Although perhaps taboo nowadays, I started gaining interest in real estate buy and hold transactions via Morris Invest. My goal was to utilize my current (non-performing) asset to kick-start a strategy for generating passive income for my fiance and I. Using BP's amazingly detailed forums, I've discovered that utilizing MI would not be a prudent choice. I'm now researching other vendors, such as roofstock.com, dfy-realestate.com and others. Below is my plan and my concerns. Hopefully someone can jump in and provide much needed advise...
What I own: In 2012 I purchased a 1BR condo in Jersey City that is now worth approximately $380k. I purchased it for $240k and have $170k left on my mortgage. The current tenant is paying $1800/mo but between the mortgage, taxes (which just jumped 66%!) and insurance, I'm receiving no cash flow.
What I planned to do:
Step 1: Start a single-member LLC and transfer the deed (via a quit claim?) to the SMLLC away from me personally.
Step 2: Conduct a 1031 exchange on the property and purchase multiple rental properties (in the 60-90k range)
Step 3: In order to replace the value of my debt, enlist a service like Fund & Grow to get a loan that is 0% for 2 years.
Step 4: Contribute all net proceeds from the rents, plus wedding gift money (assumed to be $50-100k) towards paying off the loan during the first 2 years.
Step 5: Before the 2 years is up (and the 9-18% interest kicks in), take the remaining debt amount out from my 401k to stabilize my debt interest rate to ~6.75%
Step 6: Pay off all debts over years 3-5.
My concerns are;
1) How hard will it be to find multiple properties in the allotted time frame of a 1031X using these services?
2) Am I wasting my time trying to find many B & C type investments when I should find one or two A type investments?
3) Is there a completely different strategy I should focus on given my ability to convert $380k into a better investment than a NJ condo that provides no cash flow?
Any advise, recommended books, articles or professionals to chat with would be greatly appreciated! I'm currently reading Real Estate Loopholes and have done much research online, but I think it is time to speak to real professionals. I look forward to utilizing BP more and more and building relationships while sharing my journey with other new investors in the coming years.
@Steve Genna I think your plan is very complicated. If I were you, I would sell the condo tomorrow and take advantage of this peak seller's market. You didn't say how much of a gain you will have, but it is only 15% on the gain, not the sales price. Then I would slowly and methodically search for distressed property owners who "need" to sell. Distressed properties are out there. Buy something that will actually cash flow after all expenses.
Wow this is a lot but it seems like you have done a ton of research. My points would be:
Have you ever managed B-C property? Even if you get a PM company you will still need to make sure they are doing their job. I would be very cautious if you are jumping into this especially in the state with the highest property taxes and more tenant friendly laws.
There are 1031 rules about buying enough assets that equals more than the profit from the initial sale so yes, you may have a hard time locating and selecting enough properties. I have never done one but my dad just finished one and the rules about which you select as possibilities vs what you actually purchase are strict and a little bit prohibitive.
Another option is to not 1031 this condo and just pay the taxes. That will still give you a good chunk of change that you can take your time with instead of being under the deadline of the 1031.
If you do put it into an LLC and sell it a bank will be much more willing to work with you on financing it through the LLC since you will have a big chunk of cash. Plus it is good for liability protection.
With that big of a down payment you could look into vacation rentals or commercial property as well but see my first point.
Another investment to look into is whole/cash value life insurance policies that pay annuities when you reach retirement age. I mention this because I notice your picture with a new baby and because I just did it because it looks like a wise investment.
Overall you are in a good place it seems and you are taking the time to make sure you do it right so I think you will be just fine. Just don't get stuck in analysis paralysis.
Don’t sell your property in JC. NYC market isn’t like other markets, as you know.
You can find those properties in PA or South Jersey.
Did you ever occupy the condo as a primary residence? If so, when? If you don't qualify for any exclusion of the gain, I'd still probably go ahead and lock in your profit. As you've experienced, the reval has wreaked havoc on cash flow for older downtown condos. I suspect appreciation on those properties is going to be limited going forward.
It's hard enough timing one 1031, but trying to do multiple? It's not going to be fun, and you'll probably end up feeling forced to make deals you wouldn't otherwise because of the timing pressure. I would sell and then take your time finding properties that actually meet your goals.
@Anthony Dooley - I appreciate your input. Yes, this seems complicated, especially for a relatively new investor but my fear is that I may be throwing good investment money by paying capital gains tax on the profits. I think my taxable gain would be on $180K assuming a sale price of $380k, debt of $170k and ~$30k in closing costs. Am I being too stubborn with keeping the ~$30k with overly complex solutions?
@Peter M. - I have done nothing but research in my free time during the past month! There is so much more to learn and I'm hungry for knowledge. So... much respect and appreciation to people like you folks who share your knowledge.
In regards to managing B-C properties, the answer is ... I think so? 15x months ago my fiance and I purchased a 5BR single-family home in Bridgeport CT to rent to Sacred Heart students. Our 2nd round of students just moved in a few days ago and we're happy with the results thus far. The home cost $220k and we rent it for $3250/mo, which is great as long as we continue to find tenants. I frankly don't know if it would constitute a B or C class, but certainly isn't an A.
I have also subrented a 3 BR apartment in Brooklyn for 6 years so I've dealt with showing prospective tenants, marketing the place, dealing with mishaps and the usual. With these experiences in mind, I still prefer to hire a property management company in my future investments. Also, I have little to none interest in NY (where I live) or NJ (where the condo is), precisely for the reasons you mentioned (high taxes!).
I have researched a bunch about the 1031X process and have spoken to 3x different companies that handle such transactions. I find myself attracted to this path since I can put my equity (and debt) in NJ to work immediately, defer losing 15% to taxes and if I go with a "turnkey" provider - do so without taking on too much work. Is there an easier way? Perhaps just rolling the condo into 1x property of like value with better cash flow? I'm not afraid of hard work, but I already work for multiple companies, a union and will be getting married in 4 months (no kid yet, that's my nephew!).
Thank you for your input. I never occupied the condo, it has been rented the whole time (I thought about moving there for the required time, but my commute would be the end of me!). I agree with your assessment about the appreciation on the property and it's attractiveness to other investors.
My strategy with the 1031X replacement properties was to find a seller/broker who had multiple rental units in their portfolio (such as those found on roofstock.com). The hope (keyword) being, in one fell swoop I can grab multiple listings at once.
@Steve Genna, financially speaking, a 1031 makes sense on paper. However, given the low inventory of the type of property you want plus your seemingly hesitant nature, I don't think it is worth the stress to you at this point in your investing journey. You have to pay the taxes eventually.
@Anthony Dooley - I wouldn't call it hesitant as much as hyper aware of the complexities and a desire to not run afoul of the 1031 process. Also the buy and hold strategy is alluring to me, so I don't plan on selling any more property after this NJ transaction.
Another thing to remember is depreciation recapture. Even if you haven't been taking the deprecation deduction each year since it became a rental, you will have to factor that back into your cost basis. Talk to a CPA but here is a good article about it.
I am not a CPA or expert but I was curious so I ran the numbers you provided with the following assumptions: You are in the 24% tax bracket, this condo has been rented since 2012, the full 240k is depreciable (land is not but since it is a condo I just assumed there was no land rights but if there are the depreciation will be lower). All numbers are rounded and most of these assumptions are a little high so your actual numbers would be less.
So here it goes:
Annual depreciation = 240,000 / 27.5 years = 8,700
Depreciation recapture = 8,700 x 6 = 52,000
Adjusted cost basis = 240,000 - 52,000 = 188,000
Realized gain = 380,000 - 188,000 = 192,000
Long term capital gains = 192,000 - 52,000 = 140,000
Long term capital gains tax = 140,000 x 0.15 = 21,000
Depreciation recapture taxes (taxed at normal tax bracket) = 52,000 x 0.24 = 12,500
Total Tax due to Uncle Sam = 33,500
Actual Gain = 380,000 - 170,000 = 210,000 - 30,000 (closing costs) - 33,500 (taxes) = 146,500
That's a bummer if you were expecting 210,000 to be able to re-invest.
But if you do the 1031 and since most closing costs are able to be applied using those funds, the formula changes to:
380,000 - 170,000 = 210,000 - 5,000 (the closing costs that can't be applied) = 205,000
That is a 50k savings in equity that you can put into your next property. Might be worth the hassle of the 1031 time limits. The other option would be wait until you find the property you want and do a reverse exchange.
@Peter M. Thanks for crunching those numbers, very helpful to have a professional do it. I only trust those online calculators so much (and my own spreadsheets).
My thoughts exactly on the 50k in equity... it might be comlex but where else will I earn/keep that much $$$ when you take into account the effort/risk to produce it?
I'll go check out the article you recommended as depreciation recapture is new to me. As always, I'm grateful for your input, thanks bud!
I hadn't heard of rootstock but just looked at their site and read all the reviews here on BP. If you can find a single package with them (or someone else) for the exchange then that obviously makes it a heck of a lot easier.
@Jason Lee that's what I'm thinking/hoping. I have a call scheduled with one of their reps to inquire about the possibility of picking up a bundle of properties at once. Hopefully this is within their normal scope of work.