What Exactly Would You Do In This Situation?

5 Replies

Hey people-

It has been a long while since I last surfed around here on BP site. I would like to ask the entire BP community about your advice/suggestion/feedback based on your real estate/tax expertise in a dilemma of exit strategy my business partner and I will have to deal with our properties.

Back in a couple of years ago, we bought a 2,100 sq ft resident property with an adjacent empty land in same size for $400k. We are now working with a developer and architects to construct a two units building with a rooftop on that land. They said it would cost about $500-$600k to construct and based on our analysis via sales comps around the area with similar characteristics, it will immediately have a valuation of $1.3m at conservative number ($600k for the lower unit and $700k for the upper unit). The existing property appears to be currently valued at mid-$500k range.

We are trying to figure if we should sell the existing property we have now, using our respective 250k capital gain exclusion option so we won't pay any cent on capital gain taxes to the government as we have lived on the property for at least two years. Or if we should sell the newly constructed lower unit then use the whole proceeds to pay off all the construction loan, meaning there will be no mortgage on the upper unit. Then whatever the remaining proceeds, if any, will be then taxed at our ordinary rates.

We did discuss about the possibility of using 1031 exchange on the lower unit to defer taxes and purchase other investment properties that generate higher COC % than if we choose to keep and rent it. Other possibility is to rent the lower unit just for one year then sell to qualify for the 15% long term capital gain taxes instead of having to pay at our ordinary rates if we decide to sell immediately within less a year after the construction is completed. We intend on moving from our existing property to the upper unit and live there for at least 2 years. We plan to have our existing property converted into a rental investment property and hold it as long as possible. It has excellent loan terms so we do not want to lose it.

So, all in sum, the simple question here for all of you here in BP community is:

What exactly would you do if you were in my shoes with the situation I just explained? I am trying to figure out what the best approach should be taken in this case that favors in building wealth in real estate. Thoughts or have questions to ask for further clarification? Feel free to chime in!

Looking forward to your responses and they are usually pretty good here in BP. Very impressive.

Thanks for reading.


I just re-read my post and realized there are comments that are somewhat contradictory to one another and I apologize for this. For clarification, we currently do not want to sell our existing property because of the excellent loan terms it possesses. However, if things make sense, we may consider selling. We believe that keeping our current existing property makes a lot of sense for us and we think we should do something with the lower unit. Unless you disagree, feel free to bring up some good questions in this discussion. I want to see what you guys have in other perspective. Thanks.

If you keep your current unit for more than 3 years after you move out, you'll lose your tax exemption.  You won't qualify for a 1031 on the new lower unit.  Can't really advise on your choices though.

@Wayne Brooks care to elaborate why wouldn't the lower unit be qualified for 1031? I thought it can as long as it is intended for investment purpose. No? Thanks for commenting.


Account Closed There is a school of thought supported by some case law regarding raw land and 1031 exchange that as long as it remains raw land it is much easier for you to establish your intent to hold it as is for investment - even if you do some preliminary exploratory planning such as entitlement/renderings etc.

Once you turn a shovel you are now seen as creating something that is construed as inventory. You are building for resale. You need to establish your intent again regarding the completed unit.  Can you do that?  That's a question for you and your legal and tax advisors.  

But conventional thought is to sell land before you turn a shovel if you are trying to establish your intent to hold for investment.  Once you break ground you're a builder and you've got inventory - no more 1031.

@Account Closed  

But conventional thought is to sell land before you turn a shovel if you are trying to establish your intent to hold for investment.  Once you break ground you're a builder and you've got inventory - no more 1031.

Yes, but if you "turn the shovel" and then hold the property for rental or investment (instead of selling) after you complete the project you can demonstrate that you did in fact have the intent to hold for rental or investment purposes.  It is all based upon your intent and whether you can prove that you did in fact have the intent to hold the property after construction for rental or investment vs. held for sale.

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