How to fund debt for a 1031 if I don't have the DTI?

Question

I am preparing to sell a condo that I've owned and rented out for the last 15 yrs in NYC. It has appreciated quite a bit, but the cash flow is just ok, and I think that I would like to deploy all the appreciated equity into some better cash flowing properties - probably SFH or MFR. The problem is that I make a pretty modest annual income between my wife and I, which won't be able to support the DTI on new debt for any new investment properties. (We make about $75k/yr. We are also in the midst of relocating to Winston-Salem, NC for a new job and buying a new home down there, which is where I would expect we will search for new rental properties.)

Rough numbers: $400k purchase price with quite a bit of depreciation for a tax basis around $200k. Sale price around $1.4m. Current debt is about $500k, and I'll have about $800k in equity proceeds (after brokerage commissions and ny transfer taxes) to roll into new properties.

I'd obviously take a huge hit in taxes if I don't roll that debt into new properties. I've looked into going the commercial 1031 route (NNN, etc.) where we'd have better luck securing debt, but that market seems so compressed right now and I wouldn't get the cash flow I'll be able to get with residential rentals. DSTs seem similarly frothy. I don't want to 1031 into something without a great exit just to save the taxes.

Any creative ideas for how to take on the required debt when conventional lenders aren't going to fund me and it'll be two years or so before any new cash flow will qualify me to refinance? Will portfolio lenders take me on? Does finding an equity partner make the most sense? Seems like too much money and too long a time for hard money/p2p lending? I've got quite a bit of experience renovating and renting out both long and short term rentals, but with my new job I'm not quite sure how much I want to take on at the moment. Appreciate any advice...

Dave Foster · Answer

@Christopher Brown, just to be clear, there is no specific requirement that you take on similar debt in type or amount. Your requirements to fully defer tax in a 1031 are that you purchase at least 1.3 ( or whatever your net sale ends up being) and using all of the proceeds, 800K in the next purchase or purchases.

So here's some thoughts.

1. Putting 800K down on 1.3 is 61% down. This should be very attractive to private money and especially a local community bank who holds their loans in portfolio, knows the area, and knows you.

2. Find a seller willing to carry back a 2nd. This would work well on a distressed property where you may be willing to price the purchase with some of the down line equity in return for favorable 2nd mortgage financing.

3. Look for several replacement properties and allocate that 800K in whatever way you want to get to 1.3 of purchase. Find a MF for 600K and pay cash for it. Then find a farmer with a tract of land that he would take 200K down and finance the rest giving him a lease back while development heads that way.

4. Do a partial 1031 exchange. You can buy less than your net sale but you will pay tax on the difference. So in your worst case scenario with a 1031 exchange you could purchase 800K of real estate with the 800K in cash and would be liable for tax on the remaining 500K that you bought down from 1.3. In really rough numbers your recognizable gain including depreciation recapture is about 1.1 mil. So doing a partial exchange like described above you would pay tax on 500K but would shelter the tax on the remaining 600K of gain. That's still savings of over 120K.

You've got a lot more options than you think. Don't write that tax check yet!

How to fund debt for a 1031 if I don't have the DTI?

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