1031, refinance, or HELOC

[J Gold]

I own an investment property that my wife and I obtained for a great deal in Vallejo, Ca in 2016. We lived in it for a couple years then needed to move for a new job opportunity. Long story short we rented the property out and it is cash flowing about $700.00 a month. A recent appraisal puts us at about $125,000 in equity.

We have a current eviction in place and are looking to grow our portfolio.The three options we have come to include doing a 1031 exchange for a similar property, in a better area, with similar cash flow potential. Keeping the orginal property and doing a refinance or using a HELOC for the purchase of a second property. We are new to all this and would some professional insight.

Thank you in advance for your time.

[Dave Foster]

@Kerry Baird, It is correct that you can only use the 1031 for the actual purchase of real estate itself.  And you cannot exchange into improvements you already own.  But, there is a way to back door this called an "improvement or reverse exchange".  

What happens in a reverse or improvement exchange is that we as the QI take title to the new property before you do.  For relatively minor improvements that won't take a lot of time you can close your sale and have those funds sitting in the exchange account.  You use those funds to have us purchase the new property in a special single purpose entity called the "Exchange Accommodating Titleholder" (EAT).  The EAT exists to hold title while you improve it (again using funds from the exchange account or any other source).  Once those improvements are complete . you then take title to the property and complete the 1031.  But since the improvements are complete you take title to it at a price that is the price of acquisition plus the cost of improvements.  So the improvements can then be included in the 1031 purchase.  

IRS approved under the safe harbor of Rev Proc 2000 - 37. But it's a very specific process so relatively expensive. The break even for the cost of such an exchange would need to be improvements of at least $30K - 40K. But there's some benefits. You get to take your time and find the perfect new property. the forced appreciation is all yours. During the time that we hold title to the new property you have complete use and control so all appreciation from that point is yours. Meanwhile if you haven't sold or listed your new property all appreciation there as well as any gain in equity from mortgage pay down is all yours as well. And generally in a reverse exchange we end up giving you the membership interest in the EAT rather than reselling the property to you. This is allowed by the IRS and it lets you avoid a second real estate closing and get a free management LLC in in the process.