Selling: 1031 vs. Personal Residence

[Adrian M]

Hello Fellow Investors!

I would really appreciate your advice on this matter.

Background Information
I own a condo in Santa Monica, CA that I am currently renting-out. I'd like to sell the condo in 2 or 3 years (after a bit more appreciation).

The condo is in a nice area. Although the condo is small (in sq footage), I wouldn't mind moving back to it if it makes the most sense financially.

When I eventually sell, I will use the equity to buy about 5 or 6 SFRs, in cash-flowing states (not California).

By the time I sell, I will have about 7 properties. So, the acquisition of an additional 5 or 6 will put me over the 10 property Fannie Mae limit.

Essentially, I am trying to decide between the following strategies.

STRATEGY A - 1031
Continue to Rent the Property to Tenants.

Then, in 2 or 3 years, do a 1031 into SFRs in a cash-flowing state (not California).

Pros
- I can avoid Capital Gains Tax on all of my equity.

Cons or Concerns
- I have never done a 1031. I'm concerned about hidden fees, the strict 1031 timelines (45 days to identify, 180 days to close). I'm very concerned about Underwriting 5 or 6 Loans at the same, especially since I will be going over the 10 property Fannie Mae limit.

STRATEGY B - Owner Occupied Capital Gains Exclusion
I would move into the Condo (and use as personal residence).

Then, in 2 or 3 years, use the Owner Occupied Capital Gains exclusion.
- I'm single, so this exclusion would be $250k.
- The equity in the property is currently about $250k.
- I expect the equity to be more in 2 or 3 years.

Pros
- This will allow me more time to find the properties that fit my investing style.
- I could possibly take-out a Home Equity Loan (or Line of Credit) to buy more cash flowing homes now. Are Lenders making Home Equity Loans again?

Cons or Concerns
- Equity over $250k will be taxed.

Please share your related knowledge/experiences. Any advice

offered will be appreciated!! Thank you for your time!!!

[Dave Toelkes]

Eric does not have a perfect understanding of the exchange rules. When you are doing a direct exchange (you and I exchange properties with each other), you only have a totally tax deferred exchange if you are trading equal or up in equity AND debt.

In the delayed exchange that you are proposing, you engage the service of a qualified intermediary to sell your relinquished property to a third party, then acquire your replacement property from a fourth party. In this type of exchange there are only two basic qualifying rules that must be satisfied to have a totally tax deferred exchange: (1) you must trade equal or up in value, and (2) all of the net exchange proceeds must be applied to the acquisition of your replacement property. There is no need to trade up in debt because you are paying off the old mortgage loan from the sale proceeds on the relinquished property, and you are either bringing new cash or new debt to the replacement property acquisition.

NOTICE: That I used the term "tax-deferred". In a 1031 exchange, you don't avoid capital gains taxes, you only delay the time that you eventually have to pay them. Eventually, if you sell the replacement property in a taxable event, all of the deferred capital gains will be taxed at the capital gains rate in effect at the time of the sale.

Contrast this to your "sell as primary residence" strategy which may exclude up to $250K in profit from appreciation from taxes (forever). If you have the time and patience to resume occupancy and meet the two of last five years ownership AND occupancy tests, then I would opt for a tax free deal over a tax deferred deal.

Of course, as Wayne suggested, profit due to depreciation will still be recaptured even if you reestablish the property as your primary residence. This may be a wash because depreciation is recaptured when the sale of the 1031 replacement property is a taxable event.