What do I do with all this money?

Question

Hey everyone, I have a question about a duplex I'm looking at for a 1031 exchange. I have a house I'm flipping now, and will have about 55k into it, hopefully selling for 110-120k. I would really like to not pay taxes on $50k, so I was looking at a property in a good town to 1031 it into. I ran the numbers in the images below, and wondered if this is a wise investment? I realize it is expensive, but the furnace electric roof and other capex items were just done in 2018. My idea is that I can do a 1031 to save on taxes, end up owning a duplex rental in good area, and have my money sit there until I'm out of college, in a more tax favorable investment than the stock market. I realize the 3% cash on cash is pretty depressing, but considering what I'll save with the 1031 on taxes, and that my money is not just sitting in the back, and I learn how to manage a duplex and graduate from a single family flip into the rental game, I have to admit I'm enticed. the property is with a realtor but the person selling is also an investor moving to larger property. I also thought maybe I could (for lack of a better phrase) "go behind the realtors back" and negotiate something with the seller to my advantage and his? Being a newbie I'm not sure how all of this would work but throwing myself into something large and learning along the way has worked so far. Not afraid of hard work or a little stress to build a business before I'm 30. So what do you guys think? Am I insane? thanks in advance, I couldn't have even thought of doing this without BiggerPockets and all I've learned from you guys

Dave Foster · Answer

@Spence Kal, I'll let others speak to the potential property specific.  You do have a powerful motivator in the potential taxable gain.  But at the end of the day that only represents probably 10 - 12K in taxes.  So while it would definitely be worth your while to do a 1031 to shelter the tax, make sure you're not positioning yourself $10K worse just to save $10K.  I'd ask myself if this were not part of a 1031 exchange would I buy the property.  If so then go for it.  If not then ask yourself how much you have to benefit from a 1031 to still make it worth your while.

Also, be careful with doing a 1031 if you truly bought this property intending primarily to resell it (a true flip).  Property bought primarily to flip does not qualify for 1031 treatment.  1031 property is property you bought with the intent to hold for investment use.  Your intent can always change but you want to be able to demonstrate it.  Start by eliminating the word "flip" from your vocabulary :)

Jason D. · Answer

@Spence Kal unfortunately, there is a simple answer to your situation. You can't 1031 a flip, so you'll have to pay the taxes when you sell.

Chris Babcock · Answer

Numbers are pretty black and white, your story eludes to this being a more grey decision for you if you catch my drift.

Here's some cliff notes I'm taking away from your story:

- You have an interest in making a competitive return vs securities, the numbers don't sound like you will. There are ways to potentially fix this problem.

- You have an interest in investing in a learning experience. This sounds to me like a good investment from this standpoint. Question, will you be able to manage this while managing your college career. If you want my opinion college should come first over PM.

- I think your goal is noble and ideal. I don't think a 3% return + learning experience +  owning a multi + potential appreciation is anything to discount. In fact I know people who buy into situations where they break even in hopes of attaining future appreciation returns.

Here's my main doubt, it's hard enough to manage finances when your wallet is tight (assuming yours is) in the transitional period of obtaining a property. I imagine balancing the flip + 1031 + acquiring this new property and managing finances through the appropriate order of operations would be an order of magnitude more difficult than a standard purchase. Something to keep in mind while also minding your college career. But I commend you for evaluating and thinking through the deal and hopefully making it a reality.

Also, if you can do private sale you are correct in that it could save the seller or potentially you some cash in the process. You only really need an attorney ($500ish) to close out a private sale.

I don't think you're insane, sounds like you're motivated. Good luck!

Edit: You can get a loan for 2.5%? Sign me up!

Double Edit: Why not take your amortization over a longer period?

Jason D. · Answer

@Spence Kal the single family you are flipping, is a flip, and therefore you can't defer the taxes on the sale through a 1031 exchange.

Spence Kal · Answer

@Eric Wagner Ahh ok, so there definitely are tax advantages to the flipping industry as apposed to a W-2 job, there are just more for the rental industry.

So in this current flip its definitely wise to keep firm track of expenses and invoices from any contractors? I probably shouldn’t be paying cash for anything so my contractor doesn’t have to count it as income, because then I cannot count it as an expense? Or can I still pay him cash and count it on my expenses, then its up to him to report that cash?

Eric Wagner · Answer

Hi Kal,   Yes flipping is more like a job and less like investing.  You can make a chunk of money and then buy something that you keep longer term, more like an investment. That said if you had a job and made $60k you'd pay taxes...

The advantage is you have many ways when flipping to write off expenses.  If you send up a entity of some sort and have it taxes like an S-corp then there are ways to lessen all the taxes you mentioned in your post.  You don't get away with no taxes but you can have a lot less.

If you are going to flip one house then probably isn't worth it, but if you are going to flip regularly, definitely setup an entity and learn the legal ins-and-outs of lowering your taxes.

It's a big subject, a lot to learn but worth it for the savings if you do lots of flips.  -Eric

Spence Kal · Answer

Here are the numbers on the SFH I have now, In a way I'm scared to rent it because I spent so much time and work renovating it and everything is new. But these numbers do look better than the duplex

Spence Kal · Answer

So my understanding of what I’m reading about taxes is that I have to pay a 15.3% tax for social security and Medicare plus 9.2% for income between 50-100k for a total of about 25% of my flip money taken by the government. And if I get lucky and sell the SFH for 120k and make 60k I lose $15,000 instantly. Then after the taxes I’d have 45k to put into an investment. This is all rather discouraging, it appears I’ve bought myself a job rather than an investment. Need to correct that in the near future

Spence Kal · Answer

@Jason DiClemente ahh ok. my original intent was to rent it out but I’d have to “prove” that by actually renting it out then for I assume a longer period of time like 2 years. Or living in it for 2 years

I wanted to avoid the income tax but also I think if I show that much income this year my grants for college will disappear as well, so I was hoping to avoid that as well. I guess this is why rentals are such a tax benefit

Jason D. · Answer

@Spence Kal it's not about time of ownership, it about intent. Because your intent with the property is to flip it, it is inventory, and not an investment. Therefore, you cant defer the taxes.

What do I do with all this money?

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