Cashing Out in NJ - Sell, Hold or DST?

[John Haelig]

I am a 64-year-old landlord with 2 condos adjacent to a medical school in suburban New Jersey. For 30 years it’s been a never-ending supply of tenants who are almost never home and always pay on time.

Why would I want to get out? Well - sale prices are through the roof right now. These are wood frame Hovnanian units built in 1986 that are holding up well, but windows are starting to fog, HVAC units are coming due for a second time and the kitchens are beginning to show their age. Their sky-high value will begin to decline at some point.

End of year I am grossing $25k each unit, and netting $11k on the paid off unit after taxes, insurance, HOA fees and modest repairs. The mortgaged unit gets the full $25k and is 2 years from paid off. It will then net about the same $11k. Our living expense needs are pretty well handled by Social Security and pensions, so there is no crisis at hand.

First unit is a $410k listing with no mortgage. Purchase was $134k and it has fully depreciated after 27.5 years.

Second unit is a $350k listing with a $45k mortgage remaining. Purchase was $188k and has been depreciated for 12 years to date.

The online Capital Gains calculators show an outright sale losing over 30% to capital gains, depreciation recapture and the 3.8% Medicare tax (an extra stick in the eye). Then New Jersey comes knocking. I lost my lunch when the net take-away number appeared.

It looks to me like a 1031 exchange into a DST is the way to go. I did a 1031 for my 88-year-old father and turned some farmland into 3 other condos by the med school. The math showed that was the right choice to get the step-up in basis within the foreseeable future. However – it would be nice to get out of the property manager business – without giving up a gigantic portion of the proceeds.

We are very fortunate to be in a position to ask these questions, but we absolutely need to process a lot of information before committing to any sales.

What do you think – Take immediate advantage of huge sale prices, then get into a DST (or several)?

Keep the units until we die?  Perhaps hire a property manager to handle the phone calls and factor in the (depreciable) window, kitchen, HVAC costs?

Eat the sickening cap gains taxes and enjoy what’s left?

Many thanks -

John

[Bernard Joseph S.]

Why not 1031 into cash flowing properties out of state? We did that and with property management doing most of the work, turned out well. We looked into DSTs but did not like locking up our money for long periods. Everyone is different, and in your situation a DST may work very well. Main thing is the 1031, best decision you can make IMO.

[Sean Ross]

@John Haelig,

From what you've written, I think your first option is to look at 1031ing into a passive investment of some stripe.  DSTs are the most widely known passive 1031 replacement option, but they are far from the only one. 

The 1031 exchange (if executed correctly) will defer all of those long-term capital gains, depreciation recapture, and the NIIT taxes (3.8%) along with state taxes. 

Tax deferral isn't everything, though, and I wouldn't rush you into a 1031 if you can't find a property that you like and that makes the math work for you. 

Which brings me back to the idea of looking at multiple passive cash-flowing options.  You could also buy a traditional property and hire a property manager, but in this scenario you end up paying property manager fees (and likely higher-than-you-like financing costs to replace the debt from your condos). 

There are plenty of NNN tenant-in-common investment providers out there, along with DST sponsors, deal syndicators, etc. Some are on BiggerPockets. Some advertise very aggressively on Google, so you can just do a search. We've been in this space for 31 years and I can certainly share some resources with you.

[Natalie Bender]

@John Haelig I think you are on the right track exploring your options. My company has worked with many investors in your shoes ready to get out of active management and unlock their trapped equity. Here is a blog post from the Founder of my company that may speak to you. Would love to chat if you have any follow up questions. 

https://www.biggerpockets.com/member-blogs/7993/48729-are-your-rental-properties-weighing-you-down

[Jonathan Bock]

Do you have to sell them together or in the same year?  

This decision is too important to trust an online calculator; making a tax forecast is not rocket science on this but the gut punch because your basis is so low is understandable.    

[Brandon Bruckman]

Good questions John.  

Do the math first. I'd talk with your CPA about your tax liability first. Verify what the on-line calculators are telling you. Next I'd understand the economics of each of your options, taking the cash, DST, NNN, etc.

The final decision will go beyond the numbers.  What goals do you have?  Are you creating wealth for the next generation?  You already mentioned you have the cash flow from other sources to live. 

[Dave Foster]

@John Haelig, in addition to the deferral of tax and gaining a significant bump in cash flow, a DST purchased correctly would greatly increase your depreciable basis. And in many cases you're able to write off almost off of the income from the DST against depreciation because of the nature of the non-recourse loans and your ability to buy additional depreciable basis.

[Amit M.]

The issue imo with DSTs is that you’re buying into a market where a lot of commercial RE is presently priced high, and some is going down in value too.

You should do a thorough analysis of the tax impact. 
1- definitely try to time sales into two separate tax years

2- I’m unclear why you expect 30% cap gain hit. Keep in mind: For the 2024 tax year, individual filers won't pay any capital gains tax if their total taxable income is $47,025 or less. The rate jumps to 15 percent on capital gains, if their income is $47,026 to $518,900. Above that income level the rate climbs to 20 percent.

But ultimately it’s  personal decision, loaded with plus and minuses. 
let us know what you decide to do!

[Peter Tsambounieris]

Hey there @John Haelig. Also from NJ. I personally don't like DSTS. Fees from broker dealers are excessive in the 15-20% range. 

If I were you I'd look into NNN. With a little debt you might be able to get a better property or if you rolled in your father's properties in a bulk 1031 deal.

Feel free to PM me!

[Natalie Bender]

I am sure there are some DST Sponsors charging 15-20%, in my experience the fees are closer to an average of 7.5%-10% in total; not a single Broker Dealer fee. This 7.5% - 10% is not taken from the investment a client makes, if you investment $100K your ownership in the DST is $100K, unless the DST has debt. DST's with debt will give an investor additional ownership.

In most spaces there are bad actors and or inexperienced sponsors. It is very important, no matter the investment vehicle, to do thorough due diligence, ask for track records, know the risks, make sure there is a great deal of transparency and excellent communication with any Sponsor. 

[Taylor Black]

Have you looked into 1031 into mineral rights? Passive income for the next 25-75 years with zero holding cost, zero liability, zero insurance. Just monthly passive income