When Can You Refinance and How to AVOID Taxes on a Home Sale

Ashley:
This is Real Estate Rookie episode 260.

Amanda:
The tax benefit of a lease option is that the options money you get upfront, you don’t have to pay taxes on it until later on when the option is exercised. During the lease option term, you still own the real estate, which means you continue to get the depreciation benefits, the write-offs, and things like that. So it’s getting more money upfront, but also retaining the tax benefits because you still are the owner.

Ashley:
My name is Ashley Kehr and I’m here with my co-host Tony Robinson.

Tony:
And welcome to The Real Estate Rookie Podcast where every week, twice a week we bring you the inspiration, motivation, and stories you need to hear to kickstart your investing journey. I want to start today’s episode by shouting out someone by the username of Leo Zhang, and Leo left a five star review on our podcast that says, “Goldmine for real estate investment. Tons of valuable information and suggestions from real estate investors. You will find the roadmaps to success here”, with four exclamation marks. So Leo, we appreciate you and for all of our rookies that are listening, if you had not yet left us an honest reading review on Apple Podcast or Spotify, wherever you listen, please do. The more reviews we get, the more folks we can reach, the more folks we can reach, more folks we can help. And that is what we like to do here at the Real Estate Rookie podcast. So Ashley Kehr, what’s up?

Ashley:
Well, we are a week away… Well, days away, not even a week away from your short-term rental conference, the summit. And I’ve been nervously checking the weather because each time I go somewhere it’s bad weather-

Tony:
Bad weather.

Ashley:
I did get the email from your event planner today saying there is a chance of rain over the weekend. So I really hope that it’s not me that’s bringing it because I need warm weather. I’m super excited. It does say 80s.

Tony:
Yeah, so hopefully it’ll be warm. Not too crazy Florida. The weather’s always unpredicted. But yeah, we’re excited. We leave in less than 48 hours to take off and we actually almost spend almost a week in Orlando because we’ve got some stuff to do before hanging out a little bit afterwards, going to Disney World with the team and stuff. But we’re pumped. We’re going to have almost 400 people there, so it should be a fun couple of days and I’m glad you’re coming.

Ashley:
And I’m bringing my mom and my kids, so they’re just coming for the weekend. They’re flying down Friday night and then they’ll fly back Sunday night and then I’ll stay for a couple more days. But yeah, it’s just a great excuse to have a family day.

Tony:
We’ve been traveling a ton because we had Rob from the real estate show. He had his short term rental event in Houston last week. So Sarah and I went there and I spoke on stage for a little bit, and then we came home and it was a slew of birthdays, so it was Sarah’s birthday yesterday, it was her sister, my sister-in-law’s birthday two days before that. And it was my cousin, who’s one of my best friends’ birthday in between their birthdays. So it’s just been literally nonstop. So I’m excited after the summer, we’ll get to relax for a couple of weeks before we keep moving.

Ashley:
Yeah. Hey, I have a question for you before we actually get into the episode, what are some of the things you look for when you decide what conferences you are going to attend? Obviously the ones you are asked to speak at, but what are some things you look at?

Tony:
That is a fantastic question, Ashley. I think the majority of the conferences I’ve been to as of late, I’ve gone as a speaker, so that that’s kind of been the main driver. But honestly, as I think about the things that I want to learn, it’s not even necessarily real estate strategies at this point. I think what I’m more so focused on at this point in my career is the business principles to support my real estate business. And those are the kind of things that I’m starting to look for. I haven’t really bought a ticket for any new… But anyway, that’s what I’m looking for. Actually, let me rephrase my answer. There’s one thing that I’m really looking to exceptionally get at in short-term rentals, and that is revenue management. So there’s so much that goes into pricing your properties the right way. And there’s a big conference over the summer that we’ll be going to that has a deep dive into that topic specifically. So that’s the one real estate thing I’m really focused on. What about you?

Ashley:
Yeah, well, my son had his football banquet this past weekend and I had someone come up to me and say they have two short-term rentals and I’ve talked to them about it before, but they’re like, we are just ready. She was an attorney and actually has retired as an attorney to focus on the real estate, and she’s like, I just want to learn more about these short-term rentals we have and how to maximize them and run them better and all these things. And so she’s like, I just don’t know what conferences to go to and all these things. And she’s like, as an attorney, I did conferences all the time. She’s like, I’m sick of them, but I know I should get back into it for the short term rentals. I was like, I know exactly which one you should go to. I was like, there’s going to be one in Austin, I’m going to the one in Florida.
And I was like, when I went to the one that was in Newport Beach, I went on stage and I did a shot of tequila, not you’re normal conference. But anyway, I thought it was such a great question as to, I don’t even know which ones to attend and what to add value. So maybe we can actually do a rookie reply on that as to how to vet your conferences that you’re attending. And I think you made a great point as to figuring out what you actually want to get out of the conference first and then kind of narrowing it down from there too.

Tony:
Yeah, there’s so much information out there. I think most conferences that are put on, you’ll probably get some value from. I think what’s more important is your level of preparation going into that event. Conferences are those things where you get out what you put in, and if you’re in there, you’re taking good notes and then after the event, you’re spending some time to let that information actually percolate in your mind and identify how you can use it. And then you implement that stuff. That’s where you really get the value. But I think the unfortunate truth is that you see a lot of conference junkies who go from one conference to the next, and they’re well known at these different places, but they aren’t actually implementing what they’re learning when they go there is they’re not getting the full benefit from it. So I think the prep beforehand is probably what’s most important.

Ashley:
Yeah, I agree. The one thing I like to do is at the end of the day is just sit down and jot down what I learned or what’s the action I want to take care of. And usually by the end of a conference, I’m just itching to get home and get back to work. Those flights home after a conference are the most productive[inaudible 00:06:38]-

Tony:
Productive[inaudible 00:06:38].

Ashley:
I’m so motivated from all the people I’ve met, everything like that, and it’s just getting stuff done and things I want to do. Yeah.

Tony:
So just last thing, our friend Tyler Madden actually told me that he does this, because he and I, we’ve been to two different conferences together and both times he almost always spends an extra day after the conference in the city and he uses that extra day to really go through everything that he learned over the course of that conference. So I think I might say a lot from our friend Tyler and add a buffer day after each event so I can just sit down and really deep dive, what did I learn, how can I implement it, and so on.

Ashley:
And just to get caught up on work from being at the conference because the last time we recorded, we both had pulled all-nighters, and one reason you had is because you were at a conference all day, so at night you had to do your work. So being able to still be on your trip and to relax, be in a different setting than your house, because when you get home you have to do laundry, you have to unpack, you have house stuff to do, you got kids to take care of, things like that. So having that extra day to get caught up, I think that’s a great point too, is taking the information you learn from the conference and kind of putting it into action.
So with me taking my kids this week, I think it’s a kind of great segue into a guest that we’re actually having on the Rookie Reply. I’m going to a conference. This is a business write-off. My kids are coming with me, my mom is coming with me as a nanny, and they get to hang out at the pool all day and have fun. So that is definitely a great way to maximize business travel, taking your kids with you and turning it into a little vacation for them. So we are bringing on Amanda Han, who we did a full episode with for episode 255, and we are going to have her answer some of your reply questions. So make sure you guys listen to the end to hear Amanda answer your questions.
Okay. Our next question is from Katie. If you purchase a property using personal private money and use personal money for rehab and plan to use the property as an Airbnb, what is the seasoning period before you can go to a bank and refinance it to pay off the private money loan and use proceeds for another investment? This is a great question because it really depends on the bank. I’ve seen it where there is no seasoning period, but very typical is six months to 12 months. So my business partner, he’s purchasing a primary residence that he used hard money, now he’s going to refinance with the bank and the one bank that he’s talking to right now, it’s a 12-month seasoning period. Tony, what are you typically seeing?

Tony:
Yeah, I think it varies as well. So when I first started investing, the bank that I was using, it was no seasoning period. As soon as your rehab was complete, you were able to refinance. However, it was only a rate-and-term refi, so essentially you weren’t able to pull out any additional capital. You were just paying off that initial mortgage that was on there. So for me, I had increased the value of the property by whatever, 50, 70, $100,000, but I couldn’t tap into that equity. I could only refinance up to an amount that was equal to the existing debt. So yeah, like you said, I think it varies by the bank.
In the short-term rental space, though and most banks that I’ve talked to, they typically do want to see somewhere between 6 to 12 months because they need some proof as to what kind of income that property will produce as a short term rental. There are some banks out there that are now doing their own projections and underwriting to say, Hey, we think this property will do X, Y, Z as a short term rental, but most banks still want to see at least six months of actual booked revenue in order to do that refinance as a short-term rental.

Ashley:
Tony, you brought up a great point as, and I think we should highlight this, is that there is a difference between refinancing and doing a cash-out refinance. So how your bank didn’t have the seasoning period, but they would allow you to refinance the property as to what the existing data is. And typically this is based off what the purchase price is for the property, and they’re probably going to give you the same loan to value that the first lender did onto the property.
So that’s one thing my business partner just ran into now, is that he can refinance at any time with this small local bank, but he can only pull out 80% of the purchase price of the property, and that won’t include any of the rehab. But if he waits 12 months, then he’ll be able to pull out whatever the appraised value is, 80% of the appraised value of the property. So that’s definitely something you should be doing before you’re purchasing a property is talking to banks, talking to loan officers and finding out that information before you go ahead and purchase the property so you can kind of have your game plan, your timeline spread out.

Tony:
Yeah, the bank I actually worked with, they were slightly different because it wasn’t just a purchase price. They actually did allow me to include the rehab cost in there as well, but it was only because it was a construction loan that they owned. So they said, here’s a construction loan for you to purchase and do the rehab and then we’ll convert you to long-term debt. But that’s the beauty of it is that there are so many different lending institutions out there, banks, credit union, small, big, medium, and every single one is going to have a different flavor in terms of what they can offer. But Ash, what we didn’t define as seasoning period, so maybe you want to define what that is for folks maybe aren’t familiar with that phrase?

Ashley:
Yeah, so the seasoning period is how long the property is gaining value. So it’s like letting your property set because a bank is looking at your property and if you go and refinance in 30 days, they’re going to say, wait, you just bought it for 200,000 and now you’re saying it’s worth 300,000, 30 days later? So they want that seasoning period for the property to appreciate and for you to add value to it doesn’t make sense. Not really, especially if you’re going in and you’re blowing a hundred grand to appreciate this property, but the seasoning period is where they want to see the appreciation on that property. And there’s not always going to be appreciation there either.

Tony:
And I think what I’ve seen most cases, Ash, let me know if it’s the same thing on your end, is that typically that seasoning period doesn’t start from the day that you purchase it. It starts from the day that the rehab is complete. It’s like if you’re doing a BRRRR and they want to see six months, what I’ve been told from the banks that I work with is usually it’s six months after the rehab is complete. Is it the same for the lenders that you work with in your neck of the woods?

Ashley:
No. If I’m just going to a bank and I haven’t used any kind of existing financing with them, I used hard money or private money or cash to purchase and I’m going to do that refinance, the seasoning period starts the day that you purchase-

Tony:
Purchase it.

Ashley:
… the property. On the residential side, at least. On the commercial side, I’ve seen that you can refinance it anytime.

Tony:
Talk about that then. So you’re saying on the commercial side, as soon as you buy, if you rehabbed it in a day, theoretically they’d allow you to refinance on day two?

Ashley:
Yeah. So to give you an example, this is one of my favorite financing deals ever, and this happened in 2018, 2019 maybe, where I went to a bank and I said, I want to purchase this property, what can I do? And they actually said, we can give you a 90-day unsecured loan. So this was a no collateral and this was what I was going to go and purchase the property for. They wrote me a check for the exact amount to purchase the property and as we closed on the property, and the deal was is that I would go with the same bank to refinance it and put long-term financing on it.
I purchased it with that loan, they gave me that 90-day loan, and then I put in a $800 new fridge of one of the units. I got it rented out, and I think it was within two days of the purchase, we had the appraisal done. I don’t remember the exact numbers off the top of my head, but we bought it for around 35,000 and it appraised for I think around 50,000 and we were able to pull out $42,000. And so we were able to take to pay off that 90-day loan, pay for that $800 fridge, but that was just two weeks after closing and we were able to go and refinance it on the commercial side of lending.

Tony:
I wonder if that was because they maybe took the line of credit more so as a cash purchase and not necessarily a mortgage that was secured by the property itself. Do you think that had anything to do with it?

Ashley:
No, because for this property that my business partner’s trying to purchase now, its was a cash purchase that he’s pay… I think it was maybe a private moneylender, I don’t remember exactly, but on paper it’s a cash purchase and they still want that one year seasoning period. It doesn’t have anything to do with the [inaudible 00:15:50] on it because they’re going off of the purchase price. Where commercial lending, they’re looking at, okay, I put tenants in that property and it’s added value that way. And I do remember the bank being very shocked at how much it appraised for, but that’s also the value of buying under market. I know that we got a great deal on this property and that’s why I purchased it.
And so I think the bank was actually kind of upset that I was able to go and refinance and pull so much money out when I bought it for 35,000 and then two weeks later I’m able to pull out $42,000 out of that property. But yeah, the commercial side I haven’t at least run into any situations where I have to have a seasoning period on the commercial side, and that’s when the property is in an LLC. So in this example that Katie gave us, she has the property in her personal name where you most likely will have to use the residential side of lending.

Tony:
Interesting. Well, Katie, hopefully that that’s helpful for you. I’m trying to think if there’s any other loan products that might be beneficial. I mean, even on the DSCR side that’s what we’ve been kind of exploring for a lot of our short-term rental purchases as of late, if you are doing a rehab or anything like that, they still typically want to see that seasoning period as well. And for us even if we weren’t commercial, they still wanted to see it if you’re using a DSCR for short-term rental. And just to give all the listeners some context, the lending space for short-term rentals is still incredibly new, and the loan products you can get on the long-term rental side haven’t quite all made their way over to the short-term rental side. So you still do see less options, kind of more hoops you have to jump through when you’re trying to get loan products specifically built for short term rental. So keep searching, keep digging, and hopefully you’ll find a bank that can kind of work with you.

Ashley:
Okay. So our next question is from Robin. Good morning. Good morning. So at what points can you raise rents? In Oregon, each year you can raise rents at 9%. I can also raise rent after the lease is up, right? When can I make adjustments to the lease after it’s up? Okay. So we kind of have two questions there on leasing and increasing those rents. So that’s definitely a hot topic I see especially if you are inheriting tenants as to when you can actually increase the rent to market rents or at least bring it up a little bit as to what the rent is currently.
So great question, Robin. The first thing I would say is that you have to know what your state laws are. So if you already know that you cannot raise it more than 9% of the current lease agreement. This is definitely something you want to look into when you are purchasing the property to see how long it’s going to take you to actually bring the rents up to market rent. Where I live in New York State, in our county, I know in New York City there’s some limits on what you can charge for rent, but as far as where I’m currently investing outside of Buffalo, New York, there are no limits as to how much you can increase or what that rental price can be. Tony, did you run into any of that when you were doing long-term rentals in Louisiana?

Tony:
For us, in Louisiana, luckily we didn’t inherit any tenants, so we didn’t have to necessarily worry about increasing rents on anyone. But to your point, Ash, if I were in a situation where I did have inherited tenants, I would want to know what is our current lease state and then what are the local laws and regulations and really lean on my property management company to help give me, I guess, the right information in terms of what that looks like. Because it is super specific and what we do in California and my city is probably super different than what Robin’s doing in Oregon and so on and so forth.

Ashley:
And I think a good resource is to look at your county or your city at some of the nonprofit organizations that, look, they’re housing specialists. So in Buffalo, New York, there’s Belmont, and Belmont actually gives out the Section 8 vouchers in our counties. So look into where people get a Section 8 voucher in your county. And a lot of times these organizations have free or very low cost training as to what these laws and regulations are, and especially teaching landlords how you can appropriately increase the rent or how to handle that. So I recommend looking for some kind of organization like that and taking one of the training classes. A lot of them even provide a book too with the updated tenant landlord laws or if you even go to your local town hall, a lot of times they have pamphlets too. Here’s one for tenants, things you should know, and here’s one for landlords, things you should know.
And then the second thing, you can raise rent after the lease is up. That is correct. When somebody is currently in a lease, you cannot raise their rent until the lease expires. So make sure you’re looking at that information when you’re purchasing the property and seeing when that lease agreement is up so that you can raise rent and then also be cautious of giving proper notification. So in New York state, depending how long the person lived there, you have to give them so much notice that their rent is going to increase.
So they live there less than a year, so their first one year lease is coming up, you have to give them 30 days notice. If it was more than that up to two years, then it’s 60 days and then after that it goes up to 90 days notice. So make sure that you’re planning for that too. And then the last question of that was when can I make adjustments to the lease? And that would be the same period as to when the lease is up. When you send that rent inquiries, you would also make the new lease with the changes in it.

Tony:
Ashley, have you ever purchased a property where there were tenants in place but no documented lease?

Ashley:
Oh, yes.

Tony:
So how do you handle that? Do you come in and do you raise rents immediately if they’re way below market rates or what’s your process to handling that?

Ashley:
Yeah, so I bought a portfolio from an older investor who just had people send him money and it’s kind of a handshake deal with most of his tenants. And so when you purchase a New York state, a lot of times when you fill out the real estate contract, it can have a rent rider addendum to it. And this rent rider basically states how many units there are, what the tenant’s name is, what unit it is, how much they’re paying in rent, and when their lease term is up. So the seller had filled that out for me and then I went and I sent an estoppel agreement to all the tenants with his permission that stated that I was going to be purchasing the property and if they could give me their name, their contact information, what they pay in rent, when’s the last time they paid in rent, things like that.
So I basically took what they were saying and what he was saying, and then I compared it and I had one tenant that was living in a two bed, one bath, and it was a six unit and all the other ones were paying $500 a month and she was paying $300 a month. She had lived there for 30 years and she took very good care of the place. So what I did instead was I increased it by increments. So I think for the first two months it was increased by $25, then the next two months and went up another 50 and we increased it over, I think maybe the course of nine months or something to get her up to that comparable rent. So that’s one way to do it and I always like to include what are the market rents?
So if you were to move to a different unit in that same market, how much would it cost to show that I’m usually still below market rent when doing these increases. Plus you’d have to pay your moving costs, change your mailing address, all the other headaches that come with moving too. And I really have never had an issue of increasing rent and getting a lot of pushback on it.

Tony:
Is that tenant still there? The one that had been there for 30 years?

Ashley:
Yeah. Yeah.

Tony:
Wow. That is a crazy longevity with one person.

Ashley:
Yeah, so now it’s been… I bought that in 2017.

Tony:
That was five years ago.

Ashley:
So longer than 30 years she’s been there. Yeah, so 35 years.

Tony:
It’s also crazy to think, not to go too far off on a tangent, but the people do rent for that long. That could have been a mortgage that was paid off almost. It’s an interesting dynamic for sure.

Ashley:
Okay, you guys, next up we are bringing Amanda on and she was going to answer some of the Rookie Reply questions.

Tony:
All right, Amanda, well welcome back to a Rookie Reply episode. We had you on episode 255, but you provided so much value. We knew we had to bring you back to answer some more questions from the Rookie audience, so thanks for chatting with us again.

Amanda:
Yeah, excited to be here.

Tony:
All right, so we’re going to lob a few questions at you. The first one comes from Greg Carroll, and Greg’s question is, I started on my five-year goals and one of them is to be able to buy houses to put into a trust for my nephew and nieces and kids to pay for college if they choose to go like Brian did for his daughter. Is it possible to do that for someone else’s children? If so, how do you do it?

Amanda:
Yeah, that’s a great question, Greg. So you can put a rental property into a trust and have the beneficiaries be whoever you want it to be. It could be your own kids, could be, like you said, nieces and nephews. Could be my kids too. My kids would love to benefit from that too.

Ashley:
Amanda will provide her kids births and social security numbers for you guys to add them.

Amanda:
And not just Greg could be anybody. But in all seriousness, it also depends on what kind of trust we’re talking about. So in our previous episode that we did, we kind of mentioned it a little bit, there’s various different types of trust in how it’s treated for tax purposes. So what you are describing definitely could be done, beneficiaries could be anyone you want it to be, but I think maybe a better, or maybe a more flexible way to do it is to not put it in kind of a special trust. I mean, could be like your living trust or it could still even be in your name or like your LLC name, but really just earmark for the future cash flow or future equity to go to these various kids and nieces and nephews. The reason for that is if the properties are in your living trust or your name or your LLC, then you continue to get the tax benefits of the rental real estate during your lifetime.
And then at some point in the future, if your intention was pull money out and help them pay for college or just even passing it to them eventually when you pass away, then the people who inherit the properties from you, you could get step up basis, which is a huge benefit. It basically means that they nor you will be paying taxes on the appreciation through your lifetime. But I love what you’re trying to do, but definitely worth a conversation with your tax advisor to see if it should be a trust at all and if so, what type of trust might be best?

Tony:
So what you’re saying Amanda is that Greg might be over complicating it a little bit by trying to set up the trust and there might be some simpler ways to achieve the same goal of using the cash loan equity from this property to pay for his kids and nieces and nephews college?

Amanda:
Yes, you’re exactly right, Tony. I love how you summed up what I said in five minutes, in five sentences, and that’s why you’re the host of the show.

Ashley:
Okay, Amanda, are you ready to move on to our next question?

Amanda:
Yep.

Ashley:
This question comes from Matt. I wonder, my renters want to buy my condo they live in. There are some benefits to it like no agent fees, no repair cost, no grace period when property is empty waiting for purchase, no repair costs, et cetera. What are the best options to sell it? Thinking about doing rent to own, me providing seller financing, how that looks from an operation perspective or just doing a regular sale. Are there any tax benefits versus the other?

Amanda:
Gosh. Well, great question Matt. There’s so many different possible exit strategies. So we can talk through some of the consequences of the ones that you listed. So if you were just to do an outright sale, like you say, you can skip on the commissions and great benefits of doing for sale by owner, that doesn’t change into the tax impact of it. So if you wanted to, you could do a 1031 exchange, which means you’re selling this property and then you reinvest the money into another rental property. And so if you’re following the tax rules of doing it correctly in a 1031 exchange, you can get out of this property and then into maybe a bigger, better property without paying any taxes currently. Or you mentioned maybe rent to own or maybe like a lease option, things like that. What I like about the tax benefit of a lease option is that the options money you get upfront, you don’t have to pay taxes on it until later on when the option is exercised.
During the lease option term, you still own the real estate, which means you continue to get the depreciation benefits, the write-offs and things like that. So it’s getting more money upfront, but also retaining the tax benefits because you still are the owner. And then you mentioned seller financing is another one. So seller financing is good as well. The key difference in seller financing is that when the contract is executed, you’ve essentially sold the property. So you no longer own the real estate, meaning you don’t get depreciation anymore. Now the buyer has depreciation, other deducting mortgage interests and things like that.
But as a seller, there is still a benefit. Then the benefit is that you get to defer the taxes on the gain over X number of years as you collect money from your tenant buyer. So instead of just selling it outright, maybe you have a huge taxable gain. If you do a seller financing, you carry a note for five years or 10 years, you can defer the capital gain slowly over the next five to 10 years as money is collected on your part. So all different possible solutions with differing tax benefits.

Tony:
So Amanda, and me, I just want to make sure I’m following here too. So it sounds like the 1031 exchange could work well if Matt has the desire to quickly acquire another property, but if Matt just wants to take the profits and use it to whatever lifestyle, whatever it is, then probably going lease to own and might make more sense because that’s still going to give him the tax benefits of owning the property and then he’s not getting this big tax bill at the end of the year. Am I following that correctly?

Amanda:
Yep, exactly.

Tony:
Okay, awesome. I actually never really thought about the differences as the seller between lease to own and seller financing, but now it’s almost more beneficial for the owner to do lease to own versus seller finance. So that’s interesting.

Amanda:
Sometimes, and I don’t know if there’s a distinction, a technical distinction between lease to own versus a lease option. I mean lease option, meaning we have a lease agreement and we have a options to purchase agreement. So you’re a tenant, but you’ve given me some money upfront to say, okay, at some point in the future you can buy it at a stated price, and that’s slightly different than a lease to own where you pay after X number of months or whatever, then you own the property. So that’s maybe a little bit more like a seller financing, so not to get into the woods of.

Ashley:
No, that’s great that you broke it down. Yeah.

Tony:
All right, Amanda. So going on to our next question here. This one comes from Amber, and Amber’s question is I’m looking to best leverage $98,000 in profit from a sale into a bigger opportunity for cash flow and equity. I also want to reduce my tax liability on that sale. Right now I have an approval to only purchase a home at a minimum of $250,000 ARV with a $200,000 loan with hard money at $187,500. Since my approval, the interest rate has gone from six and a half to the high eights. So Amanda, just to sum up this question, they’ve already sold the property, they’ve made $98,000 in profit. So my understanding is maybe 1031 exchange is already off the table because they’ve already completed the sale. So what other options does Amber have to get the best tax treatment on that $98,000 in profit?

Amanda:
Yeah, I mean, answer depends on the timing of it, in terms of when was this property sold. If it’s still within the same year of us addressing this question, then even though she can no longer do a 1031 exchange after the fact, she could still do what’s called a lazy 1031 exchange. And that’s just something that we made up. So if you Google it, probably won’t find any definitions about that. A lazy 1031 exchange is basically people who’ve already sold the property but are looking for ways to offset the gain by reinvesting into other real estate. So as long as you’re doing it within the same year, so I sold property one in January of this year, but before December 31st, I buy more real estate. With my new rental properties I can maximize my expenses and write-offs, I can do cost segregation and the loss I create can be utilized to offset the gain on the property that I sold.
Even though they’re two completely different transactions, but that’s just how tax law works. If you have loss on one rental, you offset the gain on the other rental. So definitely still possible to do. I know she mentioned the interest rates are going up, and unfortunately there’s not much that we can do as investors to control what the rate is going to be. You can look for cheaper financing, you can look at partnering with other people to make the numbers work out, or I mean, you find the best deal that you can right now, and you can always refinance when the interest rates decreased again. So yeah, a couple different options there, I think.

Tony:
Amanda, something I learned. Well, first, the big benefit obviously of the 1031 exchange is that you get to defer those capital gain taxes from the sale of that property. But the challenge is that it’s a tight turnaround time. It’s a tight timeframe to identify that next property and enclose on a property. Someone mentioned to me earlier this year, oh gosh, its 2023 now, so last year.

Ashley:
Last year.

Tony:
Yeah. Someone mentioned to me last year about a reverse 1031 exchange. Have you heard that phrase? And if you are familiar with it, would you mind breaking down what it is and kind of how it differs from a regular 1031 exchange?

Amanda:
Yeah, definitely. So in a 1031 exchange, the way that it works is when you sell a property, and this has to happen at the time of the sale, so maybe for someone like Amber who’s already sold, we can no longer do it because you have to have an intermediary involved in the transaction before you sell. So when you sell, you have 45 days from the date of sale to identify which properties you will buy as replacements, and within 180 days you have to close on one or multiple of what you’ve already identified. So you meet those two rules. And there’s other number rules too, in terms of sales price, purchase price and things like that. But let’s say you meet those timelines, then you can defer all your taxes. But yes, what we’ve seen recently when it was a hot seller’s market, that was really easy for an investor to list the property and be sold the next day, but now they’re sitting on this money in the intermediary and they’re trying to replace it a lot more difficult to find the right properties to close on where the numbers make sense.
And that’s why we saw a lot more of the reverse 1031 happen. So reverse 1031 just means that you already have your replacement properties identified and maybe even purchased. So I already know I’m going to buy this property on Main Street for X dollar amount. I’ve identified it, I might have even closed on it. And then you list your current existing property for sale. So that’s really the only difference, and I encouraged a lot of my clients to do it the last year, year and a half for that exact reason. You don’t want to be in a bind where like, oh my gosh, now I have to quickly look for a replacement property where the numbers might not make sense.

Tony:
And the big benefit of the reverse is that it takes away that time pressure because you’ve already identified the property, you already know the property. Obviously the downside is you have to come up with the capital to purchase that new property first and then go back and kind of replace it from that other capital. But I think the ability to search for the property without the pressure of 45 days, 45 days that allows you to find a better deal potentially, and you might get more value out of your 1031 exchange by doing it that way. Well, thank you for bringing that down, Amanda. Something that I learned that was new to me, I figured I’d share with the Rookie audience as well.

Ashley:
And Amanda, if somebody else wants to do that, who should they go and talk to? Is it their CPA or should they go right to a 1031 intermediary?

Amanda:
Yeah, great question, Ashley. So I typically recommend you start with the CPA, and the reason is because your CPA will be able to tell you whether there’s a gain on the sale of the property, and if so, how much is the gain, right? I mean, doing a 1031, whether a regular one or a reverse one, there’s cost associated. It’s not free to do, right? You have to have an intermediary do it. And like Tony was saying there’s kind of the downside of the timelines and the stress of all that. So for some investors, maybe if the gain is small, they don’t care.
Maybe it’s like, Hey, I’m only going to save a thousand dollars in taxes. I’m not even going to worry about it. And you don’t really know what the gain or loss is going to be unless you talk with your tax advisor. Even for someone who like, Hey, I’m selling Main Street property, I know it’s going to be a gain, but I might have other losses from my other rental properties or my other business that I can already use to offset. In which case, maybe 1031 is not really needed. So that’s why I talked to the CPA first. They’ll let you know whether it’s needed, how much it’ll actually help you to defer taxes, and then you can decide, does it make sense for me to hire an intermediary and go through those steps?

Ashley:
That’s such a great point too, as to what are kind of your goals or what are you looking to do within the next year too, because maybe you want to go and purchase your own primary residence where it’s not going to be based off of rental income. So you want a year where you’re showing high income, so you’re actually going to pay the taxes on that profit instead of doing the 1031 exchange to show that to get approved for a loan. So just another great example of why it’s important to do that tax planning with your tax professional. Okay. Well, Amanda, thank you so much for joining us for this week’s Rookie Reply.

Amanda:
Thank you.

Ashley:
Can you let everyone know where they can reach out to you and find out some more information about you?

Amanda:
Oh, yes. Keystonecpa.com is my website. If you want more tax tips and tax strategies, we have a lot of free downloadable resources. And if you just want to follow me personally and see what I’m having for lunch and what I’m doing on the weekend, you can find me on Instagram @qmanda_han_cpa.

Ashley:
I’m Ashley @wealthfromrentals, and he’s Tony @tonyjrobinson. And we will be back on Wednesday with another guest.
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