What Do You Do With the Last 80,000 Dollars?

Here is a problem almost every exchanger meets and almost no article addresses. You sell for 1.48 million dollars. The replacement property you want costs 1.4 million. There is no version of that building priced at 1.48 million, and the seller is not interested in your tax position.

The 80,000 dollar difference does not sit harmlessly in an account. It is boot, and on a long held rental it is generally taxed against depreciation recapture first, at up to 25 percent federally plus state tax. That is roughly 20,000 to 25,000 dollars of tax on money you never wanted in cash.

Why does the gap exist?

Because real property is sold in whole units at negotiated prices, while your reinvestment requirement is an exact figure derived from your sale.

The requirement is not approximate. To defer fully you generally need replacement property of equal or greater value, all net proceeds reinvested, and all debt replaced. Falling short by any amount creates taxable boot.

What are the usual options?

Buy something more expensive. Simple, but it may mean overpaying or choosing a property you like less.

Buy a second small property. Transaction costs and management effort for a small amount of capital, and it has to close inside 180 days.

Accept the boot. A legitimate choice, and sometimes the right one for small amounts.

Add the gap to a fractional interest. Interests such as Delaware Statutory Trusts can be subscribed in precise dollar amounts above the offering minimum, so an awkward 80,000 dollars can be placed exactly rather than taxed.

How do fractional minimums work?

Most offerings set a minimum investment, commonly starting near 25,000 dollars for 1031 exchange investors, with some higher. Above the minimum, investments can usually be made in precise amounts rather than fixed units.

That precision is the point. A trust interest can absorb 80,000 dollars, or 137,412 dollars, which no building will do.

What are the trade offs?

These interests are not a neutral parking place. They are investments with real characteristics:

• ›Illiquid. No exchange, no redemption right, and a hold often projected at five to ten years
• ›No control. The trustee makes every decision
• ›Costs. Sponsor, acquisition and offering costs commonly total 10 to 15 percent before your money reaches the property
• ›Accreditation required, because they are securities offered to accredited investors only
• ›Real risk, including loss of principal

Placing a remainder there to avoid 22,000 dollars of tax only makes sense if you would be content holding that investment for a decade.

How does the debt side interact?

If your relinquished property carried a mortgage, the calculation has two parts: value and debt. A remainder placed in an unleveraged interest replaces equity but no debt. A leveraged interest brings allocated debt with it, which can help if you are also short on the debt side.

Work out both numbers before deciding what the remainder needs to do.

What does the planning look like?

• ›Calculate the exact reinvestment and debt replacement figures as soon as the sale is under contract
• ›Identify the main replacement property and note the expected gap
• ›Identify a fractional option on the same form, sized to absorb the gap
• ›Confirm the sponsor can accept the precise amount and can close within your window
• ›Have the intermediary confirm how funds will be split at closing

Because identification is fixed at day 45, the remainder plan has to be on the form. Deciding on day 120 that you need somewhere to put 80,000 dollars is too late.

Is it always worth avoiding boot?

No. If the remainder is small, the tax may be less than the cost and inconvenience of a second investment. If you actually want some cash, taking deliberate boot and paying the tax is a reasonable plan.

The distinction that matters is between boot you chose and boot you discovered at closing.

What to do first

Ask your intermediary for the precise reinvestment target the day your sale goes under contract. Then, when you identify, decide in advance where the remainder goes. Either plan to place it or plan to pay tax on it, but decide before day 45 rather than after.

Nothing here is tax, legal or investment advice. DST interests are securities offered to accredited investors only through licensed broker dealers and definitive offering documents, and investing involves risk including loss of principal.