How Does Debt Effect a 1031 Exchange?

Debt is a big consideration in a 1031 exchange of real estate. In this article, we are going to discuss how debt impacts a 1031 exchange of real estate.

Debt Considerations in 1031 Exchange Transactions

In a 1031 exchange, debt is your friend. Some people that are selling highly appreciated real estate but have to pay off a mortgage on their relinquished property only want to reinvest their cash proceeds into a new property that they will own free and clear.

When you’re doing a 1031 exchange, there are three benchmarks that you need to satisfy in order to complete a successful exchange. Specifically, your replacement property needs to be equal to or greater than your relinquished property in:

1. Value

2. Equity

3. Debt

The debt relief can be offset by either taking out new debt on the replacement property or by adding your own cash into the deal. If you want to squeeze all of the tax-efficiency out of a 1031 exchange, you need to know what the accounting rules are and you likely want to take out debt on the replacement property side of the equation.

Start Your Like-Kind Exchange with CPEC1031, LLC

If you’re ready to get started with your like-kind exchange of real estate, you’ve come to the right place. CPEC1031, LLC has been providing qualified intermediary services for 1031 exchanges for over two decades. We have the experience and in-depth knowledge to walk you through the process of exchanging your property under section 1031 of the Internal Revenue Code. Contact us today at our Minneapolis offices to learn more about our services and how we can help you with your next real estate exchange.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2022 Copyright Jeffrey R. Peterson All Rights Reserved

3 Tips for Managing Unsecured Debt in a 1031 Exchange

When you're selling a property in a 1031 exchange, you need to move all of your equity into the new replacement property in order to defer all of your capital gains taxes. However, you are allowed to pay off debt associated with the relinquished property. So how do you handle unsecured debt in a 1031 exchange transaction?

Unsecured Debts

Oftentimes people have recorded mortgages or deeds of trust against the old relinquished property and that’s clearly associated with the property. But what about unsecured debts? What if you'd borrowed $60,000 from you Aunt Matilda and you just had a promissory note or I-owe-you? Is that associated with the property?

One way to tie the debt to the property so that it's associated with the sold property is to have the note specify that if the subject relinquished property is ever sold the note has to be paid off at the time of closing.

Contractually Tie the Debt to the Sale

Furthermore, you can state in the purchase agreement with your buyer that as a material and substantial condition of this sale, the debt owed to Aunt Matilda must be paid at the time of closing. So you can contractually tie the debt to the sold relinquished property. The regulations state that you can offset the debt relief on the old relinquished property by taking out new debt on the replacement property. That means you can pay off the debts on the old relinquished property without recognizing any gain, provided you offset that debt relief with new debt or new cash in on the replacement side.

The trick is to plan early. Make sure your debts are recorded against the property or that you’re contractually required to dispose of that debt in conjunction with the sale of your old relinquished property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

The Importance of Balancing Value, Equity & Debt in a 1031 Exchange

In this article, we are going to discuss the importance of balancing value, equity, and debt when it comes to 1031 exchange transactions.

Balancing Value, Equity and Debt

Typically, an Exchangor will acquire replacement property that is “up or equal” in Value (price) and will roll over all of the Equity (net proceeds) from the relinquished property into the replacement property.

Further, to the extent that the Exchangor was relieved of liabilities and debt, such as mortgages on the relinquished property, the debt relief must be offset by (1) new liabilities or mortgages taken on the conjunction with the purchase of the replacement property, OR (2) by investing additional cash in the replacement property equal to the amount of liabilities and debts that were discharged.

A QI’s Role

A Qualified Intermediary (QI) is a critical component in the success of a transaction:

• Provide a safe harbor structure to exchange transactions according to the Treasury Regulations.

• Hold proceeds from the sale of relinquished properties.

• Isolate the receipt of any taxable proceeds.

• Utilize the proceeds to purchase like-kind replacement properties.

• Prepare the required exchange documents and instructions.

Qualified Intermediary Professionals

If you are looking to defer your capital gains on the sale of real estate, your first step is to contact a qualified intermediary who can get you started with the process. At CPEC1031, our qualified intermediaries can help you through every stage of the 1031 process by advising you, answering your questions, and preparing your 1031 documents. Contact us today to speak with a qualified intermediary about your real estate transaction and see if you are a good candidate.

• Start Your Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2018 Copyright Jeffrey R. Peterson All Rights Reserved

Can I do a 1031 Exchange of Underwater Property?

Sometimes investors will buy a property, it'll go up in value and when the value is high they'll refinance the property and extract a lot of the equity. Oftentimes, the property will then decline in value such that the debt on the property exceeds the value of the underlying collateral property.

A Potential Tax Problem

So now if you sell that property or have an involuntary sale such as a foreclosure, you may find that you have a sale for tax purposes and that you have a gain on the disposition (because your gain is determined by the difference in the debt relief and your basis). So you may have a low basis, high debt amount particularly if you're giving the property back to the bank. You may have a tax problem because for tax purposes you've conducted a sale in which you have a gain, but in reality you have no cash proceeds because your property is under water.

1031 Exchanging Underwater Property

How do you do a 1031 when you're trying to defer a gain and you have no sales proceeds to reinvest into a replacement property?

The answer is you have to acquire a replacement property - typically the target would be highly leveraged replacement property in which you don't have to put a lot of cash down. Somehow you're going to have to scrape together enough financial resources to acquire a replacement property of equivalent or greater value and which would have enough debt associated with it that you'll be able to offset the debt relief on your old relinquished property.

You may have to scrape, scrimp, beg and borrow to acquire the down payment to get a sufficiently big enough replacement property to cover all the debt relief of the disposition of your old relinquished property. But the benefit of doing so is you keep the taxman at bay and defer those gains indefinitely into the new property.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges of underwater property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

The Benefits of Syndicated Real Estate Investments

If you're an older investor you might find that you are getting more conservative in your older years and there are many replacement property options that suit your more conservative position.

Investing by Age

In your younger days you were all about wealth accumulation. In your latter years you're more about wealth preservation and creating a steady stream of income.

To that end there are 1031 replacement property options that are all cash, debt free deals. There's no leverage or risk of having to refinance a property (or to pay off debt service). And if the economy starts to peter out you're going to be in a safe and steady investment.

Syndicated Real Estate

Syndicators such as AEI Fund Management in Saint Paul have properties that are available for people to purchase, assuming that they are accredited investors, that will be steady bastions of stability. In your latter years it's more about putting your wealth on a steady plain so that you can eventually pass the property to your heirs with a stepped-up basis. Meanwhile you want to create a steady stream of income. So debt free, all cash syndicated real estate Investments fill this unique niche in the market.

• Start Your 1031 Exchange: If you have questions about debt-free real estate investments, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved