1031 Exchange / 121 Exclusion to buy investment property in NYC

[Dan A.]

Hi all,

I’ve just recently discovered BP and I’ve been pleasantly surprised at the wealth of information available and the number of people who are so willing to help. Hopefully I can tap into this knowledge pool with some questions about my own real estate situation.

After having purchased a few homes in the Midwest that have turned into investment properties over the years, I’m interested in buying a multi-family property in NYC. I’m ideally looking for a 3-6 unit building, something that I can own for the next decade-plus. Here’s my current thinking on how to go about this purchase, I’d truly appreciate any thoughts / feedback from the more seasoned investors in the group.

Right now, I have one investment property in Chicago that I’ve been renting out for a few years. The property is currently worth ~$425K per Zillow and the mortgage is about $275K. I intend to rent for one more year and then will sell the property next summer. To keep the numbers simple, I’m going to assume I have a net gain on the property of $100K.

At that point, I will have lived in the property for exactly 2 of the most recent 5 years. I’m obviously trying to minimize my tax bill from the sale, so I’ve looked into both the Section 121 exclusion and the Section 1031 exchange.

Based on my understanding of the Section 121 exclusion, I would still need to pay the pro-rated capital gains tax for the years that I rented the property (basically 3 of the 6 that I would have owned it at that point) as well as taxes on the depreciation recapture. So ~$50K from the gain and then whatever the depreciation recapture is, so a pretty sizable tax bill. Does that sound about right?

HOWEVER, if I utilize the Section 1031 exchange in conjunction with the Section 121 exclusion, does that mean I can shield the remaining ~$50K gain from capital gains tax assuming I can find a suitable property in which to reinvest? That’s my understanding of how the code reads but would appreciate any second opinions. The other part I’m a little unclear on is the depreciation recapture – will I pay this no matter what? Does it matter that I’ve lived in the property for 2 of the last 5 years? How is this treated in a Section 1031 exchange?

So the plan is to sell the property in a year and then be prepared to buy in NYC at that point.

In the interim, I had a few questions if I may:

• What’s the minimum down payment % that I would need for one of these properties? Is there a specific bank in the city that is known to take on credits with higher loan-to-values?
• What are the sites that you guys use to monitor potential investment properties?
• The 1031 mentions that you need qualified intermediary – is this typically just a bank that will take care of the rest of the mortgage or should I be looking into third parties for this?

Any advice on these questions or thoughts on what I can do over the next year to ensure that I’m best prepared would be most welcome. Thanks to all for reading.