1031 Exchange vs rental mortgage paydown

[Steve Testori]

Howdy all - first time poster here, and thanks to any who offer advice.

I own several rental properties (one in NJ and two in AZ), and am preparing to sell one (NJ). I’m weighing options regarding the proceeds. Here’s what I’ve come up with:

1) Using a 1031 Exchange to buy another property in AZ and generate more income, as well as continuing to enjoy the tax advantages from rental investments 

2) Skipping the 1031, paying all the taxes - capital gains, depreciation recapture - and using the net proceeds to pay down one of the AZ rental mortgages in hopes of having it paid off sooner so it creates better cash flow

I’m 59, anticipating retirement in three years - all of my finances are in good order with no debt outside of the rental mortgages, own my home outright. I’m a bit wary of taking on more debt at this stage of my life, but do like the idea of not leaving thousands on the table - the second option is appealing in it’s simplicity and keeping on Uncle Sam’s good side.

Thoughts/insight? Am I overlooking anything?

Thanks again for any input -

[Dave Foster]

@Steve Testori, Love how you've steadily put yourself into such a good position.  I'm not a fan of debt either (except when they're giving it to you for 2-3% it's hard to resist).  But here's a different way of thinking about your debt situation.

If you went with plan B you would be paying off debt and in theory further recession proofing your portfolio. But the reality is that

1. Your payments would not go down until the house is paid off completely.  So you're not reducing outflow but by selling and not replacing you are actually reducing your in flows.  So this actually becomes a riskier action because you're limiting your income but keeping your expenses the same (you're reducing total debt but not affecting payments).

2. Second, since your outflows are the same, ask yourself how many months/years you could make supplemental payments if your were short on a mortgage with the tax you'll defer in the 1031 exchange?  If you simply sell and pay the tax where is the cash bank to cover shortfalls if you simply pay a mortgage down.  Banks are not interested one bit in lending you money when you need it.  So your paid down mortgage might actually work against you and make you equity rich and cash poor.

Given your solid position I wouldn't hesitate to 1031 and then even do a refinance of that property after the 1031 is complete.  Take the refi cash and invest it somewhere rock solid safe.  Make it liquid so its' there when or if you ever need it.  That becomes your safety net if the economy turns and one of the properties is in trouble.