Should I do 1031 Exchange or keep cash durin Covid-19 ?

Question

This is my first post on BiggerPockets, I been reading  around for advice but have have a question so I decided to post, please help me out :)

Im in a little bit of dilemma. I bought an investment home in Chicago for 40K around 2.5 years because I got such a good deal, the rent for that is $1200 a month. Now Im currently in escrow and have a buyer that willing to buy it for 92K and it is paid off.

My dilemma is if I sold this property should I do a 1031 exchange and buy another one? Or save cash and pay Uncle Sam?

I been reading and a lot of people are saying keep the cash because in the next couple months there will be more layoff and the housing market will drop, however if I keep the cash then I have to pay 15% tax. Should I not do a 1031 exchange, pay tax and keep the cash ?

My property suppose to close the first week of June and I would need to identify properties within 45 days then purchase them within 180 days. I been looking in to Kansas City, MO with a real estate agent and found a 4 units for around 235k and rent is $2600 a month. With a down payment of 90k. After mortgage and expenses, i will pocket around $734 a month. What should I do ?

Bill B. · Answer

The property in MO isn’t as good a deal as you’re selling. It costs 250% and brings in 210% of the rent of your property. You’d be better of keeping yours and buying another one.

I don’t think the property is worth doing a 1031. $1000 for depreciation recapture and $7500 in capital gains if you have ZERO selling costs (commissions, transfer taxes, title fees). But then I wouldn’t have sold. You were getting 3% of cost per month. An insanely good deal. Even after doubling in value you’re at 1.3%.

But good job on a $40k investment. Collecting $36k in rent and $50k in cap gains. 300% in 2.5 years.

Dave Foster · Answer

@Jake Pham, very good thoughts by @James Storey and @Bill Brandt.  In a vacuum that looks like a great property to hold.  But that ship has sailed unless something falls apart tween now and then.  It's not the biggest tax in the world.  But for the size of sale it's still a bunch and James is right on - you've got to factor in state tax as well although the depreciation recapture isn't going to be much at all.

So the real question becomes - can you find a good replacement now.  Or is it worth paying $10k in taxes to eliminate the deadlines and sit on cash?  It's hard to argue with Warren Buffet, Apple and McDonalds who are among tons of companies hoarding cash in anticipation of unforeseen need.  Looking for something to buy that works is not quite the same thing.  And that kind of strategy is really just market timing which usually isn't something  us regular folks win at.

To give yourself some more flexibility though why not stretch out your runway and get some flexibility.  You're toying with the idea of paying $10K now.  You could pay the price of a 1031 and be equally willing to let it go if the market hasn't shifted in your favor and you can't find a replacement.  But if does shift in the next two months and you find something you'll still be in position to take advantage of it and keep the tax deferral.

All depends on how strong your convictions are that there will be a significant drawback of prices.

James Storey · Answer

@Jake Pham Congrats on the appreciation made in just 2.5 years! Seems like you made a good bet on that house.

Based on the numbers you are giving, it looks like you are going to increase your returns with the quadplex in MO for the $90,000 you have. Just keep in mind, you probably wont have $90k at your disposal after paying for prorated taxes, title fees, and other closing costs. You will be close though.

Keep in mind that you will pay 15% on the appreciation you made but you will also pay 25% on the unrecaptured depreciation that you took over the 2.5 years you owned it. Depending on Illinois tax law, you may also have state capital gains to pay also. If you haven't yet, you need to talk with a qualified intermediary to ensure you are compliant with the 1031 stipulations. They will need to hold onto the funds after you sell your property in Illinois and they also will disburse the funds when you buy the quad in MO.

If it were me, I probably would have refinanced your property in Illinois and took the cash out from the refinance to the property in MO. You had plenty of unleveraged cash flow returns in your property in IL to be able to use leverage in a positive manner and maximize your cash flow potential. However, since you are already in the process of selling, I would go ahead and talk with a qualified intermediary and do a 1031. No need to give extra money away when you can put that money to work in the nice cash flowing property in MO.

If for some reason the property sale in IL falls apart, really think about the refinance options. You might have already given it thought but the numbers really would make sense in your situation.

James Storey, CCIM

Steve S. · Answer

@Jake Pham The right Opportunity Zone Fund is the way to go. weallascend.com is an OZF that is solving the homeless problem and providing great returns

Jake Pham · Answer

@James Storey

Thank you James for your post. This is my first property so I never thought of refinancing, I will take a look into that for the next home.

Jake Pham

Bill B. · Answer

@Jake Pham

Very good reasons. I can’t believe the taxes and repairs some people are paying.

Jake Pham · Answer

@Bill Brandt

Hi Bill,

The reason why Im selling it because, even though it has rented out for 2.5 years with no gap. I barely making cash flow due to the repairs, Chicago high property tax rate. I didn't actually making much money. That is why I was thinking about selling it and buying another property since the property more than double in value.

Should I do 1031 Exchange or keep cash durin Covid-19 ?

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