Real Life – Real Time Case Study – 1031 Exchange – Feel Their Pain

Many of you have repeatedly asked for the occasional case study, something that would illustrate much of what I talk about in my daily posts. As Lani (A RE blog owner herself) said in a comment last week, “I’ve been waiting YEARS for this side by side comparison.” It’s been her contention these comparisons shoulda been part and parcel of this blog all along. Though my clients live these comparisons, I think my reply to Lani hasta be — guilty as charged.

Sometimes we get too close to a thing, and wonder how anybody could look at two things and not see huge differences — if they indeed exist. My mistake, if you’ll allow me to self-diagnos, is (using baseball analogy in Lani’s honor) akin to me constantly makin’ the point that Major League Baseball (MLB) is vastly superior in quality of play than is seen in the Rookie ‘A’ Ball League in East Toilet Seat, Montana. Problem is, if the reader isn’t either a baseball fan, or would like to be but has no context in which to compare, merely reading about it doesn’t quite do the job.

I get it — mea culpa.

Jason Robins called me earlier this year about improving the current Plan he and his wife, Marianne had in place for their retirement. Though that Plan and their current Purposeful Plan is more involved than just this portion of it, here’s what they’re doing with Jason’s rental property.

It’s a single family residence in Washington (state) which has produced roughly $2-300 monthly cash flow, though Jason admits some months it’s a whole lotta break even. To their credit the house was kept in as close to excellent condition as possible. Jason is a salesman who pretty much makes his living on the road, while Marianne is a long time banking pro, very good at what she does. Here’s a picture of the rental.

Oh, did I forget to say it’s 85 freakin’ years old?! Hellllllo San Diego real estate investment property owners.

In a nutshell, it’s about 760 square feet with two bedrooms and a bath. It sports original fir ‘n oak floors, and a decent sized 1-Car detached garage. The neighborhood is better than decent, as it was worth braggin’ about in the listing — always a good sign. It sold for the low $200′s, less than $210,000 once it was re-roofed as part of the sales contract. He netted enough, give ‘r take to acquire a couple Texas duplexes — he may add a bit to make it happen.

Here’s a picture of one of ‘em — if only one side.

His equity to value ratio on his Washington house rental was roughly half or so. He’s puttin’ 20% down on a two of the above pictured duplexes, located in two separate locations of the Dallas/Fort Worth ‘MetroPlex’. His cash flow will approximate $5,000 a year for each — a total of $10,000 annually. This is based on today’s interest rate (Hat tip to Chad Emerson) which is 5.25% — 30 years fixed rate.

Here’s how the numbers look when the two properties are combined.

Gross Scheduled Income — $61,200
Vacancy/Oper Expenses — $24,480 Includes Professional Management
Net Operating Income — $36,720
Annual Debt Service — $26,506 5.25%/30 years/fixed rate
Annual Cash Flow — $10,214

Their tax shelter has improved significantly also. The Washington house delivered about $5,000/yr in. That figure should now be enhanced by $10,000 a year or so. Remember, he’s doing a tax deferred exchange so he’s bringin’ his ‘old’ basis with him. Any new depreciation is generated by the amount of new debt he acquires — X the percentage allowable for the improvements of the property into which he traded. Land isn’t, for the most part, depreciable. (Surely you can infer that’s a whole ‘nuther post, right?)

They’ll be taking the cash flow along with a modest $500 a month, and adding to the monthly payment of one of the duplexes. This will result in that loan being eliminated completely in just over 8.5 years. Then they’ll take the increased cash flow and the same $500 a month to finish off the other duplex.

Here’s how that’ll play out.

Balance at the point the first duplex is paid off — $169,870. The cash flow from the newly free ‘n clear duplex is $18,360/yr — or about $1,500 a month rounding down. This duplex’s annual cash flow is $5,000 or about $400 a month rounding down. Add the $500 a month previously used against the first duplex and they’re now applying an additional $2,400 to the month payment.

Let’s see what happens and how quickly.

In just over 4 years (49 months) that duplex is also completely debt free. In other words, in just under 13 years they will have engineered an annual cash flow of nearly $37,000 — a large minority of which will be tax sheltered for quite awhile.

Show me where you can put in about $110,000 +/- today, add $500 monthly to it for less than 13 years, and end up with over $3,000 a month in income. Since they both make decent income at their jobs, and don’t live according to the ‘Keep of with the Jones’s’ philosophy, that $500 extra outgo a month won’t be a problem. Furthermore, if they wish, they have other significant assets which would easily provide them the option of making this happen slightly earlier.

Let’s look at the differences both now and in the future — comparing keepin’ the status quo vs making the move to the Texas income properties.

Cash Flow

Stay = Max of $3,600 yearly.
Trade = About $10,000 yearly.

Tax Shelter

Stay = $5,000 a year.
Trade = An additional $10,000 a year.

Future Retirement Income — Oh sure, NOW yer payin’ attention.

Stay = About $8,400 a year — none of which will be tax sheltered.

Trade = $37,000 a year — much of which will be tax sheltered for about the first 14 years of retirement.

Let’s see here…

There is one huge benefit they’ll be giving up, which has been causing them many anxious nights. They won’t be able to drive by their new units.

Don’t ya just feel their pain?

You can do what they’re doin’. It starts with a call — 619 889-7100. You’ll be helpin’ me with my daily fix. Have a good one.

Related posts:

1. How A Purposeful Plan Makes Use Of A Partial 1031 Tax Deferred Exchange — A Case Study
2. There’s The Best Way To Go — And Real Life — A Case Study
3. A Kinda Sorta Case Study In The Making — Turning Lemons Into Mojitos
4. How To Minimize Your Retirement Income – A Case Study
5. Case Study: A Real Life Phoenix — Flying Higher Than Ever