The Exchange Update
A Newsletter For 1031 Tax-Deferred Exchanges
How Much do I Need to Buy to Structure a Fully Tax-Deferred Exchange?
Equal or Greater in Value and Equity
One of the most common questions we receive from taxpayers who plan to do a 1031 exchange is “How much do I have to buy in order to defer my taxes?” While it’s important to have your tax advisor weigh in on this, there is a shorthand way to figure out whether the purchase you are contemplating will be enough to successfully complete your exchange.
To structure a fully tax deferred exchange, you must do two things. First, you must acquire replacement property that is equal to or greater in value than the relinquished property you disposed of. In addition, you must use up all of the net cash that you get from the sale and invest it in the new property.
For example, if you are selling a property for $500,000 that is subject to debt in the amount of $300,000, you need to acquire property that is worth at least $500,000 and you must invest all of the net proceeds ($200,000) into the new property. The balance of the $300,000 in debt can be replaced either by debt on the new property or by investing additional cash.
If you fail to both acquire something that is equal to or greater in value than the relinquished property and invest all of the net cash from the relinquished property into the replacement property, does that completely ruin your exchange? The answer to this question depends on the deal you are attempting to do. If you trade down too much in value or equity, it may not be worthwhile to do an exchange. As mentioned above, it is important to have your tax advisor review your numbers, but it may be that you are able to defer some tax but will also owe some tax on the transaction.
If you trade down in either value or equity, the short hand way to compute how much tax you would owe would be that the greater of the trade down in value or trade down in equity would be your taxable gain.
Let’s look at the following example:
Sale Price: $500,000
Sale Price: $450,000
In this example, the taxpayer buys property worth $50,000 less, borrows more and invests $100,000 less in the replacement property. The taxpayer is trading down in value by $50,000 and trading down in equity by $100,000, and therefore would need to pay tax on $100,000. If $100,000 is less than the actual gain the taxpayer would have if he sold the property outside of an exchange, he would still have a good reason to do an exchange.
Some expenses paid at a closing reduce the amount that you need to invest in the replacement property. These are called “exchange expenses” and most tax advisors agree that they include broker’s commissions, title, escrow, exchange fees and transfer taxes, among other costs.
If you would like more information about the 1031 exchange requirements, or you would like to set up a 1031 exchange, please contact us at First American Exchange and we would be happy to help you.
What IRS Tax Forms Do I Need and Where Do I Get Them?
It’s tax time again and getting started on your taxes can be daunting. To help you get started, some of the most popular IRS forms are listed below with explanations for their use. Using the right form is important to ensure your return is processed quickly.
- 1040EZ – This form is used for taxpayers claiming the least amount of adjustments to their income.
- 1040A – Most taxpayers will use this form, which allows for claiming the most common adjustments to income.
- 1040 – This form is for taxpayers whose income is above $100,000, itemize their deductions or have more complex investments to report.
- 8824 – If you have completed a 1031 exchange, you will need to report it on this form.
- 4797 – This form is used to report the sale of business property as well as involuntary conversions (§ 1033).
- 6252 – This form is for taxpayers who sold real or personal property using an installment plan.
For a more complete list of tax forms and more details on the forms listed above, visit http://www.irs.gov.
The IRS has discontinued mailing out forms to taxpayers; however, there are a number of different ways to get tax forms and publications:
- The IRS homepage (http://www.irs.gov) has a list of forms and publications available for download.
- Participating local libraries and post offices.
- There are Local Taxpayer Assistance Centers throughout the country. Go to the IRS website; click ‘Individuals’ and then click ‘Contact My Local IRS Office’ to find a location near you.
- You can also call 1-800-TAX-FORM and request to receive these forms by mail.