1031 Exchange - Buy Cash or Finance?

[Gustave Stroes]

I think this is the right forum for this question...

I have a rental property with high equity and low cash flow. I am thinking to sell it and exchange it via a 1031 for other rental properties with better cash flow.

The sale of the current property would net about $1.1M to $1.5M depending on what it sells for.

I've been reading about cash flow, NOI, cap rate etc. I'm not a finance expert but trained as an engineer so if something is explained to me I can usually figure it out.

Would it be better to buy several rental properties all cash? Or would it be better to finance some, or all, of each purchase, so that more properties can be purchased?

The current property is in West Los Angeles (90210). I prefer to invest the money in TX, but am open to other areas also. I am also trading SFH rentals vs small multiplexes vs a larger complex.

Any input would be appreciated.

[Bill Exeter]

Originally posted by @Joshua McGinnis:

Hi @Gustave Stroes

For a 1031 exchange, you must be buying (exchanging) one property for a "like-kind" property (single to single, duplex to duplex, etc). That said, I don't think that you would be able to 1031 exchange your investment for one or more out-of-state properties. 

In general, if you leverage, you can buy more properties and therefore, increase your cash flow.

For example, let's say you have $100K to spend. You could buy one house for $100K all-cash and get somewhere between a 8-15% return in some Texas markets. Alternatively, you might be able to finance 2 or 3 properties with 20-30% down and end up with more cash flow (8-15% * 3 houses). 

There are nuances to this scenario, but that's the general idea.

Hi Josh,

The description above regarding like-kind is NOT correct.  The Qualified Use requirement means that the properties sold and subsequently bought must be held for rental, investment or business use.  The Like-Kind requirement simply means that the investor must sell real estate and then buy real estate.  So, to be clear, any kind of real estate qualifies for 1031 Exchange treatment as long as all of the properties satisfy the Qualified Use requirement.  The proposed structure above of selling in California and then buying in Texas (or any other state) is perfectly O.K. from a 1031 Exchange perspective.  California does have the California Claw-Back reporting requirements, but that's it.