Wouldn't you always 1031?
1) you pay the taxes at a future point in time when you are in a lower tax bracket or more favorable jurisdiction? E.G., move to Texas without any state income tax, and then sell your property in California? how would that work?
2) 1031 lets you benefit from a greater amount of passive income than you otherwise would have been privy to? In no circumstances would it be less income? As your investable base will be higher.
3) is there a flaw in your logic, when you say you will flip more properties in order to pay the tax bill -- those flip gains are also taxable. So are you undercounting your tax bill?
4) I would have to think the 1031 is a compounding benefit. But your ability to earn for a year to pay the prior year tax bill is a looper. I need to think about this out loud...
Say you have $1.00 value, that doubled off $0.50. with your 50% tax rate, that is $0.50 gains taxed at 50% = $.25 liability. So no matter what path you choose, that's your tax liability today.
Now say you 1031 and compound it.. after a year you have $2 value, and after year 2, you have $4 value. You cash out, and owe your original $0.25 liability + 50% ($4 current value - 1 today value) = $1.75 total tax liability. $4 current value = $1.75 = $2.25 net value.
Now say you paid your taxes after a year. So after a year you still have $2 value, but you pay the $0.25 original liabilt, *as well as* the $0.50 new tax liability on the Year 1 gains. ThSo your $2, less $0.25, less $0.50 = $1.25. You compound that $1.25 in year 2, for $2.50 value. You cash out, and your taxes are 50% ($2.50-1.25) = $0.625. Your net value now is $2.50 - $0.625 = $1.88.
Thus, 1031 resulted in greater value.
as far as (4) above goes, I think this is the compounding benefit: You are compounding off a larger base via the 1031. Ultimately, you will cut your final value in Year 10 by half, regardless of whether you did 1031 or paid taxes today. Its better to cut a larger number in half, than a smaller number in half.
Agree/disagree? I could be wrong. Don't make a $1.5MM decision off my little blog post.. I've been working late.