1031 exchange: When is it worthwhile? When is it not worth it?

Question

Is there an approximate dollar amount of gain that makes a 1031 exchange worth the hassle? Is there an amount where I should just pay the tax? Another amount where there might be this gray area? Another higher amount where it's definitely worthwhile?

Alex Olson · Answer

It is really all about your resistance to paying taxes. A QI will cost you around $2,000. Depending on your location your taxes and other fees may be about that amount or more at a minimum. Many of the clients that are on the lower side that we have get about $100,000 to $250,000 in total equity that they can place here in KC and buy something for $500,000 to $1mm or so. If you are doing a 1031 exchange on 25,000 in net gain that will be taxed on capital gains - it may not be worth it or it may...depending on your resistance to paying taxes.

Carini Rochester · Answer

@Alex Olson @Dave Foster @Julio Gonzalez @Carlos Ptriawan ,

Thank you for your responses. Your answers have helped me quite a bit. It's very nice of you to take your time to help me out!

Carlos Ptriawan · Answer

1. If PAL > capital gain = don't do 1031, better use PAL to offset cap. gain2. If capital gain > 500k and you do MFJ --> 1031 is a must3. if you are near retirement age --> 1031 planning is sometimes extremely important (due to lender DTI etc)4. if you want to move to your new 1031 home tax free after selling primary --> 1031 is the only answer LOL5. If your IRR > 15% --> 1031 is good

The best usage for 1031 in my eyes is when converting the rental to primary vacation spot OR when primary owner want to move to new home after selling primary for free capital gain tax.

Julio Gonzalez · Answer

@Carini Rochester While the dollar amounts are important, I also think having a good understanding of why you want to get out of the current property or into another property is extremely important. Maybe the current property is old and requires a lot of maintenance and time on your part, but the new property is a newer build and would require less time. Maybe you're going from small, self-managed properties to a larger multi-family where you will have property management and commit less of your own time to the property. Maybe the neighborhood your current property is in is harder to rent out or draws in less reliable tenants, but the new property wouldn't have that same issue. While time doesn't have an actual dollar amount tied into it, it's also something to consider. Are you for sure wanting out of your current property?

Dave Foster · Answer

@Carini Rochester, If you're exiting real estate then a 1031 isn't good for you regardless of the tax savings.  If you can't find a good replacement and the market is in huge turmoil.  Maybe it's worth not doing a 1031.  But in general if it gets you where you want to go.  And it saves you money it's probably worth it.

I always encourage people to do a quick comparison of the tax they'll pay immediately vs how long it will take them to recoup that if they place the money into another investment.  The compounding effect you get from a 1031 and the resulting deferred tax is huge and beneficial to you whether it's one day or a lifetime.  But that doesn't make it worth it to you.

For the record - The average sales price of a 1031 exchange property these days is still less than $400K.  And 1031s in that range are not near as expensive as $2000.  It's not just for the 1%.

James Hamling · Answer

@Carini Rochester I have a very different take then what I have seen others post, which is going to sound a lot like a CPA response because it comes from my CPA's, and it's just smart to be blunt about it.

A 1031 is a DEFERMENT of tax payment. The tax is still there, it's just an ability to choose WHEN it is realized to be paid. So, the answer lies in when is the best TIMING to realize that tax for payment.

Now, everyone's situation is going to vary when is best and when is worst. And that's why there is no 1-size-fit's-all answer, and any are just BS answers. Because it's based on your specific situation.

Commonly, if in portfolio building phase, it's often best to utilize that 1031. BUT, there can be other factors, right. Say you also for whatever reason have a ton of write-off's in a given year making that tax impact a "softer" hit vs other years on the horizon, it could be a good time to take that hit.

As for the time window to identify another property, sorry but I say that's a novice excuse because there is a list of ways to mitigate that item, legally. You can do a delayed closing with allowing buyer to take earlier receipt of property on a leasing basis, or there is account methods to set those funds aside to gain more time to identify. Options exist, it's not impossible just detailed.

So again, your PRIMARY motive should be TIMING based upon your specific situation. When is best to take that tax, now, 4yrs from now, 4 decades from now, or 17 decades from now (yes, there is ways to do that also.).

I have one client who's REI holdings are now transferring too generation 3, and it has 1031's in it from generation1. There plan is to keep rolling things for eternity, because they can. Every situation is unique unto itself.

1031 exchange: When is it worthwhile? When is it not worth it?

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