1031 Exchange or Cash?

Question

Hello fellow BPs

I am looking for your thoughts on my current situation.

I am selling a duplex I've owned for 9 yrs and it looks like I will be getting about $30K profit at closing.

My questions is;

Should I proceed with the tight deadline & somewhat scary but beneficial 1031 Exchange? With a goal of finding a triplex or fourplex to invest in.

OR

Should I just cash out at closing, pay the capital gains and other tax penalties from depreciation all these years, but still plan to invest the cash into another property?

Look forward to your thoughts! Thanks.....

Jake S. · Answer

Hey @Jose L.! Have you considered refinancing or are you wanting to disposition the asset?I'd highly recommend a 1031 to do what you said, avoid the taxes and the depreciation recapture. Start networking now and build a team to help you find a potential next investment, rather than go it alone

Natalie Kolodij · Answer

@Jose L.

Are you sure $30k is the amount of taxable gain you'll have? A lot of people mix calculate cash, profit, gain ect on the sale of rentals

1031's can be great but have some drawbacks including the time line, and then your new property carrying forward that same smaller basis/ depreciation amount from your old property

Your tax on sale is likely under $10k.  You might make that up in depreciation in a couple years if you're buying a new/bigger property.

I would sit down with your tax pro and nail down the numbers and big picture and see exactly which makes more sense.

Jake Marmulstein · Answer

Hey @Jose L.

Doing the 1031 exchange is definitely the way to go. I know the strict timeline can be threatening, but if you have an idea of what you want your next investment to be, you should be able to meet the deadline. Being able to defer paying capital gains taxes sets aside more capital to invest in similar properties. Engaging in a 1031 exchange can also help you avoid potentially large increases in taxable income that depreciation recapture would cause later on.

Bill B. · Answer

@Elliot Marszalek

Sorry elliot, I wish that were true, as I’m about to do that very thing. It used to be true but too many of our elders took advantage of that sweet deal.

If the property is a rental first, even for only a year, you have to live in it for 2 of the last 5 years, but then you only get the percent of total years owned it was your primary as a tax free sale.

In this case, rental for 9 years, then primary for 2 years, means primary was 18.18% of total owned time, so that percent would be capital gains tax free.

Matt S. · Answer

@Jose L. I did a 1031 exchange at the end of the last year. I didn't have anything lined up at the time I put the property on the market and had minimal real estate experience. The 45 day timeline seems intimidating, but at a minimum it will get you to start networking, looking for deals, having valuable conversations. Worst case, to @Dave Foster's point, is you don't find a replacement and lose ~$700 or so...not the end of the world.

In my case, I had a replacement property lined up that fell through on day 25 or so - the seller backed out a couple weeks after after signing an LOI. I was a bit worried at that point, but with 20 days remaining I was able find 2 great replacement properties. Repeating what @Steve Graves said, it's a tight window, but definitely doable. Good luck.

Jose L Martinez · Answer

@Natalie Kolodij @Dave Foster @Bill Brandt @Jake Stuttgen I really appreciate your feedback. The insight shared here has definitely added to my list of questions for when I meet with my CPA. There are some Pros and Cons regarding the 1031, I can see where people (including myself) can miscalculate and potentially hurt or delay the overall goal as an investor. I've already put a plan in place with my team for the acquisition of my next property.

Thanks again BPs!

Dave Foster · Answer

@Jose L., I don't do this often but I may (key word - may) disagree with @Natalie Kolodij on this one.  I think your tax could be substantially over $10K.  If you've owned that property for 9 years  then it's 1/3rd depreciated and if you don't do a 1031 you'll have to recapture that at 25%.  So on top of a roughly $6-10K capital gain tax you will have depreciation recapture.  If your starting constructed basis was $150K then that's another $12500 in recapture tax.

Nat's absolutley right.  You need to get a firm handle on that.  Because the 1031 is only going to cost you around $700 - $1000 and that let's . you explore if you can find that triplex do defer what might be a $10K tax or a $22K tax.  There's no penalty in starting a 1031 and not completing it.

Natalie Kolodij · Answer

Dave if the full gain calculated on the depreciated current adjusted basis is $30k, the depr. recap woudln't be ADDITIONAL to. It would be a portion of, that may be taxed at a higher rate.

What ever portion of that $30k gain was generated by depreciation.

Elliot Marszalek · Answer

@Bill Brandt Thanks for the reply, that is unfortunate we can't do that anymore. Saving some as a percentage is better than nothing though I suppose. If I tweaked the plan slightly and only held for 5 years, living in it for the last 2, I'd get tax free 40% cap gain and assuming my understanding of opportunity zone investing is correct I could move the other 60% of the profit into one of those investments and collect it tax free after 10 years. That would probably be the best scenario assuming I didn't have an immediate need for the extra 60%.

Dave Foster · Answer

And @Jose L., there's a lot of ways to kick the can down the road forever and never pay that tax.  Ways to put it into your pocket tax free.  Ways to generate income off the deferred tax forever.  And ways to get the properties to your heirs tax free.  It's a long and happy road :)

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