Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
I have a problem and would love to hear some opinions on this.
Here is the scenario: a $1.5M tax exposure (net profits on sale of property) and a lack of desire to pay Uncle S. and CA 50% of that ($750k).
So the question is, would you pay the tax and keep gong or would you 1031 exchange this into a buy and hold deal (perhaps commercial deal or 100+ unit apartment building) to avoid the tax?
If you pay the tax, keep in mind you would have until next year to pay it so perhaps take the $1.5M and reinvest into more deals that would net profits to pay s the tax so at the end of the day, perhaps you would still be left with $1.5M or 1031 and with the buy and hold, obtain cash flow passively to semi passively for years to come and not pay any tax.
I don't know much about 1031 so I could be way off. However, is it possible to take the 1.5 mil, buy a property all cash using a 1031, wait the year to meet seasoning requirements, and then cash out refi the property? You wouldn't be able to take 100% out obviously, but 75% out with 25% equity is better than 50% to Uncle Sam.
Real Estate Investor · Milford, NE · Member since 2011 · 201 posts · 140 votes
13y
Until our fine government shows me that they can responsibly manage money, I would do every legal thing in my power to make sure they see very little of mine......1031 all the way.
Investor · in, MI · Member since 2013 · 226 posts · 102 votes
13y
I skimmed through this thread. Basically the benefit of a 1031 is paying no tax on the gain. The downside being you won't have cash for a lending business. So if you are going to pay 50% tax, $750,000, to sell the property, is that what you are willing to spend to "buy" your lending business.
Essentially, the lost gains (equity) of $750,000 is what you have to pay to "buy" your lending operation. If you think think your potential lending operations is worth $750,000 dollars, then it would be worth it. If it won't be worth $750,000 do a 1031.
As others have said it is a "good" problem to have with those types of gains, but I can see your anxiety as your decision has very large financial implications. A general rule of thumb is always 1031 when you can, but circumstances vary for everyone. I feel its best to frame it as paying $750,000 for another $750,000 in cash. Otherwise, you have the full $1,500,000 to buy additional properties.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
13y
Here is the question,
You can cash out typically 60-70% LTV on a commercial property.
So on 1.5 of GAIN. Figuring there is no mortgage and the ORIGINAL price was $1m So total value of $2.5m. Consider that you'd be able to cash out 1,500,000(60% of 2.5m). That could then be used to lend.
Unless you are are looking at a gain from lending of that much in within a year or two, 1031.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
13y
If 1031 was the choice, and an apartment building was the exchange, for me, it would have to be a deal with upside like mentioned. Again, the refi out would have to come 12 months later and leave me with the same problem of no cash to add to the lending side.
Others mentioned an immediate HELOC. That would not be available on an apartment building so out of the question.
As I am reading all the responses (thank you all) my wheels are spinning and perhaps a private investor looking for some cash flow would be in order for temporary (12 month) funds. Then I could do a cash out refi after the upside was realized and building stabilized.
I am definitely leaning towards the 1031 at this point and will likely be posting a new thread for BP Nation assistance in the search for such property.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
13y
Steve posted a link stating that flips do not qualify for 1031 exchanges and Jon replied that flips are not specifically identified. Anyone know for sure and can point to a reference?
I did not post specifics and some have guessed based on knowing what I do, they are correct. Profits mentioned would be derived from a rehab flip, though at time of sale, it will be right around the 12 month mark.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
13y
Will Barnard,
What Steve Babiak said is correct in the terms that it is stated held for investment, whereas flipping is considered a business and that would be sale of inventory. The big question would be if it was done in an entity that flips, or holds property as well as holding period.
There are some things you can consider doing that could assist in altering the nature of such transaction.
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
13y
I once had a discussion with the attorney that I refer to for 1031 exchange matters. Topic was some other investor I know who was doing 1031 on a property where he was leasing to somebody and this tenant was also given an option to buy by the investor (typical lease option). I thought this would not qualify for 1031 exchange; the attorney indicated that it could, depending. So Steven Hamilton II might be onto something, but I still believe that your asset is "inventory", not an "investment", based on flip nature of the original intent.
Now, your "tenants from hell" property might be another story, since you've held that with a "tenant" occupant of sorts. I would be checking into what might get that to qualify for a 1031 exchange.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
13y
Big thanks to Steven for taking the time to discuss this and other tax matters via phone today while being sick! Let me know if I can return the favor.
Investor · in, MI · Member since 2013 · 226 posts · 102 votes
13y
Dealer properties are not allowed to due 1031 exchanges. Flippers are dealers as they are selling seen as selling off "inventory".
All the aspects are very judgmental but I know the IRS always prefers to label everyone as a dealer. Things like holding period, implied intent upon purchase, solicitation, frequency of sales etc... can all affect the IRS's interpretation to whether you are a dealer or not.
Involved In Real Estate · St. Petersburg, FL, FL · Member since 2013 · 22 posts · 5 votes
13y
Couple of thoughts:
If you were thinking about taking the money and lending it, then why not finance the deal for your buyer - pay taxes as you collect the principle under the Installment Sale rules, not all at once. Enjoy the cash flow.
Second idea... Taxes are generally optional if you have a long term strategy and can wait for your payday. Here's a crazy idea that will actually work. 1031 into a beautiful single family home that you thought would be a good investment. Rent it out for a year so it actually shows up on a tax return as an investment property. After a year, realize that it wasn't a good investment property but you'd love to live in it. Move in. Live there 5 years. Sell it and take most of the profit under 26 USC 121 (sale of principle residence).
Add your HELOC idea to the above, and you can still get the money to lend out.
Third idea... no idea if this will work because I don't know if California has figured this one out... What if you 1031 into a property outside California into a state that will abuse you less with taxes? Can you get the money out of California that way and then sell that out of state property later to avoid at least the California taxes?
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
13y
Originally posted by Steve Babiak:
I once had a discussion with the attorney that I refer to for 1031 exchange matters. Topic was some other investor I know who was doing 1031 on a property where he was leasing to somebody and this tenant was also given an option to buy by the investor (typical lease option). I thought this would not qualify for 1031 exchange; the attorney indicated that it could, depending. So Steven Hamilton II might be onto something, but I still believe that your asset is "inventory", not an "investment", based on flip nature of the original intent.
Now, your "tenants from hell" property might be another story, since you've held that with a "tenant" occupant of sorts. I would be checking into what might get that to qualify for a 1031 exchange.
Nature of certain transactions can change based upon added circumstances.
I can't go into details of what was discussed.
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
13y
Originally posted by Shawn H.:
...
Third idea... no idea if this will work because I don't know if California has figured this one out... What if you 1031 into a property outside California into a state that will abuse you less with taxes? Can you get the money out of California that way and then sell that out of state property later to avoid at least the California taxes?
I know that in PA this third idea won't work; PA is one of those states that does not recognize a 1031 exchange as deferring taxes, so taxes on the relinquished property sale will be due in the tax year of sale.
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
13y
Will Barnard
I've been doing 1031 since 1986 and think that they are one of only three real benefits in the IRC.
In most cases I would strongly recommend that a 1031 be used, though there are situations that may argue against a 1031.
There are lots of options, more than here.
1. Borrow to the hilt on the relinquished property, so that the cash involved is as little as possible.
2. Acquire multiple properties, diversifying the profits, by investment class, geography etc.
3. Use some of the gain to acquire a future personal residence, to be rented out as investment and eventually be your home, then get up to $500,000 tax free capital gains. (MFJ)
4. Acquire vacant land that has growing commercial possibilities. When that materializes, lease the land and let somebody else build "it" and collect NNN rents until your retirement and beyond.
5. Don't sell 100% of the relinquished property, retain an ownership position, therefore reducing the amount needed to roll over and reducing your capital gains.
6. Don't sell any of the relinquished property, but sell an option to purchase with a hefty option fee. Option fees are NOT taxable until exercised or extinguished. In the meantime that money is yours to use how ever you please, invest or not.
Landlord · NY · Member since 2013 · 23 posts · 5 votes
13y
Do a 1031 into an RE vehicle you are comfortable dealing with. The taxes are deferred, not eliminated. You are essentially gaining a $750k loan from the government to use. Keep in mind that to defer all the taxes, the new property has to be at LEAST the value of the relinquished property and the debt on the new property should be more than the debt on the relinquished property, otherwise the difference between the two debts (if you were to de-leverage) would be a taxable long-term gain.
Investor · North Wales, PA · Member since 2013 · 116 posts · 44 votes
13y
Do you have any assets that you could sell at a loss to offset some of your gain?
With the recent crash and the magnitude of numbers being kicked around, it seems plausible that you could have a bad investment somewhere in there. Say you bought something for 400k, it's now worth 250k, sell it for the 250 cash and the 150k loss. Then this is 150k less that you'd need to 1031... 400k cash to lend with, 1.35M in a new place etc.
Obviously it doesn't address the entire amount, but with this amount of money, you may want to combine a few strategies.
Specialist · Kirkland, WA · Member since 2013 · 1k+ posts · 817 votes
13y
I too am for the 1031, but let's go about the right way shall we:
You gain 750k after taxes from the sale of your property. The Future Value of this amount lent at 15% in one year is: $862,500.
1031 a $1.5 mil property all cash purchase, with a 65% L.T.V. cash out in one year (assuming no variances in value) is: $975,000
So here's the difference: $112,500 realized in one year from not paying taxes, not to mention the benefit of cash flow and tax advantages of continuing to hold a property.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
13y
Originally posted by Troy Fisher:
I too am for the 1031, but let's go about the right way shall we:
You gain 750k after taxes from the sale of your property. The Future Value of this amount lent at 15% in one year is: $862,500.
1031 a $1.5 mil property all cash purchase, with a 65% L.T.V. cash out in one year (assuming no variances in value) is: $975,000
So here's the difference: $112,500 realized in one year from not paying taxes, not to mention the benefit of cash flow and tax advantages of continuing to hold a property.
I hear you, we are on the same page. The only issue I may have is if this does qualify for a 1031.
Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
13y
Lot's of great advice here. We have done many 1031's. One was into a beautiful place in Naples, FL that will be converted into a personal residence. Since you can buy up to three replacement properties, you have alot of options. As mentioned, you can take some "boot" and pay the taxes. I'd rather wait the year and refi. It's probably too late to put more debt on the property that you intend to relinquish, but I've gone that route as well - to put cash in my pocket tax deferred. I'm too old (lazy?) to be moving every couple of years, but that deal is truly a winner.
Specialist · Kirkland, WA · Member since 2013 · 1k+ posts · 817 votes
13y
Will Barnard, here's what I understand about 1031, it's like the rest of the law; Intent is 90% of the law. If you can prove that you intended to hold the property for 357 days but market situation changed... best to talk to a 1031 specialist or your RE Lawyer at this point.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
13y
Originally posted by Troy Fisher:
Will Barnard, here's what I understand about 1031, it's like the rest of the law; Intent is 90% of the law. If you can prove that you intended to hold the property for 357 days but market situation changed... best to talk to a 1031 specialist or your RE Lawyer at this point.
I agree, and that is the plan, to speak to a specialist and see if this qualifies as an investment and not inventory.
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
13y
Will Barnard
In your original post, one option expressed would be to not take the 1031 and have the $1.5M available for the next year to invest then pay the tax by April 15, 2014. One problem with that is that the IRS would expect a quarterly estimated tax in the quarter that the transaction was settled. If you did not pay any quarterly or under paid, you would be subject to a penalty. Maybe the penalty is just a cost of doing business, and as long as you pay the tax when due there would be no further penalties.
The IRC does say that dealers and property held in a trade or business does not qualify for a 1031. Some assume that means that only Buy and Hold property held more than 1 year qualifying for long term capital gains is also a qualifier for a 1031, That is not true. You could have a property that does not qualify for a LTCG and still qualify for a Section 1031.
Also on the back end the acquired property does not have to be held long term, but if not held long term you would either have to do another 1031 or pay the accumulated taxes upon the sale of the
acquired property.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
13y
Originally posted by David Krulac:
Will Barnard
In your original post, one option expressed would be to not take the 1031 and have the $1.5M available for the next year to invest then pay the tax by April 15, 2014. One problem with that is that the IRS would expect a quarterly estimated tax in the quarter that the transaction was settled. If you did not pay any quarterly or under paid, you would be subject to a penalty. Maybe the penalty is just a cost of doing business, and as long as you pay the tax when due there would be no further penalties.
The IRC does say that dealers and property held in a trade or business does not qualify for a 1031. Some assume that means that only Buy and Hold property held more than 1 year qualifying for long term capital gains is also a qualifier for a 1031, That is not true. You could have a property that does not qualify for a LTCG and still qualify for a Section 1031.
Also on the back end the acquired property does not have to be held long term, but if not held long term you would either have to do another 1031 or pay the accumulated taxes upon the sale of the
acquired property.
David Krulac,
They would not be expecting him to pay anything more than 110% of his tax liability from the prior year until April 15th.