What would you do...?

Question

Just looking for some guidance on a important decision.

I'm in the process of selling a parcel of land that is currently paid for.

My basis in the property is pretty low.   My plan was to unload the property before cap gains rates increase.

My original intentions have been to sell the land and apply the funds towards the loan on a small strip mall I own.

I should be closing on the property within the next month, so I've been over analyzing all my options. .

If I convert the funds into equity it would basically be earning 5% which is the current interest rate I'm paying on the commercial loan.

My thinking today has me more inclined towards doing a 1031 exchange and purchasing a 4 plex.

My goal would be to purchase the 4 plex for 100-110,000.  Gross $2,000 per month.   Leaving me with $12,000 per year in clear theoretical profit.

Roughly a 12% return vs a 5% by investing the money in the mall.

At the same time I would pick up some added depreciation on the 4 plex and also would help diversity my portfolio instead everything tied up in the commercial property.  I'd also save some funds on taxes by doing the 1031.  Although that might backfire if Capitol gains rates go up.

Is this sound reasoning?

Should I hassle with the 1031 or should I just pay uncle sam while the rates are still low?

What would you do/done in similar situation.

Jeff S. · Answer

Ironically, my friend currently has a lady that has bare land in a 1031 that is sold waiting for a suitable property to exchange into.

His property, the property she plans to exchange into, is a commercially zoned place with rental houses and a commercial shop. The reason she wants to exchange it is to get income because the land just eats up money. Her plan all along was to get into something that produces income.

There is a facilitator involved so imagine she has been versed on what she can and cannot do.

Dennis Tierney · Answer

Remembeer the old saw: "It's not how much you make but how much you keep that's important." To me if you have a 1031 option and can keep the money invested at a good return, which it sounds like you can, then it's the best option.

Jon Klaus · Answer

Ed, you haven't sold the property, right?  Once you do, you have 45 days to identify what you are going to exchange in to. And you have 180 days to buy it.  Plus you can identify a number of possible acquisitions, but potentially buy just one of them  There is still time. If you do go this way, you need to pick your QI immediately and make sure the proceeds (equity) go directly to the QI at closing.

Account Closed · Answer

Ed,

15% is the federal tax rate for capital gain.  Here in CA, we have to pay state tax on top of the federal tax, which could be up to 9.8% depending on your tax bracket.  If we wait till next year, the tax rate might be as high as 33.6%.  (20% + 3.8% + 9.8%).  Not sure about your state tax.

Jim M. · Answer

Like someone said before you have some time to identify the new rental property to trade for.  You have some great cheap debt for the mini mall and if it were me I'd get a 8-12 cap rental instead of pay down that nice debt.  I'd then reinvest the money from the rental and eventually pay off the mini mall early with the idea that you can get better than 5% on your money.

Steve Babiak · Answer

My understanding of the rules is that the seller of a relinquished property cannot even accept a deposit directly in order to qualify for a 1031 exchange.  All proceeds from the sale must go through the 1031 QI.  Down payments on the property to be acquired can be paid directly from you.  there is another thread from the last few days where I have posted a link explaining some of these 1031 exchange rules.

Ed L. · Answer

Minh,
Thanks for pointing that out!  My CPA forgot to inform me of the additional 5% state tax..  Sucks, but it's better to find out now instead of April.

I can't seem to find any steals at the moment so I guess it's going into the Mall.. Bank agreed to a LOC so at least I will still have access to the funds to reinvest.

Ed L. · Answer

Well it seems the plan was solid, but unfortunately the quad is a no go.  I was under the impression it was 2/1 units but instead it is 1/1.

I was banking on being able to raise the rents to $500 each with no problem if they were 2/1.  They are currently 400 which is about average.

I can't seem to locate any decent rentals at this time so I guess I will just go with plan "a" and pay down towards the mall.

Tax gurus please check my math on what my tax bill will be.

Sales price is $130,000.    Basis in the property is $50,000.

I've owned the property for over a year so it should qualify for long term Capitol gains I believe??

$80,000 x %15%= $12,000.

Is that all the tax liability I would incur?   Would I have to pay self employment t also?

If my math is correct I will probably just sell and wait for the right deal to come along.    I imagine this will be my first and last time to enjoy 15% gains rate.

Steve Babiak · Answer

As it was explained to me by an attorney well-versed in 1031 exchanges, the like-kind property is broken by trading real-estate for a truck, for example.  Real estate held as an investment exchanged for other real estate to be held as an investment should qualify.  Your QI would tell you otherwise if it didn't qualify.

Bill Gulley · Answer

Jeff  S. I'm reading it, but seems to say an existing home is like kind to land, seems to me that says you can sell the house, exchange it for a residential lot or land to build a home, which makes sence. It is not saying that land is like kind to a home or commercial property....or is this even an issue any longer? When I did my last one, it was a second home for a second home. Timber land for pasture land was similar enough. Thanks for the find!

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