673: Update on 1031 Tax Deferred Exchanges

SHOW NOTES FOR EPISODE 673: UPDATE ON 1031 TAX DEFERRED EXCHANGES

1031 Exchanges are one of the greatest tools of wealthy real estate investors, but is it true the government is taking them away?  In this podcast, real estate investor, 1031 expert and senior vice president of Asset Preservation, Inc Scott Saunders shares the inside scoop of how the 1031 Exchange benefits real estate investors, other great tax hacks and the truth about the future of 1031 Exchanges.

What You Will Learn

• The definition of what a 1031 Exchange is
• Is the 1031 Exchange being eliminated?
• The multiple benefits of 1031 Exchanges for real estate investors
• How 1031 Exchanges expedite your portfolio growth strategy
• What “Like Kind” investments are to exchange into
• Other tax codes that can generate millions of dollars of tax savings
• Three tips to use 1031 Exchanges for maximum tax advantage

About Our Guest

Scott Saunders

Scott Saunders is a Sr. Vice President with Asset Preservation, Inc., a leading national 1031 exchange qualified intermediary. Scott has been in the 1031 exchange industry since 1988 and has overseen over 100,000 exchanges. He is a former President of the national 1031 exchange industry trade organization, the Federation of Exchange Accommodators, and he is a well-known national expert on 1031 exchanges.

More About Scott

• In 1988, graduated college with a Business Economics degree
• He first got involved with 1031 exchanges, in Los Gatos, CA
• He was both an investor and as a professional for a company that did 1031 exchanges
  • He owns single family properties in a number of states
  • He uses 1031 exchanges for his own properties
• He moved to Colorado (south of Denver) many years ago
• He works with Asset Preservation training sales teams
• He does a lot of training and education on 1031 exchanges on how to use it and all the potential in the tax code provision

Definition of a 1031 Exchange

• If you look at a taxable sale, selling a property where you receive cash
• That cash is taxable to the extent that you have a capital gain in the property
• In a 1031 exchange, you give up your property and you get another “like kind” property – you receive property instead of cash
• It goes back to the provision in the US tax code since 1921 that says, “as long as you exchange a property that is held for investment, or used in your business for other “like kind” property, also used as an investment or used for business, you can defer the capital gains taxes
• You also need to set up a 1031 exchange and select/identify a “like kind” property before the closing sale transaction occurs
  • You have 45 days from the day you close to identify the replacement property
    • Scott recommends that, when you list your property, you start looking for the exchange property
    • There’s also a structure out there called a “reverse exchange”
      • In this, you close on the purchase property BEFORE you close on the property you’re selling
  • You have 135 days to close within the 180 day exchange period to close on the property, after you’ve identified the property to buy

The Key Benefits of a 1031 Exchange

• You don’t pay taxes on your gain
• Also you redeploy all of the gross equity into one more larger property or multiple properties
• If you sell today, there are four potential taxes you would have to pay:
  • 25% tax on depreciation recapture
  • Federal capital gains tax at 15 or 20%
  • State taxes – California, for example,  has a 13.3% state tax on gain
  • Net investment income tax – 3.8% tax on net investment income on $200,000 on single filers and $250,000 for married filing jointly
• Instead of paying all those taxes, you get to keep your equity and redeploy it into other “like kind” property
• It allows you to build your portfolio much faster

“Like Kind” Investments

• “Like Kind” investments is fairly broad
• Conceptually, “like kind” properties are “any property you hold for investment or you use in your business
• You can do an exchange, let’s say, a single family residential property for:
  • an apartment
  • industrial
  • retail
  • vacation home
  • easements
  • air rights
  • water rights
• You can’t exchange for an LLC or apartment interest
  • Your interest in partnership is a personal property interest in an entity that holds real estate
• But you can go in as a tenant in common co-owner or in a Delaware Statutory Trust (DST)
  • A DST would help someone who is going from a property to a passive real estate investment, like a syndication
  • A DST meets the requirements of a 1031 exchange

Current Status of 1031 Exchange

• Recently, there were a number of proposals submitted by President Biden to restrict 1031 exchanges
• Congress was looking at ways to get rid of the 1031 exchange to generate more revenue
• Last year, Scott spoke around 60 people in Congress, educating them on the value of 1031 exchanges
• Biden proposed to cap 1031 exchanges at $500,000 for an individual and $1,000,000 for a married couple
  • Scott shared with congresspersons that if they do that it may not bring as much revenue as you think
    • A house in California above $1 million in most areas
    • It’s not just affecting small investors – it would affect everyone
    • It would also affect rural property owners (ranchers, farmers, etc.)
    • It would affect people doing economic redevelopment
    • There was a study done by Ernst & Young that said that Biden’s proposal would create a $98 million hit on GDP
  • Scott also shared the benefits:
    • It’s a valuable tool for transactional activity
    • It allows a small investor to have one property, leverage into two, two into four, maybe get a small apartment complex
    • All that activity helps the economy
    • It helps the real estate industry
    • It helps capital keep flowing to where it’s most efficient, where it’s going to create the best returns
    • It helps people who need to sell a property
  • Congress did not see the benefits of cutting it as Biden proposed
  • Therefore, today, there is not a threat of losing the 1031 exchange
• Scott does not see any changes to the 1031 exchange at this time
• Midterm elections may make a big difference

Past Changes to the 1031 Exchange

• A few years back, they eliminated personal property exchanges (aircraft, machinery, cars, etc. ) when President Trump was in office
• Both political parties have viewed restrictions as another way to generate revenue for other programs

Other Tax Codes That Benefit Investors

• Section 1033 – Involuntary conversion
  • Property gets destroyed in a hurricane, condemned because they are widening a highway for the public good
• Section 721 – An UpREIT
  • If a REIT wants your asset
  • Let’s say an apartment REIT wants to buy your building, you can actually contribute your apartment to a REIT and the REIT will give you OP units, which is a tax dferred transaction
• Cost Segregation
  • Buying an asset and doing a cost segregation study where you break out the personal property components for tax purposes
  • Right now, you get 100% bonus depreciation
  • Scott did this 20 times on assets he purchased last year
  • And you can use that bonus depreciation offset investment income or, if you qualify as a real estate professional on your rental income
  • Next year, bonus depreciation goes down to 80%, then, the next year 60%, then 40% and 20% in subsequent years and then it will be gone
  • Mid-year elections may change that because there are some in Congress who want to maintain the 100% depreciation

Biggest 1031 Mistakes to Avoid

• #1 – Don’t change your entity
  • The person or entity that is relinquishing their property has to be the same entity or the same tax owner buying a new property
• #2 – The requirements for referral are very simple
  • Just reinvest your net equity after closing costs
  • Have the same or greater amount of debt or mortgage depending on what you’re buying compared to what you have sold
• #3 – Plan ahead with your exchange
  • Realize that you have that 45 day time period to identify
  • Start looking right away
  • Get properties under contract
  • Start doing your due diligence
  • Where he sees people in trouble is they don’t starting looking for properties until a week from the end of 45 day limit
    • Then you end up making offers on properties that aren’t your first or second pick

Other Tips of Value

• Any entity can make an exchange
  • A trust
  • An LLC
  • A Corporation
  • A C-Corp
  • An S-Corp
  • A partnership
    • Partnerships can be a bit more complicated
    • You can’t to an exchange in to or out of a partnership interest
      • If, for example, you own real estate with 10 partners
        • And 6 want to exchange and 4 want to cash out
        • There are some things you can do to set yourself up to do an exchange
          • But you have to get it out of the partnership and into Tenants-in-Common co-owners
            • And you would need to do that earlier rather than later in the process
  • You can come out as a single owner and buy as “single member disregarded” LLC
• Review your individual transaction with your tax advisor
  • A 5 or 10 minute call with your tax advisor saying, “Here’s what I’m selling.  Here’s what I want to buy.  Here’s the entity that I want to buy it in.”
    • Just a quick check-in phone call is really a very critical piece that many people DON’T DO
    • This will help you avoid your tax advisor saying to you, “Gee, I wish you would have told be this earlier.”
• When you’re looking for a property to exchange into and find one, also identify one or two other “back-up properties” should the first one fall through

Advice for Old Dawgs Looking at Real Estate Investing to Help Them in Their Retirement Years

• There’s no need to do a 1031 Exchange within your retirement account
• Investing in real estate as you are approaching retirement or even in retirement can seem overwhelming but you can ramp up faster than you thing
  • Scott just started buying properties aggressively last year, going from 10 to 60 properties
    • He did two 1031 exchanges last year and they really helped him grow his portfolio faster
  • If you have an asset with good equity and you’ve got good investments out there that made sense, it might help accelerate your investing plans and ROI if you consider doing an exchange
    • You could take that equity and redeploy it into a larger asset or multiple properties
      • Or you could seek more market diversification and expand into other promising markets

Current Business

• Scott is excited about continuing to help people
• He enjoys listening to people share their goals and helping them to accomplish those goals
• They’ve exchanged cell phone towers, air, easements
• They’ve helped farmers who are retiring to sell of their farms and move into more passive investments
• With just a few couple of 1031 exchanges can help people accomplish more than most people know

Rap-It-Up

• Favorite real estate book: The Wealthy Code by George Anton
• Favorite business book: Tax-Free Wealth by Tom Wheelwright
• Most valuable web site for success (other than your own): Zillow
• Favorite app: YouTube
• Favorite quote: “Success is 90% perspiration and 10% inspiration.” – Ben Franklin
• If you lost everything – all your assets – and had to start all over, knowing what you already know, and you only had $1,000, what would you do to re-launch your real estate investing business? I would partner up with someone, bring a deal to them as partners, because I can bring a good asset and the right team to manage it.  That’s what I would do to add some value. I would partner up and scale that way.

How to Reach Scott

• email: Scott@APIExchange.com
• By phone: 800-282-1031
• Website” APIExchange.com

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