1031 Exchange or Cash Out Refinance

3 Replies

Hi - I am looking to invest up to my next buy and hold property. I have a pretty good single family home with nice equity. I also have a pretty good tenant and the unit cashflows for $500.  The debt service is almost paid on the property. Does it make sense to give up this cashflowing unit to purchase up? My thought was to take out a cash out refinance to purchase a multi unit or does it make sense to a 1031 exchange for multi unit?  My original thought is to keep the $500 a month, a cash out refinance may only change the mortage by 100 or 200 but I can then afford the downpayment on a multi unit and if the math is right I'd keep this property and be able to cashflow well on a multi unit.

I'd do the cash out refi and buy more units, while keeping the one you have. The 1031 just defers capital gains, it doesn't cancel them. Additionally, you have a pretty tight timeframe in which you have to make a deal happen. With the cash-out refi, you can take your time to find the next deal, and the only time pressure is that which you put on yourself. 

You know what to expect with the property you have, why not keep it?

@Victor Collins , it's not a question of which is the right course of action. It's a question of what is the right course of action in this specific circumstance. Giving up $100 - $200 of $500 cash flow is an estimated range of 20 - 40% loss of income monthly. There's not a lot of companies out there that could easily sustain a loss like that. So you want to really nail that down the true impact of a cash out on your NOI.

The other argument against a refi vs 1031 is that in a refi you leave equity in the first property so your leverage is less than in a sale and redeploy.  Not a problem if the first property is performing well and is a good fit for your portfolio.  But if it's only an average performer and you also leave additional equity captured in it that might not be such a good thing.

So refi and buy just isn't an automatic strategy.  But neither is defer till you die.  @Taylor L. is right that in a 1031 the tax is deferred.  But that deferral is indefinite and I'm pretty sure most folks aren't going to stop contributing to their retirement plans just because the tax is only deferred.  That actually is the power - the longer you defer the greater the benefit.

I wish I could remember who said this in a forum the other day so I could give credit.  But they said to ask yourself this question, "If I didn't own this house right now and it was for sale, would i buy it under the terms of the refi I'm looking at?"  If so then you've got a nice addition to your portfolio.  If not then unleash all the equity sell and 1031 into properties that meet your standards.

@Taylor L. and @Dave Foster - thank you very much! Very helpful - I was thinking cash our refinance - the home cash flows really well and this perspective is very helpful. I definitely would like to keep it because a cash out refi would only change the payment by $100 - I could still make $400 and you are right I could put the equity into another property. Do you have recommendations for cash out refis?