Use 1031 Exchange or Hold onto Funds For Recession?

Question

Should pay taxes or too much for a property?  I have 2 weeks left to ID a property for 1031.  The taxes owed would be around $15,000. Stuck myself in a situation without doing any prior marketing for deals because I was spending all my time working as a real estate agent and a flip project that turned into my personal family house. I was actually under the impression, because I was also told this, that I could not 1031 because I wasn't going to be using the same LLC going forward.  I am a Realtor and have been looking deals on the MLS is the worst so now anything that may work is not a 1% deal or it's pretty far outside my radius, maybe 1.5 hrs or more drive, but also not very attractive anywhere I have looked.  Two weeks is not much time, so here are the few ideas I would love the BP community to weigh in on.

1. This is the "worst" case scenario, and it's not that bad: Go ahead and identify 3 properties and maybe I get none of them and just use the cash to buy something else next year. I could invest in a flip, BRRRR, Gold, silver, Bitcoin even another type of business.

2. Buy something at retail and do some improvements, barely achieve the 1% rule, but hope to sell it in a year after I do much more marketing, and in the meantime make a bit of cash flow. Maybe this could be a BRRR property deal?

3. Try and find a syndicator of sorts who may need about $100k and hope to get 6% "guaranteed" and sit on a MF or Storage deal for the next few years. (least favorite idea -- Unless you know of a really good performing property that I should invest in)

4. Some idea I haven't thought of or don't know about.

Alex Olson · Answer

My favorite option in this scenario, and it is one I've seen clients do successfully, is to buy a really great property with little leverage (meaning a large down payment by using proceeds from sold property). By doing that, it will cash flow extremely well and you have several options.

- keep the cash flow coming,

- refinance within a period of time, ,

- 1031 exchange into a better property in a year or so.

in my view these are all better than eating the $15k and better than DST which you have no control over.

Steve Vaughan · Answer

Take the tax (and fee) hit and fight another day.  $15k is survivable.  The serenity alone from not stressing about which dog to buy is worth that.

In the future If you are selling a vanilla property, ID your buy first of course.  The buy/replacement side is the hard part for most. I did that and the process still sucked.  Probably a covid thing but communication between title and the QI was a joke and my seller got pinched on his next purchase.

Pay the tax, relax and re--invest into whatever you want.  Don't buy a loser👍

Mark H. Porter · Answer

You should also look in Delaware Statutory Trusts (DST).  I actually always list one as my third choice in case the other two fall through for some reason.

Dave Foster · Answer

@Ethan Atkinson, Like @Steve Vaughan said - never buy a bad property just to save taxes.  But hey $15K is $15K.  And the question of how far the market would have to correct before it was break even with giving up that $15K up front is something to consider.

@Mark H. Porter is spot on with how he's approaching things also.  The idea is never play to lose. Play to win but have a back up that is still a win just not so much a win.  A DST could be a nice consolation prize for you.  At least it's income coming in instead of a big tax check going out.

The other huge consideration is that the folks who started shouting out the 3%, 2%, 1% numbers did it in a vacuum.  If you take into consideration the current interest rate environment I think you'd find that a slightly less than 1% rent number with a low low interest loan actually makes your IRR substantially superior to a higher rent with higher interest situation.

That didn't make your choice any easier did it :)

Stan M. · Answer

@Ethan Atkinson you could also explore qualified Opportunity Zone funds as a backup. There's no need to ID an OZ fund for 1031 purposes. You can read up on the details, but you would have a 180 period to invest your proceeds.  Some downsides are lack of cashflow the first year or two during construction/improvement, a deferral on 90% of those capital gains taxes only until 2026, and a 10 year hold period. But all future appreciation is not taxable if you hold the investment more than 10 years, which is a big upside. Just another potential option...

Ethan Atkinson · Answer

@Paul Moore Thanks for the info. You and I actually sat down and spoke briefly about self storage at the Deal Maker Live of 2019.  I actually haven't heard about the DST so now am intrigued to dive into all the details and more. I will reach out soon.

Leslie Pappas · Answer

@Ethan Atkinson, if you’re in a time crunch, I’ll quickly share my experience I have had no issues at all in placing my clients into DSTs replacement properties within the 45-day guideline.  In fact, I often have my clients closed on their replacement property within 2 weeks of their relinquished property sale. I've written a few blogs about syndicaton/DSTs you might find of interest. https://www.biggerpockets.com/...

Please let me know if you'd like some help. Best- Leslie

Paul Moore · Answer

Hey @Ethan Atkinson. You got some great counsel here. I agree that if you are going to name 3 properties, you should consider a DST as one of the options.  There are some storage DSTs out there that we researched this past year. I know of an off-market DST that has no sales commissions as well (self-storage).

Also, for others who see this post, if you can sell in the same year that you acquire a steeply depreciating asset, you can often wipe out the tax and more in that current tax year through bonus depreciation from the acquired asset.  There are situations, limited in number I admit, where the replacement property can be as good or better without a 1031 exchange.  I am in that exact situation in 2020, and I have identified a replacement property that should wipe out a substantial tax from the sale of a property this year.

Feel free to reach out to me to discuss this further.

Alexander Szikla · Answer

#2 makes sense because although yield might not be spectacular, you are getting more cash flow due to your higher basis (no tax) and those yield markets may provide higher appreciation in coming years

#3 is totally a viable option as well

Mark H. Porter · Answer

Shoot, just realized you were from Athens. Send me your email and I’ll introduce you to my guy in the morning.

Use 1031 Exchange or Hold onto Funds For Recession?

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