In a recent post about different Schools of Thought in real estate investing, a frequent reader said I’d ‘suggested’ a post topic. Before we get into it, my experience has clearly demonstrated to me there are schools of thought on most any topic related to investing. In fact, there are dueling schools even on sub-topics. What I’ve learned for sure in my 41 years, is that truly objective analysis never lies. An investor — given complete and reliable information, will almost always choose the strategy most personally beneficial. Even Captain Obvious rolled his eyes on that one.
The topic — refinancing vs completing a tax deferred exchange.
First, let’s set up the scenario most investors face when they’ve decided to make a move to improve their status quo with one or more multifamily properties.
Ralph and Liz, in their mid-40′s, have owned a four unit multifamily a long time, for which they paid $200,000. It’s currently valued at $500,000. Their current loan balance is a couple Starbucks visits over $140,000. If they sold in the process of completing a tax deferred exchange, they’d net approximately $310-315,000.
OR
They can obtain a 75% loan at 5.75%, 30 years fixed — $375,000 from my go-to lender, Chad Emerson. If they opt for this strategy, they’d retain a $5-6,000 annual cash flow. They’d net, give or take, $227,000.
The exchange option
This results in the ability to acquire properties totaling $1-1.2 Million in value. Another way to look at it is that Ralph and Liz would be at least doubling their income property portfolio. Their annual tax shelter would be increased by roughly $20,000. Cash flow would also rise, but probably by no more than $5-700 monthly when the smoke cleared.
The refi and hold option
This one ends up with Ralph ‘n Liz keeping the long held multifamily and acquiring about $750-800,000 in addition multifamily units. Their tax shelter would increase by about $25,000, give or take. The annual cash flow on what they kept would wind up being $5-6,000. The new props would generate an additional $15,000 — a grand total of 20-21,000 in yearly cash flow.
BawldGuy Axiom: Knowing your options and the data for them does not mean we know which one is superior. A 5-10 year analysis, often both before and after tax, is required so as to choose wisely. We must go below the surface.
Next time, we’ll poke more deeply into the numbers and options. But just for fun, and based upon the numbers so far, which way would you suggest Ralph and Liz choose? What would you do?
Need a fix, bad. Gimme a call at 619 889-7100 and we’ll sift through your status quo together to see what’s what. Have a good one.
Related posts:
- How A Purposeful Plan Makes Use Of A Partial 1031 Tax Deferred Exchange — A Case Study
- Tax Deferred Exchange With a Twist — How Purposeful Planning Makes a Difference
- Section 1031 Of The IRC – The Tax Deferred Exchange — Not Always The Right Tool
- #1 Formula For Knowin’ When To Execute A Tax Deferred (1031) Exchange
- A Timely Warning To Those In The Middle Of Current Tax Deferred Exchange (1031)
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Jeff– Fantastic post. I can’t wait to see your future article taking a more in depth look into the numbers and options.
Looking at the information you’ve provided, it seems that Ralph and Liz should go for the Refi option. When all is said and done, they’ll have a portfolio roughly equal to that which they would have acquired via exchange; however, with the Refi they would have more tax shelter and cash flow. Assuming they use the cash flow for paying down the principal, their capital will grow way faster with the Refi option than the exchange.
Hey Kyle — You’re correct . . . as far as you go. I’m not sayin’ your choice is necessarily incorrect, or not. But — think longer term, especially with the property with which they started. Think after tax in retirement. Let it simmer. It might take a bit for it to hit you.
Jeff,
Knowing your slant toward the long term and going into retirement with a fresh property that still has plenty to depreciate for the tax shelter i’m guessing your thinking the exchange option is the better play.
Most of your scenarios revolve around having a regular J-O-B and having rentals as a retirement tool. What would an ideal scenario look like for someone like my self who is in their early 40′s but has very little income outside of the rentals i have aside from the occasional flip deal. I have been trying to par down personal debt so that less income can still carry a reasonable lifestyle. Unfortunately much like San Diego i live in a high dollar part of Maryland and invest in low cost Baltimore City but dont want to live there.
Welcome Bob — You said, “Knowing your slant toward the long term and going into retirement with a fresh property that still has plenty to depreciate for the tax shelter i’m guessing your thinking the exchange option is the better play.”
Long term for sure. But exchanging isn’t always the answer, not by a long ways. If planned well, and enough in advance, many clients are able to take long term capital gains without exchanging, and while paying little or no taxes. There are about half a dozen long posts in that statement.
But let’s address your status quo directly.
You have more light at the end of the tunnel than you might suspect. You can use the ‘occasional flip’ as a catalyst to your primary goal of income on which to live. I’ve talked with many in your position, and they almost always have more options than previously believed.
I strongly urge you to gimme a call when you have time. I’d love to show you some of your options. Have a good one.
I didn’t consider that they were in their Mid-40s. But there is lots of other information needed to make a truly informed decision on which is best: unused depreciation, retirement goals (namely “when?”), descretionary income…
Regardless, I’m sticking to my guns. I can see the virtues of both scenarios depending on one’s particular situation.