1031 and reduce risk

4 Replies

For example, I have 8 properties average loan to value around 50%. I want to consolidate into 4 properties, all paid off.

Form my understanding of 1031 rules, this is not possible. I still want to ask, even if I sold off all 8, buying 4,is there any trick I can use to accomplish this?

Thanks in advance. 

The only way you could do this is to bring additional cash from other sources in the amount of the mortgages you are getting rid of, as you know....you must buy an equal or greater dollar value of the properties you sell (in addition to using all the cash from the sales).  If you had that extra cash, of course you could just pay off the existing mtgs.

Otherwise no, no way.

@Mike Chern I totally get what you're after.  I call it "Defensive investing".  You're trying to mitigate and consolidate risk anticipating an uncertain market.

You can't get totally there the way you propose but you can get a long ways down the road.  Start with the two requirements to avoid any tax in a 1031.  You must first of all purchase at least as much as your net sale and second you must use all of the proceeds in the purchase or purchases.

This implies that there will be a replacement of the debt but you don't have to.  You can bring in cash from the outside if you have the capability.  And you don't have to allocate the proceeds in any particular way.  The amount of properties you purchase is not important either - only the amount of the purchases that makes the difference.

 Here's some other options:

1. Assuming all the properties are similar in size and if you purchased fewer properties of similar size and all you did was eliminate debt then you would pay tax on the difference between the amount you sell and the amount you purchase as if it were profit first.  So you're right - that doesn't work. 

1. Sell the properties and replace the debt with cash of your own from the outside.  This still lets you get into an all cash position.  But presumes you've got a substantial stash of cash.

2. You could sell the 8 properties and consolidate them into the same number of properties but allocate your proceeds differently. Purchase several for cash and purchase the others with maximum leverage. By doing this you are starting to separate cash and debt - and this begins to mitigate risk. You now have some properties with no debt so any risk to them is minimal. But you also have some properties with maximum leverage so although you're still carrying some leverage risk you're also getting the arbitrage of higher ROI through debt.

3. Another twist on #2 that a lot of my clients have chosen is to purchase replacement properties for cash and place the debt into passive instruments like DSTs that carry debt requirements.  

4. Options 2 and 3 defer tax and depreciation recapture entirely while going a long ways to  mitigate your risk.  There is another hybrid - You would take a long hard look at your portfolio.  Identify those with the greatest equity but least amount of gain and depreciation recapture.  Sell those, pay the tax and use the proceeds to pay off the other properties.  You keep your best performers, eliminate risk and position yourself well for the next buyers market.

Everyone likes leverage.  But no one's ever gone broke taking cash into a correction.

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@Mike Chern , Dave is correct, you could take something like a zero coupon offering DST with as high as 83% leverage to satisfy the debt component. Great tactic 👍