Cashing out of high gain home

Member since 2022 · 25 posts · 22 votes

I would like to get opinions to help me determine my best financial options.

I am 59 and last year was forced into retirement and also got divorced. My settlement was a single family home I purchased for $295,000 in the 1990’s. The last 8 months it has been rented for $4550. I just received an out of the blue offer to sell for $1.5M, which is a reasonable offer for the neighborhood.

I hate being a landlord and would like to sell but don't know what to do with the money. I can take $250,000 exclusion and 1031 the rest into…. what? DST's? 721/upreits? Mineral rights? A turnkey rental? the options are overwhelming and every advisor I ask gives conflicting advice - I suspect they only know what they get commission on.

I would like $5000 month income after banking the $250k. I don’t want to risk the principal. Am I better off just paying the capitol gains and banking the rest?

Finally, I had a property manager but found them creating false repairs and fired them. The sale of the house is about 2/3’s of my wealth.

thoughts?.

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Dave FosterBusiness Member

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

@Russell Sherman, All of the options you list that you could 1031 into come with some risk.

Mineral rights and Oil is a roller coaster ride.

Vacation rentals??? Well they're not making any more beach front. But your experience with managers make this iffy.

DSTs? not sexy or high returning but fairly stable. Especially if you took the rest of your 1031 and put it into several different ones to mitigate risk.

A 721 - I'll probably get flamed for this but I never think converting tax deferred to taxed is ever a good idea. But if you're going to do that then do it quickly and take the bandaide off quickly. Don't go into a 721 with limited options at a time when many reits start to under perform. Take the cash and don't a 1031. Pay your tax and invest in something that you know or.... don't invest at all. Do you have a mortgage on your house? Pay it off.

If you are done with work then you need to first provide for your future and then after that is secure you can invest if you have any excess money.

I know I know. It's not the exciting answer. But the kind of exciting that comes from a sinking investment that represents 66% or your net worth is not a goood feeling exciting.

If you have options to work again. Then my advice would be completely different.

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Caleb Brown
Real Estate Agent · Kansas City · Member since 2018 · 5k+ posts · 3k+ votes
3y
Is 1.5M a great offer or under market value? I'd maybe have an agent run comps to get an idea. If you want passive I would take the tax hit and put in a 401K or something in that sense. From the real estate perspective you can 1031 into something else. I would research syndications. That kind of money would be ideal and it'd be passive. There are plenty of other vehicles in real estate so you can't really go wrong. BUT be very careful of sharks. With that much money people will want a cut. Take time to research different avenues, if you are not in a rush to sell don't. Sit on it, take your time
3 Reply
Alejandro Ferro
Member since 2021 · 3 posts · 6 votes
3y
How about the seller financing it for them? You gain your monthly desired income. Ask for a hefty downpayment up to 250k. And finance the rest at a rate and term that makes sense to you. This way you don't have to stress about where to put the funds, how to manage it, buying other properties etc... Also won't have a large tax burden...
End of the day in real estate the ones who make the most money and do the less work are the financiers.
4 Reply
Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
3y
@Russell Sherman, All of the options you list that you could 1031 into come with some risk.
Mineral rights and Oil is a roller coaster ride.
Vacation rentals??? Well they're not making any more beach front. But your experience with managers make this iffy.
DSTs? not sexy or high returning but fairly stable. Especially if you took the rest of your 1031 and put it into several different ones to mitigate risk.
A 721 - I'll probably get flamed for this but I never think converting tax deferred to taxed is ever a good idea. But if you're going to do that then do it quickly and take the bandaide off quickly. Don't go into a 721 with limited options at a time when many reits start to under perform. Take the cash and don't a 1031. Pay your tax and invest in something that you know or.... don't invest at all. Do you have a mortgage on your house? Pay it off.
If you are done with work then you need to first provide for your future and then after that is secure you can invest if you have any excess money.
I know I know. It's not the exciting answer. But the kind of exciting that comes from a sinking investment that represents 66% or your net worth is not a goood feeling exciting.

If you have options to work again. Then my advice would be completely different.
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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
3y
Quote from @Russell Sherman:

I hate being a landlord and would like to sell but don’t know what to do with the money. I can take $250,000 exclusion and 1031 the rest into….

I've never seen a former primary where you can take the $250k gain exclusion and combine it with a 1031 or any kind of exchange for the balance. It's either or, right? Maybe @Dave Foster can confirm.

The first responder here was very incorrect on one front. Can't take profit from an asset sale and put into a qualified retirement plan like a 401k ever.

I sold the bulk of my 5+ unit multi portfolio last year with owner financing to spread out the tax hit. Minimum down payments. That in itself has risks.

If it were me and this offer is legit (out of the blue offers rarely are), I'd probably take the 121 tax exclusion for $250k, eat the l/t cap gain tax on the balance next spring and put it in a money market account earning roughly 5% risk-free in the meantime.
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Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Dave Foster:

@Russell Sherman, All of the options you list that you could 1031 into come with some risk.
Mineral rights and Oil is a roller coaster ride.
Vacation rentals??? Well they're not making any more beach front. But your experience with managers make this iffy.
DSTs? not sexy or high returning but fairly stable. Especially if you took the rest of your 1031 and put it into several different ones to mitigate risk.
A 721 - I'll probably get flamed for this but I never think converting tax deferred to taxed is ever a good idea. But if you're going to do that then do it quickly and take the bandaide off quickly. Don't go into a 721 with limited options at a time when many reits start to under perform. Take the cash and don't a 1031. Pay your tax and invest in something that you know or.... don't invest at all. Do you have a mortgage on your house? Pay it off.
If you are done with work then you need to first provide for your future and then after that is secure you can invest if you have any excess money.
I know I know. It's not the exciting answer. But the kind of exciting that comes from a sinking investment that represents 66% or your net worth is not a goood feeling exciting.

If you have options to work again. Then my advice would be completely different.

This is one of the most direct-honest from Dave that totally knows his field.
3 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Russell Sherman:

I would like to get opinions to help me determine my best financial options.

I am 59 and last year was forced into retirement and also got divorced. My settlement was a single family home I purchased for $295,000 in the 1990’s. The last 8 months it has been rented for $4550. I just received an out of the blue offer to sell for $1.5M, which is a reasonable offer for the neighborhood.

I hate being a landlord and would like to sell but don't know what to do with the money. I can take $250,000 exclusion and 1031 the rest into…. what? DST's? 721/upreits? Mineral rights? A turnkey rental? the options are overwhelming and every advisor I ask gives conflicting advice - I suspect they only know what they get commission on.

I would like $5000 month income after banking the $250k. I don’t want to risk the principal. Am I better off just paying the capitol gains and banking the rest?

Finally, I had a property manager but found them creating false repairs and fired them. The sale of the house is about 2/3’s of my wealth.

thoughts?.

Sometimes paying tax is just okay, or what you can do is you sell everything but keep one house as rental and then 1031 those house, and move there within one two year. When I'm in 60 something, I don't think tax deferral strategy is interesting anymore.
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Bill B.
Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes
3y
Do you have to stay in California now that you’re divorced and unemployed? You could cut your cost of living and your taxes significantly by leaving the state.
A 1031 isn’t an all or nothing deal. You could do an exchange in to a dream duplex where you rent out half (the 1031 portion) and live in the other half. Florida Texas Nevada and Tennessee are all tax free states. Two have ocean front and one has lots of nice lakes. Pay taxes on whatever part you don’t exchange but you have some income and paid off primary home while saving some taxes.
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Noah Laker
Real Estate Broker · Sacramento, CA · Member since 2021 · 556 posts · 427 votes
3y
Definitely 1031 exchange into something that makes sense.

Sacramento is my home, this is a fantastic market with consistent historical appreciation but also possible to cashflow positive, as opposed to places like LA and the Bay Area.

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
3y
@Steve Vaughan, I read that this was an investment property all the way. But since you bring it up...:).

You absolutely can take advantage of any part of the tax code that you qualify for.

1. To qualify for a 1031 exchange you must be selling investment property. It must be used for investment when you sell it.

2. To qualify for the primary residence exemption you don't have to be living in it when you sell it. You only have to have used it as your primary for 2 out of the 5 years prior to selling it.

So, if you bought your primary and lived in it for 2 years and then converted it into a rental for a year you would qualify for both. You would do a 1031 exchange and take $250/$500K of taxable boot. But because you qualify for the 121 exemption you would not pay tax on it.
So powerful I have parts of two chapters dedicated to this concept as it relates to house hacking and converting from investment to primary and vice versa in my book "Lifetime Tax-Deferred Wealth: The Real Estate Investor's guide to The 1031 Exchange"

What a country eh!!!
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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
3y
Quote from @Dave Foster:

@Steve Vaughan, I read that this was an investment property all the way. But since you bring it up...:).

So, if you bought your primary and lived in it for 2 years and then converted it into a rental for a year you would qualify for both. You would do a 1031 exchange and take $250/$500K of taxable boot. But because you qualify for the 121 exemption you would not pay tax on it.

So powerful I have parts of two chapters dedicated to this concept as it relates to house hacking and converting from investment to primary and vice versa in my book "Lifetime Tax-Deferred Wealth: The Real Estate Investor's guide to The 1031 Exchange"

I had no idea about this, Dave, so thank you. I'll check out your book!

The OP has only been renting it out for 8 months I think. If it were me, I'd wait to sell for at least 4 months to have a partial 1031 exchange be available to me.
1 Reply
Russell Sherman
OP
Member since 2022 · 25 posts · 22 votes
3y
Quote from @Dave Foster:

@Russell Sherman, All of the options you list that you could 1031 into come with some risk.
Mineral rights and Oil is a roller coaster ride.
Vacation rentals??? Well they're not making any more beach front. But your experience with managers make this iffy.
DSTs? not sexy or high returning but fairly stable. Especially if you took the rest of your 1031 and put it into several different ones to mitigate risk.
A 721 - I'll probably get flamed for this but I never think converting tax deferred to taxed is ever a good idea. But if you're going to do that then do it quickly and take the bandaide off quickly. Don't go into a 721 with limited options at a time when many reits start to under perform. Take the cash and don't a 1031. Pay your tax and invest in something that you know or.... don't invest at all. Do you have a mortgage on your house? Pay it off.
If you are done with work then you need to first provide for your future and then after that is secure you can invest if you have any excess money.
I know I know. It's not the exciting answer. But the kind of exciting that comes from a sinking investment that represents 66% or your net worth is not a goood feeling exciting.

If you have options to work again. Then my advice would be completely different.
Dave, regarding the 721: I thought of it as a traditional IRA where you don’t pay taxes up front, while allowing the principal to grow tax free. The 30% I don’t pay in capitol gains will be able to earn a dividend. If I ever need to sell I can sell only the percentage I need as opposed to everything all at once. Am I missing something looking at it this way?

Another question: if I roll only a portion into a 1031, do I pay the tax rate only on the portion that is boot? Or the whole thing? So if I keep $200,000 out of a 1.1M gain, do I pay 15% or 20%? Maybe I keep a smaller portion on only what I am comfortable paying tax on…

I have no personal debt and have been drifting through Mexico for the last year trying to figure out what to do next, for what it’s worth. Time to make a decision
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Russell Sherman
So, if the home was purchased in 1990's... How was it used in the time prior to the last 8 months?
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Russell Sherman
And let me see if I get this right: Roughly your cost basis is $1.2mil. If it was a primary before it was rented, then roughtl ahve $950k as a taxable gain. At 20% that's $190k in tax... If its free and clear, then you walk away with about $1.3mil. The $190k tax, which is Federal only, is a pretty hard pill to swallow. So lets say you have $1mil to invest with the other $300 (less fees etc) as cash in hand for living, liquidity, etc.

$5k /mo is $60k or 6% of your $1mil. 6% annual return isn't really that bad. If you do NOT do the 1031, it opens you up to a number of investing potentials to include diversification. Just something to think about... Especially if you are open to investments other than real estate, or even still real estate related acitivieis.

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Russell Sherman
OP
Member since 2022 · 25 posts · 22 votes
3y
Quote from @David M.:

@Russell Sherman
So, if the home was purchased in 1990's... How was it used in the time prior to the last 8 months?
I hired a property manager to rent it out and manage it. I moved to another state. I intended to rent it for 2 years and then sell. But I received an offer out of the blue. Inventory is tight in this neighborhood and someone just lost out on a nearby house.
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Russell Sherman.
Maybe its because others know better, but have you found out if the cost basis changed due to the divorce settlement?
Also, since the 90's have you done any improvements to the house? All would help in increasing the cost basis.
So it would seem you are eligible for the sec121 exclusion. Again, it doesn't sound like anything you could 1031 into is to your liking. So, get the money "freed up" and invest in something income generating that is to your liking / risk profile.
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Russell Sherman
Oh, it might have been mentioned, but make sure the $1.5mil isn't a low ball.
You could also "spread out" your tax burden with installment payments (consult a qualified professional) which should help get your capital gains tax rate down to 15%, at least while this tax law holds. However, any sort of "advanced" financing/payment scheme carries more risk and requires a suitable buyer.. So, just beware.
0 Reply
Matthew DrouinPro Member
Developer · Rochester, NY · Member since 2016 · 412 posts · 340 votes
3y
@Russell Sherman

The good news is, you expectations and goals are VERY realistic. I think you might be able to exceed those goals without taking on risk to your capital preservation goals.

I had a client in exactly the same situation you are in a few years ago. They needed long term predictable income post sale and did not want to lose their principal.
A couple of scenarios:
1.) You could sell the property and hold the mortgage and customize the terms of that mortgage to whatever your goals were. You could even negotiate no prepayment to lock in the terms for longer and defer your capital gains. If you were to seller finance, it would be considered an installment sale and you would only pay gain taxes on the principal payments. Of you course you would pay income tax on the interest payments. I have no idea how the owner occupant gains exclusion would work in this scenario so check with a CPA. The problem is you tie up 2/3 of your wealth into this mortgage.
2.) 1031 Exchange DST. Now, check with your CPA to see if this is even possible based upon what you have claimed as residency to see if a 1031 was possible on some place that you may have claimed as your primary residence. Assuming you can do a 1031, you do have the option of rolling your sale proceeds into a Delaware Statutory Trust. These are usually sold by RIAs (Registered Investment Advisors). They present a fractional ownership interest in a large investment property. They are usually designed for income. Usually fully stabilized, institutional class, in core markets, with very low leverage. You have the option of directing your sale proceeds through your Qualified Intermediary into several different DSTs so as to diversify. DSTs are a little thick with fees. Usually higher than typical real estate syndications so don't be surprised at that when you start reviewing prospectus'. Again, the problem with this scenario is you CAN diversify but 2/3 of your wealth is going to be tied up in real estate DSTs. They are designed to product income but are not very liquid. The standard DST terms are five years, so when the sponsors sell the property, you will have to either take the gain or roll it into another DST(s).
3.) The third and last scenario is to completely cash out, take the hit with your gain. This option will allow you to take your time to really architect your plan that is in line with your long term goals and short term needs. Hell, you could put your money into an FDIC insured money market account and get 5% on your money in this environment. This option gives you the greatest optionality in picking your asset allocation based upon your risk tolerances and goals not based upon what you need to do to beat back the tax man. Also if you have most of your wealth in securities that are liquid and considered cash and cash equivalents, you can convert them to cash very quickly and reallocate or even get a line of credit against those securities so that you can fund passive investments in other real estate deals or private lend or whatever.
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Russell Sherman
OP
Member since 2022 · 25 posts · 22 votes
3y
Thank you for the wonderful responses. It seems DST's might be my best option. Is it realistic to invest in 10 different DST's? My thought is they would each mature at different times and it will be less stressful deciding what to do with 10 investments of 100k over a couple year period verses 1 million all at once. I then have the option of paying the tax on one DST should I want to cash out and diversify at that maturation.
In the meantime, the big question is whether I would get a better return paying the capital gains tax (federal AND California!) on $900,000 and investing freely, or taking the $250,000 cash exclusion and 1031 the remaining 1.2M into DST's? Anyone have a crystal ball?
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Russell Sherman
Well, everybody has a crystal ball...
Just double check that with 8mo of rental you can reasonable qualify/defend as an investment property. Otherwise, that would take 1031 off the table.
I looked at DST's a while ago, I think $100k wouldn't be too bad. I think the min investments ranged from $50k, $100k, and $250k. But, not my cup of tea.
Have you considered OZ funds? Almost the same risk profile in my opinion. Depending on what happens with tax laws / interpretation, after 10 years you get the step up in basis I thought.
But, again, make sure you can 1031 after 8mo of renting.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
3y
@Russell Sherman, In a 721 the tax is indefinitely deferred - until you sell the asset you exchanged into (the reit). At that point you will owe all of the deferred tax and there is no option to continue deferring because the 721 turned the asset from real estate to a security/stock investment (the reit). No real estate no 1031. That's why the 721 is the end of the road. And you have to be pretty sure you want to hold on to that reit for a while. Otherwise just sell and pay the tax now.
You can do a partial exchange. Any amount of cash you take out or any amount you purchase less than you sell is taxable. the remainder of the gain stays deferred in the 1031.
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Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Dave Foster:

@Russell Sherman, In a 721 the tax is indefinitely deferred - until you sell the asset you exchanged into (the reit). At that point you will owe all of the deferred tax and there is no option to continue deferring because the 721 turned the asset from real estate to a security/stock investment (the reit). No real estate no 1031. That's why the 721 is the end of the road. And you have to be pretty sure you want to hold on to that reit for a while. Otherwise just sell and pay the tax now.
You can do a partial exchange. Any amount of cash you take out or any amount you purchase less than you sell is taxable. the remainder of the gain stays deferred in the 1031.

I want to add, in the market currently there're two type of 721 REIT. Commercial and newcomer is residential.
The Fee for both "REIT" is high so I would expect the actual cash flow is not going to outbid the T.
They also could accept investment in large amount, a 100k home in Minnesota wouldnot be accepted by them LOL.

The 721 residential is newcomer but it comes with all the risk as well. Once you understand the actual REIT is only follow the actual income then it's "easier" to grasp the idea.
All in all , 1031 to STR somewhere in Mountain or Hawaii is still way way better -- or 1031 to rental to primary ; than a complicated DST/721. Because we have to live somewhere anyway.
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Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @David M.:

@Russell Sherman
Well, everybody has a crystal ball...
Just double check that with 8mo of rental you can reasonable qualify/defend as an investment property. Otherwise, that would take 1031 off the table.
I looked at DST's a while ago, I think $100k wouldn't be too bad. I think the min investments ranged from $50k, $100k, and $250k. But, not my cup of tea.
Have you considered OZ funds? Almost the same risk profile in my opinion. Depending on what happens with tax laws / interpretation, after 10 years you get the step up in basis I thought.
But, again, make sure you can 1031 after 8mo of renting.

The problem with all these tax deferred strategy is we as investor is focusng too much on saving the tax ; while not focusing on the actual performance of underlying strategy.

If you have 100k or 99999k to invest to save the tax but replacement strategy is to re-invest in office space, you would lose that money anyway LOL
Currently there's nothing beats residential , even single residential performs better than MF. Only Self Storage/Industrial sector is better than residential direct investment and that's also very dynamic.
1 Reply
Lane Kawaoka
Rental Property Investor · Honolulu, HAWAII (HI) · Member since 2011 · 4k+ posts · 2k+ votes
3y
@Russell Sherman
Hey Russell, it looks like you've surpassed that $250,000 exception, which means you'll have to pay taxes on the overflow. Now, I know some folks suggest 1031 exchanges or DSTs, but honestly, those processes can be cumbersome and expensive, so not many people in my world will just get losses from their investments and use those front loaded PALs to offset their capital gains.

When I sold off my turnkey rentals and went into syndications, I went this route and benefited from better passive losses due to cost segregations and bonus depreciation. This allowed me to accumulate those losses to offset my capital gains from selling the properties.

The key here is to ensure you generate those passive losses in the same year or in years prior to selling your house. This way, you'll have enough to offset the capital gain. In 2017 I sold off 7 of my turnkey rentals and had 200k of capital gains but I had built up PALs from going into a lot of syndication deals that year prior. Therefore I was able to offset the taxes completely.
If your income is under $350,000, you might consider just paying the tax bill as the taxes won't be too high, especially if you're in Texas where the AGI isn't too high.

Now, let's talk about alternative investments in real estate. It can be quite a loaded question, as there are opportunities to make good returns, say 12% to 20% with cash flow. However, it's crucial to be cautious about who you're dealing with. Many folks out there may not be genuine, so it's best to find opportunities where you can be a purely passive accredited investor.

If you need any further assistance or have more questions, feel free to reach out. Happy investing!
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David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
3y
@Carlos Ptriawan
I agree. In an earlier post I was advocating for just selling out. I think while somehow not legally paying taxes is a good thing, many investors get way to stuck on it. Just as one example, one investor wants to sell his property of ~15years at his purchase price just so he doesn't pay capitals gains tax!!! its doubled invalue and instead of keeping 85cents on the dollar of the appreciation, he'd rather not just to avoid giving Uncle Sam the 15%!! and his a Florida resident so no state income tax.
There are plenty of ways to invest.....
1 Reply
Tim Ryan
Investor / Mentor / Contractor · Arcadia, CA Buying Out of State · Member since 2015 · 655 posts · 623 votes
3y
Some really good advice on this thread! I don't have much to add except that it appears you are not very interested in the active part of real estate investing. In that case a DST or Syndication might make sense. With net worth over $1m you are an Accredited Investor so that opens you to opportunities others don't see. Another avenue is partnering with an active investor.
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