Hey everyone, and welcome to Passive Real Estate Investing. I’m Melissa Nash, your guest host Jumping in for now. Let’s dive in. Welcome to the show, you guys. I am very excited to have a special guest on today. We are talking about 1031 exchanges and I’ve got the one and only Dave Foster here. Welcome to the show, Dave.
There’s a lot of people that are happy. It’s one and only, I’ll just tell you that <laugh>. But it is great to be here.
Wonderful, wonderful. So, we were just chitchatting for a second before I hit the record button. And I have known you for at least 10 years.
I wanna say it has been quite a while, hasn’t it? I, you know, I think we first got introduced in the early days of the turnkey property. Boom. I believe you were just starting out with your company and turnkey providers were cropping up everywhere around the country in certain regions. What I really liked when we started working together was you guys truly were nationwide. And so that’s one thing we noticed right off the bat. You were able to take care of clients anywhere, which of course fits in well with us because the qualified intermediary in a 1031 exchange can work with anybody as well. So it was really just kind of a nice fit together from the early days. So, like I told you, I think we’ve each earned Thanksgiving Day invitations for each other. <Laugh>.
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That’s it. Exactly. So, you know, and one thing that I believe in firmly, firmly is I do what I am telling other people to do and I work with who I am actually recommending. So personally, on my own side of things, my own portfolio, you guys, your company has helped me with 3 1031 exchanges. And I would, you know, I mean, I’ve been recommending everybody work with you guys for, you know, at least a decade now because of how easy it is. You know, everything I do so that I can be as lazy as possible. <Laugh>, that’s kind of like my, my joke about things. But like I, I’m a passive investor, you know, I am busy. I am growing a portfolio, I’m raising a family, I’m coaching students. I have a lot of hats that I wear. And to be able to come to you guys and be like, hey guys, I am thinking about selling a property. Can you just take it from here? Has been absolutely fantastic. And if I can do it, you guys, anybody can do it.
You know what, that’s funny that you say that because you might even remember our first conversation when you were gonna do your first one. I told you something that I’ve told every potential client and that for 30 years now, and that is that the hardest 1031 you’ll ever do is your first one. Once you get through that, it’s like, oh my gosh, what was I missing all along? Because the benefits are just so out of this world. And you’re exactly right. It really is kind of an invisible, seamless process that your team picks up and carries the water form so you can do the important stuff.
Yep. So, let’s break it down and go basic level. So, for everybody listening right now, like what the heck are we talking about? What is a 1031 exchange? Why have I done a 1031 exchange? Why do investors need to know about this? So, fill us in from the very beginning day. Basic, basic level.
Yeah, exactly. Well, one thing that you might not even know is that 1031 has been around since 1920, so it’s not a new thing at all. And, but what it does is the 1031 exchange allows you to sell the investment real estate, use the process, and buy new investment real estate. And you get to indefinitely defer paying tax that you normally would on the profit. So think about that. I’m a real estate investor. What’s my job? What’s my passion? I want to sell and I want to buy real estate. That’s who I am. All you’re doing with a 1031 exchange is adding a process in between and that allows you to not have to pay the tax that you normally would’ve. Now what’s the impact of that? Well, let’s say you make a hundred thousand dollars and you’re a California taxpayer, you could easily have a $40,000 tax bill.
Oh my gosh. Instead of paying that, doing the 1031 exchange, you get to use that $40,000 of tax for your benefit. You are making the money on it. Now, Melissa, I don’t confess this to everybody, but the biggest mistake I ever made in real estate was my first transaction bought a piece of property and I actually had a $30,000 tax bill because I did not do a 1031 exchange. Now, fast forward that 35 years, and if I would’ve made 10% a year on that $30,000, it would’ve doubled about eight times. That’s real money. And instead I just get to cry myself to sleep at night knowing that I took care of the government so I didn’t have to pay it. That’s in a nutshell what it really is. But the IRS doesn’t make it easy for you. They, first of all, and most importantly, require that you use the services of an unrelated third party called the Qualified intermediary. And that’s how you and I got involved, cause you had to use a QI. And that’s what we do, is we’re that middle person that makes sure the 1031 happens correctly.
Well, and and thank you for kind of recapping that for us. So one of the things that I love is I don’t have to deal with that. Like, there, there’s a lot going on with, like you said, like how the government wants everything to be filed, how it needs to be done, when it needs to be done, the timelines, because Uncle Sam wants their money. I mean, they, they wanna tax you. They want that capital gain. And so for me, like if I had to deal with it and file it and all of that, I would just, I I probably wouldn’t do it. You know, either a would would be really worried and nervous to invest ’cause what if I have to sell it and then I’m gonna have capital gains and blah, blah, blah, blah. All all the things. And so to kind of hand that roll over to you guys <laugh> is, it’s, it’s really that easy you guys. So tell us, Dave, when does an investor need to get with you guys? If they’re thinking about selling a property, when should they be talking to you?
God. Well man, this is kind of the whole philosophy behind the 1031 exchange is that it’s the long game because every year that you can keep that tax deferred, that’s a year you are making the interest on that money. So 1031 investors typically tend to have a much longer time of rise. And the 1031 in fact isn’t for people who simply want to do fix and flips and that, that kind of thing. Your intent has to be to hold the property for productive use. So it’s really designed for buy and hold investors. Now that being said, we work with a lot of fix and flippers to help them adjust their model so that they’re still getting the same benefits, but in general, it’s got a longer time horizon. When you are dealing with longer time horizons or when you’re sailing a bigger ship, it takes longer to turn it around.
So we encourage people, first of all, you’ve got everybody else on your team. You’ve got your market analysts that are telling you what the market’s doing. You’ve got your accountant that tells you what your taxes are doing. You’ve got all of these people giving you input. And the 10th 31 QI needs to be one of those people so that as you’re planning early, probably before you even decide to sell a piece of property, you want to be looking for the off-ramps that are gonna optimize your experience. All that being said, what does a QI have to be involved prior to the closing of your sale? And again, one of those things I shouldn’t say, but I’ll expose it here, our world’s record is 22 minutes, but thank heavens it was not you and I got a lot of gray hair from that transaction. So <laugh> anytime before the sale, the earlier the better because that helps you plan.
Yep, yep. Exactly. And so, you know, I’ve talked to a lot of clients who said, Hey Melissa, I just sold my property and I wanna do a 1031 exchange and you know, can you help me? Number one, find a replacement property. Yes. Hello, I can help you find replacement properties. Absolutely. That’s what I do. Stress free chill. But then they’re like, you know, what’s, what’s my timeframe? And you know, all this stuff. And I’m like, wait a minute. I think you’re too late. You know, you’ve got to talk to the 1031 exchange folks like yourself before you sell that property. You guys have to file stuff, right?
The client cannot touch the money and there has to be documentation with the closing settlement statements. But I learned this the hard way a bunch of years ago in the northeast part of the country, and you’ve probably found this out as well, there’s kind of a convention where people will say, I sold my property. And what they really mean is I just put my property under contract. And I I get those calls every month and I go, please tell me you didn’t close on it. Oh no, no, no. It’s just under contract. Okay, we can still do the 1031, but you’re right. If they’ve already closed on the property, all I could do is sit there with a Kleenex and help ’em cry
<Laugh>. Yeah, that’s, that’s a big mistake to be had because now all of a sudden, sorry, especially if you live in California, you might be paying 30 to 40% capital gains on that property. Yep. I’m there with the Kleenex too. That’s a big bummer. Okay, so tell everybody, you know, it sounds scary. This, you know, when people talk about 1031 exchanges, it sounds like a scary thing. So, so what is the timeline? Okay, first of all, let, let, let’s back up and say, so somebody’s got a property under contract that they’re selling. They reach out to you guys, you guys make sure they have all of the information that they need. You’re gonna file everything with the closing documents. You guys are gonna put the funds in your escrow account. And I know this because I’ve done this with you guys several times. Now you guys take those funds. So now what, what is, what is the timeline? What are the requirements for this person? Right?
So by doing just that right there, you’ve kept your 1031 alive because you’re using the services of an unrelated third party, the QI. So check box number one, there’s six different boxes now, boxes number two and three are, that are the timing. And it is a little constrained. But generally I can talk people off the ledge because you only have 45 days after the closing of your sale to identify your potential replacement properties, which everybody starts flying around the room saying, that’s not enough time. I can’t do it. Well wait a minute though. Remember you contacted us prior to the closing of your sale. And that’s again, that element of planning where if you’re 30 to 45 days before you have to close your sale, that means you really have 90 days to find your replacement property. Because you could go into contract on the new property before your old property closes.
You just can’t take title to it. So right away we’re able to kind of calm people down, let ’em take a breath. And also if it is a problem, like remember that extreme sellers market in California six or seven years ago where you couldn’t buy a property ’cause it was being sold within hours for 20% more than it was listed for on the day it was listed. Well that does make it tough and scary, but there’s all sorts of things that you can do to mitigate that, including starting early, offering concessions or getting, giving concessions in exchange for floating closing dates, longer closing dates, putting a property under option to purchase before you have to buy it. All those kinds of things can work together. And that’s what we help you with in that process. The 45 days by far is the scariest of the requirements. Now you have a total of 180 days to close on it. That’s not so bad. And unless you’re buying, say new construction. And do you guys have some new construction projects right now that are in process? Yes,
We absolutely do. Yep. Yeah.
So what will happen is those may have been under process for eight or 10 months and they’re three or four months from being completed. So one of our clients could sell their property and they would list one of your new builds as the replacement property. Now why would they want to do that? Well, the biggest reason right now is because the move from existing construction that might have hidden CapEx the expenses coming down the bike into new construction where you’ve got a warranty and those kinds of things, that’s a great reason to switch because CapEx will kill your return. So, but they’ll identify that even though it’s not done yet. Well the only thing is now it’s got to be done by day 180 and then you close on it, no problem at all. But they give tips and tricks to help you navigate those kind of timeframes.
The QI has to hold your money. And as you’re well aware, the way that we do it is we set up individual accounts in each client’s name. So money can’t leave your account unless you sign a document. So, which is all good until Melissa decides to go on vacation to Italy the week she’s gonna close. And then we’re scrambling around trying to get that document signed because we have to have the signature to send money. But that protects you both from the IRS because they don’t want you to touch it and to protects you from us. ’cause It doesn’t happen very often, but once every decade, some Yahoo just goes crazy and takes a bunch of 1031 investors money if we have it set up. So you’re still in at least partial control that can’t happen. So again, that eases people’s minds. Oh, especially when they realize that it’s FDIC insured.
Well now I’m starting to feel a little better about the 1031, aren’t I? You’ve got to take title the same way in which you sell the old property. So I think for, I think for you, sometimes you add it in your name, but sometimes you also add it in an entity like an LLC. That’s okay, we just match that up. The final one is the reinvestment requirements. And this kid’s people, you, if you want to defer all tax, you’ve got to first purchase at least as much as your net sale. So if you get a contract on a property for let’s say 320,000, and there’s $20,000 of closing costs that makes your net sale $300,000, you have to purchase that much in real estate. And if there was a $200,000 loan on it, then you have a hundred thousand dollars of cash that you need to use all of to purchase $300,000 in real estate.
People say they kind of need, it’s hard to get because the iris did not make it easy on purpose. They’re willing to leave their tax in the game, but they’re expecting you to leave everything in the game as well. So if you pull money out or if you buy less than you sell, they say you’re taking profit first. Now Melissa wants to say, no, no, I’m not. I’m taking up my original down payment. And I totally agree. Unfortunately, the IRS says, Nope, it’s profit first and you’ll pay tax on that amount. So that’s probably behind the 45 days. The second biggest gotcha is the people have to understand how much they need to purchase so they don’t end up with a little tax bill at the end. But honestly, that’s really it in two minutes. We just went through every requirement. Now, can you remember all of those? No. Do you want to remember all of those? Probably not. But that’s what the QI is there for. We’ve got a job just like your realtor has a job, your account has a job and you’re the quarterback of the team.
Perfect. Well, you know what? And, and that’s, that’s one of the things why I tell people. So I’m like, okay, you’re thinking about doing a 1031 exchange, let’s get all of the team together and let’s start planning it out. So let’s say, you know, I sent a client to actually, I I sent it, this is a real story, <laugh>, I sent a client over to you guys recently and they were selling a property and I don’t even know, I think it was like 500,000 was gonna be their profit. I mean, that’s a huge, huge tax. If they didn’t, if they, if they have to pay capital gains, I mean they’re, they’re gonna lose almost half of that money. I mean that’s, that’s an obscene amount of money that we wanna try to avoid. And so we had to put together a lender and yourselves because we wanna make sure that’s a large amount.
So number one, we wanna make sure that when they’re leveraging that money, that everything is good on that end. They can qualify for it. The types of loans that they’re getting, they’re doing A-D-S-C-R loan. There’s certain requirements there with down payment. And then also, yeah, the, the, the company name that they were selling it under, like you said, has to align with if they’re gonna do A-D-S-C-R loan with that LLC or if we’re gonna be titling it in there. And I mean, there’s so many, like, there’s some little variables. And, and I don’t wanna scare you listeners who are out there, this is why we put these people in place for you. Like you don’t have to be a 1031 exchange professional and you don’t have to know all of this. And of course you’re not a lender, so you’re not gonna understand all the loans and all the things going on there.
So we are gonna put you together with these brains and these people who are on your site. So it, so we’re gonna take your exact situation, the exact property, the exact, you know, es well, we’ll say estimated proceeds from the sale. We, we don’t know that yet, but we can get the estimated, we’re gonna put you in touch with Dave and his team. They’re going to tell you exactly what is gonna be required on the 1031 exchange side, what’s gonna work, what’s not gonna work, how many properties you need to buy, what the totals are gonna look like. And then we’re gonna connect our lender over here who’s going to say, great, we’re gonna qualify you for this. If you’re not paying cash for properties. We love leverage and we always want you to buy, you know, build your wealth and buy as many properties as you can.
So then the lender over here is going to run the scenarios for you and then guess what they’re gonna do for you? They’re gonna shoot it right back to Dave and his team and they’re gonna clarify and they’re gonna make sure that this will work. And then you’re gonna come, when you’re gonna be working, whoever you’re working with, if you’re working with a realtor or if you’re working with a you know, a turnkey company or if you’re working with somebody like myself who actually has the inventory for you, then we’re gonna put together the, the numbers, the sample properties, what it would look like, and then guess what you guys, I’m gonna send it right back over to Dave and his team and I’m gonna make sure, hey guys, this is what we’re proposing. Is this going to work? So we’re kind of clarifying it all for you so you’re not alone out there lost, overwhelmed, like literally Dave, you guys have done thousands of these. I mean, you know what you’re doing. I think,
Well if we don’t, we’ve been accidentally lucky for about 30 years <laugh>. So yeah, you know, when you started talking, I realized one of the things that I’m most proud of in what you and I have been able to do together with your clients is I can’t count the number of times whereby involving all of those different parts of the team, we’ve been able to save clients several percent on their loan and let them buy more using less down payment because of the type of loan that we were able to get. A lot of people, this will be the craziest hack that I think people could take today. What a lot of folks don’t understand is that it is perfectly allowable to buy a property using a quote, second home loan, which has favorable interest and a favorable down payment and still have that qualify for the 1031 exchange.
People say, but, but it’s a second home. I can’t do that. It’s not an investment. Yes it is because when you look at the institutional requirements for a second home loans, they will say that you can use, the only two requirements are that the property be at least a hundred miles from where you live and that you agree to use it at least two weeks a year for personal use. Both of those requirements are specifically allowed for a 1031 exchange. You can buy a property and use itself for personal use and still have it qualified as an investment property for 1031. So I remember getting asked that question and then all of a sudden that opened up all kinds of inventory for you to put somebody into a great property where they were able to buy more. ’cause They used less down payment percentage at a cheaper interest rate. They got a vacation home to build memories in and they’re making money on it. And given the new statutes that were finallized, permanalized, I don’t know what it is, made permanent <laugh>, whatever that word would be, allowing for ownership of vacation rentals to be treated as an active rental activity, which means you’ve got access now to all sorts of other tax breaks while you own it. It’s a 1031 investors’ dream. But only we were only able to do it because everybody was asking the questions so that we knew where to place ’em.
Well, you know what, you, you like literally teed that up because I don’t know if you remember my very first 1031 exchange that I did with your team was exactly that scenario. So I had a property that we sold that was it was being used as a short-term rental. We sold that property, I took the proceeds and I bought a another property in Palm Springs that was, I was gonna do a short-term rental with it and my lender was able to do a second home loan on it. So I only had to put, I think it was 10% down and I had a really, really low interest rate on it. ’cause Again, this was like in 2021 when interest rates were really low. And so we did that and I then, because <laugh> all, all of this happened, then I was able to do a, you know, kind of going off on a tangent, I was able to do cost segregation on this property.
I was able to get bonus depreciation on this property. Made a huge, huge tax benefit on it. Didn’t pay any capital gains on this property. We put a little bit of work into the property. So we brought up the value of the property. I mean, there were so many things that happened with this deal. I mean, if I were to actually sit down and go, okay, well I literally saved myself about 40 or $50,000 in capital gains by doing the 1031. And then because I only had to put 10% down, we were able to put that money into the remodel. I mean, there’s so many things going on about it that, that this property itself is an amazing case study, which I should probably do sometime and really break it down. But it all started with that and it, and it was, it was talking to you guys about what my options were and then talking to the lender about what my options were and just really putting these brains together to go, how am I gonna benefit the most with the systems that are in place? These are tax laws. I mean, we are, we are expected to take advantage of these. We just need the professionals to help us do it.
And there you said it exactly right. A mentor of mine a long time ago challenged me and he said, Dave, stop thinking about the tax code as a way that government’s using to take your money. He said, that’s not it at all. Yeah, the government needs basic services, but think of the tax code as a behavior incentivizer. And if you perform the behaviors they want, they’re going to incentivize you by giving you tax benefits. And there’s reasons upon reasons why cost segregation, bonus depreciation, short-term rental activities off the 1031 exchange. All of those things. There’s reasons why the IS wants you to do them. You unlock the key and said, because these are the systems, I’m gonna take advantage of them. And guess what, you got an awfully nice reward from the IRS, didn’t you?
Absolutely. Well, and that’s the thing is, is we, we think about, you know, the wealthiest people in this country own real estate and there’s a reason for it. There’s all these amazing tax benefits. They are, they are created by the wealthiest in this country. These are the tax codes that we have to learn about and take advantage of. So, you know, and the 1031 is pretty awesome. Years ago, I, I heard rumors of the 1031 going away. But I mean, it’s, it’s here to stay. I, I don’t think there’s been any changes to it. Like you said, it’s been around since 1920.
Well I think there, there was a, an attorney Ideon, can’t remember his last name, but he once said that nobody’s personal liberty or property is safe while congress is in session. So we gotta deal with that reality. But you’re absolutely right. Under this administration and under every administration for the last 35 years that I’ve been in this, the 1031 exchange always comes up for question and everybody says, no, it needs to stay. And interestingly enough, you wanna know the whole story about this. In 1920, our country was coming out of the agricultural revolution and we had a very hungry nation going into the industrial revolution. We needed agricultural output. But if farmers tried to sell their farms to go buy new farms, they couldn’t do it because of the high taxation, which kept not only them from growing, it kept young farmers wanting to start farming from being able to buy anything.
‘Cause Starter farms firms weren’t available. And that’s why 1031 was put into place. And so you just gotta look at that and go, what makes total sense? Well, it’s still the same thing. Now our nation relies on a vibrant, active real estate economy. And as long as that’s happening and then things cook along, and part of keeping that happening is the 1031 exchange. ’cause Again, it unlocks all of those other benefits and lets you keep the tax dollars working for your wealth. And by the way, for most of our 1031 investors, their goal is to swap it till you drop or defer, defer, defer, and then die. Because again, under current tax law that was just made permanent. When you die owning a real estate asset, your heirs inherit that. And what’s called a step up in basis, which means you don’t ever pay the tax on the profit. Your estate never pays the tax, your heirs never pay the tax. You can literally use the tax dollars for your benefit all your life and then they disappear and your heirs get a legacy of wealth from you. That’s how wealth is gonna be built in this country, is through that kind of patient game that takes advantage legally of what the government’s giving you.
Oh my goodness, that is actually incredible. I I did not realize that at all. So I’m, I’m really glad you brought that up because the idea here is kind of what you were touching on is, so that first property that we were talking about that you guys helped me do is, I mean, I have no intentions of selling that property. ’cause We, again, we, we use it if you know, as, and it’s also a short term rental, but if I were to sell it, then I would just do another 1031 exchange on it. So the profits that I have made on that property through the equity, through, you know, renovations through just the property values going up there’s, there’s value there. I mean, if, if I were to sell it, I would sell it for a lot more than I paid for it.
And so I can just take that <laugh> and take the profits from that, roll it over and maybe I wanna buy an apartment complex, you know, in, in Kansas City or, or something like that. Then I can just roll it over into that. And then like you just said, if I wanted to sell then that apartment complex, then I would just take the proceeds and roll it over to the next big project. And then, you know, worst case scenario, like you said you know, if if for some reason I didn’t use all of those funds let’s say there was $50,000 hanging over that I didn’t roll over, then that is the amount that becomes taxable, right?
Yeah, that’s exactly right. And also, while this is all happening, your tax breaks are offsetting your revenue from the property and then some. So you’re really not even paying tax. The government’s giving you money to invest and you’re not having to pay tax on it. And I just like, I mean I just can’t think of a better way to roll things forward on that. There are those people and usually it’s my adrenaline junkies. We say, well wait a minute, if I wouldn’t have to pay the tax anyways, why don’t you just pay it now? Or I need money to live on, I’ve gotta keep buying and selling. If all you do is slow it down a little bit so that you’re keeping those rentals for like a year before you sell them, if you ever need money, it’s as simple as doing a cash out refinance. ’cause Remember you got all kinds of equity in these properties, so you do a cash out refinance, that money is free for you to spend, there’s no tax on it. And guess who’s paying the interest? It’s not you, it’s your tenant. So that’s Yep. Tax free, living income all your life. Again, if you can be patient enough to check the boxes and play the way the government wants you to.
Yep. Well, you know, and, and going back to that property that we’re talking about here, I didn’t realize that until you guys told me that. So when we put some value into that property, so we did a big renovation on it and then the property values went up. I did a cash out refinance on that property and that money was, was my money free and clear. And then I took that money and I bought more rentals with it. I bought more properties with it. I didn’t live on it, I didn’t, you know, go buy a boat on it. I actually put that money to work. So basically I didn’t pay taxes, capital gains on the sale of that property, got into my dream property, then took that money out and bought more properties. Like I can’t think of better system than that, honestly.
See, you were smarter than I was. I actually took the cash out money and I bought the boat, but then my family and I lived on it for 10 years.
Oh, okay.
Wow. You bought rentals so you did much better. I ended up with a boat, which is just dance for break out another thousand. But we had fun. But yeah, that’s exactly right. You can leverage your portfolio as quickly as you want and you’re gonna do it without ever paying tax.
It’s brilliant. It’s absolutely brilliant. So, okay, so this is the call to action for everybody. I would love to introduce you to Dave and his team. I’ve worked with a bunch of different people in your office. They’re all wonderful. They all work with our clients, they great communication. So if you guys are even thinking about selling a property and you wanna kind of figure this out and see if it is a right move for you or what the implications are gonna be, what your timelines are, all of that good stuff, I want you guys to talk to Dave and his teams, honestly, just have those conversations and just kind of get the answers. I always kind of say it as you know, we’re lining up all of our ducks in a row. We’ve gotta be prepared. We don’t want any surprises. I mean, Dave’s team has handled some surprises, but let’s give ourselves some time and figure out if it’s the right move for you.
Exactly. And by the way, in our bat cave, the phone has a big red light on it that goes off in sirens whenever Melissa and her clients call. So we love working with you guys, <laugh>.
Wonderful. So you guys do that, have those conversations and thank you again, Dave. I really appreciate the conversation as I’m sure our audience does and we look forward to many, many more future 1031 exchanges with you guys.
Absolutely. My pleasure. Thank you.
Alright, thanks.
That wraps up today’s episode. A huge thank you to Melissa and Dave for sharing their expertise with us. If you haven’t hit that subscribe button yet, now’s a great time so you can stay up to date with all upcoming episodes. We’re grateful you spent your time with us today. Thanks for tuning in and we’ll catch you in the next one.
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