Equal or Greater Investment Value for 1031 Exchanges

1031 EXCHANGE HANDBOOK ...

EQUAL OR GREATER INVESTMENT

The last rule under Section 1031 is that in order to defer one-hundred percent (100%) of the taxes on your gain from the sale of old property you must buy equal or greater in value than what was sold.  There are two aspects of the rule.  First, you must buy a property or properties that have equity equal to or greater than the equity of the property sold.  Second, the debt incurred on the purchase of the new property must be equal to or greater than the debt on the property sold.

Can you take money out of the deal at closing?  Yes, this money (called boot by the IRS) is taxable, but can be taken out of the exchange without invalidating the rest of the exchange if the exchange documents so provide.  You would simply pay tax on the boot taken.

Example 1:

Pete owns a property he is selling for $200,000.  He has a $75,000 mortgage against the property.  He wants to buy new property for $125,000 with cash.  Is this a fully tax deferred exchange?  No, Pete is buying down from $200,000 to $125,000.  Pete owes tax on the amount for the buy-down (i.e., $75,000).

Example 2:

As in the example previous, George decides to buy a property for $250,000 by getting a loan for $150,000 and using $100,000 of the $125,000 cash the EA is holding.  Is this exchange fully tax deferred?  No, George did not use all the cash the EA was holding.