Looking at Options for your Short-Term Rental?

As recently as last year, many were seeing their real estate investments appreciate at incredible rates, and in turn, were doing 1031 tax-deferred exchanges to defer their capital gains liabilities into new investment properties.

Today’s market presents some new challenges for short-term rental properties. Changing vacation and business travel demands and habits may create long term cash flow instability. In addition, in some markets investors may see limited or no appreciation in their short-term rental property.

Calculate your potential capital gains tax liability here.

In times like this, does it make sense for an investor to sell their property and do a 1031 exchange? In many cases, the answer is "yes."

With almost all real estate sales involving improved property, there is the recapture of depreciation. Section 1250 of the Internal Revenue Code requires that depreciation be recaptured at the current rate of 25%, which is higher than the current long-term capital gains rate. For this reason, the ability to defer the recapture of depreciation may make a 1031 exchange very attractive.

If I sell my short-term rental, do I need to exchange into another short-term rental?

The answer is “no”. A valid exchange requires that the client purchase “like-kind” property. Like-kind property is broadly defined: All real estate in the United States is like-kind. Section 1031 makes no distinction in qualities of real estate. For example, a city lot is like-kind to farmland; an apartment building is like-kind to a shopping center, a condominium unit is like-kind to a factory, and so on.

So, an investor selling a single-family home or condo that is being used as a short-term rental can think broadly about replacement property options. Investors looking for a more hands-off option can explore buying into a Delaware Statutory Trust or exchanging into a triple net leased building that has an investment grade tenant who is obligated to pay all expenses related to the property. Other investors may want to relocate their short-term rental investment to a geographic area with higher rental demand. Property sold in any state can be exchanged for property in any other state in the United States.

The value of a 1031 exchange is considerable. Leveraging the cash that would otherwise be forfeited in capital gains taxes and/or depreciation recapture makes sense in any market and a 1031 exchange is the vehicle to get it done. 

Contact First American Exchange prior to selling to set up your next exchange.