New Residential Construction - Sell or Rent?

Question

Good afternoon. I just completed 2 new construction houses and paid all cash out of pocket for these within a 10-month duration. I own the houses outright. Each home will sell for appx 160k, after closing I should get around 150k back for each home, Profit = 30k per house (23% margin), total of 60k profit. The question is, I can’t decide if I should rent or sell and keep the building. Part of me wants to rent and cash flow per house but another part of me wants to sell both. I was thinking about selling one and renting the other. I have been in the rental business for about 7 years. I have 3 rentals, one is paid in full cash flowing, the other 2 have mortgages on them cash flowing.

I know there are pros and cons to the situation. Let’s keep capital gains taxes out of it because if I sell, I will try and do a 1031 exchange.

Please let me know your thoughts on if I should Rent vs Sell the 2 new construction homes.

Thanks for the help,

Shane

I know there are pros and cons to the situation.  Let’s keep capital gains taxes out of it because if I sell, I will try and do a 1031 exchange.

Please let me know your thoughts on if I should Rent vs Sell the 2 new construction homes.

Thanks for the help,

Shane

Shane Adams · Answer

@Dave Foster, I am currently learning about the 1031 exchange but if I have to pay that much in tax I will rent for a year.  Are you saying I can use the 1031 if I sell one of my properties and build another property as a rental.  I just want to make sure I understand what you are saying..

Jay Thomas · Answer

Considering your rental business experience and the potential for income and appreciation, I'd suggest renting the new homes. It lets you earn passive income, ride the appreciation wave, and diversify your income. Plus, you can always sell later if things shift. But, be mindful of the tenant management time. If you lean towards hands-off, selling and reinvesting might be a smoother fit.

Dave Foster · Answer

@Shane Adams, the 1031 exchange is a sale of investment property (property you intended to hold) followed by a purchase of investment property (also property you intend to hold).

You can sell an investment property and buy a lot (but you cannot exchange into improvements on the lot once you own it).  So, using the 1031 to sell an investment property and build a property calls for a special kind of exchange called a reverse construction exchange.  We as the QI have to take title to the lot and while we own the lot the building is constructed.  The problem is that these types of exchanges are expensive.  And we can only hold the lot for 180 days.  So it is almost impossible to get the construction completed in that time.

You're probably better off to use your sales to position into either multiple lots you hold onto until you build (knowing that you'll need. to hold the finished products for a bit before 1031ing out).  Or use the 1031 to buy finished assets to hold for investment use.

Dave Foster · Answer

@Shane Adams, unfortunately I think you'll have to keep taxes in the mix on this.  The 1031 is available for property you intend to hold for productive investment use.  Since these are new construction you would need a pretty strong rationale and documentation that you intended to hold them for productive use.  And now something is causing you to chate that intent.

Not that it can't happen.  But you want to be able to document if ever questioned that your intent was to hold.  Otherwise, you'll have to sell without a 1031.  And that means a heap of taxes - especially if you sell immediately without holding for a year.