Make some money on first property what’s next?

Question

Hello,

I just sold our first property, it was a rental and I was fixing it to rent it out but I receive a good offer and couldn’t refuse it. Now I don’t know what to do next, I was planning on buying rental properties but what should I do with the money I earned from the “flip”? My CPA told me my only option to avoid paying taxes is to re invest in a 1031 exchange and buy a property of the same or higher value than the property I sold. My question is, is this the only option to avoid paying taxes and reinvest the money? I wanted to buy one flip and one rental but if I have to use all the money I earned in a 1031 exchange then my only option is to buy rentals.... any opinions ideas on this?

Alvaro Leis · Answer

Thanks for the information Tyler I already order the book! I haven’t close yet so I think I’m still on time for 1031

Dave Foster · Answer

@Alvaro Leis, The 1031 proceeds can only go to the purchase of a property.  And you can't exchange into improvements on property you own.  However, in a diversification exchange like your anticipating you can use your proceeds in any way that you want.  So maybe you purchase the rental for cash and use maximum leverage to purchase the value add property.  Remember that all that is important is that you purchase in total at least as much as you sell.  So in this scenario you could immediately refinance the rental and use that cash for your rehab of the other property.

Or you could hold out some of the exchange proceeds to do the rehab understanding of course you'll pay tax on what you pull out but still shelter the rest.

Of if the numbers justified it you can do what is called a reverse improvement exchange.  In a reverse exchange your qualified intermediary actually takes title to the new property and we hold it for up to 180 days while you improve it.  As soon as the rehab is complete you take title to it at the cost of acquisition plus the cost of improvements.  You can use your exchange account money for this.  And that's how you can get improvements to be paid for out of 1031 money.  The catch is that the cost of a reverse exchange is pretty high.  Unless your improvements are probably greater than $30K - $40K its cheaper to usually just pay the tax on a partial exchange.

That's great news that you haven't closed yet.  I sent you a pm if I can answer specific questions or assist.

Chris Clothier · Answer

Alvaro,

You really need to connect with a qualified intermediary (1031 exchange company) asap!  Here is the contact info. of a company that a number of investors who purchased form us have worked with.  She will be able to answer all fo your questions quickly and help make sure you stay compliant and are able to take advantage of the 1031 opportunity legally.  You can look her up since BP does not allow posters to share contact info.  Or you can send me a message and if you would like I'll share her contact info.

Jodi Ripp Bugter, CCIMDivision ManagerAsset Preservation, Inc.

Forest Skufca · Answer

That's where you would need the help of someone who specializes in doing a 1031 exchange. I don't believe you can use a 1031 for repairs. That's what makes the turnkey environment great for people in a similar situation as you that want a buy and hold property.

If you have or can acquire the funds to do the rehab then you could buy one or more properties that need work and still go slightly above the funds from the 1031 in the purchase price. But, that could get a little tricky on the backend.

Alvaro Leis · Answer

Dave, when you say I have to buy more than what I sold I understand that means that the price of the next property needs to be higher than the one I sold right? But how about if I spend all the earnings in a cash house to repair and rent but the purchase price is less that the relinquished property?

Dave Foster · Answer

@Alvaro Leis, Yes @Tyler Bobo is correct.  In order to do a 1031 exchange you must us a qualified intermediary to document the process.  And they must be in place prior to the closing of the sale.  If you're still just in contract for the sale then it's not too late.

With a 1031 you have a lot of options.  In order to defer all tax you must purchase at least as much as you sell and you must use all of the cash in the purchases.  But you can allocate those proceeds in any way you want.  So you can absolutely sell one property and purchase several - or vice versa.

From what you wrote it sounds like the dilemma is that you wanted to use one property to flip.  And that would not qualify for a 1031.  However you could adjust your model and thinking just a little and make this work (again as long as you haven't closed your sale yet).  In order to qualify for a 1031 exchange your intent in purchasing a property must have been to hold for productive investment use.  Obviously if you want to immediately resell then that wouldn't qualify.  But what if instead of buying a "flip" you bought a distressed property that was a great value add prospect for a long term rental.  And after you finished rehabbing you put a renter in.  Now your intent in purchasing it totally changed and that property would qualify for a 1031 exchange when you sell.  You could even do a refi of it as soon as the rehab was done and use those proceeds to purchase your next property.  Done this way and VOILA you just started down the BRRR path.  You get all the bang from a flip but the income finance and tax benefits of buy and hold.  And the tax avoidance of 1031.

What you described in your post was another valid twist - You purchased a property with the intent of holding it for productive use.  But you received an unsolicited offer (you weren't intending to sell) and sold.  I agree with your CPA that sure sounds like your intent would qualify for a 1031.

Tyler Bobo · Answer

If you already closed the deal you sold you may have missed your window for a 1031. I'm not 100% sure, but that's my understanding.  Call a quality Realtor and ask them for a referral to a good 1031 exchange company for clarity on that.

I'm not positive I understand your question in the last sentence, yet I do believe you can take your profits in a deal that you're doing a 1031 exchange and buy 2 properties (a flip and a rental) if you choose, but the portion that you use towards the flip, once you sell the second flip you'll have to roll it into another 1031 property or pay all the taxes then.  Again, no expert on the 1031 though I've done a few over the years, that's just my understanding.

Also, read or listen to Tom Wheelright's book, Tax Free Wealth.  He has lots of good strategies in there you might like.  Good luck.

Make some money on first property what’s next?

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