A $3M Apartment Sale With a $1.2M Loan: Full Exchange Math

Start with three numbers from the settlement statement: amount realized, net cash and debt paid off

Hypothetical: you sell an apartment building for $3,000,000, pay $150,000 in commissions and closing costs, and pay off a $1,200,000 mortgage. The amount realized is $2,850,000, and $1,650,000 goes to the qualified intermediary. You bought the property in 2012 for $1,600,000 and have taken $500,000 of depreciation, so adjusted basis is $1,100,000 and the gain is $1,750,000.

The loan payoff is part of the amount realized even though you never see the money. The Form 8824 instructions count liabilities assumed by the buyer, net of liabilities you take on and cash you pay, as boot, and reduce that figure by exchange expenses.

Selling outright, a couple filing jointly with $450,000 of other taxable income would owe $125,000 on the $500,000 depreciation layer at 25%, $250,000 at 20% on the remaining $1,250,000, $66,500 of net investment income tax and, at a hypothetical 5% state rate, $87,500 more. That is $529,000, leaving $1,121,000 of the $1,650,000.

Full deferral means hitting the value, cash and debt targets together

Section 1031(b) taxes any money or other property you receive, and Reg. section 1.1031(d)-2 treats the $1,200,000 of debt relief as money received unless it is offset. Its examples show that consideration you give in cash or new liabilities offsets debt relief, while new liabilities never offset cash you receive.

That produces three targets for this sale. Buy at least $2,850,000 of replacement property. Reinvest all $1,650,000. Take on at least $1,200,000 of new debt, or bring outside cash for any part of it you do not borrow. You can borrow more than $1,200,000; you cannot borrow less without adding cash.

Under Reg. section 1.1031(k)-1(c)(4) you may identify three properties of any value, or any number whose total value does not exceed 200% of what you sold, here $6,000,000. How many properties you can identify covers the third, 95%, rule.

Three replacement structures compared, with the tax each one leaves

Structure A, one larger building: buy a $3,000,000 apartment property with the $1,650,000 and a $1,350,000 loan. All three targets are met and nothing is taxed. Under section 1031(d) the basis is $1,100,000 plus the $150,000 of excess financing, $1,250,000, which is the $3,000,000 price less the $1,750,000 deferred gain.

Structure B, a smaller building bought for cash: buy a $1,650,000 property with no loan. The value and debt targets are missed by $1,200,000, so $1,200,000 of gain is recognized. The first $500,000 is taxed at 25%, the next $700,000 at 20%, with net investment income tax and the hypothetical state tax: about $370,600, which has to come from savings because the cash is in the property. Adding $1,200,000 of your own money to buy a $2,850,000 building cures it, because cash paid offsets debt relief, as replace the mortgage or add cash explains.

Structure C, DST interests: put $800,000 into a debt-free DST and $850,000 into a DST with a hypothetical 60% loan-to-value. The second interest carries $1,275,000 of allocated debt on $2,125,000 of property. Together you hold $2,925,000 of property and $1,275,000 of debt, so all three targets are met. Rev. Rul. 2004-86 treats a DST interest as an interest in real property, and whether a DST loan counts as replacement debt covers the debt question. Run your own numbers with your CPA.

• A, one $3,000,000 building, $1,350,000 loan: $0 tax, basis $1,250,000.
• B, one $1,650,000 building, no loan: about $370,600 tax on $1,200,000 of boot.
• B with $1,200,000 added cash, $2,850,000 building: $0 tax.
• C, two DSTs, $2,925,000 of property and $1,275,000 of debt: $0 tax.

The right structure depends on whether you want to keep managing, keep the leverage, or neither

Structure A keeps you an active landlord with a larger loan, and its depreciation restarts on the $150,000 of excess basis. It also concentrates the whole $1,650,000 in one building and one market. Exchanging an apartment building covers buyer pools and recapture specific to multifamily.

Depreciation follows the basis, not the price. In Structure A, Reg. section 1.168(i)-6 keeps the building share of the carried-over basis on the old building's remaining 27.5-year schedule and starts a new schedule only for the excess basis created by the larger loan. In Structure C, each trust reports your share of its property so that your CPA can apply the same split; depreciating the replacement shows the arithmetic. A buyer paying cash for a $3,000,000 building would depreciate far more, which is part of the deferred tax's price.

Structure B suits an owner who wants to be debt-free and has the outside cash to fill the gap. Without that cash, it is the most expensive outcome on this page.

Structure C suits an owner who wants out of management but needs replacement debt to defer the tax. A DST's loan is placed by the sponsor, so you take on no personal loan application, but the trust cannot refinance or raise new capital, and its interests are illiquid. Many owners also split the money between a direct building and a DST, which splitting an exchange between a DST and direct property walks through.