I got a $1M offer on a 16 unit building and I need to 1031...help

15 Replies

Received a $1M offer on a 16 unit building that I purchased back in March - leaving me with a nice profit.

However, I am expecting 30% in short term capital gains between the state and federal and a prepayment penalty of $6000.00.

Thus, unless I can 1031 into another deal...this transaction may be tough to put together.

Any ideas on how I should source deals and find a way to defer my taxes?

Thanks! You all are the brightest and best!

You can also consider doing cost seg and bonus depreciation on another deal you buy this year to offset the gains. That helps you a bit in terms of giving you more time than a 1031 will likely but still doesn't help you with sourcing. How did you find this deal in the first place?

@Sean Morrisey you can do it the traditional way and find another property to 1031 it into or there are a few new options out there. Some of the crowdsourcing companies like Realty Mogul, Crowd Street, Fundrise, etc offer 1031 funds via a Delaware Statutory Trust.

Or, if you're interested in bleeding edge, invest it either directly or using a fund into a 'Qualified Opportunity Zone'. Those are new in the tax law passed last year. Virtua Partners and Fundrise have recently started funds that do that.

But I lived in Aurora awhile so I would guess it probably has opportunity zones so you could put something together yourself.

@Sean Morrisey

Checkout this map and see if you're interested in investing your gains into one of these areas. If you're an investor yourself you can just create and LLC and self-certify as an opportunity zone fund. How do I know? I just did it. I used "regular" money, not deferred money but you can use them to defer just your gains.

https://www.novoco.com/resource-centers/opportunit...

Of course there is always at 1031 if you can find another prop. Here is another thing I just learned about, a Deferred Sales Trust. 

https://www.stitcher.com/podcast/kevin-bupp/real-e...

Good luck and keep us posted on what you do! 

Another option is to sell the property in a monetized installment sale. 

This is not "bleeding edge," having been done for the past 20 years. 

You sell the property through a dealer on a 30 year installment note, interest only. The dealer sells the property to the end buyer you've lined up. The dealer pays you interest only payments for 30 years, with the principal paid back at the end of 30 years in a balloon payment. 

Meanwhile, you obtain a loan from a private lender that the dealer will introduce you to. The loan is for 95% of the net sales proceeds of the property you've just sold. You can use the loan proceeds for any business purpose, including buying another real estate investment if you wish. The loan proceeds are not taxable. 

The interest-only payments on the loan are funded by the payments you receive from the dealer on the installment sale contract. All payments on the two loans net out to zero. So the net result is this: you get 95% of the net sales proceeds from the sale, and you defer your capital gains tax for 30 years. 

This has been OK'ed by the IRS (in 2012). 

If you don't want the restrictions imposed by the IRS when you do an exchange, and if you don't like the need for a trust managed by a third party who oversees your funds and charges you hefty fees for that, consider the monetized installment sale. It can be the best option if your capital gain is a significant percentage of your sales price (usually at least 15% or more). It will provide more liquidity, greater flexibility and a lower overall cost in the long run.

@Sean Morrisey , congrats on the offer.  I sense that you're still in the negotiation phase.  So if you're wanting to keep your deferral options under 1031 but get some relief from the time constraints why not counter with a floating closing date contingent on your finding good replacement 1031 property/properties.  If you can get another 90 days before closing the sale, that plus the 45 after the closing will give you in reality almost 5 months to line up your replacement 1031 properties.  It's a seller's market - use that to your advantage in this sale.  

@Sean Morrisey Have you talked with a 1031 QI yet? Chris Sayre at 1031x. He's a QI here in Colorado. His office is off of 25 and Hampden. I've had a couple really interesting discussions. He has some creative methods. I won't repeat for fear of butchering it, but he mentioned a strategy for 1031ing flipped properties.

I did a podcast interview a few months ago with him. I'll send it your way. Whether you work with him or not, it's great content.

Wow...all very creative and informative ideas! Dave's point on a floating close date is fantastic, and I've thought about a monetized installment sale but want to put my capital to work. Never heard of a deferred sales trust...will look into it.

Yes, but, I would only be receiving interest only payments. By investing directly into another building, I would receive rents, principal paydown, appreciation, and tax benefits. The IRR would be much greater - unless I'm missing something?

@Lee Ripma As it sits right now "regular" money can be used to invest in QOZ Funds however they do not give rise to any tax benefits. The investment into the fund must be a capital gain in order to get the 10+ year hold benefits from appreciation and depreciation. If cash and capital gains are mixed then it gives rise to a pro rata treatment for tax benefits.

For example if an investor invested $500k capital gains and $500k cash into a QOZ fund (and received stock) only 50% of the appreciation on the stock after 10 years would be tax free as only 50% of the initial investment was capital gains.

The form to self-certify as an OZ fund has yet to be released by the IRS.

If you have already invested cash into a QOZ for the tax benefits I would highly recommend you speak with a specialized real estate CPA who is well versed in QOZ's.

Sean,

The interest-only payments on the monetized installment sale are funded by the payments received on the installment contract. So those cancel each other out. However, you also have the net loan proceeds to work with. That amount is approximately 93.5% of the net sales proceeds of the property you sell. The point of doing a monetized installment sale is that you get a high proportion of your sales proceeds in cash at closing, tax free, AND you defer your capital gains tax for 30 years.

@Chris Lopez @Sean Morrisey I am not a 1031 expert but there is a strict process that must be followed for a 1031 exchange to be executed properly. I believe certain language must be included in your sale and purchase contract indicating that this will be a 1031 exchange. I recommend you get a 1031 QI to make sure the exchange is done correctly PRIOR to closing. You wouldn’t want to THINK you executed a 1031 exchange to defer the cap gain tax and then later find out that it wasn’t done properly, you actually owe the tax, AND don’t have the money to pay it since you invested it in the new property.

@Austin Hendrickson

Are you sure I can't get no cap gains if I hold for 10 years in an OZ even if I put in regular money? That was my understanding after talking to someone well versed in these. Maybe I need to get with someone else! I know the form hasn't been released yet, but I wrote it into the operating agreement for my LLC and plan to use the form once it comes out. Let me know if you know an expert, or are one.

@Lee Ripma Yes I am a real estate CPA for a national firm who is one of the leaders in real estate and have been dealing a lot with QOZ's. I know there were some people initially thinking you could put in cash but that turned out to be not true.

At this point only capital gains invested into an OZ Fund would give rise to the tax benefits. I have confirmed this with my firm, another top 4 accounting firm and a few fund managers.

If you want to discuss this further feel free to shoot me a PM here or on LinkedIn. We are still waiting on a lot of guidance with these OZ's but the consensus now is that cash investments are allowed but will not have any tax benefits.

Great opportunity to practice some creative financing techniques and acquire more real estate:

1031's are great - I've done several ---- put what I am reading - if you are only paying $6,000 in taxes, that's nothing! Take the hit, take the rest you wind-fall and do what ever you want.

Have fun with your cash - be conservative and always ask for seller financing when making offers to buy - we call it "contract candy", anything the seller can add, all the furniture, car, cash back at settlement, seller financing, a lot he may own, a home warranty - etc (also called "can-adds). Do this often and you will  discover the joys of investing and negotiating - and will make a ton of the cash and equity.

I should mention when buying and negotiating seller financing - offer a principal mortgage - when doing this, you can offer more for the property since there is NO INTEREST -  an important clause in the mortgage is that it should be fully assumable without qualification and that it is a subordinated mortgage (meaning that you can place the first mortgage on the property, the seller financing becomes a second mportgage and subordinate it to a new first mortgage.) The seller may argue that he wants interest - tell him "it's in there", he can report to IRS any interest he wants - but that's your offer, you are offering more for that benefit - so it should balance. Remember you are making an offer that suits you! The interest you save is great and the mortgage balance will accelerate downward faster.

So now when that is arranged and recorded - there are a number of things you can do next - refinance - put the seller first in second place - you get cash -- when you are ready to sell you can take some cash, do a wrap on your interest free mortgage and your existing mortgage and charge interest on the money you owe (it don't get no better than that - the yield is off the chart). A wrap is a mortgage that wraps around the existing financing. And don't forget - if you want to sell your WRAP at a discount - WOW - more cash in hand.

Oh - you may want to consider an unsecured mortgage or secure the seller financed mortgage on another property you own, now you have a free and clear property ---- just think what you can do with that.

One more thing I should mention while we are being financial creative - when you get a new mortgage on the property, offer the seller a PAY-OFF at a reasonable deep discount -  you win again!

I knew an agent from NJ, when ever a property was reported as sold from the MLS - he would search the records to see if there was a mortgage that had to be satisfied at settlement (seller financing mortgage is much easier to deal with) - he would run the mortgagee and negotiate an option for $100 to buy it at a discount - record his option and wait for settlement - guess what, if he was clever enough to negotiate a discount he could get a check for $5, 10,000 or more within 30-45 days. If the property doesn't settle, he does not exercise his option and he is out $100.00 ---- Wow!

Hope these ideas were helpful ---- Charlie

I do have a replacement property in Baltimore - it is a cash cow with a government lease on part of the 3 acres with 250 parking spaces, a lounge and a banquet hall that is rented for weekly affairs. Management is available. It is close to an interstate and has high probability of development - worth more than asking.