1031 exchange to new rental, DST, TIC or cash out?

[Matt Klee]

I am selling a rental property in Virginia and am deciding whether to cash out or to defer capital gains of around $220,000. This is the first time selling a rental property where I will have to pay capital gains. I am looking a 1031 exchange to either buying another rental property in Florida, a Delaware Statutory Trust or a Tenants in Common investment. The property recently had $25,000 in upgrades and repairs. My question is, assuming  part of the capital gains will be offset by closing costs and $25,000 in repairs, is it better for me to cash out and invest that money somewhere else or go the 1031 route? How do I calculate which option is best for me?

[Dave Foster]

@Matt Klee, Those can all be good choices depending on your desired involvement and the investment quality itself. It sounds like you're leaning more passive than active as an investor. And that's OK. The one caution I'd make is that if you want to go passive then accept the small hit you'll take on NOI for being passive. I've watched a lot of people try to go passive but maintain the returns that generally come with active hands on management. The result is many times that the passive investment is either not as good a class of property to make that up. Or the DST or TIC is not as secured. So the returns look like they'll be as good. But the risk ends up much higher.

As far as cashing out vs 1031, You'd have to look at where you could get a return that is significantly higher than real estate to offset the tax you'd have to pay immediately. Some of the data to estimate closely your situation is missing.

1. Does the $220K of capital gain include depreciation recapture.  This can significantly ramp up the tax bill.

2. To know closing costs we'd have to know sales price.  But say there were 20K in closing costs and $25K of improvments and no depreciation recapture.  That would make your capital gain $175K.  Your federal tax would probably be $26K and add another 10-20K for state depending on where you live.

So the choices would be to stay in real estate and invest as you mentioned but get to use the $35K of tax for your benefit - or to cash out and pay that $35K to the govt and make a return that would repay that $35K plus a better return than you can get with real estate and keeping the $35K.

The power of the 1031 is the compounding effect over time.  It's not about not paying tax at this moment.  It's how many moments can you string together where you're keeping the tax and the return from the tax for your benefit.. 

So I'd really put a sharp pen to those returns to see where the break even is between the two options.