Can I Cash-Out a Portion of My 1031 Exchange Proceeds?
The “Ins-and-Outs” of Doing a Partial 1031 Exchange
By Orrin Barrow, Vice President, Kay Properties and Investments, LLC
Many investors that come to Kay Properties are looking to fully defer any capital gains from the sale of their property by utilizing a like kind exchange or a Section 1031 Exchange. In order to obtain a full tax deferment under Internal Revenue Code (IRC) Section 1031, a seller would need to buy a replacement property for equal or greater value than the property being sold.
For example, if an investor sells their property for a net sales price of $1,000,000, in order to obtain full tax deferment of any resulting gain upon sale under IRC Section 1031, the investor must buy at least $1,000,000 worth of total real estate as replacement property. However, many investors are unaware that they are not fully obligated to use 100% of their proceeds in a 1031 Exchange. For example, if an investor sells an investment property for $1,000,000, they can receive and utilize $200,000 out of their exchange proceeds to increase their liquidity. In this example, the investor will only pay capital gains and depreciation recapture taxes on that $200,000 portion of their exchange, or in other words on just 20% of the total capital gains and depreciate recapture. The $200,000 would then be deducted from the amount the investor needs to reinvest in the exchange property, therefore, leaving the investor with a purchase of $800,000 in replacement property and still allowing the investor to defer the bulk of their taxes due.
Although, the $200,000 in cash that the investor received becomes taxable, it is now available to the investor and can be used for a variety of different purposes. Many investors have a large part of their net worth captured inside of their real estate holdings. They understand the value of a 1031 Exchange but still want the option of having cash set aside for a rainy day. During the global COVID-19 pandemic, we have seen certain investors decide to complete a partial 1031 Exchange rather than a full exchange so that they could have some additional liquidity to possibly weather a more severe economic downturn.
It is prudent for real estate investors to understand the 1031 Exchange rules and the option to complete a partial exchange. engaging in a 1031 Exchange, an investor has only 45 days from the date of the recorded closing of the sold property to identify and list exchange properties, and 135 additional days (or 180 days in total from the date of a recorded closing) to purchase and close on their replacement property.
Once an investor’s 1031 Exchange proceeds are transferred to a qualified intermediary used to facilitate the 1031 Exchange transaction, known as an accommodator, they have a 45 day identification timeline to remove the proceeds that they want to liquidate from the accommodator’s account. If the funds remain in the accommodator account past the 45th day, the investor’s proceeds will then remain with the accommodator until the 180th day. This is a critical point, and investors need to be aware of when to remove their funds from their accommodator’s account in order to complete a partial 1031 Exchange and how much their estimated tax obligation will be before considering the completion of a partial exchange.
Remember, if your tax obligation from a partial 1031 Exchange exceeds the proceeds you are left with, it may be prudent to do a full exchange. It is always advised for investors to speak with their tax advisor or attorney to obtain appropriate tax and legal advice prior to deciding to complete any full or partial 1031 Exchange transaction.
About Kay Properties. Kay Properties is a national Delaware Statutory Trust (DST) investment firm. Their online platform at www.kpi1031.com provides access to the marketplace of DSTs from over 25 different sponsor companies and custom DSTs available only to Kay Properties’ clients. The Kay Properties’ team collectively has over 115 years of real estate experience, and they are licensed in all 50 states and have participated in over $15 Billion of DST 1031 Exchange investments.