What do you think of my 1031 plan?

Question

Hello,

I have an idea I want to run by you all.  Someone's probably already done it, but I felt clever for thinking it up... if it actually works.

I have a condo in Boulder, Colorado that I bought in 2013.  It's appreciated handsomely, and I'd like to cash it out to turn it into two or three rentals.  Naturally, I want to use a 1031 exchange to avoid capital gains.  I think it's going to be a challenge to find one good deal within the 45 day naming period, let alone two or three, so here is my idea:

If I'm only able to find one good deal during the time limit, I will buy that property entirely with cash.  I won't have enough money myself to pay cash, but I can take out a short term loan from the bank of Mom to make up the difference.  I'll close on the property, fix it up, get it rented and seasoned, and then do a cash out refinance.  By this process, I will have sold a property, bought another, paid my mom back, have cash in hand without paying capital gains, and have as much time as I'd like to search for the other deals.

I've checked with a 1031 exchanger and my loan guy, and neither of them had any red flags.  I'll be doing some direct marketing to try to drum up good deals, but I feel like this is a good way to hedge my bets.

What do you all think?

:-) Teague

Teague Anderson · Answer

@Brent Coombs  Right.  If I sell my condo for $300k, say, and then only find one replacement property for $300k or more, then I'd be tying up all of my proceeds into that one property, but then I could refinance later to pull that equity out.  I would pay cash for the first transaction to avoid having double loan fees within a short period of time.

Brent Coombs · Answer

@Teague Anderson, afaik, "you must purchase at least as much as you sell". (See Dave Foster's response in an earlier thread, below):

https://www.biggerpockets.com/forums/311/topics/22...

In other words, it's not a requirement to buy "two or three rentals" during the 45 days, but, if you don't spend all the sale price of your condo, aren't you still up for capital gains tax on the difference? [Or, has there been a change in the rules, or something else I'm missing?]

I guess what I'm asking is: how is your plan different from any other 1031 exchange? Cheers...

Account Closed · Answer

The best thing you can do is make sure you have a team of superstars - an awesome agent who understands what you are trying to do and a qualified intermediary that has an incredible track record - I know several if you need a reference.  Best of luck to you and enjoy those earning with out paying taxes!

Brent Coombs · Answer

@Teague Anderson, sounds like a plan. But, why not try to find (70c in the $)  bargains every time, so that your "BRRRR strategy" [look it up] will allow you to re-use your initial funds over and over again, overcoming the "eroding leverageability" mentioned by Dave Foster. Cheers...

Teague Anderson · Answer

Thanks Dave and Spencer for your feedback.

@Brent Coombs  So I'm not trying to get all of my cash back, I'm just trying to get some of it back.  If I only find one $300k property to replace the one sold during the time limit, then I would have to put all of the proceeds into the new property to avoid capital gains and I would have none of that cash in my bank account to use toward another property.

But say I refinance that property 6 months later with a 75% LTV, then I could have $225K in my bank account to use for other down payments.  It's basically a work around to both avoid capital gains, and to get money in the bank for further investing that doesn't have a time limit on it.

Here's another scenario where I could use the same strategy:  I sell the condo for $300k, and receive $200k in proceeds from the sale.  During the 1031 exchange, I get two properties under contract for $200k each.  Instead of putting $100k worth of proceeds to each for a down payment, I put down $40k for a typical LTV on one property, but the other one I take out a loan from the bank of Mom and pay cash.  Six months later, refi that to pull $150k out (75% of appraised value).  After paying Mom back I would have two properties with conventional loans and still have $110k in the bank to use at my leisure for another two or three downpayments.

:-) Teague

Dave Foster · Answer

@Teague Anderson, It's a solid plan and the easiest way to keep your 1031 safe.  Sell one and buy one for all cash (the 1031 proceeds and mom).  Then refinance and use proceeds of refi to pay mom off and get new property.

Only thing to watch out for is eroding leverageability.  With each purchase the down gets bigger and refis typically give you a little less of equity each time than purchases.   As you go you're buying power will erode.

Other than that go for it.

Brent Coombs · Answer

Sure. But, paying all cash then financing later, only really helps you if that (next) $300k property would actually appraise for around $400k, so you'd get all of your $300k back, right?

Otherwise, why not just put down 25% and do a normal loan? Afaik, the payment for that next property doesn't have to be from the same "bundle of cash" that you got for your condo. Huh?

Surely, many people do 1031 exchanges a lot. So long as the timing and amounts match up, does it really matter if you got paid in a lump sum, here, but used funds from a different source for the other purchase, there? [If I'm wrong about that, to me it'd just seem weird, is all]...

What do you think of my 1031 plan?

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