The below 1031 Exchange scenario regarding debt replacement is a frequent topic for taxpayers:
“The rules say that I must have equal or greater debt on my replacement property.”
Taxpayers are under the misconception that the IRS mandates that they should or must have equal or greater debt on their 1031 Exchange replacement property (property they are purchasing). In reality, the IRS indicates that you have to replace the VALUE of the debt that you had on the relinquished property. However, the debt does not have to be replaced with debt. Let’s look at an example.
Let’s assume that the Taxpayer sells a single family rental at the beach for $1,000,000. That property is comprised of both equity and debt. In this example, the Taxpayer has $600,000 of equity and a $400,000 loan from AnyBank.
If the Taxpayer sells her property, does a 1031 Exchange and wants to defer all of her taxes, she will have to roll all of her net equity (a little less than $600,000 after closing costs, etc.) into the replacement property AND she will have replace the VALUE of her $400,000 loan.
In replacing the VALUE of the debt, the IRS is not concerned how the Taxpayer replaces that $400,000 loan that she had from AnyBank. In fact, the Taxpayer has a number of options, including:
And any combination of the abovementioned options would be suitable. For example, the Taxpayer could go back to AnyBank and get a $100,000 loan, bring in $100,000 of fresh cash, have a Carryback Note between her and the Seller of the replacement property for $100,000, and have a Private Money loan in the amount of $100,000. When all of those are added together, the Taxpayer has successfully replaced the VALUE of the $400,000 debt that she had on the relinquished property that she sold.
Issues such as “replacing debt” can be confusing. At IPX1031®, we pride ourselves on being the industry leader in expertise, service and security. We aim to be your complete information resource and look forward to helping you and/or your clients maximize qualifying investments through a 1031 Exchange strategy. For more information about debt replacement, our company, our complimentary 1031 Exchange webinars, or to initiate an exchange, visit our website at www.ipx1031.com or email or call today.