1031 exchange, investment exchange, or....any ideas?

Question

Hello everyone! We just went under contract for a property for $425k. I'm trying to decide if I should just use my cash for a downpayment or 1031 one of my properties for the downpayment. The one I'm thinking about 1031ing is a multi-family worth about $575-600K. After the sale, I'd have around $225K to push forward. The new property does need work. I've been reading about the "investment 1031" and it sounds expensive and stressful with the 180 time frame. :-) Plus we like to do the work ourselves because A. we like it and B. we know the quality of the work. Also I don't if we could even do the work ourselves with an "improvement 1031"? Anyone know? I acquired the current multi-family property through a 1031 exchange so the basis is quite low around $140K. I'm trying to understand how this might affect the new property basis? If we didn't do an improvement exchange, we would have to find two replacement properties but (if I'm understanding everything correctly) my budget would be around $200k-ish for the new property. There is VERY little around that price point in my area. My 4-plex cashflows well but I'm feeling nervous about the economy and more eviction moratoriums under the new president. I tend to be pretty conservative/cautious because I wasn't in 2005-06 and paid for it. The multi-family is in a lower income neighborhood and, while, I've not had a lot of problems, I'm just sort of over it. I almost sold the multi-family and take the tax hit to pay off my personal residence but my realtor convinced me that was not a good idea (we'd owe about 60k taxes that way). I thought it over a long time and then my dream property popped up and offer was accepted even though we weren't the highest. So now I have to make a decision within the next day or two. I'm not looking to build excessive (<--I know,that's relative) wealth I just want to retire comfortably and early. Any advice or thoughts are welcome! (Note: we have an extra long escrow for the new property so I have time to sell the old one.) :-) Thanks!

Danny Randazzo · Answer

@Jenn N. As @@Bjorn Ahlblad mentioned you need to talk to an expert about the timing and legal items to make a 1031 happen. You could also consider a reverse 1031 if you are in a time crunch to close the new property you have under contract right now. A 1031 can be an effective investment vehicle if it’s done 100% correctly so get with an expert.

Dave Foster · Answer

@Jenn N.,  Yes, if you don't do a 1031 to purchase the $425K house you will get the full depreciation benefit from that property and you won't have to recapture depreciation from the sale of the old property without a 1031.  The only thing that scenario doesn't provide is a down payment for the purchase of the $425 or a repositioning of the old property.  So if you're happy holding on to that old property and you don't need the down payment then there's no real need to sell.

Jenn N. · Answer

@Dave Foster Sorry for my slow response. In addition to real estate, I also homeschool a couple kids so my time online is limited. :-) I wanted to say thank you for the helpful response. I talked to my tax guy and if I do the 1031 I carry my basis over (as you said too). The current property was also acquired from a 1031 exchange so it's basis is super low around $140K. The original property exchanged was bought in 2002 in CA. I've spent all week running numbers and it seems like it may be most beneficial to "start over" so I can take advantage of the full depreciation of the new property that I'm buying for $425K. It seems like that will provide better tax relief. Am I understanding everything correctly? In this case I'll hold onto the multi-family. I don't really have a good reason to sell it. I'm mostly nervous about the eviction moratorium and future of our economy. It's in a lower income area.

Eugene Tan · Answer

@Jenn N. I had very similar situation. Yes, you can buy two properties to split your total 1031 fund and just need to pay another fee (e.g $1500) of the 1031 exchange company. Talk to your 1031 exchange attorney.

Wayne Brooks · Answer

@Dave Foster ??

Dave Foster · Answer

Dang @Eugene Tan, I gotta raise prices :).  But you're absolutely right.  We call these diversification exchanges.  They are great for fueling growth and spreading risk among more doors.

Dave Foster · Answer

@Jenn N., There's a bunch of us that share those 2006 scars :). I feel you.

You've got some decent options there.  And I think you've got a pretty good grasp on the 1031 side of that.

The improvement exchange in addition to being expensive would challenge you because you have to provide the financing to purchase the new property while the QI holds it.  That financing is a tick higher than conventional residential.  So unless that new property needs 100K ish of work I don't think an improvement exchange would be the best move for long term positioning.  If the improvements were extensive then absolutely it would be a good move because the improvement exchange lets you limit your debt exposure and cash burn by using 1031 money for improvements.  Letting you do the improvements isn't problematic.  We just need good documentation.  Nothing wrong with that at all.

Your basis in the old property carries forward to the new properties.  If you buy multiple properties then it is allocated between all of them.  Interesting choice for you here - You have around $300K of profit and depreciation recap.  If you were to sell and 1031 and only buy the one new property you would pay tax on the $200Kish of difference between prices.  But you would still shelter the remaining $100K of profit.

So you could take 145 in cash and use the other 80 as down payment for the new property.  Use the 125 to pay the Tax and improve the properties.  You'd still be saving  the tax on around $100K of gain.  That would keep the most cash in your pocket considering the renos.

Or as you mentioned you could buy another property or two.  Again this could be a great opportunity for you to recession proof some things.  Use 80K of the proceeds to purchase the first property.  And take the rest of the proceeds and buy a second property for cash or two properties for cash.  This eliminates mortgage risk going into a potential down turn on a property or two.  But it still lets you capture the higher ROI from using leverage.

So three options - improvement exchange, partial exchange, multiple purchase exchange - any one of these could work well for you.

Jenn N. · Answer

@Arn Cenedella Thank you for your contribution. We have already identified one property for $425k. The second property would need to be around $200k. The problem is there aren’t a lot of options at that price point. 😊

Arn Cenedella · Answer

@Jenn N.

If your “sale” property - the one you will “sell” and 1031 into a new property or properties is selling for $575,000 to $600,000, you will need to trade 1031 into a property or properties totally $575,000 in value or some tax will be do.

It’s a complicated issue, but to totally defer taxes you need to buy for more than you sell (ignoring the impact of closing costs).

So you can’t buy two $200,000 properties and sell one for $575,000 and defer taxes.

I second @Bjorn Ahlblad statement, talk to a 1031 exchange company, that often know more than CPAs about the specific detail on 1031s.

1031 exchange, investment exchange, or....any ideas?

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