All Forum Posts by: Clayton Mobley

@Latimer Luis There are a couple moving pieces here, so I will try to make this as clear as possible :)

If you had rented it out instead of selling, holding it as a rental until today:

Yes, you could have executed a 1031 to exchange the property into (I'm guessing) a whole little portfolio of properties. There are lots of rules and regs with the 1031, but it doesn't have to be 1-1. If your SF prop was worth $1.5mil by now, you could use that money, tax-free, to buy as many other props as you wanted. Sorry, I feel like this is salt in the wound at this point.

Even though you bought it as a primary, five years of using it as a rental would qualify it as an investment property and allow you to use the 1031.  I am hoping (really I am) that you took the Sec 121 exemption mentioned in the previous comment and took the $250k (single) / $500k (married) of tax-free capital gains when you sold, since you lived in the property (assuming you lived there at least 24 months out of the previous 60).

If you had used the 1031 and then, five years later, decided to sell the replacement property (not your stated scenario, but an important thing to note):

Since you bought it and held it as an investment for five years, you could sell it through another 1031 and leapfrog into another investment property tax-free (there is no limit on how many 1031s you can execute). 

OR

If you decide to move into that replacement property five years after purchasing (your stated scenario):

No, you do not automatically become liable for the deferred tax if you decide to convert a 1031 prop into your primary. However, when you sell that property you have some decisions to make.

If you decide to move into the house after those first five years, instead of selling, then you have converted it into a mixed-use property. If you continue to live in it for two years (satisfying the Sec 121 requirement mentioned above) then you have the option of combining the Sec 121 exemption and the 1031 exchange when you sell it. Since you bought it under a 1031, you need to have owned it for at least five years, but your scenario already covers that period, so you're fine there. 

Basically, if you bought it under a 1031, held as an investment for five years, then moved in and stayed for at least two years, you would be able to take a prorated exemption under Sec 121 for tax-free capital gains (prorated based on the amount of time you lived there vs held it as a rental) and use the remaining value in another 1031 exchange. This would allow you to continue to defer taxation on both the sale of the SF condo and this new replacement prop, and get a little tax-free cash as well under Sec 121.

If you decide to sell it outside of a 1031 exchange:

Now you become liable for the deferred taxation. It's a bit of somewhat complicated math, but the tax basis of your SF condo (that you sold under a 1031 in our hypothetical scenario) is rolled into the replacement property. This basically means that if you sell the new property outright, you end up paying the taxes on both that sale and the sale of the SF condo (here's a link: https://apiexchange.com/replacement-property-calcu... )

So, if you sell that new property outside of a 1031, the tax man comes a'calling.  You could still qualify for the partial 121 exemption mentioned above, but you'd be liable for the remaining capital gains and deferred depreciation recapture tax.

So basically, yes, you missed out on a big opportunity here, but there's no sense worrying over it now. Chalk it up to a learning experience! What you know now is that the 1031 is a massively powerful tool for RE investors and it pays to understand how it works. As I said, there's no limit to how many 1031s you can execute, so you can potentially (and many people actually do this) continue to leapfrog from one property to the next (after holding for a sufficient period, usually 12-18 months) without paying taxes, indefinitely. Then you leave your final properties to your heirs, who receive a stepped-up tax basis (equal to the current market value) when you die, meaning if they sell the properties the day after you die, they would essentially pay zero taxes. It's a strategy I charmingly refer to as "1031, 1031, Die", but I digress.

The 1031 is a bit complicated and when combined with the 121 exemption, even more so. BUT you are required to have a Qualified Intermediary on your team anyway, so they will make sure everything is as it should be. So, keep this learning experience in mind next time you have some appreciated property to sell -  it can save you tons of money and, more importantly, keep that capital working for you.

Sorry for the bummer post,

Clayton

@Jules H Yes, you can execute what is called a Construction 1031 (or Built-to-Suit or Improvement 1031, they all mean essentially the same thing). You need a good Qualified Intermediary on your team for any kind of 1031, so that should be your next step regardless of whether you intend to purchase a new build or an existing property. Standard 1031 rules and deadlines still apply, which can be tricky when you're building a new property from the ground up (ie you have 180 days from the day you close on the sale of your current prop to complete construction of the new one). A good QI will ensure that any details of a Construction 1031 are taken care of, so I would find one you trust and then consult them on the best course of action.

For a little light reading, here are some articles on this type of exchange: 

http://www.exeter1031.com/construction_1031_exchan...

https://www.1031exchange.com/improvement/

https://www.cwscapital.com/insights/understanding-...

Best of luck!

Clayton

@Matthew Dreiling out of state turnkey is definitely a viable option for first-timers, it's actually one of the REI strategies that new investors find to be the easiest transition since it is very hands off (after you do your due diligence and pick a property, of course). And while I would never encourage anyone to overlook Birmingham, I have heard good things about Atlanta lately. If you are nervous about not being able to see your investment, or you'd like to learn the ropes by being involved in the rehab, tenanting, and management processes (more a DIY approach than turnkey), then I agree with @Lane Kawaoka that perhaps you should look more closely at your own backyard. It takes a while for new investors to learn how to look for the right deals with any efficiency, so you may just need a bit more time and research to make your own market work.

But, if you're still not liking what you find in Atlanta, feel free to scoot on over to AL! It's an easier drive than the midwest and Birmingham is a great cash flow market.

Best of luck!

Clayton

@Gary Carino Welcome to BP! You will find plenty of other people in your exact position - CA, NY, or HI residents who need to look outside their own inflated markets. Investing out of state is definitely a viable option (most of our clients live outside of AL), but just know that you'll need to put in extra legwork during your research and vetting stage. 

Whether you DIY (find your own agent, contractor, property manager and then manage them from afar) or go the turnkey route (one company does everything), you need to make sure the people you choose are going to be there for the long-haul. I always recommend that out of state investors make a trip to their chosen market to meet the people they're considering working with, prior to any buying any properties. Consider it an investment in your investment that will pay huge dividends in peace of mind.

Best of luck!

Clayton

@Mike Lynch Normally I would pipe in but I think this is a job for the one and only @Dave Foster . I am fairly sure the answer 'yes but your accountant will hate you' but I think a pro should weigh in. 

@Esther Thomas I think you will like most of the answers to your questions:

Question 1: Sorry, yes you need to replace at least as much value as your current prop (net closing costs etc). So if you sell for $800k, you need to get a new prop for $800k (ignoring closing costs just for clarity). You also need to replace at least as much equity. So however much equity you have in the prop (at least $400k by the sound of it), you will need to have at least that much equity in the new props. 

So, for example, if you originally had a loan for $320k (80% of 400k) and you've paid it down to 200k (just guessing, not sure how long you've owned it), you now have a prop worth 800k of which 200k is debt and 600k is equity. Your new prop(s) need to be worth at least 800k AND have at least 600k in total equity. So you can't sell the 800k prop, pay off your 200k loan, and then use the 600k to buy a new prop through the 1031. Well, you can, but you will pay taxes on that 200k of debt reduction -  the IRS sees debt reduction and cash as the same in terms of their benefit to you. 

That 800k of value (including 600k or more of equity) can be spread around to multiple props. So if you wanted a big portfolio, you could use the 600k as down payments on several properties, buy maybe one or two in cash (in cheaper markets), and use financing to leverage your current capital into a much bigger investment. You're in a great position with tons of options for building your REI portfolio.

Scenario #1: Yes, you can move into a property purchased as an investment. There's no hard and fast rule, but most investors agree that the IRS won't look askance at you as long as you hold a prop purchased through a 1031 as a rental for at least 12-18 months (which you plan to do anyway). The Sec 121 exemption requires that you have lived in the prop for at least 24 out of the 60 months prior to selling and have owned the prop for at least five years in total (because you bought it through a 1031). Your scenario meets both those requirements, so yes you would be able to take a partial Sec 121 exemption, prorated for the portion of time you lived in it vs rented it during the five years prior to selling (called a mixed-use property). 

Since you're guessing four years here, I'd say stay one more year and qualify for the whole thing if getting some tax-free cash is your goal. But remember that only capital gains can be excluded under the 121, not deferred depreciation recapture, so you'd need to speak to a CPA about your specific situation to make sure you know what's what. 

I will also note that there are a couple different ways to take advantage of both the 1031 and the 121 at the same time, and depending on your situation you might find another option more beneficial. Here are two helpful articles that may be of use: http://www.exeter1031.com/application_sections_103... and this: http://www.exeter1031.com/article_overview_1031_12...

Scenario #2: Yes, you can sell this prop and buy 10 smaller props (in this case would be worth $80k each, which is doable for cash flow props in good markets). If you later (again wait 12-18 months to keep the IRS happy) decide to sell one, then you are only liable for the proportionate amount of deferred gain (so yes, 10% in this case). Of course, it will be a little trickier than those nice round numbers, so definitely make sure you have a good CPA on your team. 

Also, remember that there is no limit to how many 1031s you can execute. So if you decided to sell one or more of the properties down the road, you could do so through another 1031 and continue to defer taxation. In fact, it is technically possible to defer taxation indefinitely if you play your cards right.

I'm sure some much brighter minds than mine will pipe in on the thread at some point, so always defer to advice given by Qualified Intermediaries or other 1031 professionals. I (personally) and my clients use the 1031 process regularly and I definitely make it my business to understand the ins and outs, but I am a turnkey provider (and BP addict, clearly), not a 1031 pro ;) 

If you are considering selling soon, remember that a 1031 requires that you have a QI on your team before you get started, and there are plenty of timelines and rules to adhere to. So if you're thinking of selling soon, I'd make vetting your QI your next step.

Best of luck!

Clayton

You can find a TON of information on the Turnkey model, different markets and providers, and real experiences from other investors here on BP, so please don't rely solely on my little novellas to inform your investment decisions. There are some very strong opinions on both sides with regard to Turnkey, and there are definitely some scammers out there (read any thread about Morris Invest for reference). So it's not like Turnkey is pain-free, you have to do the work and know how to avoid being taken for a ride, like pretty much any big financial decision in life.

I am always happy to provide info to new investors, as it fuels my BP addiction anyway ;) But before you or your friend make any decisions, it's crucial to have a serious heart to heart about what the goals are for the investment and what your needs are with regard to time commitment, risk, and control (do you need to be near the property, do you need to be in charge of tenants?). Turnkey is a solid model that many people use, but that doesn't mean it's perfect for everyone. So use BP for the amazing resource it is and do some outside research before making an investment decision. 

Best of luck!

Clayton

Ok, to answer your last question: how much can you make on a $100k prop in AL. 

First the disclaimer: one turnkey property (or DIY rental) will not a sufficient income make. You start with one and build up.

So our average property value is about $100k (fair market value, we don't inflate our prices and any provider worth your time shouldn't either) and our average rent is $950 per month. 

That's gross rents, you need to account for real expenses, like taxes, insurance, PM fees (ours is 9%), etc. None of our properties have HOA fees but some other Turnkey providers do offer props that fall under an HOA so you have to check for those as well.

You also have to account for potential expenses, or things that might not occur every month (and shouldn't) but may be larger expenses that occur infrequently. This includes maintenance costs (to fix things and also to spruce up the place when a tenant moves out, called move-out or turnover costs) and vacancy (for when you have an empty house between tenants, for example). Some people also include Capital Expenditure or CapEx expenses in their monthly calculations as well (which means the cost of big-ticket items like a new boiler or new roof). However, because we replace the big items in our properties during rehab (new floor, new roof, new HVAC, new boiler, etc) those items are highly unlikely to come up until much further down the road. So we advise clients to keep a reserve (remember I mentioned only using the $120k and keeping the $20k?) as a buffer for if and when those things come up down the road.

So the math for how much you actually take home each month is complicated. You will find many 'back of the napkin' calculations here on BP that people use to assess whether or not a property is worth looking at further. Everyone has an opinion on them, so you'll need to look into those for yourself. What's most important is that any provider you work with has solid, statistical figures for their expenses so they can show you what the most likely scenario is for your returns. Back of the napkin is good for seeing if something is just not worth your time, but you need hard data to really evaluate any deal, Turnkey or otherwise.  Our average expenses for the past 52-week rolling period are: Maintenance 3.1%, Vacancy 3.6%, Property Management 9%. This is based on our entire portfolio for the past 52 weeks, with data updated daily. Over the past five years, these numbers haven't changed much. If memory serves, our vacancy got up to about 5% a few years ago, but very temporarily. 

Your loan term and interest rate also impact your actual net returns, so unless you buy outright in cash, some of your rent goes to the bank (but that's ok, great actually, because it means your tenants are buying you a house!). If you would like to see some more specific numbers, feel free to PM me any time and I'll send you some interactive ROI spreadsheets so you can see how all the numbers work together, it might be easier than me trying to explain it here ;)

So that's how a true full-service Turnkey investment works. The other side of rental investments is what I call DIY rentals -  which means the investor either hunts for deals themselves, hires an agent, uses a friend who lives in the market, or some combination thereof. Then the investor finds a contractor that can do the rehab work and negotiates fees etc. Once rehab is done, the investor either needs to advertise the property and vet tenants themselves, or find a Property Manager (PM) to do it for them. Property managers typically charge between 8-10% of your gross rent, so if your property rents for $500 a month (low, just a nice round number) and your PM charges 10%, you will pay them $600 a year, which really isn't much for the service they provide. Most people that invest outside of their own backyard or don't have a lot of time/energy/interest to devote to being a landlord end up hiring a PM. With Turnkey, the provider is the PM, so it's all built in.

The upside to the DIY method is that, if you're good at it and/or get lucky, you might end up with a bigger share of the profits. If you find a really good deal, get a good price on rehab, and force some appreciation, you now own a property worth a lot more than you paid, AND you get to rent it out (or sell it if you decide to flip instead of buy and hold). The downside is that it's a ton of work and steep learning curve. If your contractor screws you or drops out, if the tenant you choose ends bailing and leaving the house a mess, you may end up having to go deal with it yourself. Especially if you invest outside of your own market, DIY is simply riskier. That being said, TONS of people swear by it and are very successful with this method. Like everything it gets easier as you go along, and for many people the increased risk is worth the potential for increased reward.

The upside of turnkey is that there is very little work involved after the initial due diligence you do to select your provider. It's really just collecting money, having a call with the PM every once in a while, and signing off on any major repairs or other larger decisions. The downside is that the Turnkey company keeps that spread between what they bought the property for and what they sell it to the investor for. They did the work, so they keep the money. That being said, you shouldn't be paying more than market value for a Turnkey property (just as an aside). Turnkey takes the guesswork out of finding a property in a good area, finding a contractor that's trustworthy, vetting tenants, etc. For people who either don't have the time/energy, don't like the increased risk of DIYing in another market, or simply don't want to do all that legwork, Turnkey is a good fit.

So DIY is higher risk, but potentially higher reward. Turnkey is lower risk, but lower reward. Think of DIY as the stock market and Turnkey as more of a mutual fund. 

@Nick Tarantino Turnkey is a very common strategy, especially for newer investors. And while, yes, I do use this investment both personally and professionally, if you look through my past posts you'll see I'm pretty even-handed about recommending it - it's not for everyone and new investors need to have a very clear idea of their needs and goals before they can decide if it's the right avenue for them.

That being said, I will try to give you a brief description of the model. The term 'turnkey' has actually come to have a fairly broad meaning, so when you do your own research on BP and elsewhere (which I high recommend) you may have some confusion over what a turnkey investment is. The way I explain is that lower-case-t 'turnkey' just means a property is tenant-ready, doesn't need any work, can be leased and cash flowing today. Anyone can sell a turnkey property - an owner occupant that is selling but kept the property maintained and updated all the big items before selling, or a company that's just marketing properties sold by other entities all over the country (called a marketer) will often sell 'turnkey' properties. Lower-case-t just means the property doesn't need any work before it can be tenanted.

Upper-case-T 'Turnkey' is what we refer to when we say things like 'the Turnkey model' or 'a Turnkey provider'. This implies a much broader service. A Turnkey provider is a company (like Spartan but there are many all over the country) that does all the work for the investor. We scout properties, we get the deals, we rehab the property and replace big items, we market it, we vet tenants, we manage the rental long-term. So, ideally, the only work that the investor needs to do is upfront, loooong before they pick a property and cut a check. Many people refer to Turnkey as the 'most passive rental investment' but that doesn't mean you don't need to think about it. There's tons of homework that goes into selecting the right market and, most importantly, the right provider. 

Once an investor selects the market and provider they want to work with, the provider sends them properties that best meet their criteria and they choose whichever one they like best. Closing doesn't occur until all rehab work is done and inspections passed, so the investor should assume zero risk until the property is ready to go, or 'turnkey'. Depending on the provider and the property, you may have a tenant before closing, which is great. If not, the provider markets the property and finds a qualified tenant, deals with leases, maintenance, late payments (if any) etc. The investor just collects their net income every month -  which is why it's called a passive investment.