Partial 1031 Exchange
Posted by Andy Gustafson on Thu, Dec 01, 2011
Often, taxpayers ask whether partial 1031 exchanges are possible. Yes, they are but depend on the amount not being deferred to whether it is in the taxpayer's best interest to initiate or simply pay the tax.
What is a Partial 1031 Exchange?
1031 exchanges defer the federal capital and state capital gains and recaptured depreciation tax on property held for investment or business use and exchanged for like-kind property held for investment or business use. The recognized gain is deferred indefinitely or until the replacement property is sold when replacement property is acquired at a price that is equal to or greater than the sales price of the old property.
When the replacement property is not of equal or greater value, then a tax is triggered on the difference, otherwise known as a partial exchange. If the taxpayer knows that the replacement property will be acquired for a lower price, they can request the difference be received at the first of two closings. Otherwise, the excess cash is held in the escrow account until the 45th calendar day. Following the identification rules, if no property is identified to the Qualified Intermediary by 11:59 PM on the 45th calendar day post closing, then on the 46th day the escrow balance is returned to the taxpayer.
When a Partial Exchange Does Not Make Sense
The taxpayer wishes to exchange a $100,000 property for a $55,000 or $45,000 replacement property. To keep the example simple, the old or relinquished property is land being exchanged for land held for over one year. The recognized gain or tax of $16,995 is determined as follows:
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Original Purchase Price
|
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25,000
|
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Improvements
|
|
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0
|
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Depreciation
|
|
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0
|
|
Adjusted Basis
|
|
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25,000
|
|
|
|
|
|
|
|
Sales Price
|
|
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100,000
|
|
Adjusted Basis
|
|
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25,000
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|
Selling Expenses
|
|
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9,000
|
|
Realized Gain
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|
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66,000
|
|
|
|
|
|
|
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Federal Capital Gain (15%)
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9,900
|
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State Capital Gain (New Jersey 10.75 %)
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7,095
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Recaptured Depreciation
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0
|
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Recognized Gain
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|
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16,995
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When a replacement property is acquired of $100,000 or more, the $16,995 is deferred. When property of $55,000 or $45,000 is acquired the tax implication of a partial exchange is:
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Tax on $45,000
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Federal Capital Gain (15%)
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6,750
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State Capital Gain (New Jersey 10.75 %)
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4,838
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Recaptured Depreciation
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0
|
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Tax Due
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|
|
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11,588
|
| |
|
|
|
|
|
Tax on $55,000
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Federal Capital Gain (15 %)
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|
8,250
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State Capital Gain (New Jersey 10.75%)
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5,913
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Recaptured Depreciation
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|
0
|
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Tax Due
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|
|
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14,163
|
In either scenario, does it make sense to initiate a 1031 exchange when the tax being deferred is $5,407 and $2,832 respectively? It depends upon the value the taxpayer places on the dollar and intent to replace.
When a Partial Exchange Makes Sense
Pulling cash out at the first closing makes sense when the taxpayer wants cash. But there comes a point to be decided by the taxpayer when pulling out more than 50% radically diminishes the amount of the tax deferral.
As always it is best to seek the guidance of your CPA to discuss the specifics of tax implications. To discuss your transaction, contact our office for a free consultation.
Your Turn
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