Should I sell a massively cash-flow negative property?

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Should I sell a massively cash-flow negative property?

Ben Morris
Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes

I have a property should have been a winner but ended up being an ugly monkey on my back for the last 8 years.  It currently loses about $1k/month which is about what the principle payments are (yes, there are 2).

I bought the property in 2001 for 155k.  In 2005-2008, I pulled all of the 180k in equity out and put it into a business that ultimately failed, leaving me with a property I owed more on than what it was worth.  I ended up moving out of state and turned the property into a rental.

Fast forward to today.  I am fed up with paying interest and waiting for the market, so I have been paying 2400/month towards principal and I'm finally at the point that I can sell it.  However, I'd be hit with a pretty large tax bill (fed + state around 50k) due to the equity I've pulled out.  

In my head, I have 2 options: 1) stay the course and build up equity until I can get enough to make a 1031 exchange into one or more cash-flow positive properties, or 2) sell it and pay the taxes.

My issue with #1 is time. In a few years, I can a serious amount of equity, but at what opportunity cost?

My issue with #2 is that I don't want to pay the man. In my mind, that puts me out of real estate altogether, and I want to make real estate a serious component of my portfolio.

Is there a creative option #3 that doesn't entail foreclosure (I'd have to pay those taxes) and my income is sufficient enough that I don't think they'll forgive it very easily.

Thank you!

Ben

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y

@Ben Morris, A 1031 exchange requires you to purchase at least as much as you sell if you want to defer all tax.  It looks like your problem with that would be coming out of the sale with any cash for the next down payment.  But there are still a couple of options that may work for you.

1. A purchase of something where the owner agrees to carry the financing so you don't have to come to the table with cash for a down payment.

2. Complete your 1031 using the $40K that you've set aside to pay taxes with in  as your down payment.  

3.Do a partial exchange.  Sit down with your accountant and find a balance between a full deferral under 1031 and paying the full tax without any kind of 1031,  A compromise might be to buy something for 200K.  You'll pay the tax on 100K but shelter the tax on the other 70K.  Of course this still would require you to have resources for both the smaller tax bill and the down payment (if needed) for the replacement property.  But it's worth looking at.

If you don't have resources set aside for a potential tax bill then the 1031 exchange into a 100% owner carry property is really your only option.  I may be missing something but...

If you sell with a 1031 you've got the challenge of finding cash/financing to buy the next property but if successful you'll completely defer all tax.

If you sell without a 1031...

1. You will probably not net out 305K on your sale.  So you will come out of pocket first when you sell to cover net proceeds.

2. You will then come out of pocket again when you stroke that 40K check to the IRS (and where will that cash come from?)

Net 12 month cash out lay - probably more than 50K.  That money never comes back.

If you don't sell then... 

1. You endure a 12 month pay out of $9600 but probably get that back in principle at some point down the road.  So your annual net loss is really almost $0.

I 

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    10y

    @Louis Swingrover, Yep, it's real easy to think of it as a two part rule for complete tax deferral -purchase at least as much as their net sale and to use all of the proceeds in the next purchase.  There is no specific requirement to replace debt but that's one of the attractions to the syndicated products - their built in financing packages right?

    The other option of course always is to only do a partial exchange and remove some taxable cash from the transaction.  It generates a partial taxable event but that is something that I imagine you can also use to match up an investor with the right product at the right debt levels.

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