Is a Single Family 1031 Exchange Worth It?

[Jason Collins]

I have a few single family rental properties.

At some point I was hoping to move some or all of them into apartment complexes via a 1031 exchange.

My question is, at what point is it not worth it to bother with setting up a 1031 exchange?

My accountant seemed to think that for a single family property, by the time you spent the legal fees to set up the exchange as well as paying for a qualified intermediary, it would just be easier to pay the capital gains taxes....

[Dave Foster]

@Jason Collins, There's quite a bit of misunderstanding about how expensive and how complicated it is to complete a 1031 exchange. 

The determining factor of course is what is at risk and what are your goals?  If your goals are to continue investing in real estate as you said then any savings are worth it as long as it is worth the effort.  So start with a cost analysis.

Your gain is defined by the difference between your net sale and your adjusted cost basis (what you paid for the property minus depreciation you took plus capital improvements).  This difference will be taxed for most people at 15% federal plus state.  Depreciation is taxed at 25%.  So since it's a varying number let's just ball park for your comparison and call it 30%.

If your gain is $50K then your tax would be $10K.  A garden vafiety exchange is gonna run you around $750 plus or minus.  Here's an article I wrote for BP on the topic - https://www.biggerpockets.com/blog/how-much-does-a-1031-exchange-cost.

So if an exchange costs you $750 and your tax exposure is $10,000 then even if you pay for the exchange you'll still be saving $9150 in taxes.  Is that worth it? Only you can decide.  

I've had investors decide to not do 1031s on profit that would have resulted in a $200K tax.  And I had a lady do a 1031 on the sale of a $10,000 lot that she had bought for $1000.  

For the large investor it just wasn't the right time.  So they paid the tax.  For the lady she didn't care how much she was saving - anything she saved was her money gosh darn it.  And she wanted to keep it so the 1031 was her choice.

When you do a 1031 your actions are not one bit different than normal.  You market and sell a property.  And you shop for and buy a property.  Yes there are some critical timelines that have to be met.  And some regulations you have to be aware of.  But your actual actions are no different.  

So extra effort is not a reason to not do a 1031 exchange.  

Not enough gain to justify - sure that could be a reason.  And that will be different for you than for your accountant or me or anyone else.  I tend to notice that folks are always a little more quick to say "just pay the tax" when it's not their money :).  

But if you're reinvesting in real estate and you have a gain that justifies it then the 1031 is the vehicle that will allow you do defer that tax indefinitely.  And no you do not have to pay it at sometime later (unless you want to).  There are ways to defer until you pass away and then you can give your heirs your real estate tax free.

So don't be scared to look at them.  They're a pretty powerful tool with many applications to accommodate your personal goals.