Cash Rich Knowledge Poor

[Barry Cooper]

I bought along with 4 other investors in 2005 a 3-family new construction in Bed-Stuy Brooklyn NY. It's now come to the point to sell and each of us will make 135k before taxes selling the place. Myself and another investor have decided to stay with real- estate investing and go in together on another multi-family in the nyc metro area. My question: is it smart to pay cash for a building with the intentions of fixing it up in this area? Or would I do better going down south where my money go a little further and tax would not be so high? For most places tax has been around 8k per year.

[Dave Foster]

Hi Barry,

@Damon Bodine is right. You ought to explore a 1031 exchange for sure. It all depends on the ownership structure of the 5 investors and your reinvestment goals. If the 5 of you own the property as tennants in common it is an easy matter to spin your %TIC interests either separately or together into one or two exchanges. If you used a corporate entity to purchase the property then that entity would have to do the exchange and the unravelling of the partnership becomes a little more problematic but doable.

The other half of your issue is the reinvestment requirements.  you seem to be debating holding your next investment with your partner as cash only.   This will be fine as long as the current asset is debt free. The IRS expects you to Purchase at least as much as your sell (net sales price of your % ownership) and to use all of your % proceeds in the next purchase.  In your instance you mention that each partner is going to "make" about $135K. If there was no debt on the old property then you would need to purchase $135k of property ($270K if you and your partner want to go in together).

But if there was debt on the property then that debt adds to your reinvestment requirements.  For instance if 200K in debt is paid off then your share of that as net sale would be 40K.  So you would need to purchase at least $175K or real estate and use all $135K in proceeds to do that ( if it's two of you then that is $350k in purchase using $270 in proceeds).  There is no statutory requirement that you take out new debt.  You could simply add your own cash to the investment but for most people it means that they will have to take out new deb in order to not have part of the transaction be taxable.

Your question was really more about the suitability of a geographic location rather than tax savings but since Damon brought it up I thought I'd chip in.  The added bonus is that the 1031 can be used to reinvest in any geographical location in the US or US territories.  And you can purchase any type of investment real estate you desire also.  So it is worth looking into as part of your overarching strategy.