Opinions: Would you take the money and run or exchange the property?

[Mr. Green]

I have a piece of land in a growing area that a developer is interested in buying from me. We bought the ground (own it outright) thinking we'd build a house on it but I'm doubtful that will ever happen now. The developer owns a lot of land around me so he has a strong interest in buying my property. I'm pretty confident in my ability to assess fair market value on land around here because I look at real estate sales all the time. I believe 180k to be market rate for our property. I have 75k in the land, so we'll show 105k in long term capital gains in the sale. We'd pay about 20k in taxes between federal capital gains and state tax; we'd net about 160k.

An alternative would be to do a 1031 exchange for one half of a duplex the developer is building down the road. The house is a tad on the small side for the area (1176 sq.ft., 2 car garage) but there is a healthy demand for smaller rentals in my town because there aren't many and it's a phenomenal school district. The developer is building in a couple nice features into the homes like laminate vinyl plank flooring, a vaulted ceiling in the living room, tray ceiling in the master bedroom, and stainless appliances in the kitchen. These things will definitely make the place more appealing to tenants. The developer has the the duplex units listed at 180k so it would be a good fit for a 1031 exchange. Based on comparable rents in the area I believe the home would rent for $1,200-1,400. At $1,200 a month we would net between 9-10k per year after accounting for management company fees, HOA fees, taxes and insurance, and depreciation. The house is brand new so the chance of major repairs within the first few years would be minimal. If the unit generates 10k of income, it will be like having 250k invested in the market @ a 4% WR, which is well above the 160k we would invest with the net proceeds from a cash sale. We don't have any rentals so this would diversify our income in FIRE. After a couple years as a rental we could move into the place for two years and then sell it as our primary residence where we'd pay no capital gains tax at all, saving us that 20k in taxes we would have paid in a cash sale.

Taking the exchange for a rental seems like a no brainer but I find myself resisting the idea a little bit for some reason. Part of that could be the fact that I've never been a landlord before but the big rental management company around here has pretty good results with screening tenants and keeping places in good shape.

Am I passing up a good thing if I don't choose to pick up a nice rental unit at no cost to myself?

[former player]

No idea, but if you think a tray ceiling is a nice feature you have not been reading McMansion Hell.

[Mr. Green]

No idea, but if you think a tray ceiling is a nice feature you have not been reading McMansion Hell.

It's not what I think is a nice feature, it's what tenants think is a nice feature. If I was building it I wouldn't have bothered with a tray ceiling. I would use LVP and take a vaulted ceiling in my living room though.

[terran]

You'll pay tax on the gains someday, so it seems to me that the real advantage of a 1031 exchange is much the same as an IRA in that the hope is that you'll be in a lower tax bracket when you realize the gain than you are now.

I would also be wary of the idea of truly trading land for something this developer has built. These are separate transactions since there's no requirement that the property you buy be from the same person you sell to. In the best case scenario where you think you'll eventually pay 0% on the gain (not really realistic unless you sell the property over multiple years since the gain will go above the 15% bracket all by itself), do you think this apartment is a good investment for $160k? I've never invested in real estate myself, but just from reading things around forums and blogs, it doesn't meet the "1% rule" which would say you should pay at most $120-140k for something that rents at $1200-1400.

[powskier]

Do you want to be a landlord? Do you want to deal with property management? Do you think those returns are worth having your money illiquid?

Personally I never let the tax tail wag the dog. How does either option fit into your big picture, financially and "lifestyle/stress".

Disclaimer: Landlord trying to get out of real estate business...

[CowboyAndIndian]

I would do it. Several reasons

• Your present land is not making any money right now. It is a liability which you are replacing with an asset
• It is a great school district. That means that house prices should go up
• Good school district would also mean low vacancy rates
• A great house means that you have tenants lining up. You can pick and choose a great tenant.

Negatives are

• It does not meet the 1% rule based on $180k price
• A small amount of additional work. Based on my experience, not more than 30-40 hours per year.

The trick with a good rental is to make sure you get the right tenants.  Do the credit check, check references, get the police report, make sure that they do not have criminal records.

Treat the tenants well and they will treat you well.

[tralfamadorian]

After a couple years as a rental we could move into the place for two years and then sell it as our primary residence where we'd pay no capital gains tax at all, saving us that 20k in taxes we would have paid in a cash sale.

This is no longer true.  The section 121 exclusion now only allows the portion of the gain from the period of time in which you were living in the property to be excluded from taxes.