1031 or Pay Taxes: Selling a Place During Pandemic

1031 Exchanges
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1031 or Pay Taxes: Selling a Place During Pandemic

Erica Milano
Member since 2020 · 2 posts · 1 vote

Hey All,

I'm currently on the fence of selling my property during a pandemic and wanted to seek for advice.

I purchased my condominium in California about 10 years ago. I initially lived in the property but moved to a different city for a job so I've been using this place as an investment property for the past 5+ years.

For the last couple of years, I've lost some tenants due to some issues with the building. I've been managing this property remotely and it's been very stressful; therefore, I made a decision to sell my place.

I currently don't have any tenants and not planning to have any until I sell the place. I still have a mortgage to pay for so I'm bleeding money out the door every month.

Ideally I would like to sell the place and do a 1031 exchange and purchase another home closer to where I currently live; however, due to COVID's situation, inventory around my area is very limited.

If I were to sell the place outright and not do a 1031 exchange, I would be losing out on close to $100k in taxes (w/ my income and capital gains).

Here are some of the options that I thought over:

  1. Paying Taxes-- Sell the house now and try to do a 1031 exchange but due to limited inventory, I'll most likely won't find a place to buy in time and have to pay $100k in taxes.

Pros: Better chance of selling since the inventory is low in the area. Can hold onto the money until the pricing will lower in the next 1-2 years. Don't need to rush to buy a house in 45 days. Won't have the place vacant for too long.

Cons: Will lose out on $100k in taxes

2) 1031 Exchange-- Holding onto the condo until there's more inventory in the market (vacant for ~1 year. *Assuming prices will lower due to recession) and pricing to go down

Pros: Will not have to pay $100k in taxes. Pricing will go down due to recession

Cons: Will leave the place empty for about a year. Need to do a 1031 exchange so I'll be rushing to buy a house. Decrease in property value and may not be able to sell the house at all. My condo's pricing will decrease

By doing simple math and writing down the pros and cons, the obvious risk adverse option is (1). But losing out on $100k on taxes sounds silly and many investment related books that I read always suggest deferring taxes or finding a work around.

Thank you for reading and would love to hear your honest feedback and advice.

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Glenna Wood
So MD · Member since 2019 · 294 posts · 191 votes
6y

I agree that deferring the taxes and keeping your money working for you is the key goal. If you've decided to sell and it would sell now, I wouldn't wait. I would get a QI lined up and proceed with a 1031 exchange.  Nobody knows where prices are going due to COVID-19 this year. The peace of mind from having it gone and not paying the mortgage each month is valuable to you. In almost 40 years of owning rentals, a long term empty rental has always been a major pain. 

Not having viable inventory where you want to buy is difficult for a 1031 but I believe you can put your 1031 proceeds into a DST as an interim step instead. Someone more knowledgeable than me needs to chime in on that. The worst case would that if you do a 1031 and then can't find a place for the proceeds, it will only cost you the QI fee, which isn't much, and your tax bill on the boot will still be about the same if you just sold outright. For sure though you have to choose the 1031 path upfront before the sale which I suspect you already know, so for the amount tax deferral you are looking at, I would do the 1031 even I wasn't certain I can line up all the ducks.

Hope it all works out and wish you all the best!

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  • Glenna Wood
    So MD · Member since 2019 · 294 posts · 191 votes
    6y

    I agree that deferring the taxes and keeping your money working for you is the key goal. If you've decided to sell and it would sell now, I wouldn't wait. I would get a QI lined up and proceed with a 1031 exchange.  Nobody knows where prices are going due to COVID-19 this year. The peace of mind from having it gone and not paying the mortgage each month is valuable to you. In almost 40 years of owning rentals, a long term empty rental has always been a major pain. 

    Not having viable inventory where you want to buy is difficult for a 1031 but I believe you can put your 1031 proceeds into a DST as an interim step instead. Someone more knowledgeable than me needs to chime in on that. The worst case would that if you do a 1031 and then can't find a place for the proceeds, it will only cost you the QI fee, which isn't much, and your tax bill on the boot will still be about the same if you just sold outright. For sure though you have to choose the 1031 path upfront before the sale which I suspect you already know, so for the amount tax deferral you are looking at, I would do the 1031 even I wasn't certain I can line up all the ducks.

    Hope it all works out and wish you all the best!

    3Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    6y

    @Erica Milano, It's not uncommon at all for an investor to start a 1031 in order to get an extra 45 days to shop around and find a good replacement.  There is no penalty for starting a 1031 and not completing.  But with $100K tax bill looming, it might be worth the $750 or $1000 of a 1031 just to see if you can find something.

    This is definitely a transition time.  But as our respective areas move to open up I'm seeing the real estate markets firing right back up as well.  Even if you got a quick sale you're not going to close before late August.  So if you add the 45 day period to that you've actually got from now to Mid October ish to find a good replacement property.  That's not a bad position to be in at all. And as @Glenna Wood said, there are other options that can be used so that your $100K in tax can stay with you.

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  • Erica Milano
    OP
    Member since 2020 · 2 posts · 1 vote
    6y

    Thank you very much Glenna! Chances are very slim but definitely worth a shot! 

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  • Paul MoorePro Member
    Commercial Real Estate Fund Manager · Lynchburg, VA · Member since 2015 · 1k+ posts · 1k+ votes
    6y

    Hi @Erica Milano.  Checking in... any update on your plan and strategy? I can understand the quandary you are in and I would be perplexed myself.  We'd love to hear an update. 

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