Author Topic: Cost Basis in a 1031 exchange  (Read 2430 times)

Landslave

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Cost Basis in a 1031 exchange
« on: January 24, 2017, 08:39:03 PM »
Greetings: 
    Does the cost basis matter in a 1031 exchange?  In other words, if we have a lot of cost basis cost in the unit we are selling, does that become a full tax liability in the new unit we are buying after the exchange?  If there is a large cost basis, does this make a 1031 a poor choice?
    Thanks for your answer and advice in advance.
  Landslave

SeattleCPA

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Re: Cost Basis in a 1031 exchange
« Reply #1 on: January 26, 2017, 07:16:22 AM »
Maybe an easier way to think of a Sec. 1031, or like-kind, exchange is this:

If you have unrealized gain on the property you're looking to dispose of, as long as you follow the rules of Sec. 1031, you won't pay tax on that gain when you trade the old property for a new property. That "delay" in paying the taxes is the benefit.

You will pay taxes on the unrealized gain from the old property if you sell the new property.

jwright

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Re: Cost Basis in a 1031 exchange
« Reply #2 on: January 26, 2017, 07:21:34 AM »
The potential gain on the sale of the property is what "matters".  That sales price less closing costs less basis.  In a 1031 the gain is deferred by reducing the basis in the replacement property; the only way to avoid the tax all together is death; if you at some point sell the property outright without an exchange you'll pay the tax on the gain in that year.

So a "large cost basis" makes me think that perhaps the actual gain is small.  In that case it may not be worth if you can't find a perfect replacement property to complete the exchange.  We have clients that have millions of dollars in gain to defer and they will absolutely make it a priority to roll that into another property.  If the gain were only $10,000, the tax situation may not warrant that effort.  Certainly do not complete the exchange if you have a loss.

SeattleCPA

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Re: Cost Basis in a 1031 exchange
« Reply #3 on: January 26, 2017, 10:36:54 AM »
If there are suspended passive losses, those factor into your gain calculations too.

Landslave

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Re: Cost Basis in a 1031 exchange
« Reply #4 on: January 27, 2017, 04:56:50 PM »
Thanks for the replies.  Here it is, all layed out so that you can help us:

 bought a house for $106K
 Rehab $50K
 Current value $175K

It is titled in a land trust, if that matters.  Will have held it for just over a year (yes, I know, we are slow rehabbers!), if that matters.  Thanks in advance for further analysis.  There are no state capital gains or income taxes on this upcoming sale transaction, either way.  There are closing cost taxes, recording fees, etc totaling about 2.5% to the seller for this upcoming sale.

 Landslave

SeattleCPA

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Re: Cost Basis in a 1031 exchange
« Reply #5 on: January 27, 2017, 07:16:22 PM »
I don't think your situation warrants the (slight) extra cost and (modest) hassle factor of a Sec. 1031 exchange.

You've got a long-term capital of less than $20K.. so your tax is less than $3K... that's what you're trying to save.

jwright

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Re: Cost Basis in a 1031 exchange
« Reply #6 on: January 30, 2017, 08:15:50 AM »
If you bought the property with the principal intent to sell it (ie, flip it), then it will not qualify for a 1031 exchange.  In that scenario the home is inventory.   The property has to be held for investment or owned in a trade or business.  There are many "gray area" factors that would lend themselves to an argument either way. 

The other factor in this, is that if you bought the house intending to flip it, the gain is ordinary income taxed at ordinary rates not capital gain.

Regardless of the "gray area" argument; I agree that the gain is too small to warrant prioritizing an exchange.  If you already had a replacement property picked out, you could go ahead and do it.  But dont' force an exchange to defer a few thousand dollars.

Landslave

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Re: Cost Basis in a 1031 exchange
« Reply #7 on: February 05, 2017, 10:06:12 PM »
  Again, thanks for the information.  We bought the house with the intention of rehabbing it and holding it as an investment.  Then, the marketplace wasn't right to support this as a rental and we decided to sell it.  Also, we probably put better finishes in the property than would be advisable for a rental house.  Now we realize we need to sell it.