I received a call from my tenant last week to inform me that they stepped in dog poop in the apartment complex and therefore would not be paying rent. True story.

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Over the past 10 years of owning the property, I have also gone to court four times over tenant disputes, had over 20% inoccupancy eight times, and have been woken up hundreds of times to complaints not dissimilar to the dog poop issue.

I’m over it. I want to sell. But is it worth the tax?

Potentially – but before we look at my options, let me share my goals with you:

1. I want life to be easy. The most important thing in my life is my family and I value the time I have with them tremendously.
2. I want consistency of returns. It’s important to grow my wealth without taking on too much risk.
3. I want to own real estate. It feels good to invest in things you can touch/feel/see and I believe in the long-term benefits of real estate ownership.

Now, most of the people in my position want to avoid or minimize taxes, so they explore these options:

• 1031 exchange into another property[SM1]
• 1031 exchange into a DST
• Hold the property until you pass away and let your children/beneficiaries make the decision tax-free (if you get a step-up in basis)

Let’s explore if any of these options work for me.

A 1031 exchange into another property:

PROS:

1. I could potentially get a better property with a better tenant.
2. I defer taxes until a property is sold or I pass away.
3. I maintain control and decision-making power.
4. I build a legacy and leave a rental property to the next generation.

CONS:

1. It’s complicated to find a property quickly.
2. I would be selling and buying in the same market so it will be hard to be opportunistic.
3. I would still need to deal with the 3 Ts (tenants, toilets, and trash).
4. It isn’t freeing up time to spend with my family if I still have to deal with poop issues.
5. Maintenance costs continue to skyrocket.
6. In CA, landlord vs. tenant rights can make it challenging to evict a challenging tenant (for example, the risk of a three-year squatter)

So my other option is to do a 1031 exchange into a DST. Let’s talk about those pros and cons:

PROS:

1. I become a passive owner, so I don’t have to deal with the 3 Ts.
2. I diversify over multiple properties and geographical regions.
3. I defer taxes for the life of the DST.

CONS:

1. This is a short-term solution since the life of a DST is 3–9 years.
2. I lack control.
3. High costs eat into returns.

Now that we’ve explored the 1031 options, let’s talk about what it would look like to sell and pay the taxes instead.

I know, I really do understand that paying taxes is painful, but what does it look like in lieu of an exchange? Remember that my goal has never been to pay the least in taxes, but rather to simplify my life, get some consistency, and to own real estate, if it works out.

The Current Numbers:

• Purchased for $500,000 in 2017
• $100,000 of improvements put back into the property over 6 years
• Depreciation of $200,000
• Basis of $400,000 (taking into account the capital improvements and depreciation mentioned above)
• Current value of $1,000,000
• Current net operating income of $3,500/month, or $42,000/year, for an annual income return of 4.2%.
• Important to note: there is always the risk that a higher vacancy rate or larger than expected maintenance costs could significantly reduce this income return.

Sale Scenario:

• Without getting into the tax complexities with things like recapture, let’s use a flat 30% tax on the gains of $600,000 (current value – basis), which comes to $180,000 in tax owed.
• Net $820,000 (current value – tax owed)
• All proceeds invested in private lending/credit at 8% cash flow, generating income of $65,600/year.

Looks like the numbers might just work out in favor of selling my property. I could pay the taxes, have more flexibility with my money given the liquidity, diversify my investments, and put more money in my pocket. If I decided to continue my investments in real estate, my preferred option would be to utilize real estate experts as a passive investor in limited partnerships.

After looking at my options, it’s clear to me that letting taxes dictate my decision would not allow for all my goals to be reached. A 1031 exchange and a DST would allow for me to avoid the taxes and to continue to own real estate, but a 1031 doesn’t simplify my life and a DST may not provide the net returns I’m seeking.

I’ve decided to list my property. No more late-night calls, no more headaches, no more dealing with crap, literally.

DISCLOSURES: Information presented is for educational purposes only and is not intended as financial or investment advice. Consult with your financial advisor before implementing any transactions and/or strategies concerning your finances. Although information contained in this report is from sources deemed to be reliable, Morton makes no representation as to the adequacy, accuracy or completeness of such information.

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