Home Foreclosures and 1031 Exchanges

foreclosures and 1031 exchanges

If you're about to be foreclosed on a property and you’re going to lose it involuntarily, one opportunity that you may not have even thought of is to do a 1031 exchange (or debt exchange).

Gain on the Sale

Your gain on the sale is computed by the difference between your adjusted basis in the property and the amount of debt relief that you're going to experience when you give back that property to the lender; NOT the amount of cash that you may or may not receive.

So if your basis is far below the debt, you may have MOB “mortgage over basis,” and that will result in taxable gain to you if you just give back the property to the lender. So even though you don't have any net sales proceeds of cash coming to you, you may still want to structure it as a 1031 exchange so you can defer the gain on the difference between your basis and a debt relief.

How do you do that? You get your qualified intermediary to prepare all the documents that would normally be executed in a 1031 exchange. You give notice to the lender (the buyer), and then you go forward and acquire a new replacement property within the deadlines.  

Buying a Property with no Funds

The next question is how do you buy a replacement property when you have little or no funds in your 1031 account? It may be necessary for you to come up with some cash so that you have a down payment to make on the replacement property.

And furthermore you may be limited in what replacement properties you can buy because you're going to need to offset a lot of debt relief. That means you're going to have to acquire a more highly leveraged replacement property to offset all of the debt that you’re freed of when you give back the old relinquish property to the bank.

Fortunately, there are some syndicated replacement property options designed to fit the needs of a debt exchange. These products typically have higher leverage that hyper-amortize to accelerate the pay down of the loan and build-back equity (and stability) more quickly.

  • 1031 Hotline: If you have questions about 1031 exchanges and foreclosures, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

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