I sold a property for $200k that I purchased for $50k. I rolled $100k of it into a 1031 exchange. Can I use my $50k basis to offset the $100k that I have to report as a gain?
In a 1031 exchange, the cost basis of the property you give up is rolled into the new property you receive. In a partial 1031 exchange, where the property you receive is worth less than the property you gave up, the basis still rolls over.
In your case, that means the $100,000 gain you have to report unfortunately has a basis of $0. Your new property gets the cost basis of $50,000.
Because of this, it is usually the most beneficial to find property of roughly equivalent value. You can also acquire multiple properties at once through a 1031 exchange so long as the values are similar. So if you found two properties each worth $100,000, you could have acquired both and deferred all the gains on your original property. Of course, a 1031 exchange is already a complicated process with a narrow timeline, so adding more complexity is not always a good decision.
From the perspective of minimizing present taxes paid, it might be worth erring just a bit in the opposite direction: acquire a property worth slightly more than the one you gave up. You will have to pay the difference out-of-pocket, but the price difference is less than the taxes due on an alternative property and you might end up with better property.
Imagine you have the same $200,000 property as in your original question. You can acquire either a $100,000 replacement property or one worth $210,000. If you acquire the first property, you have to realize $100,000 of gains with a cost basis of $0. This is taxed at 15% (or, given the amount of gains, potentially 18.8%), putting you $15,000 out of pocket. If you acquire the second property, you defer all capital gains, but since your property is only worth $200,000, you have to pay an extra $10,000 to cover the difference. Between the two cases, you save more money in the second.
Of course, this also would cause more of your money to be tied up in investment property. That isn’t necessarily a bad thing, but depending on your overall asset picture, it could be.
1031 exchanges are complex and it helps to have someone on your side through the process. There are agents who specialize in 1031 exchanges who could be a good choice. The advice of real estate agents who know your property and those you’re thinking about acquiring could be very valuable. And definitely include your fee-only fiduciary advisor in the conversation. Their job is to know your finances better than you do and to do what you would if you had their expertise.
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