Selling Rental: 1031 or eat taxes?

8 Replies

I'm selling a rental property at a profit and intend to buy another rental property to improve cashflow and get into a more desirable and easier to manage rental. I've been running the numbers and trying to figure out my options. 1031 seems like a good choice, but finding replacement property would be very difficult. Looking to hear options from the BP crowd to see if I can look at things a different way.

existing property: est sale price 155-175k. about 87k pre-tax profit after closing. at 15% cap gain tax= 13k in taxes and another 6.5k in MD state witholding tax from the sale for a total 19.5k in taxes due. I'd have about 150k in pre-tax proceeds (same if used for 1031 transfer) from closing or 130k post tax if I sell regular method. Take a look at below options and let me know which might be best. 1031 would keep 19.5k in additional deferred taxes to be used for new possible property, but easier said than done.


option a: 1031 into another SFH property for 175-180 range with a mortgage and get mortgage for remaining amount. 20k mortgage seems like a waste.


option b: eat the 20k tax and use a straight sale of property. Buy another property I have an eye on in my target neighborhood for 90k with 20k rehab. it cashflows well and I would use the sale proceeds to cover the property, then refinance after rehab and pull out money again for BRRR. property would build about 35-40k in more equity following rehab in addition to the good cashflow.


option c: 1031 into multifamily or larger property find a 600k property, put 150k into property as 25% down, mortgage the rest. The problem I'm finding is there are not many multis in the MD/NE area and its hard for me to vet these properties. Those that exist are super pricey and the cap rate is super low for even blue collar areas.


So right now given the lack of realistic multis to parlay into, I'm considering just eating the tax. Unless there are other suggestions or new perspectives. Its really tough to envision a good 1031 replacement. Also I am not considering any baltimore city properties at this time even though they have plenty of multis. Thanks in advance!

I vote hard for option C- but I love the power of rolling via a 1031 into a multifamily. 

It's a fairly new strategy option, I'm actually taking a course on it next week. But look into the new qualified opportunity zones. 

https://www.irs.gov/newsroom/opportunity-zones-frequently-asked-questions

@Jeff Bridges , The problem is that everyone is chasing #3.  Late in a market home ownership is usually maximized by legislation.  So if you can position your assets into a single family with minimal debt you'll be correction resistant.  And positioned to not get hurt.

If anyone an make sense out of opportunity zones @Natalie Kolodij will do  it.

One other option that could make sense is to take $150K cash and put it into a debt free fractional product with a long term corporate lease.  Then take whatever funds are remaining and use maximum debt to buy a SF rental.  This lets you separate debt and cash which is a great defensive strategy.

@Jeff Bridges Why would you pay the $6.5K MD withholding?  That is only for out of state sellers.  Also it is only a withholding. It is not a tax. It is applied to any tax you might owe at the end of the year, any extra will be refunded.  That might change your calculations slightly. 

Also you need to figure the cost of the 1031. They are not cheap and I think you are at the very low end of what is practical. I  am no expert on 1031s, just my perception.

I’m in a similar boat - about to sell a property in DC and will have a sizable profit. It’s hard to find good places to put money to work these days, but I’m looking for a way to avoid the taxes.

@Ned Carey : how expensive is a 1031 exchange?   

I would give the 1031 a shot, but I would hold every property you buy at least two years do you can get the capital gains. The only 1031 deal I did, I had issues after I identified. One the sellers saw I was a 1031 they raised their prices immediately. The first property I looked at I worked out a deal with the seller where I would pay 10k above asking price after he first pulled out. But then after postponing for a week signing, he said he wanted an additional 40k above the asking price. So I walked. The second one demanded 10k as well, which I agreed to. Then he postponed closing until the last possible day. This experience helped me learn the importance of multiple exit strategies. So I would always recommend having a plan b if doing a 1031.

@Marla B. I am not the guy to ask about 1031 exchanges. I know there are some 1031 experts here. Maybe one will chime in.  

I do know it would be in the thousands of dollars, not hundreds of dollars, and probably not tens of thousands of dollars. My guess $2-5K.

@Jeff Bridges and @Ned Carey and @Marla B. . I think you'd all be surprised at how affordable 1031s are.  You can find them for 2K - 5K on each coast done by an attorney who is one offing them.  For most national intermediaries there's a pretty tight range around $750 - $1,000 for a garden variety exchange.  That's pretty affordable compared to the fed and state tax on 87K and depreciation recap.

Ned's right - the withholding tax should be waived in the 1031 as MD honors 1031 at the state level.  You may have to do an application through your title company but it can be waived.

@Matthew Perry , That's a downer of a story.  I've only had that happen to one of my clients once in 18 years.  My guess is that unethical folks are figuring out leverage.  One way to combat that is to hide the 1031.  Simply use an assignable contract.  All parties have to be notified but we typically do that right at the closing table to cover any unethical thoughts on the sellers part.  Also most standard mls contracts contain an automatic or "check the box" addendum for 1031 exchanges.  This leaves you open to do one but does not announce that you are.  Good choice to walk away!  

Like you said, option C  is the best, but  it is hard to find a multi-unit that makes sense these days.  

Option B seems fine, you know the area, you know it is going to create cash flow, it will create equity, you can do BRRR anyway, so what is the hesitation.