The rate on new 30-year mortgages is now around 6% (double the level in 2020) and could go higher still as the Federal Reserve intends to keep raising interest rates. So it is not all that surprising that the real estate market is showing signs of cooling from the torrid pace of the past few years. There are more price cuts, fewer bidding wars, and properties taking longer to sell.
So 2022 might be an especially apt time to reassess if property you’re holding as an investment is working for you or if perhaps some changes are in order. Say you own 100 acres of farmland or an aging apartment building in a major city, worth much more than you paid but now costing you more in time and money to maintain. With the real estate outlook more murky, what do you do? One option worth considering is a “1031 Real Estate Exchange,” the strict rules for which we described in this previous blog post.
A 1031 exchange lets you sell property you no longer want or need, defer taxes on the profit, and then in relatively short order invest in real estate that makes more sense for you. This strategy is especially advantageous if you own investment property that is not likely to appreciate as much in the future and has rising maintenance and renovation costs.
Here’s an example of how this can work: Mary and Bill are in their 50s, with a primary residence in Seattle and lots of investment real estate, including an old rental house in Renton, WA, leased for $3,600 a month (net $3,000). Estimates are that the house can sell for $900,000, a big gain from the $200,000 they paid.
Problem: Bill and Mary do not want an old, high-maintenance house on their balance sheet. What they do want is to replace it with more reliable income to be eventually passed on to their kids, ideally in a sunnier state they regularly visit and eventually want to build a vacation home in.
Solution: With the help of a property manager, they look nationally and find recently built condos in Taos, New Mexico for sale by the developer and priced at $400,000 each. They hire an intermediary to do a 1031 Exchange, so the $700,000 gain from selling the Renton rental can be tax-deferred as it is exchanged for the two condos. Each of those is then leased, netting $2,000 a month on average.
Result: A potential 33% increase in Bill and Mary’s net monthly rental income from this investment: $4,000 (up from $3,000). And they would then own newer rental property that will require little maintenance and be not far from Santa Fe, where they eventually plan to build a vacation home for extended family visits.
The above is hypothetical, of course, and the devil’s always in the details. But if you do own investment or business real estate that is not working for you, it’s worth exploring a 1031 Real Estate Exchange. If you do pursue an exchange, do so working with an expert attorney and in context of your overall wealth plan, taking into account where you are now and where you want to be years from now. Without a wealth plan in place, you risk selling yourself short.