To sell (1031) or not to sell

Greg Clatterbuck · 2019-01-30T17:34:25-08:00

Looking for critical feedback.I currently own a property (10 years) that is valued at $215k, mortgage of $100k currently cash flowing approx. $600/month (not including cap ex, vacancy, maintenance). I self manage the property as it is near where I live and takes minimal effort. The tenant would like to purchase the property. If I keep the property, it will need approximately $5-7k in repairs (carpet, paint, etc) and an HVAC (13 years old) at a cost of $5k. I am currently making an offer on a pair of duplexes out of state that I could 1031 into, however, already cash available to complete that purchase without selling current property. If I sell and 1031, I will use the cash on hand to purchase another property.If I keep the property, I can do a cash out refinance for approx $50-60k, although the current interest rate is 3.75%. My long term goal/investment strategy is buy and hold. I have never sold a property previously. Thoughts/Recommendations ??Thanks

Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

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@Greg Clatterbuck

Greg, you didn’t say how much you paid for the property. The 1031 is just to defer paying taxes on the gains.

You also didn’t mention the rent, only the cashflow.

So I have to give you a ballpark answer instead...

If you paid less than $130k then maybe. or the rent is less than $1300/mo then definitely would be my two guidelines. You might have to get a new loan of $100k to make it work, I’m not sure but our buddy @Dave Foster will know, he knows everything.

Hey Dave, if he sell property A for $200k, pays off $100k mortgage and has $100k cash to buy property B. Let’s say at $300k for this example. Does he have to get a $200k mortgage to stay taxe free or can he come out of pocket for the other $200k and pay $300k cash for new property B? ($100k from QI and $200k from savings.)

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Greg ClatterbuckPro Member

OP

Rental Property Investor · Member since 2018 · 18 posts · 8 votes

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@Bill Brandt

Purchase price was $135k with current rent of $1400, could likely get $1500 after upgrading.

The taxes would be assessed on approximately $100k because of the 10 years of depreciation and current appreciation.

With a 1031, the equity would be used to purchase a $450k property which would cover 100% of the equity

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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

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@Greg Clatterbuck

Hey Greg, thanks for the additional info. Let’s say you clear $200k so you have $65k capital gain, about $10k in taxes @ 15% for round numbers. If you calculated 80% of the $135k as building to depreciate that’s $105k give or take. 10 years of 4% give or take is anothe $40k to recapture at 25% or another $10k.

So you’d owe about $20k to sell and walk away. Call it $215k sale, $200k net after costs, $100k after paying mortgage, minus $20k in taxes leaves about $80k for better or worse if you sell.

Probably comes down to a judgement call and if the property is a headache or basically mailbox money.

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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

7y

@Chris Mason

Thanks Chris. Was my first time I’ve ever seen something like that. Didn’t use a report button (thanks for that hint) simply put at moderators and hoped for the best.

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Greg ClatterbuckPro Member

OP

Rental Property Investor · Member since 2018 · 18 posts · 8 votes

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@Bill B.undefined

Thanks Bill.

If I sold, I would do a 1031 into a property I’m about to go under contract on and would use that money instead of cash I already have. I still wouldn’t owe any taxes. I would only sell to do a 1031. I would use the cash on hand, that would go to the purchase, on something else. I feel like in this situation it isn’t as clear cut (sell or hold) and can be argued either way.

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Clayton MobleyPro Member

Birmingham, AL · Member since 2014 · 875 posts · 947 votes

7y

@Greg Clatterbuck Personally, while your rent to value was great based on purchase price, you're now at a value where that capital could be doing more, even at $1500 after that rehab. The fact that you don't have to hunt for a buyer is HUGE. The fact that you already have a replacement prop you'd want that would cover the value and equity rules for the 1031 is even better. The fact that you're coming up on some decent-sized repairs is allll the more reason to move along and let someone else deal with that.

@Bill B. already ran through the tax numbers on a straight sale, and honestly I don't see why you'd go that route when you have a 1031 basically fall into your lap. Since the property you are looking at is $450k (and yes, you can replace debt from the old prop with out of pocket cash, you must have AT LEAST AS MUCH equity in the replacement prop, but you definitely can have more), and it sounds like you have the cash to cover that purchase without a 1031, my advice would be to:

Act fast to get a Qualified Intermediary working with you, because you need one in place before anything closes. If you're already moving on the replacement prop, you may need to ask to slow that process down while you execute a quick sale to your tenant, or you'll need to talk to your QI about a reverse 1031.
Sell the current prop to your tenant (I assume they are not a related party, or that makes things a little complicated 1031-wise).
Execute the 1031, either taking out a loan for the new prop to replace the $100k debt on the current prop or replacing it with cash. For the $450 prop that would mean:
1. $100k cash from the current prop + $100k new loan (replacing debt) + plus $250K out of pocket OR
2. Pay off the $100k loan, use $100k cash from current prop + $350k out of pocket.
Use your remaining cash (my math says $100-200k) as down payments on other cash flow properties (if your goals is to grow your portfolio quickly and let tenants pay off your loans, my strategy), or hang onto it until you have enough to buy another in cash (if you're more focused on maximizing per-unit income and minimizing risk, and don't' mind having capital tied up).

If you keep using the 1031 process literally until you die (and remember you can leapfrog from one to several, from small to bigger, SFR to MFR etc), then you completely avoid all taxation and pass your properties on to your heirs with a stepped-up tax basis equal to their fair market value at the time of your death. Basically, if they sold them the day after you died they would pay $0 in taxes. Hold the props and they're only responsible for whatever appreciation/depreciation occurs after they took ownership.

You're in a pretty good position, one a lot of folks would definitely envy! I'd say take the opportunity presented to you, but makes sure you get a good QI before you pull any triggers.

Good luck!

1 Reply

Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

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@Bill B., don't forget avoiding depreciation recapture also as a 1031 benefit also. You're absolutely right. If @Greg Clatterbuck sells and 1031s he could take the cash in the exchange and add it to the other cash on hand to purchase a property or properties worth at least as much as he sells ($200K ish). He doesn't have to take out a new mortgage. So for that part of his scenario it works perfectly.

I think though I saw in the string that Greg would only use the 1031 cash to purchase the two properties. That's fine as well. And he can allocate those proceeds in any way he wants. My usual recommendation at this point in the market is to begin to separate cash and debt to alleviate mortgage risk in a slow down. So a hybrid approach would be for Greg to sell and 1031 and use those proceeds and just enough cash to purchase one of the properties for cash and the other one with maximum leverage. Now he's got one he almost can't lose but he's also got one that he's benefitting from the arbitrage of leverage.

Usual costs of selling 6-10% ($20K). Repairs $7k. Cap ex risk HVAC etc ($10K). Vacancy - 3000. You avoid all these with a sale to your tenant. I'm with @Clayton Mobley on this one. It's a 1031 dropping in your lap.

I'd tear the tenants arm off getting them to sign the contract!

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Greg ClatterbuckPro Member

OP

Rental Property Investor · Member since 2018 · 18 posts · 8 votes

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@Clayton Mobley, @Dave Foster, @Bill B.

Thank you all for the feedback. I had a direction I wanted to go, but wanted to hear other opinions. I will work the deal to sell to the tenant and 1031 into the new multi-family and keep cash on hand that I was going to originally purchase with. With the uncertainty of the market, I think would prefer to keep some cash on hand.

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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

7y

Awesome, thanks for involving us. I like to hear stories of people moving forward. I’ve been wanting to sell any 1 of my properties for a year or two. But I would only do a 1031 exchange as I have appreciationa and depreciation to account for. But my tenants keep accepting rent increases and I can’t kick out a paying tenant to sell, goes against my better judgement.

Let us know about the new property when you get it bought. Take care.

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Clayton MobleyPro Member

Birmingham, AL · Member since 2014 · 875 posts · 947 votes

7y

@Greg Clatterbuck glad to help! Sounds like you've found yourself in a great position, happy to hear you're taking advantage of it!

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To sell (1031) or not to sell

To sell (1031) or not to sell

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