Possible sale of SFH Rental Portfolio options 1031-DST-721 Pay the Tax

[Bob B.]

Hi,

I have read a lot of the posts and I will throw out my scenario and share with you were I am getting into analysis paralysis and see if someone provides some thoughts, ideas, feedback that might help me break the cycle.

I'm about to turn 54. I have about a $10M SFH rental portfolio. It is roughly a 6 cap with me adding in property management expense (I manage it for the most part with the help of some 1099 contracted part timers). To come up with the 6 cap, I did kind of figure out how much each roof, HVAC system, water heaters, etc was costing me per year to add that to my expenses to try to really figure out what my return is. Would I take a 5% return a year to not to have to deal with any headaches, absolutely. Working so hard to get to here, I also don't want to just make a snap decision that may cost me quite a bit of money by being uninformed or rash. But, I am getting tired of the rental hamster wheel after 9 years. I want to actually be able to enjoy myself and not have to worry about a broken toilet.

So a bit more about what I am arguing back and forth in my head.

1) I could 1031 out and go with any number of NNN options like Wawa, Taco Bell, etc, but I do worry that more than likely one of them would go dark and all of the sudden it is worth 25% of what I purchased it for. So that I feel a bit uncomfortable and since I more than likely will be in my early 70s when they start to renew, I am not sure I will want to figure out when to sell, what new to buy, etc at that age.

2) I could go with something like a Home Depot or Lowes ground lease which seems pretty stable to me, but that will be putting all my eggs into one basket.  I do feel more comfortable with them than the above scenario, as I feel if they did vacate, it would be easy to turn into self storage and the dirt would be worth a lot more than a vacant Taco Bell.

3) I could just pay the 20% capital gains and then invest in whatever I want, but I am not sure that will be getting me to a more passive investment stage as then I may be stressing about what the financial advisor is doing with this stock or complex fund which invest in different stock that throw dividends with put and call options....blah, blah, blah.  What I am getting at, my experience over the past 20 years is most of the financial advisors are doing well regardless if I make money or not due to their fees, commissions and such.  I just have not seen great returns and it seems like with their picks, I just always got the wrong one.  I am not saying I lost money, but rather lackluster returns such as 4%.  So all that to say I am not sure that paying the gains will give me any better options to provide a nice return that will also provide a comfortable income stream. 

4) I could 1031 into an apartment complex. That would make it easier to manage than SFH. But still a lot of the same challenges.

5) I could 1031 into some DSTs, but that seems like I have to figure out the correct ones or rely on companies like Kay or Income Property Advisors or such who tell me there is just a small commission and the DST advantage over 721s which I will speak to next is you can pick the correct one. But they don't really want to speak about the commissions and fees involved or say the returns overcome it. They also talk about how it can do the return I want, but there is I guess minimal possibility for backend appreciation and I am looking at trying to figure out new DSTs ever 4 to 8 years? I am not sure that is super appealing.

6) So I have been reading some stuff from companies like Sera Capital and it seems like they say 721s are the way to go due to the low fees vs DSTs constantly turning over with high fees. They tout the backend appreciation that is "expected" in conjunction with the distribution payments. The backend is nice, but if I can't ever get to it without paying capital gains, I am not sure how it helps. As it seems when I read other articles when you do end up selling the REIT shares, you will be selling at a discount. So in effect, does that add to the soft cost almost like a exit tax?

Here is something they wrote too about the loads and costs, but I am not sure if the math is really accurate or not.  If it is, maybe the 721 is not too bad.

https://seracapital.com/721-exchange/why-fees-matter-when-pu...

So I don't want to make a mistake.  This has been the last 9 years of work in the real estate rental world and 20 years prior working and saving to get the money to start my real estate portfolio.  

So I don't know if you have some suggestions of advisors you feel shoot straight (maybe you will say some of the ones above), recommendations, suggestions, or what have you will be greatly appreciated.

Thanks,

Bob

[Jack Martin]

@Bob B. first of all, I would echo the response by @Dave Foster on the 721 issue. IMO, he's one of the sharpest knives in these threads. 

An alternative strategy is to consider is a passive investment with bonus depreciation. This is often referred to as "the lazy 1031" and combines cost segregation with bonus depreciation. This allows investors to take a significant passive loss and one of the most attractive attributes is time. While a 1031 exchange has short time restrictions, the bonus depreciation strategy allows you the entire calendar year to execute.

Those passive losses can be used to offset the gains you have incurred (or gains you expect to incur) as long as your gain AND the investment where bonus depreciation is being taken occur in the same calendar year. Any allocation of passive losses you cannot use in that calendar year will carry over, so they can be used in subsequent years.

Keep in mind, some property types will garner more bonus depreciation than others. Bonus depreciation is derived from the portion of the property's value with a shorter useful life than the buildings themselves. Therefore the property types that are the most favorable to generate bonus depreciation will not be buildings, rather properties with a high degree of what the tax code refers to as "land improvements". Examples are mobile home parks, RV parks, and golf courses where the value of the property is not primarily derived from building(s) but rather from the improvements to the land. In a mobile home park or RV park, most of the value is in the underground infrastructure, roads, landscaping, amenities, pools, fencing, pads, utility pedestals, etc, while only a small portion of the value comes from a building, like a clubhouse or laundry facility. In a similar fashion, if you can imagine how much landscaping and underground infrastructure is in a golf course as compared to the clubhouse, that will give an indication of why an extremely high percentage of the property's value is allocated to the land improvements. Properly executed, an investment in these types of property can garner significant passive losses, and sometimes can equal the amount of capital invested, even in years where the 100% has started to sunset.

Disclaimer: I am not a tax advisor or CPA. This perspective is solely from years of experience managing mobile home park funds and working with the tax experts around us. As we acquire parks, we perform a cost segregation study and elect bonus depreciation for the property. We also make capital improvements to the parks on an ongoing basis and elect bonus depreciation on those items as well.

The bonus election allows investors significant passive losses on their K1s, which they can use against "like-kind" gains from other activities in their life. Common examples are gains from the sale of other investment real estate, income from other passive real estate investments, or investment income from other passive investments that qualify.

Also, you can "drip" into these kind of investments, so if you choose to spread your allocation around, or sell off your portfolio in chunks, that can work out well. 

Feel free to DM me if you'd like to discuss further. 

All the best,

Jack