1031-When does it make sense to NOT exchange?

Question

When does it make sense to NOT complete a 1031 exchange?

I have acquired a vacation-esque property in an exclusive gated neighborhood. I plan to sell this home. I expect to walk away with 400-500K but my investment strategy is on the conservative side and I don't see me purchasing another property with similar value any time soon (I don't play in that arena yet-but remember my name so you know me in 10 years). Not even two or three properties to equal said amount. I (like you, dear reader) can't speculate on whether I can actually sell it this year due to the market but again, I would like to do so.

So, what do you think? What else do I need to consider? What am I missing? TIA for helping me think through this.....

Dave Foster · Answer

@Christy Winchester, I feel ya. It's never a bad time to take money off the table. And using your capital to pay down debt and improve another investment at what you feel is a strategic time is a good thing (in spite of what you'll hear from all the leverage jockeys around). But it's also never a good time to sell and pay the tax. the 1031 would let you shelter all the tax. And maybe there's a path to get you where you want to go and defer the tax.One option would be to do a complete 1031. You'll need to purchase at least as much real estate as you sold. But it could be multiples of properties instead of just one. and you can allocate your proceeds in any way you want. I can't tell if you have debt at all. But you could purchase 3 properties for $175K ish. Once you complete the exchange then do a refinance and take that cash to either pay off one of the other houses or use it for your renovations. Yes you end up with debt still. But it's debt spread judiciously. and you didn't pay the $100K or so of tax.Option 2 - Do a partial exchange. Take enough cash as "boot" to do your renovation. Then do a 1031 exchange with the rest. You'll have to pay tax on the cash you take out. But you'll shelter the rest of the profit in the next purchase or purchases.Either way you done well. No one ever went broke paying tax on profit. But I hate taxes enough myself that I'd go kicking and screaming rather than write that big tax check. Avoid it if you can find another way.

Jaysen Medhurst · Answer

There are ways to keep deferring those capital gains taxes without actually purchasing new properties, @Christy Winchester. Delaware Statutory Trusts (DSTs) and a few other strategies. @Dave Foster can certainly explain the options better than I can. He's one of the 1031 Jedis around here.Oh, and congrats on that very successful investment. Well done!

Matt Said · Answer

@Dave Foster awesome response, didn't know those were options. In her scenario are assuming that she is buying the 3 properties with cash and will refi after closing? Also, for 1031's in general, does it matter if you go from having properties in your own name into an LLC or other tax advantaged entity? Just wondering if one way was easier than the other to do the cash out refi. Thanks!

Bill B. · Answer

Sell it and buy 2-4-8 properties that are closer to your “safe” price range. Giving up $150k in capital gains taxes alone plus depreciation recapture seems like a bad plan. Like burning down a house without insurance.

Joshua Schmidt · Answer

@Dave Foster I ALWAYS enjoy your perspective and REALLY enjoy anything you write about 1031 exchanges. Thank you for sharing your knowledge!

Christy Winchester · Answer

Thank you, all, for the insight. I acquired it at a tax deed sale. Honestly, at the moment, I am contemplating options. I wasn't expecting to hit a grand slam so early in my investing adventures and I need to clarify what makes sense for both the immediate future and the long term future. Ideally, I have two houses that I would like to pay off (and I have a major renovation of a third house that will happen soon). I am not opposed to obtaining another property to meet the requirements of said 1031-no true "obstacle" as I have good credit and a stable job. I am grateful to have good "problems". I have also been on the other side too so I appreciate when the fruit is sweet. Again, thank you for the perspective. You rock.

George Pauley · Answer

You have "acquired" a home. May I ask how you acquired it? If you inherited it, then the basis value is reset to the value on the day you inherited it. In other words there won't be profit to tax, as far as the IRS is concerned.If that $400-500k is actual profit for you, then I don't see how you don't 1031 it into other property. Like Bill Brandt says you are leaving ~$150k in taxes on the table! Why do you not see yourself buying replacement properties? What is the obstacle?

George Pauley · Answer

You have "acquired" a home. May I ask how you acquired it? If you inherited it, then the basis value is reset to the value on the day you inherited it. In other words there won't be profit to tax, as far as the IRS is concerned.If that $400-500k is actual profit for you, then I don't see how you don't 1031 it into other property. Like Bill Brandt says you are leaving ~$150k in taxes on the table! Why do you not see yourself buying replacement properties? What is the obstacle?