Landlords are trading up to $1M rentals

By JEFF LAZERSON / CONTRIBUTING COLUMNIST

With Orange County’s median home price at $657,500 it was simply a matter of time for million dollar rental homes to be trending.

Removing flips (buy, fix-up and immediately sell) from the query, 861 single family, 1-4 unit Orange County properties with at least a $1 million price tag were sold to investors in just the first half of 2016, according to David LaPlante, chief marketing officer at Property Radar.

The million dollar rental questions I tend to get on a much more frequent basis are from folks who have a boatload of equity in existing rentals, not people plunking down significant savings.

Mission Viejo resident Rob Earnest and his fiancée are planning on selling their separately owned Oregon rentals through the 1031 exchange process and purchasing one larger Orange County rental home with their tax-deferred proceeds.

“We see an opportunity in today’s local market just above the $1 million level, said Earnest. “It seems that properties in this price range are taking longer to sell, and we believe that there are some enticing choices.”

“Take equity and buy something bigger. The whole game is (avoiding) income tax,” said Jeff Hiphsman, CPA and partner at Tustin based HMWC CPA’s and advisors.

A 1031 exchange (Internal Revenue code section) may allow you to defer capital gains taxes when you sell your rental for a profit and reinvest the proceeds in a similar property.

Hiphsman explained that you have to at least replace the equity and debt on the property you are selling and exchanging. For example, if your rental sold for $600,000 and you had a $300,000 mortgage on it, you must purchase another rental for a sales price of $600,000 or more and slap a $300,000 or larger loan on the up-leg property.

To defer any capital gains taxes, don’t touch the proceeds. If you are not concurrently closing the property you are selling and the property you are purchasing, then a qualified intermediary or accommodator must be used.

Even though you might be buying one replacement property, Hipshman said, you should identify three replacement properties within 45 days of the sale of in case your first choice transaction falls apart. You must close escrow 180 days.

Besides positive cash flow and property appreciation, you also realize an annual income tax deduction by depreciating the building value only (land value is not depreciable) of the rental over 27.5 years, which is considered the useful life of the rental.

Assume the building value of your rental (according to the property tax assessor’s office, for example) is $1 million dollars. The deduction is $36,363 per year ($1 million divided by 27.5).

Exhausting the depreciation (be at 27.5 years or sooner) is another reason landlords think about exchanging to more expensive rentals.

Always consult with your tax advisor to be certain you are complying with the rules of the IRS road.

If you have questions or comments, please contact Jeff Lazerson by clicking here.