What is the best way to wind down the business?

Question

Does anyone know of any strategies to start winding down a real estate portfolio? I've had a good run and developed approximately 1.4MM in equity between nine different rental properties I have acquired over the years. I would really like to access this equity to semi-retire and become financially independent. If I could sell some of the lesser performing properties and then use that money to both pay off the notes on the properties I decide to keep as well as significantly pay down the balance on my personal mortgage, then I could quit my full time job and just manage the remaining properties I keep and still live comfortably.

But having to pay capital gains and ten plus years of real estate depreciation ruins my plan. In a couple of instances, I would end up paying more in taxes and depreciation recapture then I would actually get as cash back from the sale.

I know I can do a 1031 to avoid losing money but that doesn't accomplish what I'm trying to do. I don't want to trade up or buy more properties. I want less properties but with better overall cash flow. Are there any exit strategies to help wind down the business without taking such a tax hit? Thanks.

Dave Foster · Answer

@Dan Dice, to move from larger and more properties to less properties and better cash flow can be a tough go.  But a good consolidated game plan can get you there.  There's many ways it can hsppen.  But here's a few to kick start your thinking.

1. sell several and 1031 into one nice property that you use for investment for a year or two and then convert into your primary residence.  Sell your current primary - that will be tax free.  Move into the old rental - that does not create a taxable event.  Live there for a few years while you do the same thing.  Only part of the sale of the converted property will be tax free.  But that's better than paying tax on all.

2. Sell 1031 into passive DSTs.

3. Sell and 1031 into a mix of properties - some purchased with cash and some with maximum leverage.  Keep the free and clear ones.  And then in step 2 1031 the leveraged properties into DSTs which accept the debt non-recourse to you. And covers the depreciation as well

4 If you have any heirs who like real estate then 1031 into properties they would like to own.  They manage knowing that they will inherit the properties when you die.  And you get motivated management and avoidance of tax on the sales.  Plus the step up in basis when you pass away.

Most of my clients will combine several of these strategies to achieve their goals.

Brandi Jo Newman · Answer

Take on a younger partner/mentee. Leverage the existing equity to expand your portfolio. It's an easy path to a leveraged buyout with a lifetime of income without the tax consequences.

James Devoe · Answer

@Dan Dice

Have you thought of selling some of your properties using Owner Financing?

You would act as the bank and I believe you only get taxed on the payments rather than the entire lump sum of the property.

Plus you get all of the benefits of a Passive Real Estate Investor without any of the responsibilities.

It might be something that's worth looking into if you're looking to retire.

Chris Davidson · Answer

@Dan Dice Without knowing the financials of your properties I would see about paying off some of the less desirable ones and sell the owner finance, or if that would be costly sell them subject too and carry a second note for any equity. You will pay taxes on the down payment and additional income lose the depreciation but could provide a solution.

This gives you the cashflow you are used to while reducing the upfront cost of a sale, and if it all goes south you get the property back and keep the down payment.

Paul Moore · Answer

Hi @Dan Dice! Congratulations on your success! You got some great advice above. I would really think through what @Dave Foster said as well as others.

You asked if you can launch your own DST. No, you absolutely would not want to do that. My firm launched one a few years ago and it is a huge hassle with lots of regulations and it would not at all accomplish what you are trying to do. One of my investors was faced with a similar situation last year. He did a lot of research on installment sales and found a method that allowed him to sell 53 single family rentals and avoid or significantly forgo capital gains tax. I don't have all the details on that, but if you would like a connection I can introduce you.

PM me with your email address and I will make the connection. Make sure to tell me you want to meet the guy who sold his rental properties and forgo capital gains.

Julio Gonzalez · Answer

@David M. yes!

@Dan Dice Here's an article that explains the 721 exchange in a bit more detail. Feel free to reach out if you have any questions.

https://www.biggerpockets.com/...

David M. · Answer

@Julio Gonzalez thats the one to the UPREIT, right?  I could never remember the number...

Julio Gonzalez · Answer

@Dan Dice Have you considered a 721 exchange? It would allow you to still invest in real estate, but as a passive investor and would still allow you to defer the capital gains taxes.

David M. · Answer

@Dan Dice I guess you could start your own fund/trust, but that should require all sorts of SEC filings, lawyers, finding a deal, and getting the investors..  Also, these funds only last about 5-7 years.  I believe they cost seg and maximize the depreciation deductions then move on...  Its really not that passive in my opinion.  But, it sounds like you are still looking to manage stuff, and not really go passive.  So, I'm not sure if you are really looking to "wind down."

David M. · Answer

@Dan Dice

Are you looking to retire via rental income?  I know you mentioned that, but are you interested in other, more passive endeavours?

Otherwise, as mentioned you mainly can only 1031, OZ fund, or a specialized REIT transaction to keep deferring tax liability.  If you are like me and don't like those options, then just sell, pay the tax, and take the remaining equity and invest more passively.

What is the best way to wind down the business?

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