1031 Exchange on SFR - Is It Worth It?

Question

I know the question is subjective. Obviously there is a tax savings (deferred) benefit. For those who've gone through the process on a SFR, did you find it worth the extra steps, time involvement, and (maybe) hassles that come along with the process?

I'm looking to use proceeds from one SFR to invest in 2-4 other SFR.

I'm looking to use proceeds from one SFR to invest in 2-4 other SFR.

Buddy Holmes · Answer

If it is sizable, then the tax is sizable by you definition). You might consider the 1031 exchange into multiple SFR that do cash flow and with one or two of your expected multiple replacement properties having a a small or no mortgage. Then once the exchange is complete and after a "reasonable time" refi the SFR to get cash out for your BRRRR. Look at the 1031 as giving you the benefit of cash flow from one buy and hold in terms of a gift of Uncle Sam rather than paying him his tax.

Cheers,

Buddy

Cheers,

Buddy

Chris Bounds · Answer

@Dave Foster, gotcha. I'm looking to turn one into 3-4 so I'd be spreading cash around.

Dave Foster · Answer

@Chris Bounds, You're correct, when you do a 1031 all of the cash proceeds from the sale have to go into the new purchase which as you say would increase your cash basis (but not affect your real basis).  But there is a trick that may benefit you.

You're in growth mode so diversification exchanges can be very powerful. Sell one property and buy two using the 1031.  You will have to use all the cash in the purchases but it can be allocated in anyway you want.

So you could put all of the cash into one property paying cash for it or taking out a minimal loan.  On your second property you continue with your model of using private 100% financing to purchase and rehab before refinancing.

Just a thought.

Chris Bounds · Answer

@Dave Foster, most of my BRRRR properties require very little to zero cash since I get them 100% financed through private lenders. Then once rehab is completed I refi out of the PL loan.

The way I understand it, a 1031 will require me to increase my cash basis of each property. I could do a cash out refi after 6 months at a slightly higher rate, but that seems to negate the benefits, long term at least.

Dave Foster · Answer

@Chris Bounds, A lot depends on the reason for selling your current property but, Surprisingly , a 1031 actually complements rather than complicates a BRRRR strategy. The BRRRR strategy depends on refinance to grow your portfolio.  And the key is that those refinance dollars are tax free.  However, whenever you sell the property that originated the refinance dollars that enabled you expansion without a 1031 you pay the tax on all of those refinances in the past and negate a great deal of the power of the 1031.

A 1031 fits into your strategy when it is time to sell a property you've been using as a source of refi for expansion.  You can sell and keep the tax deferred had still pick up a new property at the same time.  At some point in time there is a reason to sell rather than "repeat" the refi process.  This is when the 1031 comes into play.

Chris Bounds · Answer

Thanks all. It's a sizable proceed. I'm leaning towards just biting the tax bullet for the flexibility on redeployment. I utilize the BRRRR strategy so a 1031 process may complicate things more than help.

Dave Foster · Answer

@Chris Bounds, The type of real estate isn't going to be much different in how you approach the benefit analysis.  It's about net tax savings over the expense and more importantly how you plan to use those tax deferred dollars.  Even a $10K - $20K deferred tax that you keep to use to compound your portfolio and cash flow growth will result in real money by the end of your investing career.

The other issue that seems relevant in this market is the opportunity cost of having to find and purchase the property within the 45 day identification window and the 180 day exchange window vs cash at the ready.  If you believe that is a difficult task and you can find properties if you have more time at a 15 - 30% discount above normal then you may be wise to forego the 1031 and hoard cash looking for the deal.

Most investors I see are looking at the long haul and the compounded effect of using deferred tax for their own portfolio with a plan to generate passive income and convert into future primary residences or leave to heirs.

Bill Exeter · Answer

Hi @Chris Bounds,

The answer depends on how much income tax liability you will have to pay vs. the cost of structuring a 1031 Exchange and the additional administrative items that will be involved.  The 1031 Exchange nominal around $800.00, so it really boils down to the amount that you would owe/save.

Remember, the 1031 Exchange should always put you in a better position once the transaction is complete, otherwise you should probably not structure a 1031 Exchange.

1031 Exchange on SFR - Is It Worth It?

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