Can I do this without taking a tax hit?

Question

I'm getting close to retirement and have 3 rental homes.  The least desirable of the three and the one that rents for the least amount is paid off.  The other two still have mortgages.  Can I sell the one that's paid off and use the money from the sale to pay off the other two mortgages without taking a tax hit?  It's not exactly a 1031 exchange because I already own the other two properties but the money is still staying in my rental properties.

Dave Foster · Answer

Sorry @Nick Scalero paying down debt would not qualify.  The 1031 exchange always has to be a sale followed by a purchase of real estate.

Depending on your goals/circumstances there's some other options to ponder.  Of course all of them have plusses and minuses.

1. Moving into that first house for a two year period would allow you to claim it as your primary residence and claim that exemption providing you will have owned it for 5 years prior to selling.  There will still be some proration of the gain that you will have to pay and you will have to recapture depreciation.

2.  Sell the entire portfolio and replace it with a lesser number of units whose value is the same or greater than that which you sold.  This doesn't reduce debt but it does reduce management and let's you position your portfolio more efficiently.

3.  Sell that house and do a 1031 exchange into a property that you use for investment for a period of time but might be something you would live in one day.  In a year or two you could decide to sell your current primary and take the gain exclusion which is tax free to pay off the other two rentals and convert the newest rental into your primary residence and move into it.

Dave Foster · Answer

Add another step to that plan @Nick Scalero and you'll have the holy grail.  After you sell your current primary and use the tax free proceeds to pay off the remaining rentals use another exchange to buy yet a different rental that may make another great primary one day.  Maybe that one is a condo or step down type of situation.

You've now got your next primary waiting for you to once again convert and then live in and then get the tax free gains.

Of course nothing is safe as long as congress is is session but I've got clients all over who are using the hold then convert to primary plan as their retirement vehicle.  It works now.

Nick Scalero · Answer

the problem with the 3rd property, Michael, is that I've owned it a lot of years.  I've taken lots of depreciation and it's value has gone up substantially.  I believe I'd take a big tax hit.

The wife has agreed to option 3.  If we exchange now and rent the new place out for 3 years then retire and live there, we can decide to stay if we want or sell in 2 years, take a smaller hit on recapture of depreciation and taxes and move on.

Does this sound right?  Anybody see any flaws in the plan?

Account Closed · Answer

I am sure there is some creative way you can do this. Think outside the box.

Put the 2 rental properties (you want) into a company and call them a "ABC Business LLC"

Leave the 3rd in your name.

Sell the 3rd property for what you paid or for a slight loss  so you don't yield a profit. (if you can't take a slight loss find every deduction you can in the book and record the items and then sell the property to lower your taxable liability.)

Then take those proceeds and use it to pay off the other 2 properties!

Good Luck

Michael Kowal

Dave Foster · Answer

That's a very nice profit Darrell.  Unfortunately, from the sounds of it you won't be able to utilize a 1031 to sell and purchase the 4 you have under contract.

It doesn't matter if you're a dealer.  Dealers can do 1031 exchanges.

It doesn't matter how many properties you have under contract.

What really matters is what your use and intent was of each property you consider using a 1031 for.  Every 1031 stands alone.  In this instance it sounds like you bought the property specifically to resell.  So a 1031 wouldn't be appropriate.

Regarding the other 4 however it would be a simple matter to buy rehab rent and then sell later using a 1031 exchange.  If your intent is to use the property for productive use then a 1031 works.  If only for resale then it doesn't.

Dealers do have a higher threshhold to show intent simply because your normal model is to buy to sell.  Many of our clients that want to flip some and hold and 1031 some will often set up separate holding entities or make sure that their CPA is on board documenting them appropriately.

The 1031 exchange is a huge powerful economic engine but it takes a little patience to use.

Darrell Lee · Answer

I just bought a house for $17k and expect to sell it for around $50k. I have 4 properties under contract at the moment so my CPA says I'm a dealer and have to pay ordinary income taxes on my profits.

As a dealer, I'm wondering if I can utilize the 1031 tax deferred exchange?

Darrell Lee · Answer

Smart play @Dave Foster. I like it...

Nick Scalero · Answer

I like option 3 the best.  I was hoping for a more immediate solution though.  Thanks for your answer Dave.

Can I do this without taking a tax hit?

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