Pay off a rental or not?

[Christine Krizenesky]

We recently bought a rental and have a mortgage on it, I want to pay it off quick and thought about doing flips and using that money to pay for it. I realize I will have to pay gains on it if I don’t do a 1031 exchange in so much time, but I thought if I do flips, we have to always churn the money anyway so why not pay the gains and pay down debt quickly? Thoughts???

[Dave Foster]

@Christine Krizenesky, All depends on your preference and the market for flippable properties.   An alternative would be to let the tenants continue to pay down the mortgage and add another rental when you can letting the tenants pay for that mortgage or doubling down the payoff on the one. 

A 1031 exchange would be a good idea if you're wanting to sell the first one because then you can access all of the equity.  But I can't tell from your post if it's a good long term hold or not.  If you start doing flips you don't have the option of a 1031 since fix n flips don't qualify.  You will pay ordinary income on flip profit.  And you will probably also have self employment tax and quite possibly the 3.8% ACA surcharge.  

Flipping houses is flipping expensive from a tax perspective!

If you don't like debt a couple other options might be

1. Keep your leverage 50% or less and save to buy your next one.  At a debt load of 50% your payments will be low enough that you can adjust rent quite a bit to keep tenants in.

2. If you have a primary residence pay it off and take a heloc. By paying it off you increase your security. The heloc gives you dry powder that doesn't cost you anything until you need it. And the pay down is paying you real dollars in the form of no interest. It's not much but heck the 4.5% you may be not paying on a paid off primary is every bit as good as the 4.5% you would make on a secure DST. And it's two or three times as much as you'd get from the dividends of a Walmart stock.

The 1031 exchange works best with leverage of some sort.  But don't let the leverage cowboys convince you to do something that loses sleep at night.  Slow and steady with no loss is actually a faster way to wealth then pedal to the metal with a couple BKs or foreclosures in the middle.