The 1031 Exchange…other than cash flow and a solid property manager, it’s a real estate investor’s best friend.
It is a familiar story to investors. You buy an investment property, you find solid tenants, you keep up with maintenance, it produces a decent return, it appreciates in value, and you start thinking about selling.
Then, the “elephant in the room” rears its ugly head. Capital gains! You ask yourself, “If I sell, how much am I going to pay in capital gains?”
In some cases, it could be as much as 35%. THIRTY FIVE PERCENT!!
Suddenly, selling doesn’t look like such a good idea.
BUT, what if you could avoid capital gains?
In comes the 1031 Exchange to save the day! What is a 1031 Exchange?
Section 1031 of the Internal Revenue Code allows an investor to sell a property and reinvest the proceeds in another property while deferring all capital gains taxes as well as depreciation recapture.
At Grow Properties Management and Investments, we have been a part of several 1031 Exchanges over the years. We wanted to share a recent example where our client turned a single family residence in Elk Grove, CA into a brand new fourplex in Meridian, ID. This transaction allowed the investor to not only avoid capital gains taxes, but also reinvest in a newer property, with more units, that brought him a much higher return.
Here are a few key details about the investment and sale:
Our client owned a 4 bedroom, 3 bath, 2400 square foot home in Elk Grove, receiving $2,250 in monthly rent, and he had owned the home for five years.
The home was owned free and clear.
The house sold for $589,000 and netted $556,000 after sales costs.
We have a network of professional REALTORS® across the country. We referred our seller to an exceptional agent specializing in the Boise area. Our client flew out to meet the agent and was able to identify a four-unit multi family home that was under construction.
All units had 3 bedrooms and 2 baths, with a 1-car garage. The projected monthly rent for each unit was between $1,900-2,200, totaling over $8,000.
The purchase price was $850,000.
Because we used a 1031 Exchange, our client could use his entire net proceeds, $556,000, as a down payment. He took out a 30 year fixed mortgage for approximately $300,000 at an interest rate of 3%, resulting in a monthly principal and interest payment of $1264.81.
Needless to say, our client has put himself in an advantageous position and is generating over 3x more revenue from his new property.
What would it have looked like without the use of the 1031 Exchange?
If we consider the net proceeds from the sale of the Elk Grove, CA property, $556,000, and assume a capital gains tax rate of 35%, our client’s proceeds would have been reduced by $194,600. His down payment would have been $361,400, leaving him with a $488,600 loan and a monthly principal and interest payment of $2059.96, reducing his cash flow by approximately $800 per month, or $9600 per year.
If you are thinking of moving your real estate investment dollars to a new property, or properties, the use of a 1031 Exchange to protect those dollars and grow your return is a “no-brainer.”
There are several rules that need to be followed to perform a 1031 Exchange. A reputable 1031 Exchange Services company, and an experienced real estate agent, are worth their weight in gold. They will ensure that the investor follows the correct steps and does not do anything to expose investment dollars to taxation.