Use Profit from Rental Property Sale to 1031 into several turnkey long-distance rentals?

18 Replies

Hi, BP!

I just joined after having read numerous articles and forums on here for some time now, and now I am planning my next move. 

Here's my situation: bought my first property - a condo - in the north Seattle area as my personal residence at the beginning of 2009. A growing family prompted me to upgrade to a nearby house, which we did in 2013. Thanks to reading material on BP, I'm renting out the condo from 2013 - 2016 to some ideal long-term tenants, and make about $100 in positive cashflow every month (my primary purpose was just to have them cover the condo mortgage + insurance + property taxes + HOA dues + maintenance costs until the condo appreciated enough with the recovering market to sell for a profit). The condo has appreciated quite a bit now and is predicted to keep doing so throughout the next year. When I sell next year, I may have a $75K net profit after closing costs, improvements, realtor fees, etc. I want to do a 1031 exchange with that. I could use that as a down payment on typical $375K SFH here in the Seattle area and manage it myself again, and at most I might get $300-$400 positive net cash flow every month. However, I'm busy with career and family and can probably count on more maintenance involvement with this new property, and a PM would of course decrease the net cash flow. I'm thinking of doing what other BP investors in expensive areas have done: put my money in less expensive markets where it can go further. Specifically Memphis invest with Chris Clothier. I figure I can get multiple properties with the $75K divided up into the down payments for each of them, and cash flow of closer to $1000/month from all combined. Plus their well regarded PM.

So after researching Memphis Invest and reading up on 1031 exchange rules, my initial question is whether it is realistic to identify and secure 4 or 5 properties with the 45-day identification period allowed by the IRS?

Hello again @Charles Moore,

Again, welcome to BiggerPockets.  This seems like a duplicate post.

First of all, you can do a 1031 exchange into any number of properties, in any market in the US, provided you follow the exchange rules.

You have 45 days from the day you sell your other property(ies) to identify your new 1031 properties for the exchange. The rules are very strict and you must identify those properties within that period and you cannot change it thereafter.

After that you have up to 180 days to close escrow on those properties.  No extensions are allowed without incurring taxes on your unused exchange funds.

Seattle is a pricey market, so like much of coastal Cali, I can see why you would want to leverage up your portfolio of properties using the equity from your WA condo.  (The HOW really cuts into you cash flow too.)

Memphis is a good market.  What other markets have you looked at or considered?

Continued success!

Talk to a 1031 company. It is my understanding that you can identify up to three different properties without restrictions. If you identify four or more, those four properties value cannot exceed 200% of the value of the property you wish to relinquish.

@Charles Moore I am not a tax or 1031 expert but I believe if you lived in a house 2 of the previous 5 years you can qualify for homestead exemption allowing you to have gains of up to $250 per owner, $500 per married couple tax free.   Maybe a good question for your accountant. 

Originally posted by @Mark Ainley :

@Charles Moore I am not a tax or 1031 expert but I believe if you lived in a house 2 of the previous 5 years you can qualify for homestead exemption allowing you to have gains of up to $250 per owner, $500 per married couple tax free.   Maybe a good question for your accountant. 

 That is 250k if single and 500k for married couples.

@Charles Moore , You've actually got a couple of opportunities here.  If you plan to sell within 3 years of when you moved out you will indeed get to apply the sec 121 exclusion and as a married couple take the first $500K in gain tax free as @Mark Ainley  said.  If you choose to reinvest that gain then great but you can do it however you want apart with no tax consequence from the sale.

If you wait until after 3 years from when you moved out then you no longer apply for the primary residence exclusion but you could do a 1031.  What you are talking about doing is a diversification exchange.  Selling one and buying several usually smaller properties.  Here's the trick to that process.  At the end of the 45 day identification period you must have a list of potential replacements in place and you may only complete the exchange with one or more of those properties on your list.

If your list is three or fewer properties then it doesn't matter how much they are worth.

If you want to end up purchasing more than three properties then your list will have to be more than three.  You can do that but the aggregate value of the list cannot be more than 200% of the value of what you sold.  Example - if you sold for $400K and named four $200K properties as your replacement list that would be fine.  But if you sold for $400K and put three $200K and one $250K property on your list that would disallow your exchange.

However, if you have to name more than three properties and the properties you have to name total more than 200% of what you sold you may still do it but only if you close on at least 95% of the value of the list.  In the example above naming 4 properties worth a total $850K and your sale was $400K you can only complete your exchange by purchasing at least 95% of the $850K list - or in actuality all 4 properties.  So you have to be really certain and focused to make this happen.

A good QI will steer you through this maze.  But I would definitely pursue the sec 121 exclusion first.

@Charles Moore If you can find a way out with no tax consequences then do so. A 1031 is a pain to do and often time I have seen people settle for there next investment because they run out of time. 

Originally posted by @Marco Santarelli :

Hello again @Charles Moore,

Again, welcome to BiggerPockets.  This seems like a duplicate post.

First of all, you can do a 1031 exchange into any number of properties, in any market in the US, provided you follow the exchange rules.

You have 45 days from the day you sell your other property(ies) to identify your new 1031 properties for the exchange. The rules are very strict and you must identify those properties within that period and you cannot change it thereafter.

After that you have up to 180 days to close escrow on those properties.  No extensions are allowed without incurring taxes on your unused exchange funds.

Seattle is a pricey market, so like much of coastal Cali, I can see why you would want to leverage up your portfolio of properties using the equity from your WA condo.  (The HOW really cuts into you cash flow too.)

Memphis is a good market.  What other markets have you looked at or considered?

Continued success!

 Thanks for the quick reply! Yeah, I did inadvertently make a duplicate post. My first one resulted in a website technical error message which made me think it did not post.

I've read good things about Indianapolis, Kansas City, and Cleveland. Already checked out Texas, Birmingham, and Atlanta; found some things about each that don't match my search criteria.

Originally posted by @John Thedford :

Talk to a 1031 company. It is my understanding that you can identify up to three different properties without restrictions. If you identify four or more, those four properties value cannot exceed 200% of the value of the property you wish to relinquish.

 Yes, I've read about that, too. I would search for 4-5 properties that fall under the 200% rule. Thanks for the quick reply!

Originally posted by @Charles Moore :
Originally posted by @Marco Santarelli:

Hello again @Charles Moore,

I've read good things about Indianapolis, Kansas City, and Cleveland. Already checked out Texas, Birmingham, and Atlanta; found some things about each that don't match my search criteria.

Some of these markets are pretty similar but some are very different. Depending on your objectives, there'll always be things that are more attractive about one vs the other. There's never a perfect market. Texas and Atlanta have great economies but the cash flow and ROI is much lower than in some of the other markets you're looking at. I like Indianapolis and Kansas City a lot for cash flow. I know both of those markets. Feel free to reach out if I can be of help.

Originally posted by @Dave Foster :

@Charles Moore, You've actually got a couple of opportunities here.  If you plan to sell within 3 years of when you moved out you will indeed get to apply the sec 121 exclusion and as a married couple take the first $500K in gain tax free as @Mark Ainley  said.  If you choose to reinvest that gain then great but you can do it however you want apart with no tax consequence from the sale.

If you wait until after 3 years from when you moved out then you no longer apply for the primary residence exclusion but you could do a 1031.  What you are talking about doing is a diversification exchange.  Selling one and buying several usually smaller properties.  Here's the trick to that process.  At the end of the 45 day identification period you must have a list of potential replacements in place and you may only complete the exchange with one or more of those properties on your list.

If your list is three or fewer properties then it doesn't matter how much they are worth.

If you want to end up purchasing more than three properties then your list will have to be more than three.  You can do that but the aggregate value of the list cannot be more than 200% of the value of what you sold.  Example - if you sold for $400K and named four $200K properties as your replacement list that would be fine.  But if you sold for $400K and put three $200K and one $250K property on your list that would disallow your exchange.

However, if you have to name more than three properties and the properties you have to name total more than 200% of what you sold you may still do it but only if you close on at least 95% of the value of the list.  In the example above naming 4 properties worth a total $850K and your sale was $400K you can only complete your exchange by purchasing at least 95% of the $850K list - or in actuality all 4 properties.  So you have to be really certain and focused to make this happen.

A good QI will steer you through this maze.  But I would definitely pursue the sec 121 exclusion first.

 Hi, Dave! In doing a section 121, would depreciation I took on the rental be recaptured? Might be a moot point, though, because according to the calendar days between my move out and my projected sale date, I think I will not make the 2-year minimum requirements, so 1031 is probably the next best option using the 200% rule.

I've also heard on the rich dad series that most qualified intermediaries are not regulated and pool all their clients' funds together for their own investing purposes, rather than having individual accounts for each client, and this presents the possibility of their losing some of the investor's funds that were earmarked for the 1031. Know anything about this?

Thanks!

Indianapolis is a great market!!! If you have any questions feel free to reach out. I have been investing here for 15 years and know the market.

@Charles Moore   Just a reminder: the 1031 is for the entire sales amount - not just your profit.  Any mortgage would have to be redone unless you can replace those funds from outside of the 1031.

I did a similar 1031 last year, and I hope to soon post a blog of my experience.

not sure I follow. The exchangeable amount would be sale price - mortgage payoff - closing costs - excise tax (here in WA) for an estimated $75K.

What does your scenario look like?

It's definitely an option! I work with long-distance turnkeys and you can very easily use a 1031 to buy multiple properties that will fulfill the requirements of the exchange. They key is to work with teams who know how to work it all, and you're good!

@Charles Moore

1. First of all regarding your post just above on exchangeable amount.  @Jim Workman

  1.  is correct.  In order to defer all tax you must purchase at least as much as you sell (this is defined as your net sales price after costs of the sale but before mortgage payoff).  And second you must use all of your proceeds in the next purchase or purchases.  Any amount you buy less than what you sell is first of all taking profit in the eyes of the IRS.  There is an expectation that your basis is exchanged into the next property.  Purchasing as much as you sell and using your proceeds to do so will usually result in a need for similar debt.  But if you have cash resources you can us those as long as you follow the two part rule.

2. Depreciation recapture is figured as part of your adjusted cost basis.  Depending on where your cpa ends up on the worksheet will determine whether or not you owe tax on any of that when figuring the 121 exclusion.

3. That is largely correct regarding regulation of QIs.  There is little.  However slowly the industry and states are starting to adjust processes.  You still want to do old fashioned due diligence on reputation, experience, and security to make your selection.  One of the most significant advances in my perspective over the last 7 or 8 years has been the increase of QIs and states starting to request and require using dual signatory  segregated accounts.  The strength of the dual signatory segregated account is two-fold.  First of course nothing can happen with your exchange funds without your signature.   Second, the segregation insures that your funds are separate from every other exchange in process by that QI.  

Originally posted by @Dave Foster :

@Charles Moore, 

1. First of all regarding your post just above on exchangeable amount.  @Jim Workman

  1.  is correct.  In order to defer all tax you must purchase at least as much as you sell (this is defined as your net sales price after costs of the sale but before mortgage payoff).  And second you must use all of your proceeds in the next purchase or purchases.  Any amount you buy less than what you sell is first of all taking profit in the eyes of the IRS.  There is an expectation that your basis is exchanged into the next property.  Purchasing as much as you sell and using your proceeds to do so will usually result in a need for similar debt.  But if you have cash resources you can us those as long as you follow the two part rule.

2. Depreciation recapture is figured as part of your adjusted cost basis.  Depending on where your cpa ends up on the worksheet will determine whether or not you owe tax on any of that when figuring the 121 exclusion.

3. That is largely correct regarding regulation of QIs.  There is little.  However slowly the industry and states are starting to adjust processes.  You still want to do old fashioned due diligence on reputation, experience, and security to make your selection.  One of the most significant advances in my perspective over the last 7 or 8 years has been the increase of QIs and states starting to request and require using dual signatory  segregated accounts.  The strength of the dual signatory segregated account is two-fold.  First of course nothing can happen with your exchange funds without your signature.   Second, the segregation insures that your funds are separate from every other exchange in process by that QI.  

So for item #1 (exchangeable amount) in your last post, the numbers I'm predicting are a condo sale price of $260,000. Looking at purchasing, say, 5 properties each around $90,000 for $450,000 total, well within the 200% rule. Estimating I'll have $75K proceeds from sale to divide up between down payments on these properties (can throw some cash in to level things out). Sounds like this is all playing by the rules, right?

And for your third point, thanks for clarifying!

Yes, @Charles Moore that looks very doable.  One more thing for you to think about is that you don't need to spread the proceeds equally between properties.  You could theoretically put all $75K on one property and purchase the rest with 100% owner carry.  The exercise is valuable if you have the opportunity to use those proceeds to create maximum equity on one or more of the purchases for purposes of tapping the equity for future acquisition or to have the security of at least one property owned unemcumbered. All that matters is that you purchase at least as much as you sell and you use all the proceeds in those purchases. 

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