Is it OK to go down in value and reduce the amount of debt I have on my replacement property in a 1031 exchange?
Value, Debt & Equity
Many taxpayers conducting 1031 exchanges don't want to buy a replacement property of equivalent or greater value, they just want to reinvest their equity. The reason is they don't want to get back on the debt-treadmill and have to worry about the downside risk of investing in real estate and making those debt service payments.
But if you want to do a 1031 exchange and defer every cent of tax, the regulations require that you buy a property of equal or greater value/equity, and that you offset your debt relief by taking out either new debt on the replacement property or by investing additional cash out of your pocket. To the extent that you don't hit these general rules of thumb then you will probably recognize gain dollar-for-dollar to the extent that you buy down in value or don't reinvest your equity or don't offset your debt relief.
Delaware Statutory Trust Option
If you are concerned about taking on additional debt, but still want to defer all of your gains, then you may want to consider buying a replacement property that comes with non-recourse debt that the investor is not personally liable for such as an investment into institutional grade property in a Delaware Statutory Trust.
- 1031 Hotline: If you have questions about reducing debt in a 1031 exchange, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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