“For all long-term investors, there is only one objective – maximum total real return after taxes.” — John Templeton
If you have a property you’re looking to sell, should you sell it?
Or should you do a 1031 exchange?
A 1031 exchange is a tax exempt exchange where you can roll that into another property and defer those gains.
Sometimes when looking at problems like this, it can feel like a Rubik’s Cube.
The nice thing is you really only have two choices.
Either you’re gonna do a 1031 or you’re simply gonna sell the property.
But which one will work better for you?
Let’s talk about it!
1. How 1031 Exchanges Work
How does a 1031 exchange really work?
I’m going to explain a bit of the process of how it works.
A 1031 in the tax code allows you to take a property you sell.
You have a third party group take the funds.
They will hold them for you for a period of time until you can identify a new property and prepare to close on a new one.
It allows for like-kind investments.
If you have a rental property, that investment allows you to go into another rental property.
You can’t take your own personal house, sell that, and 1031 into another house or rental property.
Those are not really like-kind investments.
In general, when it comes to deferring capital gains, that’s the reason people do 1031.
Let’s say you have a house you bought for $500,000.
It’s worth $1 million right now.
You got $500,000 in gains.
You’ve got all this money and would love to sell it.
But if you did, you would have to pay all the taxes on it.
A 1031 exchange allows you to take that money and defer it to a larger deal.
I know someone who has effectively done this over the last 25 years.
They started with a duplex and now they’ve got a $400 million real estate portfolio.
This strategy can really work!
One thing with 1031 exchange is when you close on your first property, a qualified third party has to hold the funds.
You are typically charged between $750-$1,500 for that process.
If you’re talking about a single family house, if it’s commercial, there’s more fees.
This can be substantially more expensive, but that’s generally how it’ll work.
They’ll hold this money.
You’ll have up to 45 days to identify a property.
You can identify up to three new properties and then you’ll have six months to close.
These timelines can be very tight and if you don’t make them, the money goes to capital gain and you have to pay the taxes.
My hope for you is that you will go through this process correctly.
You’ll have a plan of attack and be able to get it done if that’s your goal.
Now we’re going to talk about the other side:
What would happen if you sold the property and took the gains?
2. What if I Sell the Property?
What happens if you sell this property?
What if you don’t want to bother with a 1031 exchange?
You can totally do that!
There’s nothing wrong with that.
Let’s go through an example:
Pretend you have a $2 million multifamily apartment.
You have $1 million in gains.
There are long term gains.
When you sell that property, you get taxed.
For your state and your federal taxes, let’s say your rate is 25%.
That means you will have net $750,000 on that $1 million and you’ll pay $250,000 in taxes,
That’s a lot of money!
If you had the option to avoid those taxes, I think it’s really important.
I had this happen recently where I had the option to take the money or not.
I realized it made so much more sense to do a 1031 exchange into the next property.
I could save on a lot of those gains for the future.
There are, however, some considerations to be made.
If you can’t find another property, you might have some trouble with this option.
Especially in this market where things are so competitive!
Another consideration is maybe you have to sell right now.
Maybe your partners or family members don’t want to be involved in the next deal.
If there’s enough equity in the deal, you could potentially 1031 part of it or cash people out.
One approach is to try the 1031.
Get it set up, pay the fee, do it.
Then you look around and see what you can find.
If you can’t find it in single family or whatever asset you’re doing, you can look at commercial.
We allow for people to come into our multifamily syndication deals if they bring over $500,000 in equity.
We’ve had a couple investors do that recently.
There are some fees involved, but, in general, it’s a pretty awesome way people can get access to great deals.
And we’re not the only ones that do it!
There are other commercial groups as well.
If you’re having trouble finding a replacement property, this is something you can look at.
Now we’re going to talk about some other considerations.
3. Other 1031 Considerations
What are some other considerations when it comes to a 1031 exchange?
If you’ve never done this before, you probably don’t know what to expect.
So let’s talk about it!
Firstly, when you are going into the next property, there is a challenge that might come up.
The person who’s selling a property will know you are at a 1031 exchange and you’re on a tight timeline.
Why is that important?
It gives you a pretty significant disadvantage.
They know if the deal doesn’t close you’ll be penalized because this is one of the properties you’ve identified.
They can come back and say they won’t work with you.
They want you to pay additional charges.
They won’t have any concessions with the house or the property.
People can really take advantage.
They know that you have to close this sooner or else you’ll have a bigger tax bill.
There is another way to do it!
A friend of mine has done this for years.
This is the same friend I mentioned earlier who has gone from a duplex to hundreds of multifamily units.
You can identify the new property first before you sell the current property.
What does that actually look like?
You have the new property and get it under contract.
Then you’ll say you have some extensions built in.
You can say you’re going to close in 45 or 60 days.
Then you’ll say you’re gonna make additional money guaranteed or that you will make it non-refundable after a certain period of time (maybe another 30 days).
The person you’re buying from knows the property will close.
They’re not concerned.
This tactic allows you to identify the new property first and then you can list and sell it.
You’re going in at this already agreed upon price.
Some markets are easier with this than others.
There are also ways to make it half.
It’s challenging, but it is a safer way to do a 1031.
When a market is super hot, it can be really hard if people want cash offers.
This happens when you look at larger deals, when you see what a seller is looking for, particularly on the commercial side or larger multifamily side.
Another consideration to make is that some people have packages of single family homes or a different asset.
There’s a realtor I know in the Midwest who had 30 single family houses.
He sold them together as a package and took the funds.
He did a 1031 exchange and went into a single person, multifamily syndication.
That means he took his equity and put it elsewhere.
They bought a $10 million property and he had about $4-$5 million in equity.
He gets much higher returns than he did before.
He also doesn’t have to manage all these properties!
Investors sent us in at over $500,000 with some of our deals.
You’ll find all other operators will do similar things depending on how much it is.
The issue really is timing.
You can use a 1031 and then try to figure out where you’ll put it.
In general, when it comes to 1030, I try to defer, defer, defer.
If I can just continue to defer taxes, it’s gonna be much better than every time I sell a property.
I would be paying 25-30%.
That will really hurt my returns versus if I just defer.
I can also reinvest the money I would’ve paid on taxes.
To round out this post, I want to encourage you to check out this video about how millionaires are made.
It talks about the steps that wealthy people take to be wealthy.
Now I want to hear from you!
Have you done a 1031 exchange?
What are some concerns you have about 1031s?
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.