When selling investment real estate in Colorado, investors typically experience a sizable capital gain due to the strength of the current market. Furthermore, many have little to no mortgage left on their homes.
So, the question is, “Is it still possible to complete an IRC 1031 exchange if I put some cash in my pocket at closing?” Well, the answer is Yes. Section 1031 of the tax code permits what is known as a partial exchange. Depending on how much of the selling profits the investor receives, the investor must also decide whether an exchange is still advantageous because any cash booted at closure is deemed taxable.
What is a Partial 1031 Exchange?
In a partial exchange, the investor chooses to postpone paying some capital gains taxes in addition to paying taxes due to the cash proceeds received or a decrease in the debt associated with the replacement property.
Boot, or any property obtained in an exchange that is not regarded as “like-kind,” is the outcome of both of these events. (The term “cash boot” describes receiving cash. The phrase “mortgage boot” refers to a taxpayer’s lower mortgage obligations on the acquisition of replacement property as opposed to the mortgage on the property that was given up. Any personal belongings obtained in exchange for money are regarded as boots.)
When Can Cash Proceeds be Received?
You can get cash proceeds in the following ways:
- When the investor gives the closing officer explicit instructions to release a certain amount of the selling money straight from the closure of the surrendered property or
- If there are properties that have been correctly identified but not yet purchased, after all, the identified property has been purchased or after the exchange period ends (usually 180 days).
Why Conduct a Partial 1031 Exchange?
Partial 1031 exchanges can occur accidentally or on design. When you decide to use a portion of the proceeds from the sale for personal costs or other investments, or when you are unable to locate a property of equal value to replace the one you sold, you are engaging in purposeful partial swaps.
Accidental partial swaps happen when the value of the replacement property is less than the value of the one you sold, or when the debt on the new property is less than the one you gave up. Understanding how both scenarios affect investments and taxes is crucial.
Partial 1031 Exchange Benefits
We all agree that we are investing in something because there are some benefits that we can get from it, and that’s why Precision partial 1031 exchange also has some great benefits for you to learn.
Reduced Entrance Barrier
You can divide the expense among a few investors rather than having to come up with a sizable down payment all by yourself. If you have enough people, you might pay cash for the home instead of getting a mortgage.
Second Property Assured
Fractional real estate offers you the option of having a vacation house that you may visit whenever you’d like. If you own a portion of the property and are on the deed, you have the freedom to use it virtually however you choose, albeit you might have to make some concessions and terms.
Passive Earnings
You can rent out the house as a holiday rental on your own, manage it yourself, or even employ a management company if you and the other shareholders agree on the terms. This setup may allow you to recoup your initial investment as well as generate passive revenue or a side gig.
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Lower Investment Burden
You can begin investing in fractional real estate for as low as $5 or $100 thanks to websites like Arrived, Ember, Fintor, and others; however, the amount may vary based on the firm. Even though you don’t get to utilize the house as your own, you still get the financial advantages of being the owner.
On the other hand, certain platforms might have a larger upfront fee, but it would still be far less than what you would pay for a conventional real estate transaction, and you might even be able to live there.
You Don’t Work by Yourself
By sharing the management of an additional property with someone else, you can alleviate some of the stress associated with it. It’s also possible to divide up the duties. With all of this, you can purchase a house without assuming the same level of risk that you would if you were investing alone.
Drawbacks of Partial 1031 Exchange
Fractional real estate investing includes drawbacks just like any other type of investment.
Difficult to Fund
A single-family home for a couple cannot be financed in the same way as a property with numerous investors. Not many people, generally just one or two, are eligible for mortgages. Purchasing fractional real estate with cash makes it the simplest, but there may be issues in other circumstances.
Potentially Unknown Shareholders
If you’re managing the property and buying it through a fractional real estate firm, you’re most likely dealing with a number of strangers as buyers. In the future, that can cause problems if disagreements emerge regarding who is owed what and more.
There are two reasons why some investors choose REITs: their simplicity and the substantial yields.
Costs
If the property is being managed by a manager, you should be aware of the costs involved and any additional expenses that might apply. Even if you own shares and this is more of a financial transaction, you still need to be aware of the fee schedule. It is customary for an asset manager to get a 1 percent commission on the sale or other disposition of a property. Depending on the agreement, you may also be paid for the continued administration of such assets.
It’s critical that you comprehend the costs and what you will be required to pay. Investigate the costs involved in exiting the investment as well as how to do so while you’re at it.
Reduced Authority
Choosing what is best for you is one of the advantages of owning your own property. There is a loss of control when you share that property with others. The less influence you have over how a property is run, the more owners or shareholders there are.
Who Should Invest in Partial 1031 Exchange?
What makes fractional real estate ideal is:
- Those who want to start investing in real estate. Fractional real estate investing could be an excellent option if you want to start out small and don’t have a lot of experience.
- Purchasers seeking a secondary residence. You share ownership of a home when you purchase it with others. If you don’t intend to live in the house, then only take this path.
- Investors who are well-informed. Look through many fractional real estate investing websites to determine which ones offer information on the communities and areas you are considering. There may be restrictions on where you can purchase because some of these fractional real estate startups are centered in particular towns or areas. Even with a lower entry barrier, you may still research potential partners and make an informed decision before making a purchase. You may occasionally invest sporadically without a company’s assistance.
Final Thoughts
In summary, it is generally not advised to do a 1031 exchange if the boot exceeds the amount of the capital gain. The investor will probably gain from partial tax deferral if the boot is smaller than the capital gain.
