Q:

Subject: Exchange Question

Will I invalidate the 1031 exchange if I don't use all the money held in escrow to buy replacement property? 

A:

Not reinvesting the full amount of your disposal leg proceeds won't invalidate the 1031 exchange if everything else has been done properly.

However, it will, in most cases, not allow you to roll all of the gain from the original property into your replacement property.  The actual calculation for the Form 8824 worksheet is a little messy; but the quick and dirty way to look at is that the unreinvested funds will be taxable in the year that you receive them.  For example, if your disposal leg happened in 2007 and the 180 day reinvestment period expires in 2008, and you are sent the remainder of the funds in 2008, the taxable portion of the gain will be shown on your 2007 tax return as a deferred installment sale, with the actual gain subject to tax on your 2008 tax return.  If both ends of the exchange happened inside the same tax year, the unreinvested potion will be subject to tax on that year's tax return.

The tax rate that the unreinvested funds will be hit with will be the highest rate applicable to the property's disposal.  This normally works out to be the 25% Federal depreciation recapture rate, plus the comparable state rate, if you or the property are located in a taxable state.

I hope you're picking up on the fact that the actual tax calculations are very tricky and are not something you should even think about attempting on your own.  The services of an experienced professional tax  preparer will more than pay for themselves in a case like this.

Good luck.  I hope this helps.

Kerry Kerstetter

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/15/2008 03:09:00 PM Send this post: