Should I hold, sell or do a 1031?

Question

This is my first post, so here it goes...

I have a Duplex Investment Property that was purchased via a 1031 a few years ago and since then the property has appreciated 50% and has a solid positive cash flow.

I am not sure, if I should keep it. Do a 2nd 1031 possibly out of Cali to another state for an Apartment building (4+ units). Or do a cash out refi for the amount of my original down payment.  (or as much as possible - without going negative cash flow & also hedging price risk) The cash would just be sitting and not squandered.  Any feedback, suggestions or oversights would be greatly appreciated. The goal is more income & stable equity ...so cash on cash return is something I've been focused on.

Thank You

Bill Exeter · Answer

Hi @Andrew Severino,

You can absolutely refinance a replacement property that was acquired as part of a 1031 Exchange transaction. The refinancing does not trigger any of your taxable gain; it is merely pulling equity out of an asset that you own. I would personally not refinanced immediately after a 1031 Exchange transaction, but would wait at least two or three months before initiating the refinancing.

The proceeds that are pulled out of the replacement property through the refinance/cash out transaction can be used for any purpose. It will not harm your 1031 Exchange transaction., You should consult with your tax advisor in order to determine what tax consequences (write-offs/deductions) might be available due to the refinance.

Refinancing immediately prior to a 1031 Exchange transaction can be risky, so be sure to consult with your tax advisor, legal advisor and Qualified Intermediary if you are thinking about refinancing just prior to a 1031 Exchange.

Dave Foster · Answer

@Andrew Severino,  Ah but that's the beauty of the whole 1031 thing.  Refinancing a property immediately prior to a sale has been consistently viewed by the IRS as an attempt to inappropriately pull gain out prior to a 1031 exchange.  However, when you refi a property after completing a 1031 exchange  you are not taking profit out.  You are accessing equity in the form of debt.  And there's no tax on debt.  The debt service will be paid for by your tenants and the interest deducted from your income.

So completing a 1031 exchange and then refinancing to pull out equity is a brilliant way to access cash without incurring a taxable event.

Jim Sakalis · Answer

Ari thanks for your question.  I guess the real question you want to ask yourself is;

Can I take that profit and put it into another property to generate me more cash flow
than I am already getting? If the answer is NO than keep riding the wave. If you think
or fear that property will drop in positive cash flow as you may have the gift to see
the future than yes start making plans for moving the money onto something new.

Hope that helps
Jim Sakalis

Dave Foster · Answer

@Andrew Severino, since it is a loan against equity there really isn't a claim to be made that you are accessing gain.  Your question is really more aimed to your accountant the possible changes that might be required to interest expense and other write offs for the refi when done for personal rather than business purposes.  I've seen it both ways.  Just make sure your acct is on board.

Clayton Mobley · Answer

@Ari L. I have to agree with others here, there's no right answer. You're in a good position where you are, and CA real estate is likely to appreciate more, though maybe not at the same rate - who knows. I wouldn't discount the positives of your current situation because you're getting antsy - which is a common problem in REI. 50% appreciation is great, and if you're cash flowing well, then you may be best served to hold on. However, you say your priority is increased income, which may mean it behooves you to move that capital into lower cost states with higher cash flow, but lower appreciation. It's all about what your priorities are.

If I were to take your statement about goals at face value, I'd say 1031 that property into a small portfolio out of state. I don't know the value of your current asset, but given that its CA and it's already increased by 50%, I'd say you have a good amount to play around with and could like get a decent little portfolio of SFR in AL (for sure), the south in general, or the midwest. I'm not an MFR guy myself, but I'm sure you could find something that flows nicely if that's the direction you want to go.

You'd likely not get the same rate of appreciation, but you shouldn't lose value over time and your cashflow would almost definitely be better. Again, without specific numbers it's hard to say, but based on general CA RE trends, this is my best guess.

BUT if you like having a cash flow positive property (even if something else might flow better) that is going to appreciate well and serve as a piggy bank of sorts, you may want to sit tight. As others have said, it's all about what gets you to where you want to go - don't make a change just because it feels like you should always be 'doing' something.

Best of luck!

Bill Exeter · Answer

Hi @Ari L.,

There is no easy answer here.  It will depend on your goals, objectives and business model.  The 1031 Exchange should only be used IF AND ONLY IF the end result will put you in a better position.  So, keep asking questions until you feel that you have developed your own goals, objectives and business model, and then proceed.

Thomas S. · Answer

Risk tolerance.

When will your market drop, are you prepared to risk your equity when it drops, is the present equity earning it's keep.

What you do depends entirely on your goals and tolerance to existing or future real estate risk.

Some would say take advantage of your equity gains and refinance to invest in more. some would advise to simply hunker down and be happy with what you have some would defiantly advise selling to get out ahead of a impending down turn in the market.

You have dead cash costing you money every month since all it is doing is saving you on the prevailing interest rates.

No one can tell you what you should do, they can only advise on what they would do with the knowledge of their own risk tolerance.

I personally believe equity has negative value if it is not taken advantage of to generate greater returns. I would be thankful for the equity growth to date and sell to invest elsewhere.

Andrew Severino · Answer

You're the man @Bill Exeter . Thank you.

Andrew Severino · Answer

@Dave Foster , thank you. This is extremely valuable information. I appreciate you clearing that up. This opens up new doors.

Question @Dave Foster: just to be clear, it is ok to take those refi proceeds and do with as you please? Elimination the conundrum many face when they want the capital gains deference but also need some cash for other business or personal reasons?

Should I hold, sell or do a 1031?

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