Sell a leveraged property, 1031 into a property all cash

[Joe Gee]

Hello BP! 

I have a 4 Plex property that has appreciated quite a bit over the 4 years I've owned it. I am in a 60% LTV position on it. I've been contemplating whether to sell the 4 plex and 1031 into a duplex, pay cash for it and have no debt.

I know normally ppl use a 1031 to level up, but has anyone out there leveled down to mitigate their risk level? 

Thanks! 

[Dave Foster]

@Joe Gee, It's a good strategy.  But there's some complications that can hang you up.  When you do a 1031 exchange if you purchase less than you sell or take cash from the sale it is considered to be taking profit.

So if you sell a $100K property that is 60% leveraged and only purchase a $40K property using just your cash you will still pay tax on the other $60K you didn't purchase as if you took profit (or the full amount of the profit if less than $60K).

So your plan if executed just like you're anticipating would leave you with a substantial tax bill.  However, here's a couple twists that might work.

1. Sell your property and 1031 into two smaller properties - one which you pay cash for and one that you put the minimum down on.  The first one provides the low risk investment you want.  And the second absorbs the debt so you can do the full 1031 exchange and defer all tax.

2. If you're looking for a more exotic path there is a type of Delaware Statutory Trust called a zero coupon" or zero cash flow product. It exists to absorb debt. And generally you have to put 15% cash into it and the DST absorbs the rest of the debt.

3. Or you could forgo the 1031 route and do a cash out refi and take the cash and buy something free and clear leaving all of the debt solely on this property.