Discussion:Assumption of Mortgage in 1031 Exchange-RILEY2?
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Discussion Forum Index --> Tax Questions --> Assumption of Mortgage in 1031 Exchange-RILEY2?
| 19 October 2007 | |
| In getting my hands around 1031's (I have taken CPE, but never done a real one), I have talked with several CPA's who use the respective mortgage balances on the relinquished and replacement properties in the calculation of cash boot, and gain recognized.
They do this even though the mortgages were not really "assumed" by the other party (properties wer bought and sold to separate parties through QI). However, in a March 2007 post in a discussion: Discussion:Cash_Out_before_or_after_1031_Exchange, Riley 2 says "The fact that the relinquished property had encumbrances or was encumbrance-free will not change the fact that the TP received a total of $200,000 in boot from the other party to the exchange. My answer would change if the exchange involves loan assumptions (rare because of due-on-sale clauses)." So that seems like a major differnce in treatment, and we could be talking about huge tax liabilities in the difference. Can anyone shed light? Am I interpreting Riley 2 correctly that a Mortgage assumption has to be a literal assumption between two parties? Does anyone disagree? Thanks for your input. | |
| 19 October 2007 | |
| Small discussion at Discussion:1031_exchange_and_boot. Start with the posts dated August 15, 2007. | |
| 19 October 2007 | |
| This is not really an area of controversy. The definition of a loan assumption is a 1031 exchange is defined in Sec. 1031(d) and Sec. 357(d). Basically, if the buyer of the property is expected to satisfy a recourse debt (whether or not the seller is relieved of the debt) or if the property is taken subject to a nonrecourse debt, then it is a loan assumption. Because of due on sale clauses, this is rarely the case. Instead, the seller (or the escrow agent) is responsible for paying of the existing indebtedness at the time of the property transfer, and the buyer will find his own financing. | |
| 20 October 2007 | |
| For purposes of calculating boot in the form of "debt relief" during a 1031 exchange, I would contend that all loans secured against the property are treated the same. That is, the calculation is the same whether the transaction involves loan assumptions or the taking out of new loans. | |
| 20 October 2007 | |
| PVVCPA, if it were not for Reg. § 1.1031(d)-2, your contention would be correct. For example, if the taxpayer assumes a liability of $1,000,000 in a 1031 exchange and has $1,000,000 of his own debt paid off in escrow, there would be no netting allowed and the taxpayer would be forced to recognize $1,000,000 in boot received. In contrast, if there was a mutual assumption of debt, the two amounts would be netted against one another, and there would be no boot. See Reg. § 1.1031(d)-2. | |
| 21 October 2007 | |
| I disagree, Riley2. I, too, am basing my argument on Reg. § 1.1031(d)-2. This Reg speaks of assumed loans and non-assumed loans as if they are the same. The only thing that appears important is whether liability is secured against the property in the exchange.
There are various examples in the Reg. I do not believe that any of those examples affirm the example that you provide, above. | |
| 22 October 2007 | |
| This is where a thumbs up or thumbs down section would come in handy. Riley2 says this is not an area of controversy, but another well-respected contributor(PVVCPA) completely disagrees with him, as do some CPA's in my area who do a lot of these.
Does anyone else have an opinion? This would seem like a prime area for a suit against the CPA who calculates it the wrong way. And the incorrect taxes paid or not paid could be huge. Or am I being too paranoid? | |
| 23 October 2007 | |
| The regulation in question differentiates between assumption of a mortgage or taking property “subject to” an existing liability and encumbering the property with new debt.
Quoting directly from the regulation, “Although consideration received in the form of cash or other property is not offset by consideration given in the form of an assumption of liabilities or a receipt of property subject to a liability, consideration given in the form of cash or other property is offset against consideration received in the form of an assumption of liabilities or a transfer of property subject to a liability”.) Thus, it would not be possible to reduce the recognized gain from cash boot received by assuming a mortgage from the other party to the exchange, but it would be possible to reduce the gain recognition from mortgage boot due to a mortgage assumption on the relinquished property by paying cash to the other party to the exchange (even borrowed money). As a result of recent changes to Sec. 1031, it is now easier to distinguish between a mortgage payoff and a mortgage assumption. See Sec. 1031(d) and 357(d). Don’t take my word for anything. The courts have addressed this issue many times. For example, see COLEMAN v. COMMISSIONER, 39 AFTR 121 (180 F.2d 758), 50-1 USTC 9254. Also, see BARKER v. COMMISSIONER, 74 TC 555. | |
| 25 October 2007 | |
| Riley2, Your last post states something different than your prior post did.
I agree with your last post, that debt boot can be offset by taking on new debt (assumed or not) or by putting in new cash. I disagree with your prior post, that debt boot (in the form of a due-on-sale payoff) cannot be offset by assuming the loan on the replacement property. Note the sentence that you quoted "consideration received in the form of an assumption of liabilities OR a transfer of property subject to a liability". For the purposes of this Reg an "Assumption of Liability" = "Transfer of Property Subject to a Liability". | |
| 27 October 2007 | |
| Reg. § 1.1031(b)-1(c) allows a taxpayer to net debt boot received with debt boot given (or cash boot given).
Riley2, I think you are suggesting that the payoff of a due-on-sale indebtedness is not considered debt boot. If this were true, then this payoff would be cash boot and no netting would be allowed. A taxpayer would not be able to offset this boot by purchasing a replacement property and taking on new debt (or adding new cash). Instead, they would be required to recognize gain to the extent of the mortgage payoff. Perhaps, in the case of a simultaneous exchange a loan assumption between the buyer and seller must occur. But in the more common case of a deferred exchange through a QI, the act of assigning a property with a due-on-sale encumbrance to/from a QI is sufficient to qualify as a "transfer of property subject to a liability". | |
