A few weeks ago I shared that my husband and I decided to sell our two single family rental properties using a 1031 exchange in order to scale up and get a higher annual cash flow from our portfolio.
For those of you who have never heard of a 1031 exchange (my husband still calls it the 1099 thing we’re doing) let me give you a few details:
- A 1031 exchange refers to a section of the tax code which allows an investor to sell an investment property, and re-invest the profits into another investment property, thus deferring the taxes.
- A 1031 exchange can be done on any investment property, for any type of investment property. So in our situation, we are exchange single family homes into multi-family properties and that is totally allowed.
- You are required to hire an intermediary, a tax deferred exchange specialist, who will receive the profits from the sale of the property and distribute them to the next property.
- You can choose how much you want of the profits you want to use for the 1031 exchange. For example, if there are $200,000 in profits and you want to invest $150,000 and pocket $50,000 that is fine, though you will pay taxes on the $50,000.
- An investor is required to close on the new investment property(ies) within 180 days of closing on the exchange property, and they would need to identify a list of properties that would be offered on within 45 days.
- You cannot use 1031 exchange funds for repairs, only acquisition costs.
- The fees for the 1031 exchange range between $1500 – $6000 depending on what type of exchange you are doing.
The first house we decided to sell was my detached condo in Marysville, WA. I purchased this property in 2012, and the tenants moved right in after buying it at the foreclosure auction. In the almost five years that they lived there, we never received one repair or maintenance call. This was good and bad, the good was that we never had a maintenance bill in five years. The bad was that we knew that once those tenants moved out, the house would need some work.
Since the market is hot, we decided to go ahead and do a full remodel because we believed it would pay off and we could get top dollar. We removed & replaced all of the kitchen cabinets, removed all of the stained carpet and ugly parquet flooring and replaced with new carpet and laminate flooring, patched Sheetrock holes, replaced light fixtures, installed new doors, painted the interior and landscaped the backyard.
The remodel took about 3 weeks and ended up costing about $8,000 and in the end the house looked beautiful.
On March 5th I listed the home for sale and in a few days we had received multiple offers and accepted an offer of $15,000 over what we were asking. Before I listed, I also made offers on a triplex in Old Hickory Tennessee (just outside of Nashville) and a duplex in Mount Vernon, WA. I made both offers subject to the successful closing of my single family so that I would not be in a crunch to locate exchange properties. Both owners accepted and both new properties will close a few days after my single family home. Even better, I will have extra funds left over from the exchange so unless I can find a small single family home that works as a rental, I’ll pocket the difference and pay taxes on that.
Looking at things in another way, I was able to trade in one single family home that had a monthly cash flow of $580 per month, and trade that in for five new units which, between them, will provide $1,983 per month in cash flow, and I didn’t have to come up with any out of pocket money to do this.
We have not decided what to do with my husband’s house yet, though we did get an offer even before it was listed for sale. We may do the exchange with that one, or use the funds to invest in our syndication.
One thing to note: our initial investing strategy was to acquire as many properties as we could and then pay them off and keep them forever. This strategy allowed us to buy one to two properties per year, and that was fine. However, we changed this strategy to focus more on replacing my income so that eventually we can live off of just our rental income.
If you have any rental properties that have high equity and are not producing the income that you want, you may want to consider a 1031 exchange.
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