Eat the $100k tax on $400k sale?

Russell BrazilBusiness Member

Moderator

Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

[email protected]301-893-4635 Podcast Guest on Show #192

Quote from @Bryan H.:

I have a 1br condo in prime Dupont Circle neighborhood of Washington DC, - owned it for 27 years - could list it for $425k. Fully depreciated so $100k tax bill due at sale. It was long overdue for full renovation, (all surfaces) and I just finished that, so I’m at a crossroads.

Rent or sell.

I rely on the 20k annual net income, but that’s only a 5% return at best. 1031 exchange seems impossible in practicality with the timing etc…I’ve been looking and not finding a deal to move into.

Would anyone ever just eat the tax in this situation in order to have funds at the ready for the next deal/better investment?

I’d be left with only around $270k after selling fees, if all went smoothly. $270k in Scwab money fund would get me $15k/year while I’m waiting to pull the trigger on something. Some background information - I see new hvac $10k, new windows $10k, and building assessment $10k in the next few years on this property.

I should think a move-up property exists somewhere in the $600-800k range that would cover a mortgage on top of my $400k down payment and still net me $20k/year or more, but not in the markets I’ve looked (DC area and my local NC area) . I need time to figure that out.
More background info - I have no real W-2 income. My income is from 3 successful airbnb’s and this condo.

If I get renters in place right now, take a year to figure out which market makes sense, I still don’t see a realistic path to 1031 due to timing with renters/sale/etc…am I wrong about that?

Id just do a 1031 exchange now.

Also the condo market in DC is very slow. Would not be out of the ordinary for a 1 bedeoom to take 6 months to sell right now.

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Jack Seiden

Real Estate Agent · Washington DC · Member since 2016 · 847 posts · 656 votes

Quote from @Bryan H.:

I have a 1br condo in prime Dupont Circle neighborhood of Washington DC, - owned it for 27 years - could list it for $425k. Fully depreciated so $100k tax bill due at sale. It was long overdue for full renovation, (all surfaces) and I just finished that, so I’m at a crossroads.

Rent or sell.

I rely on the 20k annual net income, but that’s only a 5% return at best. 1031 exchange seems impossible in practicality with the timing etc…I’ve been looking and not finding a deal to move into.

Would anyone ever just eat the tax in this situation in order to have funds at the ready for the next deal/better investment?

I’d be left with only around $270k after selling fees, if all went smoothly. $270k in Scwab money fund would get me $15k/year while I’m waiting to pull the trigger on something. Some background information - I see new hvac $10k, new windows $10k, and building assessment $10k in the next few years on this property.

I should think a move-up property exists somewhere in the $600-800k range that would cover a mortgage on top of my $400k down payment and still net me $20k/year or more, but not in the markets I’ve looked (DC area and my local NC area) . I need time to figure that out.
More background info - I have no real W-2 income. My income is from 3 successful airbnb’s and this condo.

If I get renters in place right now, take a year to figure out which market makes sense, I still don’t see a realistic path to 1031 due to timing with renters/sale/etc…am I wrong about that?

That’s a really tough call, I just sold a property and ate the tax, granted it was relatively low, going through this exercise with a family member right, I’d probably lean toward’s “overpaying” for something to avoid the huge tax hit, but so much of it, is really a question of if you don’t mind managing the properties than yeah 1031 is probably best, if you hate it might be the marginal return of probably an extra 5-6k a year isn’t worth it.

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Bryan H., You've got 27 years of compounding deferral already in the bag. I wouldn't let go of $100K lightly. In your situation, most of my clients will start the 1031 and see what properties are out there. They will either purchase a property that meets the 1031 requirements. Or they will purchase both a property and a DST or second property so they can get the benefit of depreciation back. It's possible with a DST to add significantly more depreciable basis without having the risk of debt. And the depreciation benefit alone would have an additional $10K or so of real benefit to your income each year. All of a sudden $20K and 5% becomes $30K and 7.5@ - not counting amortization of loans and appreciation.

There's no penalty for starting and not completing a 1031. I'd at least try before I stroked a $100K check to the IRS.

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7 Reply

Basit SiddiqiBusiness Member

Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes

[email protected]917-280-8544

$400,000 gain is likely taxed at the following at the federal level

15% or 20% Capital Gains Tax on about $300,000 of the gain.
24% depreciation recapture on about $100,000 of the gain.

You likely are also subject to the 3.8% net invsetment income tax.

You should also factor in locality taxes as well(DC or your state of residence if different).

I am just saying this as you may have to pay more than 25% tax when you sum up all the tax rates, which makes the 1031 more attractive.

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John M.

Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 801 votes

Here is an idea: Sell it and pay the tax. Take your remaining 270K and invest it in mortgage notes paying you 12% or $32,400 a year. No tenant hassles, intermediary commissions, broker commissions, closing costs of a new property, and most of all NO capital improvements to worry about.

Bryan H.

OP

Member since 2021 · 54 posts · 26 votes

Quote from @Basit Siddiqi:

$400,000 gain is likely taxed at the following at the federal level

15% or 20% Capital Gains Tax on about $300,000 of the gain.
24% depreciation recapture on about $100,000 of the gain.

You likely are also subject to the 3.8% net invsetment income tax.

You should also factor in locality taxes as well(DC or your state of residence if different).

I am just saying this as you may have to pay more than 25% tax when you sum up all the tax rates, which makes the 1031 more attractive.

Thank you Basit!

Mike Jacobson

Rental Property Investor · Rochester MN · Member since 2018 · 64 posts · 106 votes

Would there also be a state tax on top of that?

Alex Olson

Real Estate Broker · Kansas City Metro · Member since 2015 · 2k+ posts · 1k+ votes

1031 Exchange. I would not pay taxes unless I desperately needed what is remaining. When you are old and retired and have less income, your tax burden will be less anyway because your income, in theory, will be lower than what it would be combined with this.

Bryan H.

OP

Member since 2021 · 54 posts · 26 votes

Quote from @John M.:

Here is an idea: Sell it and pay the tax. Take your remaining 270K and invest it in mortgage notes paying you 12% or $32,400 a year. No tenant hassles, intermediary commissions, broker commissions, closing costs of a new property, and most of all NO capital improvements to worry about.

John,

So would you honestly do this and eat $100k tax or is this more of a “throw it out there” idea? Mortgage notes paying 12% sounds great yet also risky. Do you hold notes of this type? Where/how do you find them and what are your parameters to vet them so you feel comfortable with the risk?

John M.

Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 801 votes

It depends on what your exchanging it for but consider the costs of ownership of a new property:

intermediary fees, closing costs, financing costs, Improvement costs, your time, and more importantly your rate of return which could be less than your getting now. So when you add that up you can be spending ANOTHER 100K!! You could trade up to something that only earns you 10K a year after financing...that's another 50K over 5 years that you would be missing from your current cash flow. The only upside is that you have more equity.

Feel free to PM about Notes.

Bernard Joseph S.

Investor · NJ · Member since 2022 · 155 posts · 224 votes

1031 all day and twice on Sunday. Never pay something you don't have to. Invest out of state, sunbelt preferred. You're not selling it tomorrow so take some time and research the markets. Come up with a plan and execute. Sounds simple because it is.

Sara Frank

Realtor · Baltimore, MD · Member since 2020 · 255 posts · 182 votes

Quote from @Bryan H.:

I have a 1br condo in prime Dupont Circle neighborhood of Washington DC, - owned it for 27 years - could list it for $425k. Fully depreciated so $100k tax bill due at sale. It was long overdue for full renovation, (all surfaces) and I just finished that, so I’m at a crossroads.

Rent or sell.

I rely on the 20k annual net income, but that’s only a 5% return at best. 1031 exchange seems impossible in practicality with the timing etc…I’ve been looking and not finding a deal to move into.

Would anyone ever just eat the tax in this situation in order to have funds at the ready for the next deal/better investment?

I’d be left with only around $270k after selling fees, if all went smoothly. $270k in Scwab money fund would get me $15k/year while I’m waiting to pull the trigger on something. Some background information - I see new hvac $10k, new windows $10k, and building assessment $10k in the next few years on this property.

I should think a move-up property exists somewhere in the $600-800k range that would cover a mortgage on top of my $400k down payment and still net me $20k/year or more, but not in the markets I’ve looked (DC area and my local NC area) . I need time to figure that out.
More background info - I have no real W-2 income. My income is from 3 successful airbnb’s and this condo.

If I get renters in place right now, take a year to figure out which market makes sense, I still don’t see a realistic path to 1031 due to timing with renters/sale/etc…am I wrong about that?

1031. If W-2 income is an issue for you, maybe try to 1031 into something 5+ units that way you can use commercial financing which wont factor in personal income as much

Christie Gahan

Investor · Hillsboro, OR · Member since 2016 · 310 posts · 153 votes

Quote from @Bryan H.:

I have a 1br condo in prime Dupont Circle neighborhood of Washington DC, - owned it for 27 years - could list it for $425k. Fully depreciated so $100k tax bill due at sale. It was long overdue for full renovation, (all surfaces) and I just finished that, so I’m at a crossroads.

Rent or sell.

I rely on the 20k annual net income, but that’s only a 5% return at best. 1031 exchange seems impossible in practicality with the timing etc…I’ve been looking and not finding a deal to move into.

Would anyone ever just eat the tax in this situation in order to have funds at the ready for the next deal/better investment?

I’d be left with only around $270k after selling fees, if all went smoothly. $270k in Scwab money fund would get me $15k/year while I’m waiting to pull the trigger on something. Some background information - I see new hvac $10k, new windows $10k, and building assessment $10k in the next few years on this property.

I should think a move-up property exists somewhere in the $600-800k range that would cover a mortgage on top of my $400k down payment and still net me $20k/year or more, but not in the markets I’ve looked (DC area and my local NC area) . I need time to figure that out.
More background info - I have no real W-2 income. My income is from 3 successful airbnb’s and this condo.

If I get renters in place right now, take a year to figure out which market makes sense, I still don’t see a realistic path to 1031 due to timing with renters/sale/etc…am I wrong about that?

You need a good accountant.

Consider reinvesting funds in to a syndication. I would start looking for one that is doing a large cost seg study that will provide a lot of tax relief. But, again, you need a professional accountant that is experienced with investors to help you get a soulution specific to you. Maybe consider a reverse 1031? Can you "disappear" any profits with contributions to retirement accounts or HSA?

Bryan H.

OP

Member since 2021 · 54 posts · 26 votes

Quote from @Bernard Joseph S.:

1031 all day and twice on Sunday. Never pay something you don't have to. Invest out of state, sunbelt preferred. You're not selling it tomorrow so take some time and research the markets. Come up with a plan and execute. Sounds simple because it is.

Is it simple though?
Did you see that I need to maintain the $20k income I’m currently netting in whatever I exchange into? I think most people are happy to just 1031 into a larger property and break even, so this adds to the complexity/difficulty.
Also, if assuming a conservative 50-60% leverage - I’ll be looking at $800-1m properties. That means basically multi-unit or multiple houses. Completing a multi house 1031 purchase out of state sounds impossible to me, but perhaps that’s just lack of experience. And multi-unit is so so competitive - doesn’t that realistically take an insider relationship/contact or off market deal to get a property that actually pens out?
I have looked at the current popular investor markets like Ohio and Sunbelt cities and not seen anything remotely close to working for my situation, but I’m just scrolling zillow.

Chad S.

Rochester, MI · Member since 2014 · 88 posts · 50 votes

@Bryan H.

Your situation is similar to mine. Although, I still have many years before I'm fully depreciated. I've looked into doing a 1031 exchange as well but found it's damn hard if not impossible to move up and even receive the same cash flow. I know you said you need the cash flow, but the only other way I can think of to avoid capital gains is to move into it for two years, making it your primary residence and then sell.

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Bryan H., and @Chad S., One easy answer to both the depreciation and cash flow issue is what is called a diversification exchange. Instead of simply purchasing one larger property you would purchase say 2 or 3 properties of the same size as you have now. By purchaseing the same size or less you can keep yourself in the same $/sq ft rent range. And since you're buying more properties with the same dollars you're getting better cash flow. And If you buy more in terms of price than you sell then you are buying additional depreciable basis.

There's no reason to have to accept neutral or less cash flow with a 1031. You can sell one and purchase multiple smaller properties. Or you can consolidate and sell several and purchase one replacement. Which would accommodate someone either wanting to go passive. Or moving to a different class of real estate like commercial or MF.

It would be very tough if all you were able to buy were more expensive properties. The 1031 let's you mix and match and change your portfolio to get the best cash flow the market is offering you at that moment.

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Theresa HarrisPro Member

Member since 2019 · 15k+ posts · 11k+ votes

Could you move into it for a couple of years and then sell it? It would give you a chance to enjoy the renos.

Austin Steed

Real Estate Agent · Columbus, OH · Member since 2016 · 593 posts · 664 votes

@Bryan H. One of the first things I heard getting my Real Estate license was "Defer until you die". Now that I've been investing for some years, this is my plan.

I have a property that I too would like to let go of in Columbus Oh. Understand how when you do a 1031 the timeframe of identifying a property can but pressure on a decision. I've been structuring offers with a 60 day close. This way once under contract I'll then list my property and 1031 into the next.

A win win. No tax to the IRS and no rushed timeline so you can make a sound financial decision.

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

Podcast Guest on Show #222

Quote from @John M.:

It depends on what your exchanging it for but consider the costs of ownership of a new property:

intermediary fees, closing costs, financing costs, Improvement costs, your time, and more importantly your rate of return which could be less than your getting now. So when you add that up you can be spending ANOTHER 100K!! You could trade up to something that only earns you 10K a year after financing...that's another 50K over 5 years that you would be missing from your current cash flow. The only upside is that you have more equity.

Feel free to PM about Notes.

every major market has Mortgage Lenders or Brokers that specialize in placing Private Money for folks like this.. its a huge business and many landlords gravitate to it as they get older and tire of rentals. Just go to any REIA meeting as see how needs to borrow money U can do it yourself just have a lawyer write up your debt instruments anywhere from 250 to 1000 bucks.. I pay a lawyer in KC for instance 250.00 for Deed of Trust and prom note. going rate right now for private money is 12 to 15% coupon and 2 to 5 points at origination and many are just 12 months.. So you can do the math on the return.. Being the sole beneficiary is a very safe way to go.. And ONLY make first position loans.. there is a bunch of White noise going around in the Pace Morby community about gap funding ( 2nds or 3rds) and or Gator lending they call it .. those are highly risky.

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Austin Steed, Structuring those offers with extended closing dates is an awesome plan. Something else to remember - You can go into contract on your replacement property even before you close the sale of your old property. You just have to close the sale of your old property before taking title to the new property. This could conceivably let you stretch your timeframes backwards.

As soon as you feel like your old property will close you use the time between then and sale to get your new property under contract.

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