If you’re interested in investing in real estate, you may be aware of a 1031 Exchange. While a 1031 Exchange can save you a significant amount of money by deferring capital gains taxes, there may be times when you need additional cash from an investment property or are unable to avoid a mortgage or cash boot. In these situations, it’s important to know how much your asset has appreciated with a 1031 Exchange calculator and whether you should consider a partial 1031 exchange. Learn more about partial 1031 Exchanges and how they can help you save money and get more from your investment with our helpful guide.
Full 1031 Exchange vs. Partial 1031 Exchange
In a full 1031 Exchange, nearly all of the tax is deferred in the investment process. To meet the requirements for a full tax deferral in a traditional 1031 exchange, you will need to 1) acquire properties that are valued equal to or greater that need to replace your current investment property and 2) reinvest all of your net proceeds from the sale of your relinquished property.
Sometimes, capital gains taxes are unavoidable. You may not be able to purchase an investment property that is equal to or greater in value than your relinquished property, or you may simply need some extra cash from the sale of your investment property. In either of these cases, a partial 1031 can help you defer a portion of your capital gains tax.
What is a Partial 1031 Exchange?
A partial 1031 Exchange occurs when you receive a portion of property proceeds from the sale of an investment property or purchase a replacement property that is valued less than your relinquished property. These instances result in taxable capital gains from the sale of the property on profits realized from the transaction, in addition, to recapture of depreciation. Capital gains are simply any profit you’ve received after selling your property, and can come in the form of a cash “boot” or mortgage “boot.” You can determine your rate of capital gains tax using our 1031 Exchange calculator.
With a partial 1031, you can defer some of your capital gains tax while still taking out cash to be used for other purposes. Any funds you choose not to reinvest in a property are kicked back to you as taxable gains called “boot.” There are two kinds of boot to be aware of when considering a partial 1031 exchange.
- Cash Boot—This is cash that is leftover after the sale or transaction of the property. It’s when you get the cash boot that a partial 1031 comes into play.
- Mortgage Boot—This occurs when there is a reduction in debt on a replacement property that is not offset with external equity that you add to purchase a property. Essentially, if you purchase a replacement property using all of your net proceeds, but the combined value of the property including both net proceeds and the loan total less that value of the property that you sold, you might be required to pay capital gains.
Learning when and how to do a partial 1031 Exchange is a complicated process. This is why it is so important to prepare and work through the process with a Qualified Intermediary and a qualified tax advisor. If you do not complete a full 1031 Exchange, any gain you receive on a property is considered taxable as income and, if you are not prepared, it may cost you much more than anticipated.
Prepare in Advance
Unfortunately, you can’t just jump into a partial 1031 Exchange if you want fast cash. Getting the most from your partial 1031 Exchange involves thoroughly planning out your sale. If you want to receive a cash boot from the exchange, you will need to specify the exact amount you will receive at closing. Because of the time and work involved in avoiding as much capital gains tax and depreciation recapture as possible, a partial 1031 is not something you should count on for emergencies or quick cash.
When Can You Get Your Cash?
It is important to work with your Qualified Intermediary and tax advisor so you can get the correct amount of cash through your partial 1031 Exchange. There are two main ways you can receive the boot from a partial 1031 Exchange:
- Determine a specific, fixed amount at the time of relinquishment. The cash will be disbursed to you at closing.
- Specify the property you will purchase when you meet with your qualified intermediary. The cash remaining will be disbursed at closing.
As you can see, it is very important to be specific and intentional regarding any cash received from a partial 1031 Exchange. You will be taxed on any proceeds you receive, so it’s important to take out only what you need, and invest the maximum amount into another property to defer capital gains and maximize your return.
The Unavoidable Consequences of a Partial 1031 Exchange
If you are looking to get the most from your appreciating assets and investments, a full 1031 Exchange is best. However, sometimes it is impossible to avoid a partial 1031 exchange. If you cannot avoid a partial 1031 Exchange, it’s important to understand that a partial 1031 Exchange is better than no exchange because it still allows you to defer some capital gains tax, and reap some of the rewards of your investment property.
If you do end up with a partial 1031 Exchange, you will have to pay some capital gains taxes. You can find out how much you might owe by using a 1031 Exchange calculator. It’s also important to work closely with your qualified intermediary as there are often closing costs you may not have anticipated. Your qualified intermediary can help you structure your closing in a way that uses some of your cash boot to cover closing costs. A professional is necessary when navigating closing costs in this way because the process has many technical requirements that can get costly if done incorrectly.
Let FGG1031 Help
Failing to obtain proper advice from knowledgeable 1031 specialists can be a costly mistake, and you might end up paying much more in capital gains than you anticipated. The advisors of FGG1031 can assist you with several aspects of a partial 1031 Exchange including:
- Providing advice on finding suitable replacement properties.
- Helping you calculate approximately how much cash boot you may receive at closing.
- Working alongside your tax advisor to assist you in deciding whether a partial 1031 Exchange is advisable in your situation.
- Helping you determine whether it may be in your interest to pursue a full exchange and then do a cash-out refinance on the property after closing—instead of a partial 1031 Exchange. In this instance, the cash you receive is not considered capital gains but is considered an increase in debt.
While completing a partial 1031 Exchange might sound like a daunting process, the advisors at FGG1031 are standing by to assist you with your partial 1031 Exchange. With more than 16 years of experience, we know how to help clients make the most of their property investments. Contact FGG 1031 for guidance at 408 392-8822 or via email at info@FirstGuardianGroup.com as you navigate the real estate market and begin your investment journey today.
This material is not intended as tax or legal advice so please do speak with your attorney and CPA prior to considering an investment. This material contains information that has been obtained from sources believed to be reliable. However, FGG1031, First Guardian Group, LightPath Capital, Inc., and their representatives do not guarantee the accuracy and validity of the information herein. Investors should perform their own investigations before considering any investment. There are material risks associated with investing in real estate, Delaware Statutory Trust (DST) and 1031 Exchange properties. These include, but are not limited to, tenant vacancies, declining market values, potential loss of entire investment principal.
Past performance is not a guarantee of future results: potential cash flow, potential returns, and potential appreciation are not guaranteed in any way and adverse tax consequences can take effect. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All financed real estate investments have a potential for foreclosure. Delaware Statutory Trust (DST) investments are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions. Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits.
IRC Section 1031, IRC Section 1033, and IRC Section 721 are complex tax codes; therefore, you should consult your tax and legal professional for details regarding your situation. Securities offered through registered representatives of LightPath Capital, Inc. Member FINRA / SIPC. FGG1031, First Guardian Group, and LightPath Capital, Inc. are separate entities.
DST 1031 properties are only available to accredited investors (generally described as having a net worth of over one million dollars exclusive of primary residence) and accredited entities only (generally described as an entity owned entirely by accredited individuals and/or an entity with gross assets of greater than five million dollars). If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney prior to considering an investment. You may be required to verify your status as an accredited investor.