We got a follow up question from our reader last week regarding Section 1031 tax-deferred exchanges:
"This is a follow up question to your answer about "Defer Gains" on March 16th Who normally is an "accommodator" and can that monies held by the accommodator be rolled to pay off our existing mortgage on our home. Does it have to be applied to a new purchase of property. ?? Thank You.."
The accommodator is like an escrow agent in that they will handle the proceeds from the sale of the property and hold them until new property is identified and acquired. There has been some losses in this area with certain accommodators using the funds to invest in risky investments and you should make sure to investigate the accommodator and make sure that they use a segregated escrow account that does not co-mingle your funds with other funds.
With regards to the question on can the monies be used to pay off existing mortgages, etc. The direct answer is no. I will get get several calls a year regarding the sale of property and then rolling that sale into a new piece of property. In almost every case, the taxpayer will tell me how much cash they are receiving and they think they only have to roll over the cash. The correct answer is that they have to roll over the net sales price including all of the cash received. Here is an example:
Sales Price $500,000 less mortgage of $250,000 equals net cash of $250,000. The taxpayer has to roll over the full $500,000 including all of the cash of $250,000.
Another common misunderstanding is that if you roll over less than the sales price, then the gain will still be deferred on a pro-rata basis. For example, if you sell the property for $500,000 and your basis is $250,000, most taxpayers assume that if they do not rollover $50,000, then 50% will be non-taxable and 50% will taxable. The correct answer is that 100% will be taxable. Also, if you roll over less than 100% of your basis (in this case $250,000), all of the gain will be taxable.
To make a proper use of tax-deferred exchange requires the use of an accommodator and it should always be in conjunction with your tax advisor.