1031 Exchange: A Real Estate Investor’s Best Friend!

[Music] you're listening to the real well show with kathy fettke the real estate investors resource [Music] when you sell a property you either have to pay capital gains tax if you've held it for over a year or you would pay ordinary income tax if you sell it within the year so i imagine if you don't want to pay as much taxes you would hold the property for over a year but what if you don't want to pay taxes at all well that's when you do the 1031 exchange i'm kathy vetke and welcome to the real well show so the irs gives us this wonderful tax break called the 1031 exchange which means that you can sell your property and as long as you buy a replacement property of equal value or more with the same amount of debt on it or more then you're basically not having to pay that capital gains until you eventually sell that replacement property now if you hold that replacement property until you die well right now current tax law says that the value of the property steps up to current market value and your heirs would inherit it and not have to pay the tax so it's a really interesting opportunity for investors and one of the many reasons that people love to invest in real estate so i know there's lots of questions from our real wealth members about 1031 exchanges and how to prepare for them how to do it right so that's why i've invited an expert on the topic on today's show to tell us how to do it right dino champagne is vice president and division manager of asset preservation inc she has over 20 years experience in the qualified intermediary industry facilitating over 15 000 exchanges nationwide so i'd say she knows a thing or two about this dino welcome back to the real wealth show well thank you kathy for having me i appreciate the opportunity to chat with you it's always good to talk about how people can save taxes and the 1031 exchange is absolutely one of those ways and it's still here tell me about that i know it's been challenged but it never seems to go away well that's the good news right that never seems to go away part yeah so far we've uh we've been and you know we've been able to get past uh you know being either reduced or eliminated at this point uh with the most recent passing of the bill over the weekend uh 1031s or not a part of it so so so far so far so good uh but as you know as an industry we're very very diligent in making our case as to why there's such a valuable tool uh for you know taxpayers uh and so you know we still be able to maintain our uh our existence so that's what we're happy about yeah it's interesting because obviously people not in real estate or who are not doing a 1031 exchange assume that it's just a a tax loop for the wealthy but it does affect the economy can you just summarize that how you see that to be true yeah it well you know what's interesting is a lot of people look at like you just said they look at 1031s as for the wealthy and i would have to say that probably this is my guesstimation but you know 70 of the people that we're doing exchanges for are the typical mom-and-pop investor you know they're not your institutional type investors at the majority of the 1031s are done with so you've got people that have taken advantage of having investment real estate you know they want to maintain and continue to grow their portfolio so when we talk about you know how it does affect the economy well it affects the economy in several ways uh one is i know while it's deferring tax okay what it does is it it creates jobs for people that are lending for escrow companies for title companies uh it gives people you know a place to to live i mean so you know this is how i see it affects the economy so it's not something that takes away from the economy i think it's something that actually helps grow the economy and then statistically they said you know over the course of ownership that ultimately people end up cashing out so it's not like the the irs or the taxing authorities at the state level never receive any funds they just may get it a little bit later but uh you know it's a good tool and people are utilizing it and should well it helps seniors too because if you've owned a building or a property for many many years maybe decades and then suddenly you find yourself unable to uh pay for the maintenance of that property but you could sell it a new investor could come in and make those changes and and bring in more money to to renovate uh and the person selling can maybe get into something newer that requires less work on it so i mean do you see that happening where it's better for seniors you know it's interesting that you bring that up uh yeah because when you think about seniors you want to maintain having some income all right because once you get to the point when you're a senior you're obviously either getting close to retiring or you're already there for retirement so investment property is one way to subsidize the the uh your social security any other kind of 401k that you might have so yeah so and then i agree with you with the you know the maintenance side of things as as you get older yes you want to maybe trade out of something that is starting the wear and tear is starting to come in and more repairs like anything is going to come into play and then exchange out of the older property into something that is like new construction or something recently built where your maintenance is going to be somewhere down the road not immediately so yeah so yeah i think 1031's for seniors especially is looking on the horizon i mean just to me from the cash flow perspective you know that you've got those funds coming in to help subsidize anything else that you might have used you've had to you know help you through the retirement years so the last two years you must have been really busy assisting lots of people who are selling maybe at the peak and maybe exchanging into other markets i mean what what have you seen over the past couple of years that investors have been doing well that's an understatement to say we were busy is like i said an understatement what was really interesting is when the whole coven thing came out you know we saw people tapping the breaks the first month that it came in and then it flattened out the following month but when it got to may uh of 2020 things just started to go and go and go and the market has been absolutely insane i mean the volume was super intense uh you know we're starting to see now that that's pulling back a bit and it's put into a more normal pace market but we were extremely extremely busy in helping people facilitate exchanges during this crazy time so it surprised me but it was a a nice surprise you know so yes it was absolutely very very busy for the last two years were you were you seeing some people having huge sales big big sales of property of apartments that where they made millions and then did you see that they might have had difficulty finding replacement property well that yeah that for that not only that but for just about every every category pretty much that was part of the challenge with finding the suitable replacement properties for the exchange because you had such a heated market that there were so many buyers coming in to come you know to you became when you're doing an exchange and you you have limited time to get what you needed to get done so that was a huge concern i mean that was that was a daily conversation uh on with numerous people being concerned about well where do i find how do i find my replacement property and it was stressful there was no doubt about it especially when you had 20 and 30 offers on a property and people didn't even get a chance to try to put a bid on a property and we saw a lot of properties as you probably have seen yourself where the prices were over bid by 100 150 500 000 i mean they were crazy numbers so that was a you know a difficult time with especially with the volume that we were dealing with uh that seems to be still somewhat of an issue because and you're the expert at this because you track this far you know far closer than i ever would but the inventory levels are still probably not to the normal so people are still having some challenges in that where you don't have enough inventory on the market so it you know so people are preparing themselves for this kind of a transaction hopefully what they're doing before they get their property on the market that they're looking to see where they want to reinvest and to start scoping out that market you know well in advance of their transaction so inventories are still low uh but you know people are seeming a little to be able to navigate their way around a little bit better yeah we we started advising people just to identify a dst or i told people we've got lots in our discovery ridge project in park city that they could exchange into and hold for a while until they figure out what they're going to do or when the market calms down a bit but let's talk about the rules what do people need to know or what do they often not know when they come to you and are thinking about doing an exchange uh okay for the the rules for you talking about the identifying or just the basis let's start with either one okay uh because when you're talking about the 1031 well everybody you know probably is familiar with the time frame you've got 45 days from the date of closing as to which you know uh to identify the property or properties what people sometimes get a little confused is the rules you know because there are three specific rules uh when somebody is facilitating an exchange there's there's only one of the three that you can select from in order to comply with the guidelines for the 1031. the first rule which is the most commonly used rule is known as the three property rule where you're physically limited to three addresses but you're not limited to the dollar amount if the taxpayer wants to identify more than three addresses now they're going to go out of the three property rule and they're going to default to the next rule which is known as the 200 percent rule under the 200 percent rule the taxpayer can identify four or more addresses however the aggregate values of all of those properties that they're identifying cannot exceed two times the sale price now sometimes kathy people get they'll go on the internet and they'll read they'll go okay well i know i can identify but i can't identify more than 200 of my sale price so we have to clarify that so let me just restate the three property rule unlimited dollar amount so you don't you're not restricted to two times your sale price it's only when you identify four or more that you're going to be limited to the aggregate values to two times or 200 percent of your sale price in the event you exceed the 200 percent and you've exceeded the three properties you're now into the third and final rule which is known as the 95 rule which means the taxpayer has to close on the aggregate of 95 percent of the aggregate value of all the properties identified so i put it very simply you have to buy your entire list so it's so important for the taxpayer to stay either within the three property rule or stay within the 200 rule a lot of times when people are asking me about this i'll go where are you selling what's going to be your sale price where do you intend to purchase and what are the values of the properties you intend to purchase so i try to help them and say you're going to be in the three property rule based on what you sold for and what you intend to buy so that way it keeps them out of harm's way because you can easily skip from the three property rules to the 95 rule if you're not careful and that's going to be very very dangerous for the 1031. now another component people sometimes think it's okay to do well what if i just put down a bunch of addresses and then go buy whatever i want it does not work that way when you're doing a 1031 you can only purchase the property or properties that you have identified on your list so in other words after the 45 days you cannot go off and buy something else that's not on that list so that's why the 45 days in the 1031 and understanding the identification rules is going to truly help toward the success of the 1031 transaction it's the hardest part to the uh to the exchange but it's one that's going to keep your exchange you know safe if you do it properly yeah the mistakes that we've seen within our own network is people not identifying enough property so sometimes you maybe identify one you think this is the property this is going to meet the exchange but then you find out you know maybe after inspections it's not you don't want that property but now you're past the 45 days or people would get into contract on new homes that didn't have their co yet so you can't close on a property that doesn't i don't think doesn't have its certificate of occupancy so if you can't close you know you don't meet the exchange and you pay your tax i mean what what kinds of things have you seen that didn't work out for people when they identified too few properties yeah got it yeah what you've identified you've described something where people get caught up and so i like this is my this is my property this is what i'm going to close on like you said they're they're here's what happens where people get into the latter part of the 45 days okay so they found that property they're going to put on the list that particular property if they fail to put any backup properties then you're going to run into what you talked about where maybe after they've done their due diligence and all their inspections they decide i'm not going to buy that property and now that property that time is after the 45th day so now what do you do if you have no backup properties so you know you try to encourage folks if you not sure that this is going to be a home run maybe you put one or two more properties in the identification in the event you need to pivot to that property if something goes wrong with your your a your a property all right so sometimes people might put that dst that you talked about a little bit earlier as a backup property because that's something that's usually going to be available in the event that you need a backup where if you put maybe a couple of other addresses you have to hope that they're they're ready now to your other point in regards to new construction um certificate of occupancy is not necessarily a criteria if you will for the closing however and i'm going to say this slowly because i don't want people running off thinking oh i can just do this uh well you've got lenders involved right so if there's a lender involved that is financing the replacement property and if there's a lender happens to be involved for the developer they're going to want a certificate of occupancy before they're going to close on the deal so i had a few months ago there i had three deals that basically failed because they couldn't get the construction wasn't completed by the 180th day so because the cabinets couldn't get in in time so therefore there wasn't any way to get a certificate of occupancy the lenders were not going to lend so there were just you know a host of things uh i have to say fortunately that's the the minority of transactions but it does happen so if you're looking at new construction especially in this particular market you want to either get that property well under contract before you even maybe put your property on the market for sale so that the construction is being dealt with while you don't the clock's not even started and then when you close on your sale then hopefully you only have maybe a three months or so before you know the construction is complete and you can successfully complete your exchange so if you're venturing into any kind of new construction acquisitions you've got to be very careful of that 180 calendar day time frame yeah tie it up soon and i learned that last time we spoke is that you can use personal funds to tie it up right you just have to close with the exchange funds is that right right yeah and a couple of things that i've seen pop up too uh is some developers all right that people are buying from they may not be cooperating with 1031s so i've seen that on a couple of transactions so if you're you know if they're going to a developer you know make sure that that developer is cooperating with 1031s or accepting 1031 buyers because i've had it happen on a couple of occasions where people thought they had a deal and they found out they didn't because the developer wouldn't collaborate with the 10th wow i had not heard that another thing that people don't realize maybe is that you have to have the same amount of debt that you had on the property you sold on the new one and sometimes people do these exchanges when maybe they're not working anymore they don't have that same job or the same income and suddenly suddenly they find themselves unable to get the financing they need to complete it have you seen that happen uh yeah actually uh fortunately it's not a lot but it has come up i mean i've been doing this for 20 years so i've run across a few things uh but every day is a new day okay there's always a new twist to the day this so there's always seems to be a question or an item for the day that comes in uh but yes uh so if somebody has been in a position where they haven't needed to acquire any financing and then all of a sudden now they're selling a property that they have to deal with replacing the debt there's two ways to replace the debt one is getting a new loan when they buy the new property and the second which is probably not your most ideal but that's where you're bringing in cash from outside of the exchange to replace the debt so in other words that they have a hundred thousand dollar loan that was paid off and they don't they can't you know they can't qualify for any new financing but they have a hundred thousand dollars sitting in their savings account then they can bring in that hundred thousand dollars to replace the debt so there's two ways of doing it uh but you know if they don't if they can't then we're going to go back to the dst again because with the dsc they have debt and you don't have to qualify for the financing and so i've had people that have utilized the debt component for the uh for the transaction uh through uh through a dst because they don't have to personally qualify for any financing so okay there's other qualifications for the dst but it does come up where yeah some people might have a slight challenge in getting financing so to me when you're getting ready to sell your property if you haven't been in the financing arena for a while you probably want to start talking to a lender to find out you know are you going to be lendable yeah you're going to be able to get that financing find that out before you put yourself into a position where uh can't replace the debt i've got mortgage boot which is taxable and then now uh you know i've got a tax liability i wasn't anticipating exactly another issue is titling we get it all the time people saying can we invest in your fund or you know in any any syndication it's like no it has to be same title to same title correct yeah so when you're talking about fund i'm not sure if you're talking about a new sense are you talking about going like into a partnership yeah you're talking about an llc yeah see that doesn't work for a 1031 period because you're not the taxpayer you can't buy membership interest into a syndication like you're describing but you know you can go into a dst which qualifies but if you go into a partnership where you're putting money into a fund that's building a project that's not going to work for the 1031. okay but other than you can do a tic attack would be fine yes yeah that works yeah as long as you're doing something like that where you have an undivided fractional interest and that would work uh but when you're talking about besting we see that not only you know in just the scenario you described but just in the general 1031 transaction so what happens is people buy property say single you bought a piece of property and then somewhere down the road you got married you never bothered to change the title and now you're selling the property and then you have a spouse so how are you taking title to the new property or for example somebody husband and wife for example created an llc where they've elected to be treated as a partnership now they they didn't change the title to reflect the new tax owner so these are the kinds of things that are so critical and we run into this situation more often than you would think so if you're thinking about selling a piece of property in a 1031 you really need to look to see how are you you're showing on title to the property that you're going to sell does it match how you're reporting it on your tax returns if it doesn't before you get that property listed now is the time to start correcting these issues or getting it into the proper order so looping in your tax advisor is so important because that person's going to give you the guidance of what they want you to do in preparation for the sale if you get it done before you even put it up for sale now you then going forward you know how how you have to buy the replacement property so vesting and title issues are a big issue when it comes to 1031s it's almost been epidemic to say the least i can imagine yeah i know i had a friend going through a divorce and it was like wait how do we do this we're not married anymore yeah you're not married anymore okay and then some people that are going through a divorce they're still in going through the divorce and trying to do a transaction where they're still the divorce is not finalized that can be some issues when you're dealing with that had some situations where uh the language in the divorce was not clear enough where they thought you know they had two properties they were selling yet you know it wasn't clear enough and they basically said no we're going to take the cash from this property which was the investment side and it created a hole it blew up the possibility for the exchange so these are interesting issues when it comes to yeah yeah you always want to talk to your cpa before and you do before you make sure they do the two are talking together so they can get proper language because let's face it divorce attorneys are generally not specialists in real estate you know uh and they're certainly not cpas so rarely they are i've never met one that is but anyway um so you want to make sure that you're they're talking to each other to get it where you're not going to have any hit any issues when you get to the end and finally uh what how do you determine the value of the of the property let's say you you bought a property for a hundred thousand dollars put 20 000 into it to renovate does that increase the basis the tax basis of the property to 120 000 so that then when you do the exchange you're exchanging 120 versus purchase price i mean how does that work it depends great answer the favorite answer right it depends all right it depends on what that 20 000 would consisted of what you know because maybe it's a combination of capital improvements and a combination of repairs so those are two things that are treated differently on the tax return so if you're putting in if you have to put in for example like a new roof then a whole new roof so that's going to be pretty much a capital improvement uh but if you're just repairing something is that considered a capital expense so you know generally we look to the cpas or the tax advisors to determine what that number is going to be but you're right if it's considered a capital improvement that would add to the basis in the property which means you know that your gain is probably going to be a little bit less because of that adding to the basis in the property uh you know and but if it's considered a repair then you know that's not gonna change anything to the basis but if you're in a 1031 transaction and you spent that twenty thousand dollars which comes up quite a bit i had to you know i had to put this money into the property to get it ready for sale and i would say hmm nine out of ten say can i get my money back so what you know how can i get my money back well that's that's an issue because any money you take out of the exchange is going to be subject to tax if it's a capital improvement there's no offset to that if it's a repair maybe your accountant can find a way to write off that that money that you're getting in as some kind of an expenditure to lessen your tax liability so when you find yourself in a situation where you're making repairs you know and or improvements to a property prior to sale you want to have this discussion with your tax person to determine you know can i get some of my money back and have either the tax eliminated or mitigated so you find these answers out early then you know that which direction you're going to have to go some people find out that they just have to let it all ride into the next property so these are things that comes up all the time what about a wholesale fee let's say you buy a property again for a hundred thousand but you have to pay a 20 000 wholesale fee does that count as acquisition price or do they just use the hud well when you say wholesale fee give me a little bit more uh so you're buying a property from a from a wholesaler and they're getting a fee so it's i don't know if it would be considered a sales commission i would say that that would be something i would run across your tax advisor is okay cost of acquiring the property so is it you know like real estate commissions we know that are considered a cost of transferring property for 1031. so would that also wholesale fee be considered something like that you know is it customary so i would run that one past the tax advisor to determine how that would be treated that's great okay we could talk forever but we're out of time dino thank you so much for joining us here on the real wealth show and people can get a hold of you they'll be show notes there'll be information in the show notes on how they can reach out to you but if you wouldn't mind just letting us know here oh okay yes my my office number is eight six 857 1031 my cell phone is area code 310-508-7367 and my email address is my first name which is dino d-i-n-o at a-p-i exchange dot com wonderful great to see you thank you same here kathy good to see you again and thank you for joining me here on the real wealth show if you'd like to find out more about how to get in contact with dino you can look in the show notes or go to realwealthshow.com and look under the resources tab and you'll see it there along with all kinds of resources for accountants and property managers and professionals who can help you on your real estate journey that's at realwealthshow.com we also have extended webinars there answering more of our investors questions i'm kathy fetke and thanks so much for joining me here on the real wall show see you next time [Music] the views and opinions expressed in this podcast are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action for more information go to realwealthshow.com

Channel: RealWealth

Views: 7,788

Keywords: real wealth show, realwealth, kathy fettke, 1031 exchange, asset preservation inc, dino champagne, real estate, real estate investing, tax breaks, avoid capital gains tax, 1031 exchange rules, real estate investing education, real estate podcast, women who invest, women entrepreneurs, real wealth show podcast, on the market podcast, bigger pockets, cash flow, single-family rentals, multi-family rentals, investment property, passive income, current tax laws

Id: Fo8grjxZd1A

Length: 29min 52sec (1792 seconds)

Published: Sat Aug 20 2022