Pay off a rental or not?

Question

We recently bought a rental and have a mortgage on it, I want to pay it off quick and thought about doing flips and using that money to pay for it. I realize I will have to pay gains on it if I don’t do a 1031 exchange in so much time, but I thought if I do flips, we have to always churn the money anyway so why not pay the gains and pay down debt quickly? Thoughts???

Dave Foster · Answer

@Christine Krizenesky, All depends on your preference and the market for flippable properties. An alternative would be to let the tenants continue to pay down the mortgage and add another rental when you can letting the tenants pay for that mortgage or doubling down the payoff on the one. A 1031 exchange would be a good idea if you're wanting to sell the first one because then you can access all of the equity. But I can't tell from your post if it's a good long term hold or not. If you start doing flips you don't have the option of a 1031 since fix n flips don't qualify. You will pay ordinary income on flip profit. And you will probably also have self employment tax and quite possibly the 3.8% ACA surcharge. Flipping houses is flipping expensive from a tax perspective!If you don't like debt a couple other options might be1. Keep your leverage 50% or less and save to buy your next one. At a debt load of 50% your payments will be low enough that you can adjust rent quite a bit to keep tenants in.2. If you have a primary residence pay it off and take a heloc. By paying it off you increase your security. The heloc gives you dry powder that doesn't cost you anything until you need it. And the pay down is paying you real dollars in the form of no interest. It's not much but heck the 4.5% you may be not paying on a paid off primary is every bit as good as the 4.5% you would make on a secure DST. And it's two or three times as much as you'd get from the dividends of a Walmart stock.The 1031 exchange works best with leverage of some sort. But don't let the leverage cowboys convince you to do something that loses sleep at night. Slow and steady with no loss is actually a faster way to wealth then pedal to the metal with a couple BKs or foreclosures in the middle.

John Thedford · Answer

Flip profits are taxes as ordinary income. The only way to avoid ordinary income is to hold them as rentals. You cannot 1031 flips--sorry. Once you are holding rentals, you get tax benefits (depreciation) and can defer some or all of the gain with a 1031 exchange. There are certain rules and qualifications to meet. @Dave Foster can shed some light on the 1031 subject.

Twana Rasoul · Answer

@Christine Krizenesky not everything is about optimizing returns numerically. Do what makes sense for you, your goals and comfort level. Best of luck!

Tim Herman · Answer

@Christine Krizenesky like @Steve Hall said it is all about leverage. you have 1 paid off $250000 house or 10 $100000 houses with 25% down. Same amount of money. Inflation of 3% your paid off house grows $7500. Your ten houses gained $30000.

Tim Herman · Answer

@Christine Krizenesky If your flip makes a profit it will be taxed as income. I am not a CPA but I don't think that rolling the profit over to a rental will then make it long term capital gains.

Jonathan W. · Answer

@Christine Krizenesky leverage/debt helps you gain the advantage by moving on and gaining things you otherwise couldn’t afford.If you pay down your rental, you’ll have just that. So you’d either get another loan or be content with a paid off house that brings incomeBut you seem to want moreSo Steven Hall is right on the moneyLeverage baby! Just a suggestion A risky suggestionA risk that can pay very wellAlthough if your following GDEN stock i feel they are going to be a classic example of over leveragingI mean interest payments ruining earnings!Expanding to literally every cornerHow many corner bars do we need! If Vegas every feels a burn for anyway that company is going in the toilet quickly..Food for thought

Christine Krizenesky · Answer

@Steve HallThanks for the reply, makes sense. I’m just not a fan of debt and I’m learning quickly how real estate debt is whole different world!

Christine Krizenesky · Answer

@Tim HermanThank you, it makes sense. Question about flipping then. If I buy and flip, how much time do I have before I have to pay capital gains if the money is not reinvested into another property? And if I buy another property with that flip money and turn it into a rental instead of a flip, I don’t have to pay gains taxes on this either correct?

Steve Hall · Answer

@Christine Krizenesky Your plan is backwards. You don't pay off the rental. You use the leverage to buy more properties.