- Hey, what's up guys.
In this video,
we are going to discuss using 1031 exchanges and entities
and putting those things together.
All right, let's get started.
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So I've received a few questions about 1031 exchanges
and how they work with business entities.
And it's not unusual.
This is a very common question
that comes up with real estate investors
who have owned an asset, an investment asset,
for more than a year.
And basically, for a 1031 exchange,
if you're not familiar with it,
what it means is that you can take an asset
and you can roll the gain,
and actually everything needs to roll,
into a replacement property,
another investment property,
and you won't have to pay any taxes on it currently.
For example, if I bought a house here,
and I bought this house for $200,000,
and it's now increased in value and it's worth $450,000.
Well, if I sold that house
and I just took the money personally,
then I would have gain of 250K
that I would have to pay taxes on.
And so if I want to avoid paying tax on that,
because if you take away taxes on this deal right here
after you sell the property
with $250,000 in gain at 20%,
you're gonna lose 50K.
So that's gonna leave you with $200,000
plus the original basis of 200K,
you'll have 400K left to invest with.
Whereas if you engage in a 1031 exchange,
what you could do is take this property here,
set up an exchange accommodator,
a qualified intermediary who will handle it,
and it allows you to sell it.
Funds are collected here, the 450K,
and as long as you don't touch it,
you don't have to pay tax on it.
You go out, you find a replacement property
that you want to invest into that's 450K or more,
and you roll those funds into that replacement property.
And so what you're able to do now
is by avoid paying tax
you get to keep that 50K to put into another investment.
Now, what you have to understand,
is that with these numbers that I just drew out for you,
in order for this to work the way I described,
you got to roll everything in.
And what trips people up sometimes is debt.
They don't appreciate the fact that
if I had $200,000 debt on this house,
I got to make sure that I've got $200,000 debt over here.
I have to roll the equivalent in.
So you have to be going in for equal
or more value on that replacement property.
So that's the basics of a 1031 exchange,
and there's some nuances and details
about timing and all that.
I'm not gonna go into those details.
There's plenty of people that have covered those
and you can find it just by looking up 1031 exchange.
What I wanna address is using entities with a 1031 exchange
because this creates a ton of confusion.
What people would many times like to do
is they realize,
"Hey, I've got this property in my own name."
Wrong way to hold it.
It should have been in a limited liability company.
So I wanna go from my name
and then when I acquire the replacement property over here,
I wanna have that replacement property owned
in a limited liability company.
So I'm gonna take title over here.
Or possibly on the flip side,
you started with the property in an LLC here.
And when you do the exchange
you wanna end up in a different LLC,
LLC number 2 over here with your replacement property.
So these are the types of questions that come up quite a bit
when we're dealing with 1031 exchanges,
and how can we put something together
that will allow us to accomplish this?
Well, here's the basic rule.
The basic rule is that on a 1031 exchange
we have a downleg and an upleg.
Downleg is sell.
Upleg is when you buy.
So when you're coming down here
and you're putting this together,
the person who sells the property, they'll tell you,
"Needs to be on title for the replacement asset."
So if you sold it in your own name,
then you need to acquire the property in your own name.
So you got to buy it in your own name.
And then the general rule from that is
if you acquire it in your own name,
you should let it season for at least a year
before you look at transferring it.
Well, the thing about the 1031 exchange
that I think that some people miss
is that the intent of the law
is to allow you to roll your gains
into replacement property,
but they don't wanna do it where you're going to gain
some additional tax advantage.
So that's the concern when this provision was put together.
They wanted to prevent abuses.
So if I had a piece of property that was in my name
and I wanna roll into an LLC,
you should talk to your qualified intermediary
about doing this,
closing in the LLC in the replacement property.
But what's key here
is how that asset's going to hit your tax return,
meaning this,
in many of these structures that I've shown you,
I talk about the benefits of using
a Wyoming holding company, LLC,
and treating it as a partnership
so you got this LLC treated as a partnership
for tax purposes.
And the reason why we're doing that is that
we want that K-1
so we look a little better to lenders
when we're going in to apply for a loan
because of where that property hits our return.
Well, this property was originally in my name
and I rolled into an LLC structure that's owned like this
by a Wyoming LLC down here,
that's treated as a partnership,
it's gonna create a problem for me
because when the IRS looks at it, they'll say,
"Hey, this was on schedule E page 1
"in the last tax year,
"and then the new tax year it shows up
"through this entity on a K-1."
That can cause a problem.
But if you set up the new entity
and you have this new entity set up as a disregarded entity,
then it's gonna show up at the same spot on your 1040.
So it's not gonna create the red flags.
And so if it's disregarded,
then you're gonna be able to pick up on the exchange
that same benefit
or having that asset protection.
So if you own in your own name,
what you could look at doing
is rolling into a disregarded LLC.
Again, you'd be the same owner.
Now, where this could run a foul
is let's assume that you and your wife,
or you and your spouse
are in a non-community property state,
that could be a problem for you
to do it this way with an LLC
because it may have to be treated as a partnership.
So if you don't do an LLC,
then what you could do instead is a land trust.
You could roll into a land trust.
So if you own the property directly and you're doing a 1031,
consider using a land trust
or disregarded LLC to take title
on the other end of that exchange.
Now, with entities,
entities can also engage in 1031 exchanges.
It is not limited to individuals
as I was just drawing out here.
So if you had a property
in a limited liability company right here,
and I want to engage into an exchange,
a 1031 exchange with this property,
it's fine, you can do that.
In fact, if it was set up like this,
where that's held down here through my Wyoming, LLC,
like we've talked about.
So you got your Wyoming structure already in place
and it's time to do your 1031,
you can easily do this.
You'll sell the property here,
you bring in your QI,
who's gonna hold the funds so you get rid of your property.
Then when you find the replacement property,
you'll take title in the same limited liability company
on the replacement property, just like that.
So you've just did a 1031
through a limited liability company.
Okay.
But here's where sometimes this can run into issues for you.
When I did this deal,
if you have any debt on the property,
this is what I tell people all the time,
if you have debt on this property
and you wanna engage in a 1031 exchange,
then when you to buy that new property
because you need to roll your debt into that new deal,
that means you have to go out and get new financing
for that new property,
if this isn't a commercial property,
multifamily, five units or more,
then you're not gonna be able to qualify
unless you find a community lender, a portfolio lender,
that's willing to do the deal for you.
So if you're thinking
you're gonna use conventional financing,
(indistinct),
you got a problem.
So I've worked with individuals
who get right up to this point,
they've already sold the property in the name of the LLC,
they're trying to close on the new property,
they're trying to get a loan in this company,
and the lenders say, "We won't do it."
What happens to their exchange? It blows up on them.
So here's what you need to do.
If you're in that scenario then,
what you're gonna have to do is pull all this property out.
Get it out into your name in advance of all of this,
do a drop.
Pull the property out.
So then when you go through the financing
on that replacement property,
you're able to clean it up.
And I would say, pull it out a good six months in advance
before you go through this.
So if you know the property is held like this
and you know financing is gonna be a concern for you,
if you haven't set up that community lender,
then you're gonna probably have to drop it out.
Now, this isn't unusual.
There's many situations
where you'll engage in a structure like this.
It's called a drop and swap.
For example,
if I had a limited liability company set up here
and there were two members involved,
so let's say it's a joint venture
between this party and this party,
and this one owns 70% and this investor owns 30%.
Well, if we have a property in here that we intend to sell,
the issue that comes up is that
unless both partners want to engage in a 1031 exchange,
you're screwed.
Because when you do a 1031 exchange out of this LLC,
all of the gain,
so if the gain on this deal,
let's say it was say a million dollars, easy enough,
a million dollars,
then this individual has to say,
"Yeah, I'm gonna put my portion,
"300,000 into replacement property."
You can't say,
"All right, we're gonna cut off a million,
"distribute 300,000 to this partner
"because this partner wants to take their profits
"and go out and buy a vacation rental.
"And I'm gonna take my 700,000
"and go buy another multifamily unit."
You can't do that.
The entity itself has to do it all or nothing.
So here's what you have to do then in that scenario.
You engage in what's called a drop and swap.
So before you enter into the exchange
and put your property under contract,
you'll deed it out to the individual owners
as tenants in common.
So this investor will own 70%,
this investor will own 30%.
Now, what I'm drawing this out here,
these could be business entities,
it doesn't have to be individuals,
but you just drop it down to the owners
and get it here like this.
And then when you sell it in this TIC arrangement,
Tenant In Common arrangement,
this investor can do whatever they want with their 30%.
This investor can take their 70%
and do whatever they want with it.
So if they wanna do 1031,
they are able to do a 1031 exchange on that.
And then you can go back to those things
I was talking about rolling into another business entity
that is set up maybe to disregarded it
or land trust to put that together
and then to go about finalizing your asset protection.
So 1031s can get complicated.
The thing about it
that I think you should realize or pay attention to
is it takes some planning.
And if you think that you may be engaging in one,
it's best to set up a strategy session
with someone who understands 1031 exchanges
to look at your options
so that you have the time to do all of this.
In my experience, what happens is that
I get contacted by people who are already at the stage
where they've sold this property
and they have a QI involved
and they're looking for help.
Many times I can't provide the service
because it's too late.
So be proactive.
If you're thinking about doing a 1031 exchange,
definitely you wanna talk to someone who understands them
and look at some of the options you have
on either the front side or the backside
of that transaction.
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Take care, everyone.
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