Many taxpayers (and tax advisors) are under the misconception that the IRS mandates that they must have equal or greater debt on their 1031 Exchange Replacement Property (property taxpayer is purchasing). This is not the case. The taxpayer does need to replace the VALUE of the debt they had on the Relinquished Property (property taxpayer is selling). However, the debt does not have to be replaced with debt. Let’s look at an example:
Assuming that the taxpayer sells investment real estate for $1,000,000. That property is comprised of both equity and debt. In this example, the taxpayer has $600,000 of equity and a $400,000 loan.
If the taxpayer sells their property, in order to get full tax deferral utilizing a 1031 Exchange, they will have to roll all of their net equity (a little less than $600,000 after closing costs, etc.) into the Replacement Property AND they will need to replace the VALUE of her debt – the $400,000 loan.
In replacing the VALUE of the debt, the IRS is not concerned how the taxpayer replaces that $400,000 loan. In fact, the taxpayer has a number of options, including:
- Traditional Financing (another loan from a lender)
- Cash (other cash that the taxpayer has available)
- Seller-Financing (the seller of the Replacement Property finances the purchase using a Carryback Note)
- Private Money
And any combination of the above-mentioned options would be suitable. For example, the taxpayer could go back to their bank and obtain a $100,000 loan, bring in $100,000 of fresh cash, have a Carryback Note between them and the Seller of the Replacement Property for $100,000, and obtain a Private Money loan in the amount of $100,000.
When all of those are added together, the taxpayer has successfully replaced the VALUE of the $400,000 debt that they had on the Relinquished Property, and when completing their 1031 Exchange will have fully deferred their taxes.
This material does not constitute an offer to sell, solicitation of an offer to buy, recommendation to buy, or representation as the suitability or appropriateness of any security, financial product or instrument, unless explicitly stated as such. This information should not be construed as legal, regulatory, tax, personalized investment, or accounting advice. This message (and any attached materials) is for the sole use of the intended recipient(s) and may contain information that is privileged, confidential and exempt from disclosure under applicable law. Any review, dissemination, distribution or duplication of this communication is strictly prohibited
This data is not meant to replace Adviser’s portfolio management/performance reporting systems or brokerage statements. Please consult your reports for actual performance data before making any decisions based on this information. Accordingly, reliance upon information in this data is at the sole discretion of the reader. Assumptions on returns are just that and may or may not come to fruition. Actual returns may not be as projected and are for illustrative purposes only.
Neither EFR (Exclusive Financial Resources, LLC), it’s officers or employees are authorized or permitted under applicable laws to provide tax or legal advice to any client or prospective client of EFR. The tax related information contained herein or in any other communication that you may have with a representative of EFR should not be construed as tax or legal advice specific to your situation and should not be relied upon in making any business, legal or tax related decision. A proper evaluation of the benefits and risks associated with a particular transaction or tax return position often requires advice from a competent tax and/or legal advisor familiar with your specific transaction, objectives and the relevant facts. We strongly urge you to involve your tax and/or legal advisor (or to seek such advice) in any significant real estate or business related transaction.
If you would like to find out more about replacing the Value of Debt please give Exclusive Financial Resources a call at (980) 242-2533, email Louis Herford at Louis.Herford@ExclusiveFinancialResources.com or schedule a 15-minute discussion here.