1031 Exchange: Should I exchange my first property to scale up?

12 Replies

Hey BP Community,

I'm a new investor on the north side of Chicago and I am in the final phases of a gut rehab of a condo unit that is my first property. Bought at $155K, $50K rehab, hoping to sell/exchange at ~$215K. Initially, my plan was to BRRRR it, but I have decided that I am not interested in holding onto an individual condo unit and I would rather have a building (ideally 3- or 4-plex). I have a few questions about the 1031 exchange because I'm wondering if that's my best option.

Also, something I think is important to share for this post: I have zero net worth, about $40K in credit card debt and about $25K on a low interest loan. However, I have a very steady job as a firefighter and I just passed the Real Estate Agent exam so I will be working as an agent within the next few weeks to pay off my debt more rapidly with extra income from that. 

Anyway, here are some of my questions: 

1) How much will I have to front for the down payment on the new property? Do 1031 exchange guidelines require more down payment than other standard forms of buying?

2) Would it be possible for me to secure a loan that would pay for my rehab project? It would be unbelievably helpful to not have to pay completely out-of-pocket again like I did for my current project (it's the reason I have CC debt at the moment). If this is an option, it would take so much financial stress out of the equation.

3) I understand that to complete the process of a 1031 exchange, I will need a "qualified intermediary" to act as an escrow agent so that I never touch the money when I sell. Any recommendations for who would be a good resource that I could consult with for this service?

Any other advice would be greatly appreciated. Also, anyone who is looking to connect and network in Chicago, I'm just starting out my real estate journey so I'd love to bounce ideas or just plain make new friends in the field. Thanks for your time in reading and thanks for any feedback. I am super grateful for this community and everything you guys do.


Best,

Tom

@Tom Casey , I think there's probably a quick answer to your question immediately.  But you're on a great track for the future.  So gaining wisdom right now along the way is commendable and will be useful - later.

First of all there's the issue of intent.  Property that qualifies for 1031 is property you purchase with the intent of holding.  Fix n flips don't qualify.  Your stated intent is good.  But the actual hold is short so you'd want to have a good rationale for why the change of intent if ever questioned. 

But the biggest issue is that right now you purchased a property for 155 and put 50 into it.  That makes your basis 205.  If you sell it you will probably have 5-10% closing costs.  So your net sale will be somewhere around 190 - $205.  In other words you're not going to make money on this transaction.  No profit = no tax = no 1031 = take the cash and pay down debt and get ready for your next acquisition.

For future reference -

1) How much will I have to front for the down payment on the new property? Do 1031 exchange guidelines require more down payment than other standard forms of buying? - There is no difference between a 1031 and any other transaction.  The 1031 portion is an added step to what is a regular transaction.  So for you a really good first step might be to find purchase and rehab a duplex or two family using FHA low interest/low down payment financing.  You get a place to live, a boost on your investing career, potentially tax free dollars when you sell (for the primary residence side), the ability to 1031 the investment side, and a commission for acting as your own agent.

2) Would it be possible for me to secure a loan that would pay for my rehab project? It would be unbelievably helpful to not have to pay completely out-of-pocket again like I did for my current project (it's the reason I have CC debt at the moment). If this is an option, it would take so much financial stress out of the equation.  The 1031 requires that you purchase at least as much as you sell.  And financing that results in cash back to you would create a taxable event on that amount.  A partial exchange where you take some cash out works.  A refinance when you buy the property before you hold it.  Or a reverse improvement exchange (more complex) would also be candidates down the road

3) I understand that to complete the process of a 1031 exchange, I will need a "qualified intermediary" to act as an escrow agent so that I never touch the money when I sell. Any recommendations for who would be a good resource that I could consult with for this service?  There are several good QIs   right here on BP who post regularly.  Your broker might have one they like.  Or the title company you work with might have a relationship with someone they like.

You're on a good path.  But I don't think this transaction is going to be the one that starts kick starts things with deferring tax.

@Dave Foster ,

Thank you for the in-depth response. So correct me if I'm wrong, but it sounds like it would be a good option to pay down my debts with income from the two jobs, do a cash-out refi on our current property/residence, get an FHA loan with a low down payment that also covers a rehab project, rent out the units once it's rehabbed while staying in our current residence, and then decide if we really want to sell it. Does that sound like a reasonable plan or am I missing something important? lol

@Tom Casey , sure. You may run into issues with multiple FHA loans or seasoning. But I love the house hack ability and terms that FHA allows for investors starting off.

@Tom Casey

I'd say your first priority is getting rid of the credit card debt, without that you will be able to qualify for a larger loan.

40k might seem like a lot but if you work at it you can probably pay it off within 2 years. Just know your first year as an agent you will have a significant startup cost (at least a few thousand dollars).And don't expect to make a killing the first year, even if you get a client who wants to buy a house on day one your probably looking at 2-3 months before you get your first check.

@Michael K.

Thanks for the advice. Paying off the CC debt is definitely my priority. And I think my job will work well while I'm getting started as an agent because it's a nice guaranteed check every two weeks. I figured it's gotta be tough in the beginning generating leads.

@Tom Casey

Are you living in the condo now? Or can you make money by renting it out? You're probably just going to want to focus on paying off your debt and getting your real estate business up and running before you jump onto the next project. After a year or two of doing real estate you will have gained a lot of knowledge and will be better equipped to acquire your multifamily building.

@Michael K.

For sure. I'm going to do my best to pay the debt down ASAP so I feel comfortable enough to make the move. I was thinking it would be ideal if I can secure a loan that pays for the rehab project so that I don't need to put financial strain on myself again.

As mentioned above there isn't enough/any profit to merit doing a 1031. I would look at renting out the condo (lots of my clients do and none have had issues with association) you can also take a HELOC out on the condo to pull equity to use for the next rehab project of a 2-4 unit if desired.