BOOT Or No Boot?
Relinquished property (RLQ) sells for $500,000 and has a $100,000 loan encumbrance. Replacement property (RPL) is purchased for $500,000 and buyer adds $100,000 of his own cash into the transaction. There is no loan on RPL (buyer actually adds more than $100K so that deal is all cash), and the loan on RLQ is paid off in escrow.
Is there boot, due to “debt relief”? Netting Rule #2 seems to indicate a NO answer. Other publications I read say YES.
The ones that say YES usually have the above scenario described a little different:
Buyer secured new mortgage for RPL and adds $50,000 cash to reduce the payments, thereby having a $50,000 mortgage. This constitutes debt relief, and mortgage boot of $50,000 ???
Confused. Can anyone explain?
You don't give enough information here.
Is the exchange a simultaneous exchange, or a deferred exchange?
Is the "buyer" in your example the exchanger, or, a third party?
It sounds to me that you are trying to fit a deferred exchange into the simultaneous exchange rules. If the scenario you describe is really a deferred (three-party) exchange, then there is no boot received as you have outlined the structure. Netting rules do not apply in a deferred exchange -- only the value of the relinquished and replacement properties.
Thanks DaveT. This is a deferred three party exchange.
Really, neeting rules don not apply to deferred exchanges? Who even does a simultaneous, these days? Everything I've read so far and people I've talked with, including accommodators, are all referring to deferred exchanges when they talk about netting rules. In fact, this very example (different values) is from a widely read book on selling real estate without paying taxes.
I answer YES. My 1031 third party company answered YES. Your new property must have the same debt or more.
For example. you could not sell your first property and take back a second either - that would be boot.
I agree with you re: netting rules and defferred.
_________________
Gregg Fous
Investor/Developer
"Under-promise and over-deliver"[ Edited by GFous on Date 03/13/2004 ]
OK, OK, I was a little too cavalier in my earlier response when I said that netting rules do not apply. Maybe I should have said they are irrelevant as long as the purchase price of the replacement property is greater than or equal to the sale price of the relinquished property.
I still maintain the position that in the instance of a three-party deferred exchange, the exchanger is normally giving clear title to his buyer for the relinquished property. In order to do this, some of the proceeds from the sale must be used to payoff the mortgage loan bringing the mortgage debt to zero. Therefore, there is no debt to gain relief from and the mortgage netting rules do not apply.
For those that insist the netting rules do apply, let's explore what happens. If you look at the mortgage netting rules you also have to look at the cash netting rules. Let's consider how the netting rules would be applied to a deferred exchange when there is no constructive receipt and only like-kind property is involved.
Assume you have a $100K property with a $50K mortgage, that you will replace with a $100K property for which you will pay all cash using $50K (net proceeds) from the sale of your relinquished property, and another $50K cash out of pocket. The mortgage netting rule says that you have gained $50K in net debt relief, but, the cash boot netting rules say that you have given $50K in cash boot. The cash boot given cancels the mortgage boot received -- therefore, no taxable boot.
As long as the value of the replacement property is greater than or equal to the sale price of the relinquished property, the netting rules are irrelevant because you do not incur any taxable liability from the completed deferred exchange.
Whether you use the netting rules or accept that the mortgage netting rule does not apply, the whole issue is moot because in either case there is no taxable boot received.
[ Edited by DaveT on Date 03/13/2004 ]
Thank you GFous and DaveT,
In my scenario above, and as agreed by GFous, some believe that mortgage boot DOES apply if your debt is less on your RPL property than your RLG property. This is without regard to WHY, and some say the IRS views such a situation as that the investor must have made a gain somewhere to be able to buy an equal/greater priced property AND throw in cash. Ergo, debt relief and taxes.
Now, I don’t support this, mind you, because cash can come from many places. But I do want to know the correct answer, and there seems to be some variance in opinion. There are people out there making a point of paying off (or down) debt on their RLQ properties before entering a deferred exchange just to deal with this. Maybe they don’t have to??
You can do a couple of things.
1. Run a sample tax return using your tax preparation software to see what happens.
2. Pay a licensed tax professional a consulting fee to get an answer to this question.