I finally sold a property. That does not mean it took a long time to sell, but I actually sold a property and used a 1031 Exchange to defer capital gains taxes. I wanted to move out of the St Paul area with my rental, and move into a growth area. The new mayor in St Paul will do nothing but increase taxes, and make life more difficult to do business. So, I sold my St Paul property.
Here is what happened to the property, and how I bought a new property with a Considerations of a 1031 Exchange.
Considerations of a 1031 Exchange.
I needed an intermediary for the 1031 exchange. So, I used Patrick Harrigan of Gain 1031 Exchange Company, LLC. He did a great job helping me through the process, although looking back it was a simple transaction. You cannot touch any of the money. The title company ‘gives’ the proceeds from the sale to the 1031 Exchange company. If you actually get a check, you did it wrong. It costs about $650 to do the transaction.
Timing of a 1031 Exchange
There are many nuances of a 1031 exchange. You can do a reverse 1031 where you buy a property, then sell. That is advantageous as it may take a while to find a property, but you already know what property you want to sell. Additionally, you can sell two properties and buy one.
I had 45 days to identify a property to buy after my property was sold. I then had 180-days to close from that same start date. Because of that time-limit, I immediately drove to Florida and looked at property. I had to make an offer, and could not afford to take the time to get the ‘best’ deal. I bought off the MLS…(sigh)
With a 45-day limit, if a property falls through at the last minute, due to appraisals, financing, title issues, or any other problems, you need to get another property on contract, immediately. In my case, that means another few travel days.
If the property falls through after 45-days and you do not have any property already identified, you are done and pay capital gains tax. Thank you for playing.
The Property I Sold
I acquired the property in December 2015 and it was sold in July 2018. It was slightly less than three years of ownership. I wrote about the purchased here. I purchased it for just over $38K, and rented it for a about a bit over a year. The ROI during that time was ~15%. Not bad for a cheap rental. The renters were hoarders, and really did not take care of the property. Unfortunately, that is why you get property for $38K. I then put in a lot of money for a fix-up, and was able to sell it for a tidy profit.
Here is how I did the 1031 exchange.
Ownership of the property
I had the old property in my own name, not an LLC. I purchased the new property in my name. It made things easy. If I was switching ownership names, from my name to an LLC or reverse, that would have caused complications. Switch the name before and after, if you want to go that route.
Wording for the 1031 Exchange Purchase Agreements
Although the wording is not 100% a necessity, it does help smooth the transaction and avoids potential issues if a buyer or seller objects.
RELINQUISHED PROPERTY
Buyer acknowledges that Seller intends to complete a §1031 tax-deferred exchange, and that Seller’s rights and obligations under this agreement may be assigned to an intermediary for the purpose of facilitating that exchange. Seller’s exchange shall not impose additional cost or liability to the Buyer
and Buyer agrees to cooperate with Seller’s exchange and execute such documents as Seller may reasonably request.
*be aware of security deposits and rent pro-rations
REPLACEMENT PROPERTY
Seller acknowledges that buyer intends to complete a §1031 tax-deferred exchange, and that Buyer’s rights and obligations under this agreement may be assigned to an intermediary for the purpose of facilitating that exchange. Buyer’s exchange shall not impose additional cost or liability to the Seller and Seller agrees to cooperate with Buyer’s exchange and execute such documents as Buyer may reasonably request.
*be aware of negotiation position
Picking out a New 1031 Exchange Property
As son as the closing was complete, I drove from Minnesota to Kissimmee, Florida. That is a ~1,600-mile trek. I had a realtor and a general idea of property I wanted to purchase already lined up. I knew I wanted a property out of Minnesota and that a Disney Vacation rental would be a great investment. Kissimmee or Orlando Florida may be the number one vacation spot in the entire world. Las Vegas may be close.
Lining up showings was a bit tough for the realtor. The number one month for vacation rentals in Orlando and Kissimmee is July. That made showings more complicated. Only about half of the properties that we had wanted to see were available to show. You cannot see a property if a vacation renter is in it. A long-term renter is OK, a vacation renter doesn’t want to interrupt their week for you.
Price of New Property
In order to avoid capital gains taxes, your new property must be a higher net price than the old property. For example, my property sold for $175K. After commissions, buyer concessions and other fees, I netted about $165K. The new property had to be over 165K after all fees. I could have purchased a property for $163K, and paid closing fees of $2K and it would have been fine.
In my case, both the sale price and the purchase price was exactly $175K. With closing costs, commissions, taxes and other closing costs, I had to put in another $15K or so.
The additional expenses of the acquisition are then added to the basis of the new property.
1031 Exchange Taxes and How to do them
Talk to your accountant, do not rely on me…
Normally, when you sell a business asset, you must fill out a 4797, Sale of Business Property. However, in a 1031 Exchange, this form is not filed, as the property is not actually sold. It is essentially traded up.
Additional investments into the old property after the original acquisition, that are listed as a separate depreciable item, are ‘sold’ for the amount that is remaining on the asset. There is no gain or loss.
The basis is the old property is what you had left to depreciate in the old property, plus the additional assets associated with the old property. If you fixed up old property, that is also part of the old properties basis.
New items, such as furniture, appliances, and other fix-up costs become part of the basis of the new property. If you want, appliances and furniture can be depreciated faster. However, paint and other fix up expenses become part of the real estate acquisition costs and depreciated over the same life as the real estate.
Have you completed, or considered a 1031 Exchange? Do you have a lot of capital gains, or depreciation recapture, that you want to defer taxes on?