Analysis Paralysis - Upgrading from SFH to MF Commercial

5 Replies

Happy Sunday BP!

I need some feedback from the community here, an intervention of sorts.  I'm on the fence here regarding some options that I have so I'd like to lay my position on the table and get some feedback from the general community in the hopes that it can help guide my decision moving forward.  I appreciate any/all advice.

Current Position

Primary Residence (Southern CA)- Between $100-150k equity 

  1. - Sept will be one year owned, will re-appraise since we've improved the land, some of the interior and there's been fairly substantial appreciation in the one year)

    2 SFH Listed for Sale (MD and Northern VA) - Anticipate net profit $110-140k range (not bad for having only owned for 5 and 6 years and living in it for 1 year each)

    - Combined Total Sales Price - $850-880k

    - I expect to close mid-late Sept on NOVA property and no later than mid-Oct for MD property

    1 SFH in Northern MI - Has ~$30k equity

    - no plans to sell, may tap equity in near future for rehab and a cash out refi to invest elsewhere

    Here are the options I'm looking at:

    1) Use the profits to pay off some "bad" debt (some of the debt was for a $80k landscaping project on our 1/2 acre bare yard primary residence and the other was to do some rehab to our MD home to make market ready for quick sell so not bad, per se). Set aside ~10% for capital gains (both primary residence-turned-rentals were due to job changes greater than 50m away at just over the 1 year mark). Rate would be ~10.25% based on the combined interest rate of the debt and we'd increase our cash flows ~$1500 a month. This will likely be my wife's preferred option (low risk, instant returns, increases available credit, lowers our DTI, etc.)

    2) Put the proceeds of both properties into 1031 exchanges and trade up. That would mean I'm looking at MF commercial properties in the ~$900k range if I go solo (preferred) based upon the projected combined sales price. I can use the net gain from the East Coast SFH sales and then either use a LOC on current property or tap into 401k for the remainder to come up with the 20-25% down payment. I've found some pretty good properties in the Midwest (Columbus/St. Louis/Kalamazoo areas) that have anywhere from 12 doors on up and around 8-10% cap, some stabilized (preferred) and some approaching stabilization (at least as far as the listings go). I prefer more doors. This is my preferred route because factoring in financing, set asides for capex etc I can net at least $1500/month (really $3000 but I'll likely set aside up to 50% depending on the area/condition/risk)

    If I go with option 1 above I plan to tap into equity in my primary residence to do something similar with option 2.  I won't have to rely on 1031 timelines and can set my own price point based upon a) how much my primary residence appraises for (i.e. equity stake) and b) what kind of deal makes the most sense for us at the time and on our own timeline.

    In all I expect to pay no more than ~$12k in capital gains taxes but I'd like to pay $0 and trade up to increase my cash flows with the intent to hold for 7-10 years to take advantage of these great rates.  I should also note that next year we plan to move out of our primary residence and rent that out so we will still have at least 2 rental properties the help us accumulate wealth so I won't be completely out of the I.D.E.A.L. market :)

    Thoughts?  Considerations?  Sanity check?

    @Brandon Beaudoin Let me add more to the confusion :)

    You could do both as a hybrid approach.  Do the 1031 exchange to defer tax and move into better cash flow.  And take some cash out to reimburse yourself for those repairs.  You'll pay tax on the amount of cash you pull out but you'll defer any remaining profit in the 1031 exchange.

    Another alternate approach would be to do a complete 1031 exchange into an investment property (or more than one) and then cash out refinance and use that cash to reimburse yourself for the expenses and let the tenants pay the mortgage.

    Or yet another option related to that.  Use your proceeds in the 1031 to purchase two properties - one for cash and one with maximum leverage.  Complete the 1031 and then refi the one you own in cash.  Same end scenario.

    You need to do some more math on your analysis of qualification for a prorated primary residence exemption.

    1. You can only take that once every two years.  So at best you'll only be able to use it on one of the two properties.

    2. You must have lived in it for 2 out of the 5 years prior to sale.  It sounds like you're already close to or over the 5 year look back on the first property and past it on . the second.  So you would not qualify any longer.

    3. if you did qualify for the 5 year look back (because of the job transfer you could prorate your two years) you would still pay regular capital gains fed and state on the prorated amount of gain at regular capital gains rate.  The amount of tax free gain is prorated not the rate.  And you'll still have to recapture the 4 and 5 years of depreciation.

    @Dave Foster

    You may have given me all the firepower I need to justify a 1031 :) I also thought the 5 year look back was a minimum, say, as opposed to a 10 year period.

    And I certainly didn't know it could be used once every two years. Does that apply even if one new job was mine and the other my wife's? I assume so since we file jointly but each move was precipitated by each of us getting new jobs.

    Appreciate the feedback!

    I believe I actually still qualify for a partial exclusion and it would be on the house in NOVA. Based on my interpretation of IRS Pub 523 and how long we lived in the house (~180 days looking back 5 years from a Sept 2019 sale) we would still get to exclude the full amount on the VA home (50% of $500k = $250k and that's less than the $80 or $90k we will walk away with).

    One thing is clear....I need to talk to a CPA pretty quickly!

    So instead of going all in on my first commerical MF deal I've acquiesced and made the wiser decision of meeting my wife in the middle. My wife and I have decided to move forward and do a combination of things:

    - Take the larger portion of our proceeds and pay off debt. A large chunk of this was for home improvements on our primary residence but also pay off the last of our two vehicles. The one frees up all the equity in our home and combined our monthly cash flow increases ~$1300 a month and has a combined rate of return of ~10%. (Bonus: wife is happy)

    - Save off a portion for cap gains and depreciation recap

    - Remainder (plus some funds from a HELOC I'm getting) will go towards a smaller cashflowing 8-12 unit property in OH, IL, or possibly MI.

    I really want to go all in but I think I'll gain more from this first deal and having my wife onboard yo show her that this can be done.

    Thoughts or suggestions?

    I should note that I do have a couple properties in mind, one of which I'm working with a lawyer on to craft/legally massage the LOI (and future PSA) and have started discussions with lenders.


    Any specific guidance on LOIs?