All Forum Posts by: Dave Foster

@Kyle Vogeler A lot of the time, if the investor already has their foot in the door and has acquired investment property they will start to sell and do a 1031 exchange, which allows investors to defer all of the tax and depreciation recapture, and purchase another investment property using the tax. Scaling this way will add 20-40% to your war chest in deferred taxes you use to benefit yourselves. This is the first way I'd scale without going out of pocket.

If you want to expand and diversify your RE portfolio, you could do a diversification exchange where you sell one investment property to acquire multiple smaller investment properties. This would allow you to test different markets and mitigate risk a bit more, especially if you purchase one cash and put a mortgage on another. Using strategic cash out refis is the second way I'd scale in house.

Partners adding partners is fine. But each time the soup gets a little more diluted. And you know what happened with too many cooks in the kitchen :)

@Breanna Green Ultimately, you want to ask yourself how hands-on or off you would like to be as an investor and whether scaling up or down makes sense with your future goals. Where are you at in your personal cycle as a real estate investor. Starting here is the most important. Then look at where the real estate market is where you want to invest. You're doing that now which is awesome.

Tell yourself how you want to invest and what kind of investor you want to be. Then let the market tell you what types or locations are best for you. This is the hardest job.

Selling your properties and 1031 exchanging them along the way will work well in your scenario. Because the 1031 will accommodate any type of real estate investing in any number and any location. Whether you want to sell a larger property and 1031 into several smaller properties (a diversification exchange). Or sell several of your properties and consolidate them into a larger property with a commercial loan. Or pick a path in between.

This time is perfect for you to reshape for the next part of your journey. Listen to yourself, listen to the market.

@Andrew Wilson, There's no option.  You have to use an unrelated 3rd party (the QI) who will document the exchange at sale and purchase, hold the proceeds in between, and provide all of the tax documentation necessary for your accountant to file the form 8824 at year end.

They are your guide through all kinds of decisions like - do you want to stay together with your brother going forward?  Or do you each need to do your own exchange?  How much and what type of real estate do you want to purchase?  The times lines, etc.

And most importantly - Do you even need a 1031 exchange???  You mentioned that you were gifted this property.  If so, depending on the nature of the gift, there might not be enough tax liability to make it worth your while to do a 1031 exchange.  There's certainly no reason to pay for an exchange if you don't need to do a 1031 exchange.  And unlike @Michael Plaks, I do these for folks.  And yet here I am trying to turn away business :). But this is the first question you need to ask.

@Amier Tutie, If you're wanting to scale then I would suggest you find a different way to pay off your personal debt.  Yes, that debt needs to be eliminated to give you ultimate flexibility.  But if you use the proceeds from this sale to do that.  You're leaving a down payment on the table that could be used to purchase that next property.

Just ball parking but you've probably got a $30K tax hit.   If you do a 1031 exchange instead of just selling and paying off debt you'll get to keep that $30K and use it for your next real estate purchase.

If you simply sell the property youll pay the tax.  and then you're talking abut using cash out refis to extend your portfolio.  Do the opposite.  Use the 1031 on this sale to buy another property.  And do a cashout refi of something else to pay off that consumer debt.

Let the Govt do some of the work for you :).  @Benjamin Aaker has been there and done it!!

@Gregory Wilson, That magical "worth it" number is incredibly unique to each investor.  I've had clients pay over $100K of taxes on a transaction because they didn't feel the 1031 was right at that moment.  My favorite client of all time was a retired woman in Cape Coral FL who saved $500 by the time her 1031 was done.  I asked her ahead of time if she was sure it was worth it.  Her response was, "That's my $500.  I want it."

Are you wanting to stay in real estate?  Can you find a new property in the required timelines? What's your tax profile outside the 1031 consideration?  All of these things have to be considered. Along with the vehemence of your own distaste for paying taxes :). 

The ones who say you should 1031 every time are just as wrong as the ones who say you should never do them.  It's a tool.  And it's a powerful tool.  But at the end of the day a tool does not build the house.  It only helps build the house along with the other tools.

@Jorge Diaz

@Ying Tang is correct! One requirement for a 1031 exchange is that you intend to hold onto the property long-term for investment use; that's why fix-n-flips don't work.

If you decide to do more of a BRRRR method and rent it out for a year, that would be fine because you have demonstrated that intent to hold onto the property for productive use.

Occasionally, there's an investor who experiences a negative catalyst that would affect their long-term goals and end up prematurely selling despite their intent to hold. This kind of accidental event does happen from time to time and is perfectly fine. However, when the same accident happens several times a year - well that starts to look a lot less - accidental. You want to be able to document your intent.

@Sam Gleadle 

@Bill B. Is 100% correct. To qualify for a 1031 exchange the property must be held for investment use, that's why fix-n-flips don't meet this criteria. 

In the event you get audited for some reason in the future, you want to have evidence that clearly shows your intent to hold the property for long-term investment use, in this case you wouldn't have a lot going for ya.

Now, if you put a renter in the property for a year and reported income, that would better support your intent.

 Occasionally, there is an occurrence that causes an investor to prematurely have to sell, like a bear moving into the neighborhood (true story), or they receive an offer that's too good to refuse despite their plans to hold. these scenarios are more justifiable until they happen multiple times. 

@Vaughn Ramcharitar, Congratulations on the incredibly hard work it took to build and hold that portfolio.  Now's the time to first ask the "why" question.  The answer to this question will inform all of your future potential actions.  Why are you selling now?

Our clients who are overwhelmed with too much effort managing a single-family portfolio like this will sell either as a portfolio and buy a larger asset commercial or MF in nature. Or they will sell clusters and buy fewer more expensive rentals - either multi-famiy, commercial or vacation rentals.  OR a combination of all the above.  They will do this because they can do 1031 exchanges on all as one, or as individuals.  And this lets them continue to defer the tax indefinitely.  It allows you to continue the depreciation schedules.  And will let you further shape your portfolio in the future.

I'm not a fan of the 721 in this situation unless you are absolutely completely pinky swear done with real estate.  And you are young enough to not be thinking about death and estate planning.  Because a 721 will defer the tax one more time into the upreit.  But if you ever sell any of the upreit you will pay all of the tax and depreciation recapture.  You've worked too hard to earn those gains to give them back unless you're sure!!  

If you're looking that direction because you want passivity then look at syndications that will accept 1031 money. Or DSTs which give you all the current and on-going benefits of real estate ownership. But are totally passive. NNN commercial properties fall one small step closer to active. But can be very attractive in the right circumstance. You only have to manage the least. But using the 1031 still gives you unlimited tax deferral options.

There may be some demographic info about your portfolio that would make it more attractive as a portfolio.  But in general, you will get your best price selling as individuals.  But you can cluster those sales to accommodate a consolidation 1031 exchange from several smaller into one larger property.  And if you're going into DSTs in particular it's easy to cluster and find DSTs available.

 @Eugene DuShawn Smith Since this was an investment property you could do a 1031 exchange like @Bill B. said. Your dilemma is trying to decide between truly starting over. Which would give you reserves, and pay off your creditors. But you will pay tax on that $100K of profit. 15% - 25% whether it's depreciation recapture or capital gain.

Or doing a 1031 exchange where you shelter that tax but have to put all of your proceeds from the sale into the purchase of your new property. So you wouldn't get to pay off those debts or have reserves from the sale. If you did a 1031 exchange, you would be able to use that extra tax to put down on another investment property that is closer to home.

If you wanted to access some tax-free cash after you complete your exchange, you could do a cash-out-refi to put towards whatever you like.