1031 Exchange v. Selling and Purchasing
If you are looking to get into the multi-family side of real estate there are a few factors which you will run into moving forward, assuming you build your portfolio to some scale. One of the big questions we get from investors with a few units under their belt is whether they should sell their property and purchase another one, or if they should exchange their property into a bigger property.
Residential v. Commercial Multi-Family
When looking at the two different segments of multi-family, we have to start with residential versus commercial multi-family. Residential multi-family is any property that has 2-4 units, while commercial multi-family is any property that has 5+ units. With residential multi-family the appraisal process is different than that of commercial multi-family in that for residential you will be dealing with comparable sales of similar property setting the price of your property, for the most part. With commercial multi-family you are going to be dealing with more of an income based approach to appraisal, which will give you more bang for your buck as you increase the NOI on the property.
Selling and Purchasing
When you purchase a property, fix it up, and then sell it, you are looking at paying the taxes on the gain in value of that property. Assuming, you are in a higher tax bracket, you will end up have to pay quite a bit in taxes on that gain. When exchanging a property, the sale must be done within a timeline and must be a purchase of a “like kind” property, which can tend to be a very broad definition giving you some flexibility in the different properties to purchase.
Note – As a side note, it is recommended to speak to your CPA, Attorney, and Broker to decide which step is best for you.
On the side of the exchange, lets assume we start with a 5 unit building. This building is about 15% below market value as far as rents are concerned and there is about $15,000 worth of deferred maintenance. Assuming, that we bring the property up to standard and take of the below market rents, we will go ahead and stabilize the property and post it for sale. Once we sell that property we have to work on a timeline to purchase another property which most of the time will be a larger property, and hopefully with some value add. Assuming, we can add value to the second property, we will then exchange that into a larger property as well, and now we are looking at having a property that could be double the size of our original property, or bigger, and we have deferred the taxes on the gains to this point. For those of our clients who like the idea of residual income, they will keep exchanging until they achieve their required amount of residual income and then they will just hold on to the property.
Lets Get Started
If you have any questions or would like to discuss the 1031 exchange process in more detail, please feel free to give us a call or reach us through any of the means below.
Until Next Time,