Eat the capital gains and do some flips? or 1031? Need some feedback, pros and cons.

Investor · Lenexa, KS · Member since 2010 · 215 posts · 121 votes

I'm receiving a contract on my multifamily (6unit) that we have had now for 10 months. It was a dump, fixed it up and now it is 100% occupied, stable and cash-flowing. My cashflow after all expenses, debt service and capital reserves is about $700/mo.

I currently stand to make about $60k on the deal - with $40k taxable above my basis in the property. So my I'm reaching out to BP for some pros and cons of either eating the tax and using those funds to flip a couple properties, or 1031 the funds into another deal.

Thanks in advance for the feedback.

0 Reply

58 views

Most Popular Reply

Bill Gulley

Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes

12y

Chances are you'll be paying the tax bill someday. I've done 1031s but probably shouldn't have, it was a popular thought.

The though of deferring taxes and paying with future cheaper dollars is rather a myth, for those dollars to be cheaper you will have inflation. With inflation comes appreciation, the tax bite 10 or 20 years later can be just as bad.

Taking the hit now provides unencumber capital, equity remaining in the walls of the next project is still encumbered, do a cash out refi and see your tax guy. Allow a partner in and see your tax guy. Have a casualty loss totaling the place, see your tax guy. Do an installment deal, see your tax guy. Pledge or cross collateralize that property, you may need to see your tax guy.

Add the cost of the intermediary and closings and that's another matter to examine.

Look to your current tax rate and your expected rate down the road and hope the rates don't change.

I'd say many who do 1031s do so for bragging rights rather than really any prudent financial planning. It can be used as a tool to employ by advisors as a justification for charging a client, making it appear they obtained some great financial plan or a tax deferred transaction as a benefit.

All, IMO. :)

1 Reply

See this reply in the discussion

7 Replies

Jump to latestLatest

Sort by

Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
12y
If you need to eat, take the cash, if you don't reinvest it and keep going.

Consider your cost of money, use of funds and ultimate goals. Can't say which is best without much, much more information. :)
0 Reply
Mat Lewczenko
OP
Investor · Lenexa, KS · Member since 2010 · 215 posts · 121 votes
12y
@Bill Gulley Once I posted, I knew that I was going to get that response :)

I guess I need to go back to my business plan and measure the two. Now I don't need the funds to eat at all, but I want to make sure and maximize highest and best use. These funds, after tax, would allow me to do a nice bread and butter flip here without a partner, which has always been the goal. So I am leaning towards that, but don't want to do something stupid if I can save tax and still accomplish the goal.

I always like to bounce the situation around here to get a couple different angles of ideas. I'm a big fan of the BP mastermind if you will.
0 Reply
Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
Not all states' tax code recognize that a 1031 exchange exists, so in those states you will pay tax on the gains to the state tax collector.

Best to calculate your expected tax obligations both ways to see how much you actually benefit; don't forget to add in fees paid to the QI for the scenario where you assume doing the exchange.

The other thing to consider is how long will it take you to find suitable replacement(s).
0 Reply
Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
12y
Chances are you'll be paying the tax bill someday. I've done 1031s but probably shouldn't have, it was a popular thought.

The though of deferring taxes and paying with future cheaper dollars is rather a myth, for those dollars to be cheaper you will have inflation. With inflation comes appreciation, the tax bite 10 or 20 years later can be just as bad.

Taking the hit now provides unencumber capital, equity remaining in the walls of the next project is still encumbered, do a cash out refi and see your tax guy. Allow a partner in and see your tax guy. Have a casualty loss totaling the place, see your tax guy. Do an installment deal, see your tax guy. Pledge or cross collateralize that property, you may need to see your tax guy.

Add the cost of the intermediary and closings and that's another matter to examine.

Look to your current tax rate and your expected rate down the road and hope the rates don't change.

I'd say many who do 1031s do so for bragging rights rather than really any prudent financial planning. It can be used as a tool to employ by advisors as a justification for charging a client, making it appear they obtained some great financial plan or a tax deferred transaction as a benefit.

All, IMO. :)
1 Reply
Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Originally posted by @Bill Gulley:
Chances are you'll be paying the tax bill someday. I've done 1031s but probably shouldn't have, it was a popular thought.
I'd say many who do 1031s do so for bragging rights rather than really any prudent financial planning. It can be used as a tool to employ by advisors as a justification for charging a client, making it appear they obtained some great financial plan or a tax deferred transaction as a benefit

I'm going to have to respectfully, but strongly, disagree with Bill here. His first comment completely ignores what many investors do which is hold property until death at which time the heirs receive a step-up in cost basis. The capital gain and depreciation recapture taxes go away. The vast majority of our clients generally intend to do just that.

However, holding the same property does not always make sense for many reasons. The 1031 Exchange allows the investor to reposition their assets over time with out incurring taxes so that they can get the step-up in cost basis at their death.

This does not apply to those who build/rehab/flip, etc., but it does apply to those who wish to continue building a solid portfolio of income properties to generate a solid income stream that they will ultimately leave to their heirs.

The comment that many who do 1031 Exchanges do them for bragging rights is just way off base. I've administered well over 75,000 1031 Exchanges during my 30 year career, and I can tell you that most are not looking for bragging rights, they are just trying to defer their taxes. Granted, there are those who get backed into a corner created by the 45 day identification period and buy property they shouldn't (they probably should have walked away and let the exchange fail and pay the taxes), but very few are looking for bragging rights.

I just wanted to make sure that newbies reading this post are not misguided by the comments.
Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.826 Reviews
Website View Page
0 Reply
Bill Gulley
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
12y
Bill, I almost mentioned you, LOL.

Actually, it's not misinformation, the claim is most investors hold till death, not sure that's really true, but what Bill stated is true and another point to consider. I didn't hold my exchanges to the grave and I know that not all are done with the same level of planning, I'd have to believe most are not.

Bill E. knows more about 1031's than I do, I just know enough to know they are not always the best route to take and that when they are done, many wish they had not.

Good friend has owned the second largest (if they never hit #1, it changes almost daily) real estate companies in the state and highly ranked nationally. She's done more deals than all of us on BP put together I'd bet and she explained all here regrets of doing 1031s years ago as I mentioned.

I'd suggest not getting into the popular thinking or promotion of doing a 1031 until you get with a good tax advisor, one who has no interest in you doing one, and ensure that your marriage to the property type will last.

1031s have a valid place in your planning when it is truly beneficial, it's just that it isn't always. Consider your age, your goals and the options of holding entities too.

I'm one that likes leaving the door open to options, to me that has value too. :)
0 Reply
Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
12y
@Mat Lewczenko

Back to the original question....it is irrelevant for you now, as this transaction doesn't qualify for capital gains, or for a 1031, since it's a flip not a "long term investment".
0 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.