Would you 1031 exchange or keep this investment?

[Priscilla Y.]

My husband and I have not been able to figure out the math on this and I hope that I can get some comments and suggestions from others. We lived in the SF Bay Area and own a townhouse as a rental. It had appreciated about 70% in the past 10 years. We are doing a bit better than break even but the amount is insignificant to be consider cash flow property.

We have some extra cash and have been looking into buying cash flow properties out of state. We have been doing research as it’s a big step for us, in the meantime, our tenant had approached us to see if we are interested in selling the townhouse to them. Now I’m not sure if we should do a 1031 exchange, and roll that into the out of state properties, or keep this longer and maybe find some other like kind properties in the area for appreciation. But even finding like kind in the area are not as appealing since we will have a jump in the property tax we have to pay. It will increase our monthly carrying cost if we do that.

My husband thinks that this is like “cashing out” on the gain and converting it into cash flow each month, and still be able to keep the cash we originally wanted to invest with us to do something else. However, I feel like it is different kinds of investment and the value where it lies is different. Out of state properties does not have the same appreciation rate as we have here in this market but provides good cash flow. And I do want to keep an investment property in the area to take advantage of the unique market here. I feel like selling the townhouse here and exchange into out of state properties is like killing the golden goose and just feed off of what its left.

To be more specific, we are looking into Oklahoma as some of our friends have bought properties there and have connected us with people who does this specifically.

I guess what I want to know is when is it a good idea to do a 1031 exchange? Or when is it a good idea to sell your investment property for something else?

[Jason Turgeon]

I had a somewhat similar situation, but not as extreme as yours and with some other wrinkles. We were making ~$10k/year cashflow on a duplex in Boston that we had about $350k into and it had appreciated to be worth double that. It needed about $50k in repairs so I decided I would rather sell it than put 5 years of my cash flow back into it. Because we had lived in it recently, I was also able to pull some cash out tax free. So I ended up with about $200k I had to reinvest.

I used @Dave Foster and he guided me through all the hard parts of the actual process. But he just makes sure the IRS is satisfied and the cash gets transferred between buyers and sellers quickly. He doesn't pick out replacement properties for you, or do rehabs, or place tenants. That is on you.

I found the process was way more stressful than I anticipated. I made dozens of phone calls, spent probably 100 hours scouring the internet and vetting deals, and flew down to Houston to check out properties. It was not really much fun. I had to kick out good tenants in the property I sold. That property had a drawn out sale process. Once it finally closed, I had a stressful 45-day identification period. Then I had to go through the headaches of making new relationships out of state and lining up financing. I had to learn about LLC formation and start new bank accounts and interview multiple CPAs and get much better at bookkeeping. I have been dealing with managing a rehab from 2000 miles away, and that rehab has gone sideways and is now costing me lots of money. It was (and is) a lot of work!

But the payoff was totally worth it. By being lazy and relying on appreciation, I was passing up huge opportunities. I ended up buying two properties in Texas, a 22 unit and a duplex. The larger one has turned out to be a very good investment. The duplex has turned out to be a dud. But once everything is rented and refinanced out, I will have net rents of ~$5000/month between the two properties. I will have a professional property manager handling the hard stuff for me. After refinancing, I will have about $200k of equity (the amount I needed to 1031) left in two properties worth ~$1M. And I will have over $150k in cash left over for me to do with as I please (because I had lived in the property).

So to sum up: I traded a $700k house with a $50k repair bill and $10k of cashflow. I had a stressful year of exchanging and improving. And I ended up with $1M worth of property cashflowing at $60k/year and $150k in my pocket. 

Now I am trying to figure out how to do it all again, so with my remaining $150k I am taking risks on markets where the appreciation may be greater than the cashflow.