$25K property to a $400K Lake House using 1031 exchanges

[Jake Thomas]

About 2 years ago I drove by this horribly ugly blue house that I could barely see from the road. I had been reading BP posts about driving for dollars and finding the seller to buy it. After an hour of google searching, I found the owners phone number and the rest is history. Finished the remodel and placed a great tenant on a 2-year lease. After 11 months into a 24-month lease, the tenant advised me they needed to break the lease. My wife and I decided to sell the property to buy something else and utilized our first 1031 Exchange. Using simple math we purchased the property for $25K put about $45K into it and sold it for $155K netting roughly $82K after closing costs. So rather than paying around $32K in taxes we did a 1031 exchange on this property.

$25K before

After

We did have three properties picked out for the 1031 exchange since you are supposed to name the addresses with 30 days and close within 180 days but 2 of the 3 fell apart two weeks in. We did close on one of them. It was a $50K rental utilizing the 1031 exchange that we still own and it rents for $900/month. This property was purchased through a craigslist transaction. It only needed a roof but the interior was good to go. I agreed to purchase the home and the seller used me as his Realtor to buy their next home netting me around $6,500 in commission which covered the entire roof. After purchasing the rental that left us with $102K in the exchange to buy something else with. We ended up finding a property on the MLS that we closed on for $125K. I had to supplement the extra $23K but it was worth it to avoid taxes on the first property.

$50,000 rental

This property we purchased for $125K with the remainder of the 1031 Exchange turned into a bigger project than expected. We closed on it in Nov of 17’ and decided in January to turn it into a flip versus a rental. Our original intention was to make it a rental as we don’t typically flip properties. I confirmed with several 1031 experts that we could sell it and do another 1031 and they all confirmed this would be ok assuming we don’t continue to do this and we do not plan on ever doing it again. We purchased this one for $125K had about $40K into renovations and holding costs and sold it for $225,000.

$125K purchase before

After 

While I was finishing up the rehab on the $125k house my attorney gave me a lead on a couple going through a divorce. They owned a house on a very popular lake not far from where I lived and we have always wanted a lake cottage. I made them an offer and they accepted at $270K. We closed on the $125K house that sold for $225K netting around $220K after closing costs and $55k profit after remodel and expenses. We did another 1031 exchange (saving around $21,450 in taxes) and purchased the lake house for $270K using the 1031 funds and supplementing another $50K cash. We intend to turn the lake house into a weekly rental for around $2K per week on the weeks we don’t use personally during the summer.

Lake house 

Now you would think it ends there but never with Real Estate investing. I found a local bank that will give me a line of credit on the two paid for properties I have acquired through the 1031 exchanges (Lakehouse and rental for $50K) at 75% of appraised price so around a $350,000 LOC I can use to buy more properties. I already have a 5 unit under contract using this LOC and plan on using this for years to come.

A quick summary of the numbers

Total cash out of pocket invested:

$25K house A purchase price

$45K house A renovations

$23K house B extra cash need for house B purchase

$40K house B renovations

$50K Lake house extra cash needed for purchase

$183,000 total cash invested

$53,450 saved in income taxes using 1031 exchanges.

Values of what I own now from this:

Rental house market value of $90,000 and rented for $900/month

Lake House market value of $400,000

Line of credit $350,000

We are very happy with how everything turned out and we have that 25K rehab to thank for it.

[Dave Foster]

@Jake Thomas, I'd echo the thought behind the question @Jay Kadlec poses.  Every 1031 exchange stands on it's own merits.  To tell you that a 1031 in one instance is "OK if you don't do another" is flat out wrong and incredibly ethically flexible.  Either you shouldn't have done it in the first place or it was OK and every time you need to do a 1031 and you meet the criteria you should be able to do so.

With the 1031 exchange it is your intent that is key.  If you purchased your investment property with the intent of holding for productive use then it the 1031 is appropriate.  I'm no sure what the 1031 sources were telling you but there is no statutory holding period.  Yes, longer is better than shorter (remember you're wanting to differentiate between buying primarily to resell and buying to hold) but most folks feel good at anything more than a year. From what I read above it appears that your intent with the first property was clearly to hold for productive use.  The second property you still hold.  

It's that third property that is your kryptonite.  The question really is did you buy it with the intent to hold and then something changed your intent.  Or did you buy it with the intent to resell (flip) and the 1031 company decided you could get away with one.  That's kind of disturbing if thats the case because there are plenty of legitimate reasons to change your intent (and in this case I do agree that an accident once in a while is fine but a patter of lucky accidents is not so bueno).  Again, your intent sounds like it was to hold and something happened to change that intent - that's fine. 

And most importantly it doesn't have any impact on future exchanges at all.  If you buy property with the intent to hold for productive use and it is now time to sell you can afford yourself the 1031 every time it is appropriate.

Any more "accidents" where you finish up a 1031 and then decide that the property really is a better flip should probably not happen.  But use the tool whenever it's appropriate case by case.

Never do something just because you can get away with it.  But don't ever not do something you can just because it might be questioned.

Congrats on the deal path BTW - that's awesome!