[Deal Story] How a 1031 Tax-Deferred Exchange Saved One Investor Over $230,000

The Challenge

A client and good friend in Nashville recently sold an apartment complex. If you’ve been watching what multifamily real estate has done in the last few years, you will understand that he sold it for well above what he paid for it. In fact, he had over a $1,100,000 capital gain. When you factor in cost recovery from the depreciation he had taken, he was going to owe Uncle Sam over $230,000 in taxes.

When I sat down with him and his wife in their beautiful kitchen in Franklin, TN, they shared that their goal was to defer the tax they would owe as well as create $10,000 in monthly passive income for their family. We decided to pursue a 1031 Tax-Deferred Exchange as it would allow them to defer the $230,000 indefinitely. It would also allow them to take their proceeds from the multifamily sale, add some debt, and buy up to $5,500,000 in income-producing commercial real estate.

This post is not going to explain how a 1031 Tax-Deferred Exchange works, but I have written a short ebook on how you can avoid paying taxes when selling commercial real estate by using a 1031. You can CLICK HERE to download it.

Our Activities

Once we understood my client’s goals, we set out looking for replacement properties that were stabilized enough to provide good amounts of cash flow but also had some value-add potential. To further diversify his real estate portfolio, we were looking for multiple properties in separate markets. We searched online, utilized our network of CRE professionals, and made calls to owners. After three weeks, we had identified 7 properties that had potential. We performed our underwriting and cut the list down to the three properties that were identified for his 1031. One property was an off-market retail center Owensboro, KY, another an industrial flex building along the Space Coast of FL, and the third a newly-listed retail center in Decatur, AL.

We then negotiated deals on two of these – the one in Owensboro, KY at an 8% Cap Rate and the one in Decatur, AL at a 9.3% Cap Rate.

The Results

At present, we have closed on the Owensboro property and are set to close on the Decatur property next month. By executing the 1031 Tax-Deferred Exchange Strategy, along with cost segregation studies on both properties – and then using bonus depreciation, my client was able to achieve the following:

  1. Indefinite deferral of the $230,000 in capital gains tax
  2. $16,900 a month in passive income by Year 2
  3. Projected 28+% Internal Rate of Return (IRR)
  4. Wipe out over $400,000 of taxable income with cost segregation and bonus depreciation in 2022. That’s $400,000 of income he won’t be paying income taxes on.

If you would like to learn more about Internal Rate of Return (IRR), cost segregation, or bonus depreciation, click the hyperlinks above for posts explaining each of those topics.