Q:

If I intentionally left $10,000 out of the reinvestment leg of my 1031 exchange, is my only downside the paying of the tax on that $10,000?

A:

First, if you were wondering whether holding out any cash would nullify the 1031 exchange, that would not be the case.  The only real issue is how much, if any, of the case held back would be taxable.

As Sherry said, the taxability of any cash taken out of the exchange isn’t a cut & dried answer.  It hinges on the numbers involved, as worked out on the 8824 worksheet, which we have posted on our website for downloading.

From a simplistic viewpoint, if there is no debt involved in the new purchase, and you end up with cash, that will generally be taxable.

If there is debt taken on the new property, any cash received on the deal is generally only taxable to the extent it exceeds the exchange expenses, which are the total closing costs from all of the exchange legs.

The tax rate on any taxable boot (cash) will be based on a number of factors.  If there was depreciation recapture on the old property, it will be taxed first at the special 25% Federal rate.  Next is the capital gain, which is taxed at ordinary tax rates if the original property was held less than 12 months or the special  long term capital gain (LTCG) rates (5% and/or 15%) if the property was owned for more than a year.  Arkansas tax will also be applicable to any taxable gain.  This is usually 5% for LTCG and 7% for other types.

I hope this helps you understand the issue.  Your own personal tax advisor should be able to more precisely calculate any potential tax for your particular situation.

Kerry