Can you help me develop some Exit Stratagies?

Question

Hey Folks,

Can you help me develop some exit strategies from house-hacking a fourplex?

My long term strategy is developing cash flow to supplant my wife and I's current income.

No specific property in mind yet....

We are willing to house hack concurrent properties.

What are you thoughts?

Best Wishes,

-Tony

Dave Foster · Answer

@Tony Gallina, You actually want to think of 1031 exchanges as a tool that you use with a buy and hold strategy to accomplish your goals.  1031s are only available on property you have purchased with the intent of holding for productive use.  That does not mean that you must hold them forever.  It means that  your primary intent must not be to simply resell them.

So these are perfect for a buy and hold strategy.  You buy and let what cash flow you get work with equity build and appreciation until it is time to sell.  Then you use the 1031 exchange to take not only your built up equity and original basis but also the deferred tax dollars and buy more real estate - You can sell one and buy more than one.  Or you can buy bigger.   You can also reshape the type and go from SF to MF or commercial.

Once you have achieved your cash flow goals you monitor geographical and demographical data to determine if you are in the best mix of type and location.  From here exit is relatively easy:

1. You die and your heirs get the property with basis stepped up so the deferred tax disappears.

2. You continue to 1031 slowly consolidating into properties that are easier and easier to manage or passive in nature like TIC or Delaware Statutory Trusts or land leases, etc.  Then you do #1.

3. Hold some of your properties as vacation rentals positioned strategically near your children and grandkids.  Use business trips to your properties as a reason to connect with them.  We used a sail boat for this but a class A RV works well also but they're not real estate so not part of the discussion except the dreaming part.  At the end of this of course #1 awaits.

3. You occasionally move into one of your investment properties converting it from investment into primary residence.  after living in it for a minimum of two years out of the previous 5 and owning it for at least 5 you can sell and prorate the gain between the time you lived in it (tax free) and the time your used it for investment (you would pay tax only on this portion and recapture depreciation).  So at least part of the gain becomes tax free.  After doing this see #1.

4. So, in combination you can grow, shrink, change, convert defer and eliminate taxes with a longer term strategy of strategic buy and hold coupled with 1031 exchanges and estate planning strategies.  I haven't found a better answer to #1 yet but I'll let you know when I do.

David Faulkner · Answer

It is all in how well you buy the property. That is the key. The better you buy, the more flexibility, safety, and exit strategies you will have. Ideally, you'd want to buy at a steep enough discount where you could sell at a profit at any point in time, from the day you close escrow, to the day after you finish rehab, to 10+ years after holding ... this is your backup exit strategy, with hold as a rental being your primary. It is this discount to retail that not only gives you the extra exit strategies, but also insulates you to a large degree from short term market fluctuations. It is an additional way to make profit so that you do not have to be 100% dependent on cash flow to make your returns and it helps out cash flow to boot.

Having said that, buying at a steep discount in most hot RE markets is very difficult today. It may mean finding off market deals through driving for dollars, door knocking, or direct mail. Also, it may mean highly distressed property that can only be purchased via cash or hard money loan. After buying this way and rehabbing, you could rent and cash out refinance (the BRRRR strategy). Some people consider the cash out refinance to be an exit strategy all its own since you could take most or all of your initial investment back out of the property.

Additional details if/when you choose to sell, yes you could 1031 into a larger property. Do that a few times to defer your depreciation then leave the property to your children after you pass, they get a stepped up cost basis and thus you can avoid taxes all together (only downside is you're dead by then). Alternately, you can live there with your wife for 2 years, rent an additional up to 3 years after that, sell, and take up to $500k capital gain tax free since it was your primary residence. Or after it is paid off you could sell it and carry back the financing to receive cash flow on the note and spread out the taxes. Or whenever the value goes up enough you could continuously pull out excess equity tax free with a cash out refinance to reinvest, stay leveraged up, and take more interest deductions. Many, many ways to skin the cat.

Ed Emmons · Answer

The first thing is to determine if there is zero chance of you breaking up. If not then you individually need security. This would determine what sort of entity you set up and how you write up the bylaws or agreement. If you don't need the money now and intend to flip, I would consider a 1031 exchange into a bigger property and leverage yourself to a higher cash flow. You can repeat this until you decide the cash flow is what you want. The advantage is that 100% of profits can be rolled up tax deferred. You should consult your accountant before setting up an entity as some pass throughs require the payment of self employment tax on earnings. Obviously the higher the noi of your property, the more it will be worth so even $10 per month raise in rents each increases value by a lot. So keep them as high as you can keep them filled. Don't be your tenants friend because it has to remain business. It becomes harder to raise rent to your friend.

Tony Gallina · Answer

It has been very rewarding reading your responses.

Thank you

Tony Gallina · Answer

Thank you

So leveraging up with 1031 until targeted cash flow occurs? What about buy and hold?

Can you help me develop some Exit Stratagies?

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