Clients sometimes inquire if they can use the balance of their 1031 funds to pay down the mortgage or debt on replacement property that they have already closed on and purchased as part of their 1031.
Can you Pay Down Debt on Already Acquired Property?
This question usually comes up when people have identified multiple Replacement Properties because they planned to buy a few Replacement Properties, and they have now expended some (but not all) of their 1031 funds on the purchase of the first Replacement Property, only to discover that the remaining Replacement Property(ies) are not suitable or cannot be closed on within the 180 day exchange period.
This prompts the following question: can you go back and pay-down the debt on the already acquired Replacement Property in order to get all of your 1031 funds used-up as part of the 1031 exchange?
Many tax commentators and attorneys think this will not work, and the extra money applied to the debt pay-down will be treated as taxable boot by the IRS. This is because the IRS takes the position that paying down debt on property that is already owned by a taxpayer is not an exchange...even if it is done within the 180 day exchange period. The idea is that the exchange on the already acquired Replacement Property is completed and done.
1031 Planning Tips
If you think that you could have this problem, there are some strategies to protect yourself, such as:
- Holding off on closing on your more certain Replacement Property purchases until you have decided if you can buy the other less certain Replacement Properties…thus keeping your options open as to how much of your 1031 funds you will apply to the first purchases until you know if the other Replacement Properties will work out.
- Doing a reverse exchange on the first Replacement Property purchases and having the title to the Replacement Property held by an E.A.T. (exchange accommodation title holder) that is owned by your Qualified Intermediary, until you have determined if the other Replacement Property will materialize.
Reverse 1031 Exchanges in Minnesota
With a reverse exchange, because the taxpayer is not the “owner” of the parked replacement property during the reverse exchange period, you maintain the option of applying all or a part of your remaining exchange funds to purchase and/or pay-down of the debt encumbering the parked replacement property BEFORE you actually receive the parked property from the E.A.T. to complete your 1031 exchange.
1031 Hotline: If you have questions about paying down debt on Minnesota property that you already own, reverse exchanges or planning for 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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