All Forum Posts by: Sean Ross

Way to "represent the 303" there, @Taylor Fortini!  You've got one more fan here rooting for you to get to 200+ doors.  And congrats on the child!

What areas do you feel like you need to learn (or want to learn) most about?

@Jon Foley thanks for the post and your transparency!  Let me reiterate what @Matt Jones said about BRRRR -- it's a craze right now for a reason (it can work very nicely for the right investors) but it's still just one of many potential strategies.

You mention having 4 young children (the wife and I are just now considering our first, so perhaps you can educate me on that investment) and that makes me worry about the time-sink involved in BRRRR for you. Are you most interested in the appreciation or the income? Or something else?

And, as with anything, you're going to metaphorically stub your toes as you learn the path. 

On the profits/capital gains front, you should consider a 1031 exchange as long as you are set on reinvesting your equity into more investment real estate. 

Just a few thoughts.  Wishing you and your family best of luck!

@Tristan Toliver congrats on your investaversary.  That's really really cool!  

My preference is always to know how to compare investments before considering any move. This may be redundant for you or it may be new, but calculating return on investment for REI is critical.

Matt Frankel at Millionacres is my go-to source here.  Try this article he wrote for Madison.com (https://madison.com/business/i...)

This includes a reasonable calculator at the end of the article. 

If it makes sense to sell and upgrade, you should almost certainly consider a 1031 exchange. 

Hope this helps and keep on keepin' on!

@Aurora Courtney, thank you for the info.  Are you asking how to sell one property and 1031 exchange the deferred proceeds into a new construction on a lot already owned by the same investor?

If so, that's a VERY tricky process with lots of possible red flags. 

Happy to elaborate, but first want to make sure that I'm not egregiously misreading the post.  

@Nathaniel Prince welcome to BP and thanks for the question.   Can I recap quickly what I've heard and then try to apply that logic to your scenario?

You've Said

• The current asset does not generate the ROI you like
• You want to purchase new assets and possibly multiple new assets (initiate BRRRR)
• You want to diversify into new asset classes (multifamily)
• Tax efficiency is one important variable (you are considering a 1031)
• Appreciation is great but you really want cash flow

Applying to the Three Options

1. If you 1031 into multifamily, I think you're hitting lots of birds with one stone. It's tax efficient, it could diversify your portfolio, it could get you out of a low-ROI asset and into something with better metrics, and it gives you lots of options with leverage on next property(ies).
   
2. The second option, as @Dave Foster said, doesn't make much sense. It looks like an inefficient version of the first option. Based on the criteria you gave, I think you can safely eliminate this. 
3. The HELOC gets a boost for not being tax-inefficient, but it leaves you with the low-ROI asset that you're already displeased with.

It's possible we don't have enough information to say this definitively, but based on what you gave us I think #1 is the way to go. 

Clear?

@Roxanne Rose in normal circumstances a cash-out refinance should not trigger a tax event because loan proceeds are not income, and therefore they don't carry the normal consequences that receipt of income can carry. 

However, refinancing to pull out equity prior to a 1031 exchange can, but won't necessarily result in taxes owed.  This is due to what lawyers in this space call the "Step Transaction Doctrine."  (In short, this doctrine means that you can't do something across multiple steps that would normally be disallowed under a single step)

Imagine that you want to do a 1031 exchange but keep $150K of your equity after sale.  This creates taxable "boot" and you won't get full value from your exchange. 

Then imagine that you try to game the system by refinancing quickly before you sell, pull out the $150K, then do a 1031 exchange.  Clever, but here's where you run into problems with Step Transaction Doctrine. In this case the IRS could argue that your refinance loan proceeds actually constitute "boot" in the 1031. 

Here are some very short guidelines

• refinancing after you buy and complete the exchange is less tax-risky than refinancing right before you sell
• If you do refinance before you sell in a 1031, then your refinance should take place as early as possible and the primary purpose should not be for tax avoidance. 
• The refinance should, if possible, be documented as separate from the exchange sale so as not to look connected. 
• You should be able to show an independent reason for the refinance (the literature calls this independent "economic substance") so that it looks like you would have pursued the refinance whether or not you sold the property or did an exchange. 

Work with a tax advisor and QI on this. Some of this is subjective; some is not.  You want to make sure you're following valid established precedent to the maximum extent possible. 

Welcome @Keri Mallozzi!  

@Leslie Fisher let me back up what Dave is saying here.   

If you sell a property in SF as part of a 1031 exchange and then try to use some of the 1031 proceeds to make improvements to ANY property (whether you already own that property or not), the IRS is going to throw a red flag.  This is because what you're spending money on is, in part, "labor and materials" rather than "real property" as defined by the IRS. 

There is one IRS-approved method for building or improving that uses 1031 funds.

Construction 1031 Rules and Process
In a nutshell, it goes like this:

1. You go under contract to purchase the replacement lot in Oklahoma
2. A 1031 company creates a brand new LLC to act as holding company (Exchange Accommodation Titleholder)
3. You enter into an agreement with 1031 company outlining your plans in the construction exchange
4. You assign the purchase contract for the lot to the new LLC
5. You arrange financing for the LLC to purchase the lot (this loan can be from you, a third-party lender, or your 1031 sale proceeds)
6. Loans to LLC is secured by Note and Deed of Trust
7. LLC buys the lot
8. Now the LLC can begin paying for improvements to construct the barn-condo
9. During the building period, LLC rents back to you and makes you "Project Manager" to oversee the improvements.
10. Once improvements are completed -- or at the end of your 180 days -- 1031 company assigns ownership of the LLC to you. (You can also set up a new closing and re-deed, but this is more expensive)
11. The transfer of ownership for the LLC counts as you "buying" the replacement property at cost of land + value of improvements.
12. 1031 exchange completed

Now, I've left out some technical details to keep this in relative layman's terms. 

If you already own the lot that you want to improve on this becomes significantly harder. In fact, I would advise trying to find a different solution (such as finding a nearby lot with similar prospects). 

And, yes, construction exchanges tend to be much more complex, much more expensive, and carry additional tax risk because they are tricky to execute. 

@Eddie Mendoza just wanted to add that your refinance doesn't affect your ability to claim your Section 121 exclusion on taxable gains (and Bill is spot on about the details there).   The refinance also wouldn't make a difference for 1031 exchange purposes if the same facts were true but you were selling an investment property rather than a primary residence. 

@Corey Jenrich I agree with @Dave Foster here. 

The blanket loan could give you some obvious benefits with fewer origination fees and maybe a larger ceiling on your principal. 

But downstream you may see some limits.  The partial release language is crucial.  And since you effectively have all properties acting as collateral for each other, default is huge risk. This means any given asset under-performing threatens all the rest. 

Most experienced lenders should work with you to customize. 

Even so, we rarely see blanket loans among 1031 clients.