Should I do a 1031?

Question

I know that most of you HIGHLY recommend doing a 1031. But I am currently in a situation that I am just considering paying the Capital Gains Tax and be done with it. So I want some differing opinions.

First off, the property is owned by our Family Trust and is free and clear. We settled on a selling price of $750,000. Just rounding numbers, net will be $700,000. It was purchased for $250,000, so that leaves $450,000 plus depreciation for NET. I am not sure how much was depreciated as I have not seen my parents Tax Returns, but even if it was $100,000, that leaves a Capital Gains tax of $82,500, leaving us with $617,500 TAX FREE.

The reason for paying the Capital Gains Tax are many. There is a good chance that the Capital Gains Tax may increase, and maybe to as much as 50%, from the current 15%. We want to purchase several SFR across several states and trying to close all of those within the 1031 time frame would be difficult. The sold property is in California and the accomodator fees could reach over $10,000.

The last, and MAIN reason, for just paying the taxes is that my mother is Terminally Ill and my father has advanced Alzheimer's. I did a 1031 for them last year, but I couldn't get my mother to agree to buy a second property, so she got some taxable BOOT back. Luckily, it was less than $10K, so not too much of a problem. But trying to get her to agree to buy new properties was like trying to get a Democrat to cut Social Program Spending. Possible, but not likely.

My goal is to buy 20 SFRs in the 50-60 range with around 50% LTV mortgages. To 1031 ONE to TWENTY would be daunting.

Any thoughts?

Scott Saunders · Answer

A few quick comments on your questions and a disclaimer that I'm coming from the perspective of both an investor who does 1031 exchanges and a QI (Asset Preservation) as well:
- Capital gain taxes are set to go up from 15% to 20% at this point in time. I don't know of any proposals where these taxes are expected to double.
- QI fees are much less than $10,000 as several have posted. You can reasonably expect to pay around $500-$700 for the services of a reliable and secure QI. There are some excellent companies that are QIs and it's essential that you perform due diligence to be sure you select a QI that keeps funds in segregated accounts and has excellent security mechanisms in place. (Please contact me if you are interested in QI referrals.)
- If you intend to purchase many SFR houses as proposed, I personally believe the exchange is the preferred strategy. When analyzing the advantages of this approach, I suggest you look at not only the capital gain taxes that you would owe today, but also the lost purchasing power and leverage opportunities. Depending upon the leverage you intend to use when acquiring replacement properties, you can be losing much more in purchasing power than just the taxes paid to the government.
- You almost certainly need to use the 95% identification rule (ie. where you identify more that 3 properties of any FMV and more than 200% of the FMV of what you sold for $750K) to purchase this many replacement properties. I've personally done this and exchanged out of one property and into 5 SFR in multiple states so, although it's challenging and requires some planning, this can be accomplished -- I think the tax saving might make it worth exploring this alternative.
- Finally, regarding your possible need for cash, there are two approaches to consider: 1) taking some 'cash boot' from the transaction and only paying taxes on the actual cash received (referred to as a partial exchange) or 2) doing a fully deferred exchange but refinancing shortly after the exchange is completed to pull out the needed cash without paying any capital gain taxes at all. Be sure that the exchange is completed before refinancing in any matter.
As always, be sure to seek the advice of your legal/tax advisors to review the specifics of your situation.
Hope this is helpful. Scott

Frank Adams · Answer

"There is a good chance that the Capital Gains Tax may increase, and maybe to as much as 50%".

While it's likely that the rate will increase (I for one think it should) what would make you think it would ever go that high? It's never been that high in the past, I could see 20% or 25% at the outside.

You'd also have to pay the TOP California rate which was 9.3% the last time I paid it. That was one big reason for me doing a 1031, I had about $275K gain and would have owed a big chunk to CA as well as the Feds. By doing the 1031 and waiting a few years to dispose of them I avoided having any of the gains show up on my final CA tax return.

"We want to purchase several SFR across several states and trying to close all of those within the 1031 time frame would be difficult."

Not nearly as difficult as MANAGING that many geographically dispersed properties. While the cost of LOCATING and doing due diligence on that many is high, I know it's doable because my former CPA did almost exactly what you're describing, a SF apartment building into a dozen or more rentals IN ONE METRO AREA of TX.

The key is to get most of the scouting and due diligence out of the way while the sale is in progress. By the time mine closed I had 7 to chose from. By CPA had about 30 to chose from by the time her sale closed so even if some of them were no longer available she still had many to narrow down to.

"The sold property is in California and the accomodator fees could reach over $10,000."

You've found an accomodator who is trying to SCREW YOU. The last CA based 1031 I did was one SFH in the Bay Area into 3 SFRs in Austin and it cost be about $500. Granted that was 8 years ago, but something is way wrong with the $10K number.

"My goal is to buy 20 SFRs in the 50-60 range with around 50% LTV mortgages. To 1031 ONE to TWENTY would be daunting."

I think the mortgages are a bad idea (I think that generally), better to just do 1/2 that number and have them free and clear is better. 1/2 the management, 1/2 the due diligence.

"To 1031 ONE to TWENTY would be daunting."

Daunting, but not impossible as noted above.

"Like trying to get a Democrat to cut Social Program Spending. Possible, but not likely."

Or like trying to get Republicans to give more "corporate welfare" to the corporate keepers; Halliburton, Blackwater, Exxon/Mobil?

Frank

Account Closed · Answer

Mike M.

I might be able to help you with buying 10 properties at the same time. A deal came across my desk just yesterday - 10+ properties worth $900K for only $700K, all of them rented and cashflowing. I have not done my due diligence yet but I will. See my signature below and let's connect.

Mike McKinzie · Answer

UPDATE: Deal closed this week and I am doing a 1031!

Steve Babiak · Answer

I had to give Scott's FIRST BP post a vote; it sounds like good and sound advice to me.

Off topic: I only wish other first time posters - who are experienced in real estate matters - could muster that sort of quality, rather than the oft-posted spammy initial posts.

Mike McKinzie · Answer

Ralph
I just got full control, "General Durable Power of Attorney." But the issue is still, 'does mom want the cash now' or 'does mom want a higher cash flow?' Personally, I love cash flow. But mom is not so sure.

Ralph S. · Answer

Ok, I'll pick up that gauntlet, Josh. If I understand what you meant.

Dad has advanced Alzheimer's, mom's terminal, she controls the trust, has agreed to the sale but scuttled a previous 1031 attempt. And now the question is 1031 or not, on a 1:10 or 1:20?

Tough. But short of the monumental task of converting her from democrat to republican, are you really prepared to wrestle control of the trust to see this through?

Sorry. I like mom. Not being critical either, Mike. Understand this is just a case of different strokes. For me, I simply couldn't introduce this kind of conflict at such a time. I'd over value moms wishes, given that she is still in control of her faculties, even if it meant lower returns or even to the point of some depletion of the trust assets. Perhaps a financially irresponsible position, it's just not in my being to be otherwise. There will come a day. Seize it then. Good luck, and sorry if I stuck my nose in your family's business.

Matt Eilers · Answer

The other potential challenge will be since you would be buying multiple properties as part of this exchange, you would need to declare more than 3 properties.
This would invoke the 200% rule. You would have to be fairly careful that the properties listed values (and I believe it is based off of list price) do not exceed 2 times the amount of your sales price.
If they do, then I believe you have to close on 90% of the properties listed in order for the exchange to be done correctly.

The ~10 replacements could be a tad harder to pull of, but doable if you start looking in advance and have a good plan of attack once the home sells.

I would shop around as the fees for a 1031 shouldn't be as high as you stated. It is not that hard to do multiple replacement properties for the company. If nothing else, call a company, ask their price and if it is too high, try to negotiate a lower price.
Best of luck.

Ralph S. · Answer

Mike
My hopes for anyone in this kind of situation remain the same. That financial differences of opinion don't create divides and conflicts that complicate an already difficult time. Watched that happen once, hence my opinion
Best of luck.
Ralph

Mike McKinzie · Answer

Dave
The property is vacant and costing around $20,000 a year in upkeep, insurance, taxes, etc.... We started full time in-home care for my folks and they need the income to help pay for it. Both of them reached the 'dough-nut' hole in Medicare last year, and one bottle of mom's pills are $5,500.00. So cash flow is more important then worrying about a step up in basis right now. If they didn't have so many vacancies on other rentals (6 at the moment), it wouldn't be quite so bad.

Should I do a 1031?

Should I do a 1031?

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