Bob Nelson, Bob Nelson, real estate investment broker, Pacwest Real Estate Investments, and Marcia Edwards, residential broker with Windermere Real Estate, look at scenarios when it might make sense to overpay for an investment property.
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There are many challenges and concerns people may face when purchasing a residential investment property. There are also many potential mistakes that loom for investors. It’s important to try to gain a window into discovering what you don’t know. Working with an expert helps.
One important issue that an expert can provide some guidance on is understanding when it makes sense to overpay for an investment property in order to avoid capital gains. It seems counterintuitive. It’s an investment. Why would you overpay for an investment?
There are times, however, when this does make sense. In fact, it makes sense the majority of the time, depending on how much you have to overpay. Let’s look at a scenario. Let’s assume that I owe $100,000 in capital gains taxation. If I sell this property, I could then simply pay the $100,000 and not have any tax obligation whatsoever from that point ever on the money that came out of that investment. Now as it earns something in the future, yes I’ll pay income tax on it, but look at it like this: What would happen if I found another very desirable property but did in fact have to overpay $100,000? When would that make sense? Well, now I own the property. The government doesn’t have my $100,000. I have it invested in the next property and let’s assume that that property’s producing a cashflow. It’s producing appreciation in value.
Bob Nelson, Eugene Commercial Real Estate Investment Broker:
I have a chance of having that property earn enough additional profit in the future to pay that $100,000 tax whenever I get around to paying it because if I use a 1031, literally I’m deferring the tax consequence until I later sell the property with no interest-bearing, no penalty. I just simply have pushed the tax down the road. So now that property produces enough to pay that tax, plus a bunch more. The whole thing is I now own more property producing more benefits as opposed to the $100,000 paid in taxation, which will always put me behind the 8-ball by $100,000.
There is a logic to doing that, but it’s necessary to evaluate: Would I necessarily pay $400,000 too much to save $100,000? No, I don’t think so. Obviously, you want to make a rational and logical decision. But it’s worth considering a 1031 every time.
When Is it Okay to Overpay for a Residential Investment Property? is from Bob Nelson and Marcia Edwards on the “Real Estate Today” Eugene, Oregon, radio show, which airs at 5:30 daily on KPNW.