What is LTV?
In real estate, a loan-to-value (LTV) is the ratio of a loan amount to an asset’s value. In a 1031 exchange, your desired LTV will vary based on your specific debt and property value requirements.
How is LTV Calculated?
Calculating LTV is straightforward. The LTV formula is your loan amount divided by the property value. For example, if you have a $150,000 loan and your property is valued at $200,000, you would divide $150,000 by $200,000, which equals an LTV of 75%.
A mathematical expression of the formula would express LTV as the loan amount divided by the property value.
What is a Boot in a 1031 Exchange?
Mortgage boot or debt reduction boot may occur when the replacement property’s owed debt is less than the debt owed on your relinquished property. Reducing your debt liability is considered income because it is cash that you once owed that will now remain in your pocket at the time the debt matures. Income, as you know, is taxable.
For instance, if your replacement property’s mortgage is $100,000 and your relinquished property’s mortgage is $120,000, then you will have $20,000 in debt reduction boot. This occurs even if you use all of your sales proceeds to buy the replacement property.
Though boot does not cancel your 1031 exchange, it may result in a large tax liability. Since you are likely conducting a 1031 exchange to defer payment of your capital gains tax, boot will counteract this benefit, as you will need to pay capital gains tax on the boot.
Avoiding Boot in a 1031 Exchange
You can avoid mortgage boot by following the debt reduction principle, a safeguard to help you determine whether you’ve completed a qualifying exchange. This principle states that an investor must take out a new mortgage equal to or greater than what is owed on the relinquished property or replace the debt with a cash contribution.
For example, if you paid off a $100,000 mortgage on your replacement property, you must do one of the following:
- Obtain a new mortgage for at least $100,000
- Contribute at least $100,000 in cash
- Apply some combination of financing that amounts to $100,000
Learn more about boot and how to avoid it
Delaware Statutory Trusts (DSTS) and Debt Replacement
When you acquire a replacement property owned by a DST, you purchase beneficial interests in the DST. You pay the DST sponsor a certain amount, and the sponsor assigns you a certain amount of interest in the trust.
DSTs are structured to maintain various LTVs to help investors meet like-kind requirements. Since a portion of a DST property is financed, you’re acquiring an interest in the property and the loan. LTVs for DSTs typically average between 45% and 65%.
You do not have to qualify or take responsibility for the loan when you acquire debt as a DST beneficiary. However, you can use the loan to meet the 1031 exchange debt reduction principle.
How 1031 Crowdfunding Can Help
A 1031 exchange can be a complex process. At 1031 Crowdfunding, we’re 1031 exchange experts. We can help you with the logistics of a 1031 exchange, making the process easier and more efficient. Our innovative marketplace includes fully vetted properties eligible for a 1031 exchange. You can find real estate opportunities that align with your financial goals, including DSTs and other properties with low LTV ratios.
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