How early is *too* early to 1031?

Question

So I was just commiserating with a coworker about how I'd love to move on a new real estate opportunity here in town, but all my capital was currently tied up. I came back to my desk, and looked at the time - it was 10:31. Thanks, universe!

So, I wanted to ask a quick question here. I've got my first investment property we just purchased and intend to fix and rent. We bought for $26,000 on a commercial investment loan, and need to put $14,000 into it; the appraisal for purchase noted the property would be valued at $60,000 after repair. We intend to rent it, but would be willing to sell in order to move up to a larger property with more income potential.

The deal we are looking at moving on is a 10-bed 3-bath old boarding house that was used as a single family. With a major construction project going through our area, we've had almost a thousand pipeliners move into our small town of around 10,000, and there simply isn't enough housing supply. By using it as a 10-bed boarding house, we think we could charge almost 600 per room per month - way cheaper than the hotels that are charging almost $75 per night. This property is listed for $200,000 but think we could get it for $175,000 - if we put everything we got over rents and expenses against the mortgage, it could be paid off in a little more than 5 years. Once the construction project is complete, we would restore the property to its 1930s charm and use it as a bed and breakfast since there isn't anything like that in our town either.

I know the 1031 wouldn't get us to a full down-payment on the larger home - we'd have to find additional capital - but it would put a dent in it.

How early is *too* early to 1031 exchange into a larger property?

Dave Foster · Answer

@Stanley Bronstein, @Richard Sherman, isn't there an old fable about a client, a CPA, a realtor, and an attorney in a car when it hits a pot hole? The attorney yells to take pictures of the pot hole so he knows who to sue. The CPA looks in the rearview mirror and says "wow you hit a pot hole back there". The realtor wants to move some shrubs and add decorative fencing to hide the line of sight to the pot hole. so the client gets out of the car and lets it go over the cliff with everyone else in it :) And for the record I am a degreed accountant so I'm throwing myself under the bus here also - no hate today!I've done exchanges where the client saved less than $1000 (but she was very quick to remind me that it was her money gosh darn it). I've had clients stroke tax checks of $300K because it just wasn't worth the effort of a 1031 at that moment. To each their own. @Samuel Glantz, @Timothy Doenges, Don't let the tax tail wag the dog.But don't be afraid of a few hoops to jump through to get some savings either.

Dave Foster · Answer

@Timothy Doenges, you gotta watch out for those tea leaves in a clock. A whole lot of craziness was also started one afternoon at 4:20 pst. Intent is the critical component as @Stanley Bronstein said. Rental income is not a statutory requirement. Nor is there a statutory holding period. Your intent must have been to hold the property for productive use. Income strengthens that claim as does actual length of time. But they are not the test. You mentioned an intent to hold and rent. Document well and evaluate.

Mary M. · Answer

I am not a pro - however I have done several 1031s. It sounds to me like you are not in a situation that would need it. Plus the constraints on a 1031 are not for the faint of heart and at this point in the cycle i would find it too challenging to complete If it were me, i would just think about selling your current property and just buying the new property.

Stanley Bronstein · Answer

@Timothy Doenges The first question I would ask is how much gain do you have on the property you plan on selling? Unless it's a lot of gain, it's probably not worth the time, expense and paperwork to do a 1031. If you're only talking a $20,000 taxable gain (probably less after expenses of sale), that's probably not enough (in my opinion), to make it worthwhile to even bother doing a 1031.

Stanley Bronstein · Answer

@Timothy Doenges It's not a question of what is enough? There can never be too much documentation. For lack of a better way to say it, document everything that supports your position.For example: Tuesday, Decided to buy rental property that I intend to hold for investment. Wednesday, talked to broker asking him to find me rental property that i intend to hold for investment. Thursday - Found rental property I intend to hold for investment. Friday - Submitted contract for rental property I intend to hold for investment. Saturday - Closed on purchase of rental property I intend to hold for investment.Just document everything. While many people have different systems, I use Evernote to keep track of the things I'm working on. They have free accounts to get you started and it's only about $50 a year if you decide to do a paid account. I use it for everything.

Richard Sherman · Answer

@Stanley Bronstein I am just playing, my CPA is probably my favorite person I pay, some of the strategies have saved us a LOT of money. I know you don't write the tax code....your lobbyists do...I AM KIDDING! :)

Stanley Bronstein · Answer

@Richard Sherman CPAs didn't write the tax code. They just help you navigate and the good ones help you navigate it better than most.

Stanley Bronstein · Answer

@Richard Sherman You left out the cost of getting your CPA to keep track of all the mess. I know I charge extra when I have to deal with one of these puppies.

Richard Sherman · Answer

@Timothy Doenges I agree with @Samuel Glantz , @Sam Shueh , @Stanley Bronstein @Dave Foster AND @Mary Mitchell ...hope I didn't leave anyone otu..haha pretty much everything above. Figure your cost on a 1031 for relinquish (selling) is around $500-750 and on the replacement (purchase) is maybe $250 or so and a lot of paperwork, timelines and restrictions, if it is 10k and you have held it more than a year so it is long-term capital gains instead of short-term capital gains, then it is maybe saving a few hundred bucks...not worth it. Maybe the 1031 costs more than that, I am not sure, those are my most recent prices but I have done several so I THINK I am getting a good deal from the exchanger.

Sam Shueh · Answer

The appraisal value is what the independent professional assess it will be selling for. Often they come out lower than owners had hoped for. So you try to sell it at 60K less 49K- 6K(Closing cost)- interest=< 14K-interest. Across the nation just about every State homes sell not higher than before March. Here it is -5 to -12% lower with a long marketing time.So you save ~20% of 14K or 2.8K capital gain tax -commercial interest rate. It is close to a wash since 1031 tax deferred tax exchange probably costs almost as much.