Selling rental properties and moving into Fixed income for early retirement

[David Charles Edwards]

I'll be 55 this and our last one graduates high school and will go off to college this year. My wife and I a debt free and own 15 rental properties worth around 1.5 million (net after sale taxes). We also have healthy IRA's and will both qualify for social security in the future.

After being a landlord for nearly 25 years,  I'm thinking about selling it all and moving the money into immediate income annuites or some other fix income vehicle so we can travel and live a less stressful lifestyle.

There doesn't seem to be an easy way to avoid capital gains and I realize many of these fixed income investments don't hedge against inflation.  Just wondering if anyone else has thought of doing this and what some pathways might be.

[Steve Vaughan]

Quote from @Jay Hinrichs:

Steve you probably thought of this but in your state you can be the bank to investors

Thanks, Jay.  I have explored lending for sellers who neeed to retail their place up or local businesses to get off the ground/ expand vie lending or fair equity splits and consulting.   

The why has to be bigger than my ROI though so not done much.

[Jay Hinrichs]

Quote from @Steve Vaughan:

Quote from @Jay Hinrichs:

Steve you probably thought of this but in your state you can be the bank to investors

Thanks, Jay.  I have explored lending for sellers who neeed to retail their place up or local businesses to get off the ground/ expand vie lending or fair equity splits and consulting.   

The why has to be bigger than my ROI though so not done much.

for me it keep me in the game .  And you find a young and up coming RE star and you can change their life..

[Kevin Mitchell]

@David Charles Edwards have you considered seller financing?

That way you may lower your tax bracket and and get fixed income as well.

[Dave Foster]

@David Charles Edwards, As we've seen throughout this thread - there aint no such thing as no risk.  Every path has risk - just of a different sort.  And that's where your personal tolerances and strengths come into play.  The phrase - "There doesn't seem to be an easy way to avoid capital gains" says it all.  

Some of the more interesting examples were

1. selling and carrying back the loans (being the bank).  What's the risk?  You can end up owning the property again after lengthy foreclosures.  But these are properties you know and have successfully managed before.    In my mind, the biggest risk here is the lost tax immediately.  It will take a lot of years of interest (post tax) before you've equaled the immediate impact of losing 20 - 40% of your gain in tax and depreciation recapture.

2. Fixed income - It feels the least risky.  But you correctly identified the inflationary risk.  And again you're starting out with a much smaller nest egg because of the immediate impact of taxes.  And if it takes you a long time to pay back that tax to yourself as a hard money lender, think about how hard it will be using 2% annuities to make you whole.

3. The path I've chosen is to keep equities and real estate separate.  And use the real estate side of my life to minimize taxes on income and compound the returns on my real estate side using variations of things including 1031 exchanges, primary residence sales and conversions of investment property into primary residences.  ultimately my real estate (including passive things like syndications, LTRs managed for us.  STRs managed for us, share cropped agricultural land, and Delaware statutory trusts) will go to my heirs and they will pay no tax.  I will pay no tax.  And the estate will pay no tax.  

There's always good reasons to just sell and pay tax.  But I only do that soooooo grudgingly.  1031s aren't that hard.  And they're designed to do exactly what you want.  Since there's more than a million done each year I doubt if most folks find them as hard to do as they think.

[Randall Alan]

Quote from @David Charles Edwards:

Quote from @Sergio A. Chucaralao:

Quote from @David Charles Edwards:

I'll be 55 this and our last one graduates high school and will go off to college this year. My wife and I a debt free and own 15 rental properties worth around 1.5 million (net after sale taxes). We also have healthy IRA's and will both qualify for social security in the future.

After being a landlord for nearly 25 years,  I'm thinking about selling it all and moving the money into immediate income annuites or some other fix income vehicle so we can travel and live a less stressful lifestyle.

There doesn't seem to be an easy way to avoid capital gains and I realize many of these fixed income investments don't hedge against inflation.  Just wondering if anyone else has thought of doing this and what some pathways might be.

 First of all congratulations on that early retirement. This is just me brainstorming ideas based on the scenario you wrote. This is not advise I'm not CPA, this is just something for you to think about. If it is necessary for you to get all the funds from the sales at once then it doesn't seem like you have another option than paying capital gains. But if this is not the case one option would be to seller finance that way you can have control of how much income you are getting every year. The other option would be if there is a possibility for you to sell your primary residence and every two years move to one of the property and gradually sell each property once you get that tax exempt which is $250 thousand if single or $500 thousand is married. I wish you the best luck with this good problem that you have whatever you decide to do make sure you consult a professional to assist you with the transaction. Happy retirement!

 Thanks for the feedback!  So we got a fairly serious offer from Pace Morby a couple years ago.  There was an all cash offer which would have cost me around $400k in capital gains.  They also made a seller finance offer which initially looked better but in the end,  didn't really save all that much money in capital gains  (like $60k) AND keep in mind,  state capital gains are due in the year of the sale and any depreciation recapture is due in the year of the sale.  For those reasons,  we decided to either keep the units until death and pass them along or sell them individually over a 4-6 year period (which saves some in capital gains as well).  The primary residence thing every 2 years isn't really an option.  With 15 units, it would take too long.  One point to keep in mind, we are either gonna be IN or OUT.  There is no middle ground with rental property.  Owning 2 or 3 is the same headache as owning 15.  Thanks again for the brainstorming.

 @David Charles Edwards

I wanted to suggest caution regarding your annuity path.

I’m just another landlord, so I’m just working from knowledge I have accrued over time.  But if you look at annuities, they are an insurance product, not as much an investment product.

What insurance companies do with your money you invest in their annuity is put it in the stock market and keep the difference of what they pay you and what they make in the stock market.  This translates to: they know they will make more with your money in stocks / & bonds long term.

I know the allure of fixed / known income is appealing… but if you do the math I bet you will find that the historical average of the market outperforms what the insurance company is offering as the return on the  annuity.  Otherwise, they wouldn’t be offering the product

In my book, annuities are always a bad choice over other investment vehicles.  I would just encourage you to do some research, because once you buy their insurance product, you can’t really back out of it.
all the best!

Randy

[Silvia Baier]

@David Charles Edwards

@JD Martin 

I think I understand the equity harvesting idea enough to explain why it's good. I don't think it's super complicated either if you look at it year by year first. JD made the spreadsheet but that assumes no further investing, which I think he may have suggested in an earlier post. Plus it doesn't explain in thorough detail. 

Assumption: 15 year loans being used below

Year 1: 

Hire property manager for all properties to get rid of the headache so you can enjoy retirement. Now let's assume that due to PM, your net rent goes from 1000/mo to 900/mo for all properties.

Refinance one unit at 8.5% (due to high rates I would only do one unit per year until the rates come back down).

Now you are possibly "net zero" on one property due to the refi. Zero taxes but zero income.

Untaxed "income": 100k (from the refi)

Taxed Income: rent from 14 remaining properties. 900*14unit*12mo = 151k - taxes = 120k?

Net "income" for Year one after tax: 220k. Whatever you don't spend on travel/fun, invest into dividend stocks, ETFs, annuity, whatever you like. I'd suggest putting at least the full 100k from the refi into investments. Since you are using a PM, you start relaxing year one.

Year 2: 

Refinance another unit = 100k untaxed "income".

13 units income after taxes = 900*13*12*0.8(tax factor) = 112k after taxes

Dividend/annuity income: 5-7k after taxes?

Net income year 2: 219k. Invest what you don't spend, preferably the full 100k from the refi.

Year 3:

Refinance one.

Net income 900*12*12*0.8 (103k) + 100k (refi) + 11k (dividend) = 214k. Invest.

Year 4: 195k + 18k dividends (net after taxes)

Year 5: 186k + 24k dividends (net after taxes)

...

Year 10: 100k refi + 43k rental income + 60k dividend income = Net after taxes 203k

...

Year 15: Now you have 1.5m in dividend stocks or annuity, and each year afterward one property is paid off again. 90k dividend income net after taxes and PM.

So in summary, 

1. If you only hire a PM now and no further changes/refi/investment, in 15 years, you have 15 paid properties and no dividend income, no pile of cash, but you still relaxed and enjoyed retirement, you can still sell the property for a pile of cash but pay taxes/recapture. Your annual income was around 90k/year for fun.

2. Equity "harvesting": At 15 years, now you could start selling off the paid units one per year for tax purposes as they get paid off, while collecting more and more dividend/annuity income. So live off the annuity income/SSA/IRA, and invest the sale money into annuity/stock. Eventually your annuity/stock is AT LEAST $3m basis (from the refinances and the sales) not to mention growth and reinvestment. Your annual income was around 105-110k/year for fun PLUS you now have a huge annuity.

Please if anyone sees holes in this, let me know, as this is my future strategy should I be in the same boat (wanting to quit landlording).

[JD Martin]

Quote from @Silvia Baier:

@David Charles Edwards

@JD Martin 

I think I understand the equity harvesting idea enough to explain why it's good. I don't think it's super complicated either if you look at it year by year first. JD made the spreadsheet but that assumes no further investing, which I think he may have suggested in an earlier post. Plus it doesn't explain in thorough detail. 

Assumption: 15 year loans being used below

Year 1: 

Hire property manager for all properties to get rid of the headache so you can enjoy retirement. Now let's assume that due to PM, your net rent goes from 1000/mo to 900/mo for all properties.

Refinance one unit at 8.5% (due to high rates I would only do one unit per year until the rates come back down).

Now you are possibly "net zero" on one property due to the refi. Zero taxes but zero income.

Untaxed "income": 100k (from the refi)

Taxed Income: rent from 14 remaining properties. 900*14unit*12mo = 151k - taxes = 120k?

Net "income" for Year one after tax: 220k. Whatever you don't spend on travel/fun, invest into dividend stocks, ETFs, annuity, whatever you like. I'd suggest putting at least the full 100k from the refi into investments. Since you are using a PM, you start relaxing year one.

Year 2: 

Refinance another unit = 100k untaxed "income".

13 units income after taxes = 900*13*12*0.8(tax factor) = 112k after taxes

Dividend/annuity income: 5-7k after taxes?

Net income year 2: 219k. Invest what you don't spend, preferably the full 100k from the refi.

Year 3:

Refinance one.

Net income 900*12*12*0.8 (103k) + 100k (refi) + 11k (dividend) = 214k. Invest.

Year 4: 195k + 18k dividends (net after taxes)

Year 5: 186k + 24k dividends (net after taxes)

...

Year 10: 100k refi + 43k rental income + 60k dividend income = Net after taxes 203k

...

Year 15: Now you have 1.5m in dividend stocks or annuity, and each year afterward one property is paid off again. 90k dividend income net after taxes and PM.

So in summary, 

1. If you only hire a PM now and no further changes/refi/investment, in 15 years, you have 15 paid properties and no dividend income, no pile of cash, but you still relaxed and enjoyed retirement, you can still sell the property for a pile of cash but pay taxes/recapture. Your annual income was around 90k/year for fun.

2. Equity "harvesting": At 15 years, now you could start selling off the paid units one per year for tax purposes as they get paid off, while collecting more and more dividend/annuity income. So live off the annuity income/SSA/IRA, and invest the sale money into annuity/stock. Eventually your annuity/stock is AT LEAST $3m basis (from the refinances and the sales) not to mention growth and reinvestment. Your annual income was around 105-110k/year for fun PLUS you now have a huge annuity.

Please if anyone sees holes in this, let me know, as this is my future strategy should I be in the same boat (wanting to quit landlording).

Nice job :) Yes, you've got it. I portrayed it as if you want to "eat your young" so to speak and just consume the principal, but if you reinvest the funds pulled from the properties, you essentially transfer all of the equity from the properties to something else tax free (assuming you keep the properties). Yes you pay the prevailing interest rate on the mortgage but now, if you are going to reinvest instead of consuming the principal, your effective tax rate on that money goes from the 5/6% that I noted to the delta between that figure and your return on the invested funds, which could be essentially 0. Let's say you take that money and put it into a Roth IRA. Well, now (assuming there's no apocalypse) you have transferred all of that equity into a 100% tax sheltered income stream. You don't get a tax credit on it, but you don't need it because the money you harvested from the rental isn't taxable.

So much of wealth in the US is not only understanding how to get it, but then understanding how to keep it. 

[Silvia Baier]

Quote from @JD Martin:

Nice job :) Yes, you've got it. I portrayed it as if you want to "eat your young" so to speak and just consume the principal, but if you reinvest the funds pulled from the properties, you essentially transfer all of the equity from the properties to something else tax free (assuming you keep the properties). Yes you pay the prevailing interest rate on the mortgage but now, if you are going to reinvest instead of consuming the principal, your effective tax rate on that money goes from the 5/6% that I noted to the delta between that figure and your return on the invested funds, which could be essentially 0. Let's say you take that money and put it into a Roth IRA. Well, now (assuming there's no apocalypse) you have transferred all of that equity into a 100% tax sheltered income stream. You don't get a tax credit on it, but you don't need it because the money you harvested from the rental isn't taxable.

So much of wealth in the US is not only understanding how to get it, but then understanding how to keep it. 

Thank you!! One thing I don't understand is the Roth comment. Between him and his spouse, being 50+ (both I assume) they could put in a total of $16k per year. Is that what you meant, or is there a way to put more in? I know you can convert a traditional IRA to Roth by just paying tax on the amount converted, but no other ways to inject more money in there. Thanks JD and everyone else for your inputs to the forums!

[Jeff Hales]

Quote from @JD Martin:

Quote from @David Charles Edwards:

I'm not referring to a HELOC, since you normally don't get those on investment properties - I'm talking about straight up mortgages on the property. Read up on equity harvesting here and elsewhere, but yes you get the general idea in your last paragraph - cash out, let the PMs deal with the properties, rinse and repeat every 15 (or 20, or 30) years. Yes, you have to open up a little bit from the Dave Ramsey mindset which works great for people on the edge but not very well for investors or those with money.

Even at 8.5%, as long as everything gets paid for it's largely irrelevant. If rates fall significantly, refinance. Now if you don't need or want the extra income, then you can just leave thing as is, but then there's also little compelling reason to sell and take the tax hit. 

After 25+ years of acquiring and managing our rental properties,  the "compelling reason" to sell is just freedom, peace of mind, reduced liability, and guaranteed income from an annuity.  I suppose I need to at least try the Property management route first before I cash out and walk away.  I've still got another year before the last one graduates high school and we are empty nesters.

Another wrinkle to consider.  I own all these properties in my name.  Rather than setup LLCs for each property and deal with the added expenses and book keeping,  we just file them on schedule E and I have a butt load of liability coverage.

If I keep them,  I might want to restructure as part of the refinancing to reduce my exposure and maybe even set them up so the kids could take over without having to be actively involved.  I'm not sure how that would be done.

 I have the same setup as you. Don't overthink it. Maximum liability coverage and a good umbrella policy is going to take care of 99.9% of your needs and exposure. As far as your kids, that's easy too - set up a trust and move everything into the trust. 

Real estate is best served by holding it forever, at least the way our current tax system is designed. 

 This definitely is a big brain move @JD Martin !! Especially if they're all paid off!! But I would definitely restructure to remove exposure, shouldn't be too much of a lift to organize LLC's and proper trust!

The only other option that I have seen that is "the best of both" is a company here in California that has setup a fund you could contribute the properties to and receive equity as an investment partner of the fund that gives equitable share of the entire funds properties without exposure to liability. Investors receive % annual cash flow, increased deprecation benefits, refinance distributions, with long-term generational returns.

Since they're focusing on multifamily units here in California I don't if it would work for you, but applying the same equity harvesting strategy is gold, imo.

Congrats on retirement btw!!   

[David Charles Edwards]

 This definitely is a big brain move @JD Martin !! Especially if they're all paid off!! But I would definitely restructure to remove exposure, shouldn't be too much of a lift to organize LLC's and proper trust!

"organizing" 15 LLC's would cost a minimum of $500 per year per unit here in North Carolina plus the headache of book keeping. Corp return for each unit plus annual $200 fee to North Carolina plus K1 preparation.

[Carl G. Moose]

100% Understand.........I had 750 Tenants living in my MF Bldg's..........

There are absolutely ways to get off the SFH treadmill, trading those assets in one shot and stepping into low-risk, single-tenant, 10+ year leased properties, backed by Nat'l Credit Tenants like FedEx, Amazon, UPS, and other solid companies

Looking for a better strategy, I combined my banking, real estate & Renewable Energy experience to develop the "Energized Real Estate" model. 

My partners and I have contracts on 3 commercial buildings TODAY - All NNN, Long-term Leases, with aggressive CAP Rates, which perfectly fit our "Energized Real Estate" model that forces 5 - 6 additional revenue streams, above and beyond the lease income, using Federal, State, and Utility Incentives (Plus Grants).

You have to think Bigger Pockets and Out-of-the-Box......

[JD Martin]

Quote from @Silvia Baier:

Quote from @JD Martin:

Nice job :) Yes, you've got it. I portrayed it as if you want to "eat your young" so to speak and just consume the principal, but if you reinvest the funds pulled from the properties, you essentially transfer all of the equity from the properties to something else tax free (assuming you keep the properties). Yes you pay the prevailing interest rate on the mortgage but now, if you are going to reinvest instead of consuming the principal, your effective tax rate on that money goes from the 5/6% that I noted to the delta between that figure and your return on the invested funds, which could be essentially 0. Let's say you take that money and put it into a Roth IRA. Well, now (assuming there's no apocalypse) you have transferred all of that equity into a 100% tax sheltered income stream. You don't get a tax credit on it, but you don't need it because the money you harvested from the rental isn't taxable.

So much of wealth in the US is not only understanding how to get it, but then understanding how to keep it. 

Thank you!! One thing I don't understand is the Roth comment. Between him and his spouse, being 50+ (both I assume) they could put in a total of $16k per year. Is that what you meant, or is there a way to put more in? I know you can convert a traditional IRA to Roth by just paying tax on the amount converted, but no other ways to inject more money in there. Thanks JD and everyone else for your inputs to the forums!

 Correct, I didn't mean to imply that you could do all of it dollar for dollar; it was 3 in the morning and I had insomnia 🤣

[Silvia Baier]

Quote from @JD Martin:

 Correct, I didn't mean to imply that you could do all of it dollar for dollar; it was 3 in the morning and I had insomnia 🤣

I've been having that lately too. I'd call it Real Estate Euphoria. ;)

[Peter Hogan]

Congratulations on reaching this exciting level of success and stage in your career. I'm fairly new to the site and not an expert on this topic but I'm interested in reading through others replies. Best of luck and congrats again!

[John McKee]

Since you said you want to be more passive, here are your only options in my opinion:

1) 1031 into A DST

2) Sell and pay capital gains tax and take proceeds to invest in mortgage notes at 12%

3) Keep what you have and hire a property manager.

4) Do a combination of all 3 above for diversification purposes.  Maybe keep those properties that have the most appreciation potential.

[David Charles Edwards]

Quote from @John McKee:

Since you said you want to be more passive, here are your only options in my opinion:

1) 1031 into A DST

2) Sell and pay capital gains tax and take proceeds to invest in mortgage notes at 12%

3) Keep what you have and hire a property manager.

4) Do a combination of all 3 above for diversification purposes.  Maybe keep those properties that have the most appreciation potential.

 How do you invest in mortgage notes for 12%.

[Carl G. Moose]

That REP Status is so important in these situations. We deal with it all the time when High W2/1099 Earners participate in our Commercial “Sale Leaseback - Energized Real Estate” deals.

I wrote a short book on that exact topic

[John McKee]

@David Charles Edwards

Mortgage note investing can be done as a syndication, but without all the drama of capital calls, bogus fees and risk like traditional MF syndications.  Your investing in people's mortgages where they live, which generally speaking have a very steady rate of return and have payouts from day one.   The syndicator will buy these notes in bulk.  Some of them performing and others non performing at a deep discount.  Their job is to get the non performing ones on a new payment plan.  I'm a big believer that these notes should be a part of everyone's passive income plan because you can't get any more passive than this.  

[Natalie Bender]

@David Charles Edwards, as mentioned above 1031 into a portfolio of DSTs could be the right fit. A DST is a hands-off, institutional grade real estate investment (apartments, self storage, commercial, medical office, etc), that allows the investor the option to diversify into multiple markets and industries around the country. DSTs can provide steady cash flow, tax deferment and will keep pace with inflation as you are still invested in Real Estate, just passively. Professionals with decades of experience and proven track records do all the heavy lifting. Investors must be accredited. Here is a blog post written by Leslie Pappas, you may find it speaks to you.

https://www.biggerpockets.com/member-blogs/7993/48729-are-your-rental-properties-weighing-you-down

[David Charles Edwards]

Quote from @Natalie Bender:

@David Charles Edwards, as mentioned above 1031 into a portfolio of DSTs could be the right fit. A DST is a hands-off, institutional grade real estate investment (apartments, self storage, commercial, medical office, etc), that allows the investor the option to diversify into multiple markets and industries around the country. DSTs can provide steady cash flow, tax deferment and will keep pace with inflation as you are still invested in Real Estate, just passively. Professionals with decades of experience and proven track records do all the heavy lifting. Investors must be accredited. Here is a blog post written by Leslie Pappas, you may find it speaks to you.

https://www.biggerpockets.com/member-blogs/7993/48729-are-your-rental-properties-weighing-you-down

Most of the 1031 to DST options I've found are rife with fees. Any tips on how to avoid these huge fees for small investors like myself. My units are relatively low priced so the fees are much more impactful.

[Natalie Bender]

@David Charles Edwards 

Due to the regulations around these investment products, I am limited on how much information I can share on a public forum without knowing your accreditation status, financial background, investment goals and risk tolerance. My email is below...I would be happy to do a deep dive on DSTs and see if they would be the best financial product for your specific needs.

My best advice would be to to look at quality sponsors that have a track record to back their reputations. There is always a cost to invest whether that is buying a new property or investing passively, however if the DST performs like projected the appreciation upon sale could out weigh those costs. Reach out any time.

[Carl G. Moose]

There are ways to offset Passive Income with Renewable Energy Programs such as the Federal Tax Credits, Modified Accelerated Cost Recovery System (MACRS), and Cost Segregation Depreciation, however, Capital Gains is another story.........This is where a skilled accountant is critical.

[Justin R.]

Such a great thread! Also congratulations on being in your position. 

Last year I sold 10 properties valued at just a little more than you from my portfolio. They were the "problem child" performers for me and all in one geographical area. I farmed the my portfolio in that region to a bunch of agents; and when I got an offer I was happy with I sent it to my CPA so he could run numbers and let me know what total effective taxes I would be paying after Cap Gains and depreciation recapture.  For me personally it was a way bigger pill than I was willing to swallow.

I came out with a plan BEFORE I started my 1031 timelines, so I wouldn't be under stress and make a bad decision. Here was my plan.

1. 1031 into one single apartment complex that would have a return that met my demand (6.5% or higher in a class B area.)

IF I couldn't find that within 40 days I would

2. Invest with a Quality syndicator in a TIC (Tenant in Common)

IF they were not closing on a deal for me to go on title within this time I would....

3. Invest by day 45 with a DST that specializes in secure cash flow investments (NNN type stuff.)

Just an idea. I ended up with my second option (Investing in a syndication) because I couldn't find a property myself that I felt optimistic about during the cap rate crunch. I didn't feel rushed though, because I had a backup plan, and even a secondary contingency plan.

I also think the loan harvesting is a great idea, especially if you mix that with a great property manager. That 8% is so worth it, you have done your job, let someone else take that part over now.

Cheers!

[Gail L boucher]

Have you thought about investing in gas and oil with about a 9 to 10 % roi.. its a 1031 exchange alternative of like kind. 

[Tyler M.]

Quote from @David Charles Edwards:

Quote from @Natalie Bender:

@David Charles Edwards, as mentioned above 1031 into a portfolio of DSTs could be the right fit. A DST is a hands-off, institutional grade real estate investment (apartments, self storage, commercial, medical office, etc), that allows the investor the option to diversify into multiple markets and industries around the country. DSTs can provide steady cash flow, tax deferment and will keep pace with inflation as you are still invested in Real Estate, just passively. Professionals with decades of experience and proven track records do all the heavy lifting. Investors must be accredited. Here is a blog post written by Leslie Pappas, you may find it speaks to you.

https://www.biggerpockets.com/member-blogs/7993/48729-are-your-rental-properties-weighing-you-down

Most of the 1031 to DST options I've found are rife with fees. Any tips on how to avoid these huge fees for small investors like myself. My units are relatively low priced so the fees are much more impactful.

@David Charles Edwards - I agree about DST fees. There are some better passive options that have lower fees and higher returns. DM me if you want to discuss.

Tyler