Cash out and pay taxes?

Question

I am looking for some advice about what to do. I would like to sell a rental property that has appreciated from 108,000 to around 295,000. It currently rents for 1,250 monthly and has no loan on it. Its in northern california and I would like to stay local if possible.

However, looking around the market, I don't see much opportunity currently to deploy the assets into a 1031 exchange that would give me similar yields on my original investment. However I would like to take some risk off the table as the housing prices have moved beyond their all time high, but I don't want to pay the tax man yet. Any advice on how to reduce the risk while not getting hit with taxes, beyond the standard 1031 exchange?

Peter Tverdov · Answer

Offer owner financing. Get paid 5% for X years, delay the capital gains hit and make more money from the interest payments while being relieved of the stress as a landlord.

David Cruice · Answer

Best to speak to a good real estate account but one option might be to sell it now and hold the note for, say, 60% LTV.  That way the new owner takes on the risk of a downturn in pricing.  You'll then have a 40% cushion should you have to foreclose in the future (worst case scenario).

Dave Foster · Answer

@Drew Y., You're right on all counts.  Your actual return on that property is pretty abysmal as a cash on cash number.  It's very difficult to find properties now in that locale that would do any better.  So you may be in for a devil you know rather than the one you don't situation - which is why you're not feeling the love for a 1031 exchange.

Many investors (we're talking like rats off a sinking ship numbers) are leaving areas like this (not it's not just CA) and putting their money to work in other geographies or other classes of property.  If you don't like long distance land lording then that kiboshes that.

A refi if you reinvest the proceeds can greatly increase your cash on cash ROI.  But refi cash has a tendancy to be more like socks in the dryer than hangers in the closet.  And in any event increased debt =increased risk.  So that' doesn't get you where you want to go.

An owner carry could give you the better return.  But you don't say how long you've owned that property.  And depreciation would have to be recaptured in the first year.  So the IRS is going to get well first in any scenario like that.  and then you're looking at the increased risk of a forclosure in a down market.  Sure you can protect yourself against loss but not against lost income or significant repairs for a property not taken care of.  Food for thought.

Another option that I have investors employing now is a combination of separating cash and debt to create an environment of lowered risk but good return using the 1031 exchange to separate debt (risk) and cash (security).  What they would do if they were you is to sell  your property and 1031 into one of the two following scenarios:

1. They would by a small property for cash (or a fractional ownership in a debt free 1031 compliant product).  And they would use the rest of the cash as leverage on another actively managed rental.  By doing this you are creating a very low risk cash flow instrument.  And the leverage can then be used extensively to maximize net ROI between the two properties.

2. Since your property is already all cash, if they're perceiving a near correction they'd jump right into a total all cash investment through the 1031 that provided a good return and had a 1-2 year exit so they could come out if wanted and take advantage of a buy opportunity.  Good off ramps are not easy to find on the freeways sometimes.  And 6-8% for 20 years while still getting the tax deferral of the 1031 and stepping out of the overheated market might not be the worst thing.

Hector Bilbao · Answer

Agree with Scott and Austin. Opportunity Zones might be a good option for at the very minimum deferring the tax another year or two.

I did a good article on Opportunity Zones here https://realtaxadvisors.com/blog/new-opportunities...

Austin Hendrickson · Answer

@Drew Y. more info on OZ's here if you are interested

https://www.biggerpockets.com/forums/51/topics/586...

Drew Y. · Answer

@Dave Foster thanks much for the advice , I will definitely have to noodle on it a bit more.

David Cruice · Answer

@Drew Y. it can be something as simple as a promissory note written on the back of a napkin (not that you'd ever want to do that but it is legally binding).  Do a search on Google for something like "real estate promissory note template" and you should get a few examples you can use.  Keep in mind that if your buyer is also going to be taking out another loan to cover all or some of his portion of the payment of the balance to you, the lending institution is going to want you to take a subordinate position to their first-lien note.  However, this does not preclude you from coming in later and assuming or paying off their note to protect your interest.

Drew Y. · Answer

@David Cruice Do you have any advice or reading material on how to offer a note for sale or structure a deal like that?

Tom Nguyen · Answer

If you think market is all time high and you really love this property and it will cash flow.

best option would be Cash out Refinance at 80 LVT and pocket the different without paying the tax man. It will be your money in your pocket.

Cash out and pay taxes?

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