Rolling money into a new deal through a 1031

[Abigail Gibson]

Hey all - first time poster, long time listener. 

I would like to expand my portfolio but I have a hesitant partner so I am working on doing this slowly. I own a rental home, a personal residence that I turned into a rental, with a 2.75% APR 15 year mortgage.

My current cash flow is around $375, but once the house is paid off, in about 7 years, I will cash flow around $1200. 

I put $100,000 down on the house and did approximately $10,000 in repairs going into it. 

My question is, should I sell the house and roll $135,000 into a four-plex that cash flows around $800 a month? I would be putting myself into a 30 year mortgage, rather than a 15 year, so I would achieve the higher cashflow number at a much slower rate. I have suspicions that the rent is undervalued in the 4-plex, but where they currently stand my cash-on-cash numbers are between 6%-8% return depending on if I have to put 20 or 25% down. If I did this, I guess I could take the remaining $65,000 I am going to get from the sale of the house to purchase a second rental that could also cash flow. 

As I have started running numbers, I have found that I am stuck in the classic analysis paralysis more than I thought...

[Dave Foster]

@Abigail Gibson,  Here's where you start to get into the deep weeds :). First your profit calculation is correct but not complete.  Your profit is determined by the difference between your net sale and your adjusted cost basis.  And your adjusted cost basis is the purchase price + capitalized improvements - depreciation.  You can't forget depreciation because that's the shell game the government plays with you and makes it look like you made more than you really did on the sale.

OK so that's determining profit.  Here's the other shoe dropping - Profit has nothing to do with your 1031 reinvestment requirements!!  The two requirements to fully defer tax in a 1031 are that you purchase at least as much as your net sale (contract price- closing costs) and you use all of your net proceeds (net sales price-mortgage payoff) in your replacement purchases.  The IRS doesn't care how much profit you have.  Any amount of cash you take out or any amount you purchase less than you sold is considered to be taking profit first by the IRS and would be taxable.

You wont pay tax on your original investment ever.  But when you do a 1031 and take cash out the IRS says you are not taking your original investment out. You are taking profit first.  The dollar bill looks the same but you call it one thing and the IRS calls it another.  Guess who wins that argument?? :)

So if you want to defer all tax purchase at least as much as your net sale and use all of the cash.