tell me i'm not crazy - 1031 related

[kenmoremmm]

i'm planning to sell a townhouse in the seattle area (boomtown, usa). a friend and i purchased in 2006 just before the bubble burst. it's a marginal rental now with breakeven results.

i've been looking at selling and doing a 1031 exchange. however, there are two parts to that process that don't sit well with me:
1. identify a property you will purchase within 45 days of closing on your sold property
2. new property value to be greater than or equal to sold property

i put together what i believe to be a correct spreadsheet to calculate the taxable amount of the property using capital gains (15%) and depreciation recapture (25%). can someone take a look and verify that my logic is correct?

if we did the 1031 exchange (my friend would not do one, so that's another complexity), the net savings would be about $34k.

if my math is correct, i'm pretty sure i will opt to straight up sell it and use the proceeds to purchase a new property anyway, but not with the 1031 exchange option. i am middle of the road for risk tolerance. i would prefer to buy a $125k property with a little cash flow rather than a $350k property with a $1400 mortgage for 30 years and more rental income and slightly more cash flow.

thanks

[Malaysia41]

Why does the new property have to be equal or greater in value to the sold property?

I don't see any requirement for that on the IRS site - unless I somehow glossed over it on reading, which is possible.

It seems that buying a property that's higher in value would make the process simpler, and would allow deferral of the entire gain,  but I don't know that it's a requirement.

https://www.irs.gov/newsroom/like-kind-exchanges-under-irc-code-section-1031

[kenmoremmm]

every blog and how-to i've read on 1031 talks about 2 requirements:
1. equal or greater equity in the new property(ies)
2. equal or greater value in the new property(ies)

i agree that IRS link is silent on it, but it seems odd to me that the industry standard would be as stated above.

example: https://forum.mrmoneymustache.com/real-estate-and-landlording/1031-exhange-anyone-ever-deal-with-one-and-how-does-it-work/msg1254770/#msg1254770

What if I want to buy a property that is worth more than my old one? Or, what if I want to spend less than I make on the old one?:
No problem! If you sell one building for 1 Million, and buy another for 1.2 Million, you can either pay out of pocket for the difference, or you can finance it.
Conversely, if you sell one property for 1 million, and buy another for $750,000, then the QI will cut you a check on day 181 (they usually hold it for the full 6 months) for the difference, and you pay tax on that difference.

[Malaysia41]

So it's not a requirement of the IRS.

It's a requirement for people who want to defer 100% of their gains and pay 0 taxes until they sell the new property.

But you could still defer taxes on a portion of your gains if you buy a property that's cheaper than the old one, assuming your gains are substantial.

makes sense.

[tralfamadorian]

@Malaysia41 is correct that it is not required for the new property(ies) to be >= sold property(ies) but if it is not, then tax is paid on the difference, called 'boot'.

Article here with details:
https://www.efirstbank1031.com/advancedTopics/rulesOfBoot.htm

[jwright]

Your friend not wanting do to the 1031 complicates things.

You need to have continuity of title for both the relinquished and replacement properties.  So if you own in an LLC, the same LLC would have to own both properties.  Essentially, you'd have to buy your friend out before closing, or go through the exchange together and then buy him out.

[kenmoremmm]

my friend and i never had a contract. there is no buyout needed. from my reading, i understand that this should make the 1031 a little easier. we have split costs, taxes, etc 50/50 for the duration of the ownership.

for the boot, how does that work for depreciation recapture?

for example, if the difference in purchase/sale price between new/old property is -$100k, would you just pay 15% (cap gains) on that $100k, or would there be some percentage of it that's also depreciation recapture?

[Wile E. Coyote]

my friend and i never had a contract. there is no buyout needed. from my reading, i understand that this should make the 1031 a little easier. we have split costs, taxes, etc 50/50 for the duration of the ownership.

for the boot, how does that work for depreciation recapture?

for example, if the difference in purchase/sale price between new/old property is -$100k, would you just pay 15% (cap gains) on that $100k, or would there be some percentage of it that's also depreciation recapture?

As long as you don't have a partnership (through active management) for tax purposes, it should not matter whether your friend elects to recognize gain rather than enter into a 1031 exchange as well.  As for the depreciation recapture, any boot will result in gain which will first be recaptured as ordinary income to the extent of your share of depreciation.

[kenmoremmm]

so, in the net -$100k example, let's say i had $70k of depreciation. that means the tax due on the boot would be: (70k x .25) + (30k x .15) = 22k?

[Wile E. Coyote]

so, in the net -$100k example, let's say i had $70k of depreciation. that means the tax due on the boot would be: (70k x .25) + (30k x .15) = 22k?

That would be the maximum tax, but the tax could be less.  If all of the $70K is "unrecaptured Section 1250 gain, depending upon your tax rate a portion of it could be taxed at 10%, a portion at 15%, and the rest at 25%.  There could be some 1245 recapture in there as well which could complicate things a bit.