To exchange or not to exchange - Is a 1031 exchange right for me?

Question

I'm struggling with whether I can have my cake and eat it too.  Situation:

• Selling my portfolio of 8 SFR's (6 I have had greater than 1 year and 2 I have had less than a year) for $1,200,000
• I need to get with my CPA to determine the depreciation.  But minus that and considering the purchase price + improvements, my basis is approximately $1,075,000. So a gain of $125,000.
• Based on my tax bracket and the fact that the two newer properties would be taxed as a short term gain at ordinary income rates and the older properties would be taxed at 15% long term gain rate...I figure it's about $23,000 in tax savings.
• I'm looking to purchase a MF apartment with a target price of $1,100,000.

Some questions:

• Can I even do the exchange given that I have two properties I have held for less than a year?  My logic is that I am not a flipper and my business is buy & hold.  I am selling as a package.  Not sure if the IRS rules are black and white or shades of grey.
• How does "value" get measured?  Sales price or appraisal?  In other words, if the $1.1M apartment appraised for $1.3M which is considered in the replacement calculation?
• I believe I can reduce the replacement amount by deducting commissions and closing costs? Is "close" good enough...is there a tolerance?

The numbers are all close and would love to save $23k.  But I also want to make sure it will all work and this doesn't get crazy complex.  Any 1031 exchange gurus out there?

Juan Vargas · Answer

This might be a good set of questions for someone like @Dave Foster. Look him up here on BP. He should be able to help you out.

Account Closed · Answer

@Tony Castronovo check with your QI on how they will view the properties....@Dave Foster can clarify possibly.  You will want to make sure you do it correctly for your exchange.

Dave Foster · Answer

@Tony Castronovo,  yep that’s what boot is - just the difference.  And if you’re selling All as one portfolio that is better for those two short holds. And there’s a way to structure the entire the transaction as one exchange. PM if you want to get into particulars.

Tony Castronovo · Answer

Thanks guys!  Is the difference I would pay @Dave Foster called a "boot"?  Paying tax on the difference is fine....just didn't want to have the entire exchange disqualified, which was my worry.

To address some of the good questions raised...this is not a hypothetical scenario.  I am under contract on the sale of my SFR portfolio.  And have a few options for the replacement but one in particular I am about to put an offer on.  I've been trying to keep from making this a lateral move...but to me a lateral move is if I sold/purchased at the same NOI.  The NOI on the MF is significantly higher than my SFR portfolio.  And there is not much upside in my SFR homes.  This is the age old argument but I see plenty of good things about holding SFR's....but I'm looking to scale more quickly and see a path through MF.  I do not think this is a lateral move....but thanks for challenging me.

@Darrin Gross I had never heard of the DST. Sounds interesting.  Answers to a few of your questions:

• I do not have enough equity to borrow against the portfolio to allow me to keep it.  Would have loved that but would not be able to pull out enough.  
• I am selling on my own.  Just paying buyer's agent commission.
• Upside to the buyer is a great SFR portfolio that generates a healthy NOI.  Fully rehabbed properties with many of the capex items already addressed. I am not selling to get rid of a problem (I would prefer not to sell).  But I feel this is the move I have to make as an inflection point in my investing career.
• Retail on the portfolio is around $1.26M.  I got a couple low ball offers but also received several strong offers....one which we took and one backup.  Still a long way to go before we get to the closing table.

Dave Foster · Answer

@Tony Castronovo  it sounds like you’ve got a pretty good demonstration of your intent to hold for productive use. So the two shorter hold properties probably can be justified as @Curtis Bidwell Said.

Your reinvestment target is the net sales price of the old property so closing costs and commissions come off of that.  And close is ok - but if you purchase less than what you sold you will pay tax on the difference.

I think your biggest challenge will be grouping the sales and finding a suitable replacement all within the tight time frames.  A reverse exchange could help but the cost of a reverse and the cost of financing would eat into that gain as well.  Still what you’re thinking could work.  Keep noodling

Curtis Bidwell · Answer

@Tony Castronovo  So, yes you can do a 1031 but as has been said, is it worth it for a lateral move with time constraints, etc....

The time you have held a property is not an issue for a 1031. The issue is intent. You are trading a group of investment properties for another of like kind. Shouldn’t be an issue.

Value is sales price minus sales expenses.  Find a good Qualified Intermediary. They’ll be able to give you specific details and direction.

Good luck!

Darrin Gross · Answer

I believe you only have to be $1 greater in a 1031 exchange.  Have you ever heard of a Delaware Statutory Trust?  As I understand, you can invest in a DST to balance your trade, ie the overage from your sale that would not be required for the purchase of the replacement property.  I will message you some contacts who can provide more answers.

My opinion, this will be tough for two basic reasons.

1- Selling 8 properties at full retail at the same time will be tough and unlikely.  If you are able it will not be for full retail.

2- You are spending a lot of money and energy to make a lateral move.

Some questions I would answer

Q: Is the $1.2m estimated sale price retail?

Q: What is the upside for the buyer of your portfolio?

Q: How much are you getting for rent?

Q: How much equity do you have in your portfolio?  Is there room to borrow against the current portfolio?

Q: Do you have other funds for your down payment on the apartment building?  25% down on $1.1 = $275,000.

Q: Will you be selling these yourself, or will you have to pay commissions?

Tony Castronovo · Answer

Hi Account Closed.  Thanks for your comments and questions.  Yes, it is quite complex and I think I am getting a good education (might even sit for the CPA exam when it's all said and done ha ha...kidding).  To clarify, I am not selling the properties separately.  That would be way to complicated and stressful.  I would never be able to time that right.  I am selling as a package.  Under contract.

Account Closed · Answer

Hi Tony!  This may be an obvious statement but you do realize you are selling each properties individually, right?  So each of the 8 will do an exchange, starting at the close of escrow on each sale.   So your timing and replacement requirements will be on 8 escrows.  You can move all the gain from the 8 in to one property but the timing will be tricky to coordinate 8 sale closings into 1 replacement closing.  Am I understanding correctly you think its a total gain of $125k?

DSTs could be an option as mentioned by Darrin, but the minimum on a 1031 is $100k,you must be an accredited investor and anyone in the business less than 5 years may not understand and properly educate you on the risks involved in DSTs.  They are a very sophisticated investment.  If you go that route, you should speak with several reps who sell these as they all have different inventory and different industry knowledge.

Your strategy may be a bit complex for BP posts given the sale of 8 properties.....very tricky.

To exchange or not to exchange - Is a 1031 exchange right for me?

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