Can You Gain Access
To a 'Blank Check' Loan?

Question: I am in the process of learning how to buy a foreclosure-type property (either pre-foreclosure or at auction). I live in La Jolla, Calif., where real estate has gone crazy and bidders at auctions bid without seeing the properties. It also seems as if every investor is using money orders and cash to get preapproval to bid on the foreclosures. How can I get access to a real-estate loan that acts like a "blank check" up to a specific amount allowing me to bid on properties at auction?

-- Jeremy, La Jolla, Calif.

Jeremy: You can't get access to a real-estate loan that acts like a blank check up to a specific amount. But you can get access to credit, which would essentially enable you to be able to bid on foreclosure and auction properties. According to real-estate professionals I talked to who specialize in financing these types of purchases, your options include home-equity or personal lines of credit.

Question: Can you sell a property for $400,000 using a 1031 exchange, pay off a mortgage of $200,000 and then reinvest the other $200,000 in real estate and defer capital-gains taxes? Or will I have to pay capital gains on the unused portion?

-- Paula, Chicago

Paula: It really depends on your tax profit. In a 1031 exchange, owners defer capital-gains taxes on the sale of their property by exchanging it for a property of equal or greater value. In most cases, a third-party intermediary prepares the exchange agreement and handles the money. The property the seller wants to buy has to be identified within 45 calendar days of his sale and purchased within 180 days.

According to Louis S. Weller, a principal at Deloitte & Touche LLP's national real-estate tax-services group in San Francisco, if you don't acquire a property that requires you to obtain a new mortgage or assume an existing mortgage, then the gain on the sale will be recognized up to $200,000. If there's less than $200,000 in gain, then the exchange creates no deferral of capital-gains taxes. If there's more than $200,000 of taxable gain on the sale, you could defer a portion of it by buying another property for $200,000.

So if you pay off the mortgage on the initial sale, "you will get some deferral by taking the $200,000 in equity and buying $200,000 worth of replacement property," Mr. Weller explains. "The amount of the deferral will only be the excess of the gain over $200,000."

If you're buying property that costs more than $200,000, the difference has to be made up with money from other sources, whether it be a new mortgage on that replacement property, the assumption of an existing mortgage on the replacement property or money from some other source such as savings, in order to defer the gain.

"The rules mean that every dollar shortfall on the price of the replacement property below the $400,000 sale price of the sold property equals a dollar of gain," he says. "Also, while you can buy a $400,000 property with a $200,000 existing mortgage and give the seller your $200,000 in equity, what you can't do is find a $400,000 property that had a $300,000 mortgage on it and take that over. That would mean you're giving the seller only $100,000 cash, which creates up to $100,000 taxable gain."

-- Mr. Smith is a staff reporter for The Wall Street Journal. His "Building Value Q & A" column appears each month exclusively on RealEstateJournal. Click here to e-mail him a question about investing in real estate.

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