Sell a leveraged property, 1031 into a property all cash

Investor · New Orleans, LA · Member since 2012 · 53 posts · 30 votes

Hello BP!

I have a 4 Plex property that has appreciated quite a bit over the 4 years I've owned it. I am in a 60% LTV position on it. I've been contemplating whether to sell the 4 plex and 1031 into a duplex, pay cash for it and have no debt.

I know normally ppl use a 1031 to level up, but has anyone out there leveled down to mitigate their risk level?

Thanks!

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Joe Gee, It's a good strategy. But there's some complications that can hang you up. When you do a 1031 exchange if you purchase less than you sell or take cash from the sale it is considered to be taking profit.

So if you sell a $100K property that is 60% leveraged and only purchase a $40K property using just your cash you will still pay tax on the other $60K you didn't purchase as if you took profit (or the full amount of the profit if less than $60K).

So your plan if executed just like you're anticipating would leave you with a substantial tax bill. However, here's a couple twists that might work.

1. Sell your property and 1031 into two smaller properties - one which you pay cash for and one that you put the minimum down on. The first one provides the low risk investment you want. And the second absorbs the debt so you can do the full 1031 exchange and defer all tax.

2. If you're looking for a more exotic path there is a type of Delaware Statutory Trust called a zero coupon" or zero cash flow product. It exists to absorb debt. And generally you have to put 15% cash into it and the DST absorbs the rest of the debt.

3. Or you could forgo the 1031 route and do a cash out refi and take the cash and buy something free and clear leaving all of the debt solely on this property.

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Brad HammondBusiness Member
Real Estate Agent · Portland, OR · Member since 2016 · 1k+ posts · 605 votes
5y
Hey @Joe Gee, I believe to do a 1031 the replacement property needs to be more expensive than the original property. You could get multiple properties but the sum needs to be more than the sales price of the original property.
1 Reply
Joe Gee
OP
Investor · New Orleans, LA · Member since 2012 · 53 posts · 30 votes
5y
Hi @Brad Hammond,
So help me understand. If I sell for say $400k, I owe $200k. Gain of $200k. My plan was to buy a prop for $200k cash but your saying I couldn’t do that cause the prop would have to be $400k or greater?
I haven’t done a 1031 so if that is the case then there goes my plan…
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Andreis Bergeron
Member since 2021 · 134 posts · 46 votes
5y
Hi Joe, there's no reason you couldn't do this, however I think their may be rules on how much you are required to 1031 into the new investment.
If you can do this through a 1031, and think the market is at its peak, it might make sense to reduce your leverage the way you described. Let us know what you decide!
1 Reply
Brad HammondBusiness Member
Real Estate Agent · Portland, OR · Member since 2016 · 1k+ posts · 605 votes
5y
@Joe Gee the gain and amount you owe isn't a factor. The government just cares about how much you sell it for and how much you purchase your next property for. I would double-check with a 1031 qualified intermediary on this just to be sure.
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Joe Gee
OP
Investor · New Orleans, LA · Member since 2012 · 53 posts · 30 votes
5y
@Brad Hammond
I see. Def will. Thanks!
0 Reply
Troy Zimmerman
Investor · Mount Pleasant, SC · Member since 2015 · 20 posts · 15 votes
5y
Joe, I've used IPX 1031 before, and they did a nice job. In a 1031 you have to buy a property of equal or greater value.
2 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
5y
@Joe Gee, It's a good strategy. But there's some complications that can hang you up. When you do a 1031 exchange if you purchase less than you sell or take cash from the sale it is considered to be taking profit.
So if you sell a $100K property that is 60% leveraged and only purchase a $40K property using just your cash you will still pay tax on the other $60K you didn't purchase as if you took profit (or the full amount of the profit if less than $60K).
So your plan if executed just like you're anticipating would leave you with a substantial tax bill. However, here's a couple twists that might work.
1. Sell your property and 1031 into two smaller properties - one which you pay cash for and one that you put the minimum down on. The first one provides the low risk investment you want. And the second absorbs the debt so you can do the full 1031 exchange and defer all tax.
2. If you're looking for a more exotic path there is a type of Delaware Statutory Trust called a zero coupon" or zero cash flow product. It exists to absorb debt. And generally you have to put 15% cash into it and the DST absorbs the rest of the debt.
3. Or you could forgo the 1031 route and do a cash out refi and take the cash and buy something free and clear leaving all of the debt solely on this property.
The 1031 Investor5137 Reviews
Website View Page
5 Reply
Jeffrey Proeh
Member since 2020 · 8 posts · 10 votes
5y
Hi Joe,

I was just in New Orleans at the end of May for my daughter's graduation from Tulane Architecture School. Love the city. Anyway, feel free to reach out to me but when you have a 1031 like-kind exchange you must replace both debt and equity in order to quality for tax deferral.

Good luck!
1 Reply
Joe Gee
OP
Investor · New Orleans, LA · Member since 2012 · 53 posts · 30 votes
5y
@Dave Foster Thanks for the insight Dave!
1 Reply

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