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Adding a loan to the property exchange mix
Dear Tax Talk,
I plan to sell an investment property and do a
1031 exchange in order to defer taxes. However, what would happen
if I decided to do a partial 1031 instead so I could pull out some
of the money from the sale in order to pay back a personal mortgage
loan (secured by the property)? Will I have to pay capital gains on
the loan amount?
Daphne
Dear Daphne:
In a Section 1031 exchange you don't pay taxes on the gain
of a sale of a property if you reinvest the net proceeds in a similar
or like-kind property. A lot of investors avail themselves of this
option to trade up on the value of their investments thus increasing
income. The net proceeds from the sale of the property are the amount
you realize on the sale less expenses such as commissions and repayment
of loans.
Forgetting the tax aspects of the deal, when you sell
a property all mortgages have to be satisfied so I'm not sure why
the "personal mortgage" would not be paid off when you
sell the property.
In other words, you wouldn't have to pull out some
of the money, as you wouldn't be entitled to it anyway. If, for
example, the loan was not a mortgage and you pulled the money out,
then you would have to pay tax on the capital gain.
In a like-kind exchange any cash that goes to you,
the seller, is taxable at least to the extent of the gain on the
property. However, you could borrow against the property prior to
the sale and keep the cash without tax consequence. In the end you
got the same cash, except maybe for borrowing costs, and you avoided
the tax. It's kind of a loophole.
-- Posted: Sept. 9, 2003
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