EQUAL OR GREATER BOTH EQUITY AND FAIR MARKET VALUE. This means that all cash received from the relinquished property must be used as down payment on the replacement property. AND, the replacement property must be equal or larger in fair market value to the relinquished property.
1) All of the investor’s capital from the sale of the relinquished property must be reinvested in the replacement property. This includes all down payment, capital improvement, principal reduction, and appreciation on the relinquished property. Any cash received by the investor at the sale of the relinquished property or at the purchase of the replacement property will be treated as “cash boot” and taxed. However, cash received in refinancing arrangements often will not be taxed.
2) Tax basis from the relinquished property is carried forward into the replacement property. The investor is not allowed to take another depreciation allowance. Tax basis in the replacement property is calculated by carrying forward the basis of the relinquished property and increasing it based on additional cash and mortgage.
3) The investor must exchange for like kind property. Real estate must be exchanged for real estate, not some other investment.
4) In order to fully defer gain the investor must acquire a replacement property of equal or greater value to the relinquished property. Trading down in value will result in recognition of some or all of the gain.
Conclusion: The only time you should sell rather than exchange is when you are getting out of real estate altogether.