Today’s market is red hot for those with inventory, but that creates a double-edged sword for the seller. On the one hand, a hard-earned profit is likely being made. On the other hand, inventory is low out there, and that creates a decision tree problem that many people are facing right now. Let me explain that problem and what that decision tree looks like.
Here is the hypothetical: You have held your property (or properties) for a few years now, and with the current market, you are making a nice profit on your current sale. That’s great — congratulations on jumping in and doing the hard work to manage your investment in real estate.
It’s late October when I write this, so for purposes of this hypothetical, you are closing on Friday, October 22, 2021. The money will hit your account on that day. From this deal, you are going to pocket a cool $250K profit. With most banks, you can leverage this amount to buy up to $1,250,000 of real estate as an investor. This is great!
Now the decision tree.
A.) If you are going to do a 1031 exchange, you have 45 days to identify a property and 180 days to close. This saves you capital gains taxes and recaptures of depreciation. A great tool. You can identify something within 45 days — not get under contract, simply identify some properties to buy. You think you can do that, don’t you?!
Here are the problems this current hot market is facing. With COVID-19 still a factor in our economy, investors are pumping funds into rental properties and real estate investments of all kinds, commercial and residential. The net effect of this activity is to provide you amazing gains on your recently sold real estate, but now you are buying the same or similarly situated property at retail prices. Deals are scarce, multiple offer scenarios are common, and cash is king. You have $250K in cash, not $1,250,000. And you have 45 days to identify to conform to the 1031 exchange requirements. Can you do it? What do you do?
B.) You have made $250K and have chosen to NOT use a 1031 exchange to find another investment. So, now you have a little over 60 days to find a property and close on that property. However, you must buy a property valued enough to offset the capital gains needed (if you cost segregate your new purchase to wipe out the capital gains) and the depreciation recapture. Your buying power is still that listed above, but you have really only bought yourself until December 31, 2021, to close on the new property. You are in the same seller’s market and are still facing a low inventory market. Can you do it? What do you do?
This decision tree is the dilemma faced by investors closing in the third quarter of 2021. Read The Decision Tree Problem – Part 2, where I address some answers to this decision tree.