Should I exchange or take the hit now?

Question

Hi everyone,

I have a complex decision I am trying to wrap my head around. I am selling two SFH set to settle in Jan and am trying to decide if 1031 exchange is the best option. My main goal is to have funds for a development deal that I am pending the seller to clear some title issues on the land (this could be 6-8 months now with Covid). It's highly unlikely that I would be able to close on the target property in 180 days. The added benefit here is that I had 2 Helocs on these SFHs that I used to purchase a MF property. I just refinanced that property and have the cash to pay the loans in my account but did not apply it to the HELOCs.

Here are some numbers:

1) 156k in capital gains on the sale of the two SFHs2) Only 76k in gross proceeds of the sale since I still have the Helocs outstanding3) 40k estimated capital gains tax

So I am trying to find a way to 1031 out but in a way where I can still quickly pull out the proceeds from the 1031 within the next 6-9 months and leave only the 40k that would have gone to the government invested. Essentially getting the cash I need to develop and instead of giving 40k away, using it to own another property.

Note that the total sales price is 285k so I would need to buy something at least for that. and I know doing so and leaving only 40k invested is not an exact science but if I can come close to that it would still work.

Dave Foster · Answer

@Igor Messano, There's two key pieces of information missing that would be beneficial. But in general this isn't a bad scenario for you.

Here's a rough framework of how it could work.

1. Do not use your cash to pay the helocs now. Save it for the development.

2. Sell your single family homes and start 1031 exchanges. Let the closing pay the helocs. You'll be left with around $76K and the need to purchase at least as much as your net sale of the SFs if you want to defer all taxes

3. Purchase just enough replacement property to satisfy your 1031 and make it one piece to simplify finance and refinance (use cash if you can (maybe the cash that you didn't pay the heloc back with), it will cut financing costs quite a bit.

4. Immediately after completing the 1031 do a refinance of the property. Plenty of lenders will refi at purchase price level without seasoning.

Steps 1-4 would all be done within that 6-8 months before your development property was ready. You'd have all the cash available with no tax liability because that all went into the 1031 exchange. And you could then use the tax free dollars to purchase the development property.

Bob E. · Answer

Would your buyer for the property agree to delay closing if you offered then a NNN lease for 3-6 months? Include an Purchase option agreement for a set price.

Or sell it to them with an occupy before close agreement lasting 3-6 months. That way they are locked in on price and settlement date but you have some time to work your other deal.

You may have to give them a sweet rent rate but it would almost certainly be less that the 40k in estimated taxes.

Taylor L. · Answer

Do you have any good options to exchange into? That would be my first question. Deferring capital gains is great but not if you have nothing good to defer them into

Steve Faucette · Answer

@Igor Messano

Just a short note nothing negative, sometimes in life when we try to force things, just look at it from 4 sides of the coin maybe the deal is for you at this time.

Carlos Ptriawan · Answer

You mentioned there are two SFR rentals. Is that located in the same area where you live now? do you have three homes (with one as primary) or do you have one primary and one rental?

You could always sell your primary tax-free and move to the rental, if you live in the rental for two years and sell, your taxable portion is only (years rented/years owned). Thanks.

Basit Siddiqi · Answer

@Igor MessanoYou calculated the capital gains tax, is that only the federal capital gains tax?Did you factor in tax on depreciation recapture?Did you factor in States and City taxes as well?You may be surprised to learn that your tax hit may be higher than you originally calculated.This may be all the more reason to do a 1031 exchange or a QOF contribution.

Alex Olson · Answer

I would buy a replacement property that is a bit more than the property you are selling. Finance it with a lender that does not have a prepayment penalty. Then, refinance in 6-9months to pull out the equity you need. Hope that helps!

Should I exchange or take the hit now?

Should I exchange or take the hit now?

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