I recently tried 1031 exchange for multiplex, finally gave up. Here are the details I know.
Before closing sale escrow, you need to have 1031 approved Title company another escrow to hold the proceeds. IRS needs specific procedures/documents that this title company will do. I tried to open with FirstAm title company, finally dropped it one day before closing.
You need to be in contract within 45 days of closing the sale escrow, but can actually close with 180 days (which is meaningless in bay area).
Two important facts.
The purchase price must be at least $1 above your departing sale
The mortgage of new property must be at least $1 above the departing sale property.
There may be additional clauses/rules which I have not gone through in details as pulled out of 1031 exchange.
Paying tax next year, but paid off one of my mortgages, as promised sfdragonboy, to come out debt. Hoping to enjoy the super positive cash flow ! Moved funds to stock accounts rather than bay area real estate.
Another useful fact. You can actually be in contract on your upleg before your downleg is closed. You just need to ensure that your upleg closes after your downleg. So i have been hunting for properties for quite a while once i knew the sell side was solid.
Jil: sure about (2)? that was news to me. I checked with my agent he thought that wasnât the case but is checking with the exchange he regularly uses. I am also checking with my exchange. Because if (2) is true, it will prevent buyers in a 1031 from doing all cash offers
Appreciate it, @Jil and @BA_lurker . I am doing everything humanly possible to make sure I do not pay the capital gains tax after all. I worked too hard to give it all back to Uncle Sam. That means, identifying a property that is not openly marketed and which more than likely I will have to pay a premium on, which is fine (just get it done!). Option is looking at reverse 1031 route too since I donât need the proceeds from sale in order to buy the new property. The conventional way (sell, then buy) I suspect would pass IRS scrutiny probably easier, but I am not seeing/hearing that a reverse couldnât fly either if done to the letter of the law.
Whatever stated is from my memory, but Best is to go through IRS rules.
If you receive cash, itâs taxed.
You may have cash left over after the intermediary acquires the replacement property. If so, the intermediary will pay it to you at the end of the 180 days. That cashâknown as âbootââwill be taxed as partial sales proceeds from the sale of your property, generally as a capital gain.
2.You must consider mortgages and other debt.
One of the main ways people get into trouble with these transactions is failing to consider loans. You must consider mortgage loans or other debt on the property you relinquish, and any debt on the replacement property. If you donât receive cash back but your liability goes down, that too will be treated as income to you just like cash. Suppose you had a mortgage of $1 million on the old property, but your mortgage on the new property you receive in exchange is only $900,000. You have $100,000 of gain that is also classified as âboot,â and it will be taxed.
Bay Area is tough, esp on bullish run. Either you have to pay premium on property (1031 exchange) or pay tax (IRS).
45 days are very low to get a competitive cash flow home. All investment Multiplexes are going to wealthy, high cash down payers.
As he said, I offered many properties during the escrow period and but sellers eventually prefer to sign up with non-contingent offers even though we were in escrow as they had many full cash or high cash payers out in the bullish market.
Probably, and understandable under the circumstances right? No one in his/her right mind would want to fork over the full capital gains tax due to some mishap with finding a suitable property in time. If that means paying an owner a bit more so that he/she can coordinate/wait with me, I am fine with it.
Ditto. Same reason why I willing to overpay up to a substantial portion of my tax savings. but there are so many people richer then me in the bay area who are even crazier.
Are you also looking at subject properties on your own without an agent, so that perhaps you do find a greedy listing agent willing to double dip? Hey, whatever it takes, right?
No worriesâŚI am one to make sure a deal is airtight or it simply wonât even start. In addition to my IRS buddy, I am prepared to hire a Sec 1031 exchange lawyer/tax advisor if it comes to it for overkill. I am smart enough to know the classic rule: surround yourself with folks smarter than yourself.
Lawyer & Tax adviser are overkill or not so much useful in the process as you can read clearly from IRS site and other places googling easily !
The issue is too tight 45 days timeline.
Bay Area is wild with many wealthy investors.
Lenders and timing
Here are the details I want to share, before I forget the 1031 exchange !
1031 is for rentals not primary. The moment you elect 1031 exchange, lenders quote is 0.75% higher than primary as any time current rate.
You need to hold 2 years before turning back to primary (If you like to do !). Mortgage must be greater than existing mortgage. In my case, I had 3.25% ARM (old rental), new rate was 5.375% (fixed) or 5% ARM. Even if I go ARM, I do not see any savings with growing interest rate environment. Even though too difficult to account what exact rate in future, but I am confident that lender is going to eat away my profit. Based on my assumption, if I hold the new property 5 to 7 years as rental (After 2 years primary), I may effectively pay interest which may equal to my tax savings !
Essentially, lender is eating away our money here.
I found it is not economical to buy a SFH home as rental, rent it two years before making as primary !
I happened compete a big like that above, there was another 1031 exchange bidder with 110k above my price ! Note that my quote itself 115k over the list price, while the topper is 225k above list price !
Seller (using competitor bid) eating away the amount here.
In such case, we are forced to go for good cash flow property, say multiplex. With current environment, multiplexes are flooded with cash rich investors and seller is easily able to decide on cash rich buyers over 1031 exchange unless we also match similar cash rich.
Bidding against Bay area cash rich people is tough.
The best thing is to have a good strategy. Before invoking sell, pay down the mortgage to the lowest so that you become cash rich person !
It needs planning and strategy so that you effectively make use of 1031 exchange. I did not know this trick until I faced the issue, end up repeated failures and finally gave up.
Yeah, I know pinch next year when I pay the tax !!
just to close on my findings. There seems to be no mortgage requirement (per the 2 accommodators I checked with) and at least on my non-expert reading of the IRS rules.
This is the correct rule (I may have understood wrongly). This may not have mortgage requirement, but you should not get the money from escrow and all money has to go to new purchase.
Here are the details you need to deep-dive further. Check it clearly.
If you receive cash from 1031 Escrow back to you , itâs taxed. You may have cash left over after the intermediary acquires the replacement property. If so, the intermediary will pay it to you at the end of the 180 days. That cashâknown as âbootââwill be taxed as partial sales proceeds from the sale of your property, generally as a capital gain.
2.You must consider mortgages and other debt. One of the main ways people get into trouble with these transactions is failing to consider loans. You must consider mortgage loans or other debt on the property you relinquish, and any debt on the replacement property. If you donât receive cash back but your liability goes down, that too will be treated as income to you just like cash. Suppose you had a mortgage of $1 million on the old property, but your mortgage on the new property you receive in exchange is only $900,000. You have $100,000 of gain that is also classified as âboot,â and it will be taxed.
