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Posted On: 03/13/2013

Question:

We own a condominium, free and clear, which we rent out. We would like to purchase a duplex and use the condo to aid in the purchase. What might be the best action to follow: Sell the condo and use the proceeds, or offer the condo as part of the purchase?

Answer:

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If you sell the condo, there are marketing and closing costs that will reduce the net cash you receive. Instead, consider these two alternatives.

First, if the cash flow from the condo is strong, you have a written lease and you want to keep the property, then consider a refinance instead of a sale to raise cash.

A lender today might allow a 75 percent loan-to-value ratio with a cash-out refinance, meaning that if the investment property is worth $300,000, a qualified borrower might be able to get a $225,000 mortgage. To hedge against inflation, you want a fixed-rate loan to effectively lock in today's low interest levels.

The money gained is then available to buy an additional property, the cash flow from the condo continues and there are no marketing costs or capital gains taxes from the transaction – because nothing was sold. Speak with lenders for details.

Second, if you really want to sell the condo, then consider a Section 1031 tax-deferred exchange. In this situation, you sell one investment property and use the funds to purchase replacement investment property. Although such transactions are sometimes described as “tax free,” in reality the capital gains tax on the sale is postponed.

According to the Internal Revenue Service, “Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.”

You'll want an experienced broker, attorney and tax professional to help with exchange transactions. You'll also need a “qualified intermediary” to hold cash from the sale during the transaction process.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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