You may have bought rental property for its income producing aspect.Now wish you had bought a larger property or one closer to you. These and many other reasons may have you wondering about what to do. With an inconvenient rental property you may want to sell. There is good news here. You can defer capital gains taxes through a 1031 Exchange with a like-property that is more to appropriate to your needs. You will need a Realtor who understands and can explain how to navigate the IRS requirements. Keep in mind that even with an expert Realtor, you are going to need a 1031 Exchange Intermediary. Your Realtor should know at least one such person.
Some questions you will want to ask the Realtor are:
How does the 1031 Exchange work?
You have 45 days from the completion of the sale (close of escrow) of your current property to identify the property you want to buy. Then you have 180 days or the end of the filing time for your current tax year (including extensions) to negotiate the deal and close escrow on the new property.
Start your search before or at least simultaneously with listing the current property for sale. Both the property you are selling and the property you are buying have to be rental, industrial or commercial properties. They can not be your home where you rent out one or more rooms under the same roof.
How is this financed?
There are many options available but the simplest is to get a second conventional loan. As long as you have 20% down payment, six months’ reserves and the income to justify the loan, you can do this for up to 10 loans. These kind of loans are ideal as they are usually 30 year fixed-rate loans. The Federal Reserve has already made it clear that rates will go up even after 2022 is over. So acting sooner than later will allow you a better return on your investment for 30 years!
Can IRA or 401(k) funds be used?
In a word, yes but there are requirements. You need to turn your IRA/401(k) into a self-directed IRA and can not make any property repairs or improvements yourself. You must be a passive investor and you must hire a custodian or third party administrator to handle all the funds for you. Failure to follow all the rules will result in massive penalties. Custodians you might want to consider: U-Direct IRA Services, The Entrust Group and Equity Trust Company.
What is a cap rate and why is it important?
The cap rate is the net operating income of the property divided by the price you paid for the property. Take the total income (rent) and subtract the expenses you had to arrive at your net operating income. These include repairs, utilities, trash, water, etc. If you financed the purchase you will need to include the interest you are paying on the loan. The cap rate needs to be at least two to three times the interest rate the bank will give you on a Certificate of Deposit or other interest bearing account to make this worthwhile.
Should you use a property manager and, if so, who?
Being licensed by the state is vital, having two or more years of experience is important and their having a way you can access where your property’s income and expenses are at all times (these days this can be done on-line) needs to be a given. Make sure your contract with the property manager is explicit and covers all the basics, as well as any matters important to you specifically.
Once upon a time, we invested in property for the upside potential of the value of the home. These days most counties are experiencing rent increases and this is expected to continue into the future so rental property can become cashflow positive earlier than you may think. This is a great time to invest in a rental or buy another home for yourself and rent your current home.
if you have questions or wish to discuss any part of this, you can reach me at 760 622 5087 or [email protected]