Pyramiding Equities Tax Free

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Topics: Buying & Selling

Last time we were trying to solve the riddle of being able to buy houses at today’s prices and rents that would be feasible as long term rental investments that would generate current positive cash flow. I think trading in one house for another is the solution, but it’s almost impossible to find two people who can make a straight property swap.

Fortunately a tax-free exchange of one property for another can be accomplished by using the funds from a sale to buy a replacement property. If, each time this were done, it would be possible to sell at retail and buy at 70% of fair market value at a foreclosure sale, or from a motivated owner of a house in need of refurbishment, then exchanging multiple times with multiple houses would build wealth at an incredible rate. Here are some fine points:

When money from a qualifying Section 1031 exchange is combined with a loan to buy another house, both the basis of the house that was sold and the holding period are “tacked on” to the holding period of the replacement house.

In so many words, if the property you sold had been bought in 2000 and fixed up at a cost of $100,000, for tax purposes you would have held the replacement house since then. If your adjusted cost basis (the combination of down payment and debt, plus improvements, and less any depreciation taken) on the old house were $100,000, and you added another $100,000 in loans to buy the replacement house; your basis in that house would now be $200,000 even though the fair market value that included all your profit, might be much more.

Assuming that you could buy a replacement house with a fixed-up value of $300,000 for 70% of value, or $210,000; you would be adding the profit on the first house to the built in equity profit on the replacement house tax free.

So long as you bought houses to hold for investment rather than resale, with every tax-free move, you would be upgrading your house and the rent it would command, even though your actual out-of-pocket investment would be going down.

If those who have convinced themselves that there is no longer much future in the house business would invest time and money in themselves to learn a little more about the possibilities, they, like me, would view the current price/rental situation more as a terrific opportunity to capitalize on today’s stagnant market than a disaster.

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