Exit Strategy for 1031 Investors?

Question

From the time I learned about 1031 exchanges, I’ve been all in on the concept. Lately though, I’ve been second guessing myself.

What if I ever want to sell off my properties and cash in if I feel a recession is coming? All that deferred tax would be brutal.

Do most of you 1031 investors plan to keep building your portfolios for cash flow and will weather the next recession? I am in sell mode at the moment and could use some guidance.

Thank you,

Eric Mayer

Dave Foster · Answer

@Eric Mayer, the investors I've seen get hurt are those who go all in on the growth and leverage.  The 1031 is great for leveraging up and up and up.  But you're right.  There can come a day of reckoning where the portfolio is too highly leveraged and a sale without a 1031 is required and it doesn't generate a lot of cash because of the leverage but does generate big tax bill .  Not a good situation.

So your choices though are

1. Pre-empt that and just pay the tax now.  So basically you're accepting an expense and avoiding a benefit because of an uncertain outcome.  That's certainly planning for the worst (combined with a self-fulfilling prophecy)

Or

2. Plan for a worst probable case outcome and keep your leverage within parameters that you can weather a storm.

The whole premise of 1031 is the deferral which gives you the use of the tax dollars for your benefit.  So the goal of the average 1031 investor is to keep doing that life-long.  And the way to do that is to craft your portfolio so that you never have to unload a property.  You just adjust rent and hang in and hang on.  I had several investors who saw their net worth drop 80% in 2008.  But is was only on paper.  They didn't have to sell.  The just kept renting.  And they're doing pretty good again on paper now too.

If you want to have cash available for a bad moment then pick out a property as you go that has the greatest equity and least deferred tax and depreciation.  That's the property you sell if you have to.

Eric Mayer · Answer

Thank you @Dave Foster!

Tough call...

David M. · Answer

@Eric Mayer

I’ve heard you either put it into a trust and have it passed to heirs since when your estate passes over the cost basis is raised — that’s what I’ve heard.

The other I’ve heard is to do an installment sale to slowly realize the deferment while still getting interest.