Rental-property owners often conduct an exchange under IRC Sec. 1031 for one reason: to defer recognition of capital gains.

In order to avoid a taxable event, a client must acquire at least as much real estate as she sold. This includes replacing all of the relinquished property’s prior debt with new debt or additional equity.

However, clients often find a great replacement property that has a lower value than the property they just sold.  As an example, suppose client Betty is doing a 1031 exchange, and her relinquished property sold for $1 million net of costs, with a $250,000 gain (let’s suppose there is no outstanding loan). If she finds a desirable replacement for $750,000 and keeps the other $250,000 after the exchange, the entire $250,000 will be taxable, just as if she had never done an exchange in the first place.

Should Betty give up on her chosen property? After all, she may not find anything desirable as a second property to own and manage for only $250,000.

Not necessarily—there are several other options for Betty, including 1031-qualified investment programs designed to accept the “leftovers” or “stub” amounts in an exchange.  If you are advising clients in a 1031 transaction, do not let them put highly-taxable dollars into their pockets without discussing all the possibilities with someone like us.

Investors should understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment. Neither 1031 Capital Solutions or its representatives, nor DFPG Investments, LLC provide tax or legal advice, as such advice can only be provided by a qualified tax or legal professional, who all investors should consult prior to making any investment decision.