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Can you do a partial 1031 exchange?

Question

Can I conduct a 1031 exchange where only a portion of the proceeds from the sale of my relinquished property is reinvested into a like-kind replacement property, and if so, how would this affect the deferral of capital gains taxes?

ARTE's Answer

Yes, you can do a partial 1031 exchange, but it's important to understand the implications and how it works. A partial 1031 exchange occurs when you do not reinvest all of the proceeds from the sale of your relinquished property into the replacement property. This can result in a portion of the gain being recognized and taxed, which is often referred to as “boot.”

Boot can come in two forms:

  • Cash boot occurs when you receive cash or other non-like-kind property in the exchange.
  • Mortgage boot happens when the debt on the replacement property is less than the debt on the relinquished property, and you do not replace the difference with additional cash.

Let's walk through an example to illustrate how a partial 1031 exchange works, using Deferred.com as your qualified intermediary.

Imagine you own a rental property that you originally purchased for $200,000, and it now has a fair market value of $500,000. You have a mortgage of $100,000 on this property. You decide to sell this property and use Deferred.com to facilitate a 1031 exchange.

You find a replacement property worth $450,000, which is less than the value of your relinquished property. You decide to take $50,000 in cash from the sale proceeds, which will be considered cash boot. Additionally, you take out a new mortgage of $90,000 on the replacement property, which is $10,000 less than the mortgage on your relinquished property, resulting in mortgage boot.

Here's how the numbers break down:

  1. Sale of Relinquished Property:
    • Sale Price: $500,000
    • Mortgage Payoff: $100,000
    • Net Proceeds: $400,000
  2. Purchase of Replacement Property:
    • Purchase Price: $450,000
    • New Mortgage: $90,000
    • Cash Invested: $360,000
  3. Boot Calculation:
    • Cash Boot: $50,000 (difference between net proceeds and cash invested)
    • Mortgage Boot: $10,000 (difference between old and new mortgage)

In this scenario, you have a total boot of $60,000 ($50,000 cash boot + $10,000 mortgage boot). This $60,000 will be subject to capital gains tax, while the remaining gain is deferred through the 1031 exchange.

At Deferred.com, we offer a “No Fee Exchange,” which can save you money on the transaction. As your qualified intermediary, we ensure that the exchange is structured correctly to maximize your tax deferral benefits while handling all the necessary documentation and compliance requirements.

It's crucial to consult with a tax advisor to understand the specific tax implications of your partial 1031 exchange and to ensure that you are making the most informed decision for your financial situation.

Have more questions? Call us at 866-442-1031 or send an email to support@deferred.com to talk with an exchange officer at Deferred.

Deferred's AI Real Estate Tax Expert (ARTE) is a free research tool. Trained on 8,000+ pages of US tax law, regulations and rulings, ARTE outperforms human test takers on the CPA exam. This is page has ARTE's response to a common 1031 Exchange question and should not be considered personalized tax advice.

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