This post is for folks who own at least one investment property and are looking to build their real estate portfolio. Investment = not your primary residence. This tool doesn’t apply to people selling their actual house.
The tool in question? A 1031 exchange: use the proceeds from the sale of your property to build up other investment properties.
I’ll cut to the chase and give you what I would do if I were in this position. Full disclosure: I’m not a real estate investor because I like liquidity too much and see other investments I’m more interested in, i.e. stock and Bitcoin. But hey, maybe if I get *too much* money I’ll feel the need to diversify a bit into real estate, but that’s unlikely.
Build Your Real Estate Portfolio Using the 1031 Exchange
- Sell Your Property. Hopefully you’ve made a profit, especially this market in mid-year 2021.
- Designate a Replacement Property within 45 days. This essentially means you make an offer on a new house and they accept. You have 180 days from the sale of your own house to close on this new one.
- The new house you buy has to be of equal or greater value. BUT here’s the big opportunity. If you invest in multiple properties, their combined value has to be of equal or greater value. So you can sell one awesome property and buy into three other properties that are all 1/3 the price of the original home you sold.
Did you catch that? Sell your investment property and take the cash and buy 3 new properties with it.
Doing a 1031 exchange isn’t something you want to get into real estate for, IMO. It’s more something you want to be aware of if you happen to own a property you want to sell. It’s a way to minimize tax burden and optimize reinvestment (especially for diversification and liquidity purposes since your investment will now be split up into multiple properties instead of just one).
What’s the downside?
Lots of caveats. The 200% rule. The 95% Rule. Kind of annoying (Source).
The biggest one outside of managing these rules is the time constraint. You have to designate your properties within 45 days and close (on at least one) within 180.
You’ll need to know ahead of time roughly what properties you’ll replace it with. Assuming you’re getting three properties, you don’t have to close on all three (just one) but you will have to name 3 potential ones to replace.
You also can only do this with like-properties. So if you owned a single-family home, you can’t sell it and buy commercial real estate next (or vice versa).
To sum it up…
“Okay, lots of info. Give me a practical plan to build my real estate portfolio with this.”
- Sell your investment property (let’s say it’s worth $350,000).
- Buy a good-enough home for you (worth $200–250,000) and a fixer-upper (worth $100–150,000)
- Fix up one or the other, flip it, and repeat, OR
- Fix up one or the other, rent it out, and use the BRRR method to buy another.
Consider this if you already own investment or rental property you’re wanting to sell. Instead of eating it on capital gains taxes, time your reinvestment so you avoid taxes and start to grow your real estate empire into multiple properties.
This is not legal or investment advice. Use your noggin.
Thanks and credit to my sources: this tweet thread which sparked my interest in this tool, Clever Real Estate, and of course the ineffable Investopedia.