When you sell a home that had the debt reduced due to a loan forgiveness program such as the Mortgage Forgiveness Debt Relief Act of 2007, you may have a lower basis in your property (than what you paid for it). In this situation, there are some additional precautions that you have to take in order to ensure the success of your 1031 exchange.
IRS Regulations
IRC Section 121 gives a $250K exclusion of income ($500K for married couples filing jointly) on the sale of a principal residence. This may cover all of your gains, but you need to check with your own CPA or tax accountant to be sure.
IRC Section 108 {Part H} is an exclusion of income from “discharge of indebtedness”. The debt forgiveness could have triggered an offsetting reduction in you basis. Gain is determined by subtracting your current basis from your net-sale price (after subtracting selling expenses like commissions and title/closing fees and recording charges). The amount of debt relief that is excluded generally reduces the owner’s cost basis in the property.
Work with Your CPA
As always, you need to work with your own CPA or tax accountant to see what your current basis is (after any subtraction for the debt relief) to see if you GAIN or profit for tax purposes is more than the exclusion amount under 121.
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.
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