We often work with Exchangors that wish to downsize in today’s market and there is much confusion on what value requirements must be met in a 1031 Exchange.
When discussing exchange basics we always discuss the “napkin test” as one of our cornerstones. The Napkin Test was conceived literally on a napkin at a seminar by California tax attorney Marvin Starr of Miller, Starr and Regalia. It’s a simple exercise to determine the potential for exposing taxable assets or “boot” in an exchange. The Napkin Test compares the values of the relinquished and replacement properties.
An often mistaken belief is that exchange values must be thoroughly met for an exchange to be effective. Today, more than ever it is most important to meet your investment needs, whether total tax deferral is achieved is just not important. Consider an investor’s desire to downsize to a smaller property with less or no debt, a partial exchange can be the perfect solution.
Another mistaken belief is that an Exchangor must “replace the debt” in an exchange for total tax deferral, this again is simply not true. An Exchangor can offset mortgage “boot” with additional cash, in other words debt can be reduced on the acquisition property if it is replaced by additional cash. Many of our Exchangors find themselves in a situation where the new loan requires a lower loan to value than was on the relinquished property, adding cash to reduce the LTV is a easy solution if the cash is available.
Learn more about the “napkin test” download our free pdf here: The Napkin Test PDF
