How to fund vacation rental condo?

[freed2012]

Hello ER universe! DW and I are 64, retired since 2012 (it has far surpassed my very high expectations!).
$2.8 M IRA, $540 K Roth IRA, $3.6 M taxable mutual funds/ETFs, 800 K vacation rental property, no debt.

We found a beach-front property (2 BR around 550K, or 3 BR around 750K) that we really like and would buy as a vacation (i.e., use it more than 14 days/year) rental. With a mortgage, it would be cash-flow negative, which we really don't want. Without a mortgage, it would have a cash on cash return of about 4%. Factoring in our personal use, about 5%. So the question is how to fund an all-cash purchase. I am considering liquidating the Roth IRA to do that, but hesitate to give up the tax deferral and source of tax-free cash if needed. On the other hand, we should have plenty of income when we start SS at 70 and IRA MRDs at 72, so maybe keeping the Roth is not that important? Don’t want to fund it with IRA, nor with taxable investments as these have significant capital gains and am trying to make full use of lower income until age 70 to take capital gains, IRA distributions, Roth conversions strategically at lower income tax rates.

Another wrinkle: We wouldn’t mind getting out of ou existing vacation rental property (would probably bring about $800K) which has significant cap gains and depreciation recapture. This brings up the possibility of a 1031 exchange, but from the little bit of research I’ve done, this seems like it could be complex, difficult and risky. If we went this route, we would want to replace that rental property with a purely vacation property in the same area, so there would still be a need for 500-700K for a cash purchase.

I have gone round and round on this in my head and can’t seem to get anywhere. I’m sure there are options, pitfalls and consequences I am not considering, so hoping to get the collective wisdom of this esteemed group to point me in the right direction. Thanks!

 

[Sunset]

I would mortgage the property.
Right now mortgages are cheap, so lock in a long term and enjoy.

Yes it will be cash flow negative, and this will mean zero taxes on the rent collected, while the cash in the Roth grows at 6%->9% per year tax free.
You can probably accumulate the "tax loss" over the years as your income is probably high, which will be good if ever sell.

The best move is the 1031 exchange, not sure why you think you have to buy in the same area.

 

[euro]

I would mortgage the property.
Right now mortgages are cheap, so lock in a long term and enjoy.

Yes it will be cash flow negative, and this will mean zero taxes on the rent collected, while the cash in the Roth grows at 6%->9% per year tax free.
You can probably accumulate the "tax loss" over the years as your income is probably high, which will be good if ever sell.

The best move is the 1031 exchange, not sure why you think you have to buy in the same area.

Agree: get a mortgage.

Not sure I full understand what you are saying with regard to the new property (will you rent out also or just use it as a 2nd home?). @Sunset is right, there is no need to stay in the same area for a 1031 exchange, but you DO need to keep the new property as a rental. You can't exchange a rental into a non-rental vacation property.

 

[OldShooter]

I did a couple of 1031 exchanges on rental properties years ago and I don't remember that it was any big deal. I think I did the forms myself.

This spring I was in a deal where one of us bought his piece of a property we were dividing via an exchange. He used this firm: https://ipe1031.com/ I really don't know much about them, but things seemed to go smoothly and they didn't do anything to make the deal bubble. So they satisfied my two criteria. AFIK our deal partner was happy as well.

 

[bearkeley]

Since you mentioned cash flow on the new purchase, I’m assuming you still plan to rent it out. If so, I would recommend doing a 1031. I’m not a cpa but we have done several 1031s into full time rentals, DSTs (syndicated commercial) and a beachfront vacation rental that we now use as our primary residence half the year.

Consider the following:

- Your use of the rental simply requires you to prorate expenses in your schedule E. If you use it half the year and rent it out the other half, 50% of expenses can be applied to any rent received
- Buying a cheaper rental simply means you pay taxes on just your boot (in simple terms, variance between sales price and purchase price), deferring the rest until you dispose of the replacement property
- To avoid any boot, consider buying a second rental or even a DST
- Yes, there is a risk with 1031s going away in the future along with other risks of a new rental. However, there’s also the benefit of getting out of your appreciated asset and possibly diversifying your investment

 

[Badger]

If you are going to put any money down then consider some of that 2.8M in the IRA. In 10 yrs you will have even more. The RMD on that money could be well over $100k that may put you in a higher tax bracket. Just a thought.



Cheers!

 

[freed2012]

Thanks all for the thoughtful and thorough responses. Turns out we were pretty much scared off this condo by the specter of hurricane risk and the possibility of never-ending increases in cost of insuring it (via the condo association for the exterior and an individual policy for the interior/lost rental income, etc.). Then we attended the annual owner's meeting via Zoom and found out the association is about to embark on $7-8 M in capital projects against which they have only $500 K in reserves. This will result in an assessment of around 70K best case. We'll steer clear for now and as several have remarked, are realizing that beachfront property might be better rented than owned.