What is a partial 1031 exchange?

Question

Could you explain what a partial 1031 exchange is, including how it differs from a full 1031 exchange and under what circumstances a taxpayer might choose to pursue a partial exchange instead of a full one?

ARTE's Answer

A partial 1031 exchange occurs when a taxpayer does not fully reinvest the proceeds from the sale of a relinquished property into a like-kind replacement property. This can happen when the taxpayer either receives cash or other non-like-kind property (known as "boot") or does not replace the full value of the relinquished property. In such cases, the taxpayer will recognize gain to the extent of the boot received or the shortfall in reinvestment.

To better understand this, let's break down the components of a partial 1031 exchange:

  1. Boot: This is any cash or non-like-kind property received in the exchange. Boot can be in the form of cash received at closing, debt relief (if the mortgage on the replacement property is less than the mortgage on the relinquished property), or other non-like-kind property. Receiving boot results in a taxable gain.
  2. Reinvestment Requirement: To fully defer capital gains taxes, the taxpayer must reinvest all net proceeds from the sale of the relinquished property into the replacement property. Additionally, the replacement property must be of equal or greater value than the relinquished property.
  3. Taxable Gain: If the taxpayer receives boot or does not fully reinvest, they will recognize a taxable gain. The gain is recognized to the extent of the boot received or the shortfall in reinvestment.

Let's illustrate this with an example:

Imagine you own a rental property that you sell for $500,000. After paying off a $100,000 mortgage and $20,000 in closing costs, you have $380,000 in net proceeds. To fully defer taxes, you would need to purchase a replacement property worth at least $500,000 and reinvest the entire $380,000 in net proceeds.

However, suppose you decide to purchase a replacement property for $450,000 and use Deferred.com as your qualified intermediary to facilitate the exchange. In this scenario, you reinvest $350,000 of your net proceeds and receive $30,000 in cash boot. Additionally, you take out a new mortgage of $100,000 on the replacement property.

  • Relinquished Property Sale: $500,000
  • Net Proceeds After Mortgage and Closing Costs: $380,000
  • Replacement Property Purchase: $450,000
  • Reinvestment of Proceeds: $350,000
  • Cash Boot Received: $30,000

In this example, you would recognize a taxable gain of $30,000, which is the amount of cash boot received. The remaining gain is deferred under the 1031 exchange rules.

At Deferred.com, we specialize in helping investors navigate the complexities of 1031 exchanges, including partial exchanges. Our "No Fee Exchange" service can save you money while ensuring compliance with IRS regulations. By using our qualified intermediary services, you can focus on finding the right replacement property while we handle the intricacies of the exchange process. If you have any further questions or need assistance with your exchange, feel free to reach out to us.

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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