Hey guys, it's Matt. Today we're going to talk about 1031 exchanges. They can seem very
complicated and they are somewhat complicated, but I'm going to tell you everything that
I know, and it's hopefully everything that you need to know about these types of transactions
and how you can utilize them when you're selling your real estate. So let's jump into it. So
for those of you that don't know, here's what a 1031 exchange is. Okay, let's say you've
got a piece of rental real estate, and I need to accentuate the word rental. We'll get into
that in just a minute. Let's say you've got a piece of rental real estate right here.
That's a cute little house. Let's put a little smokestack on it. There you go. Okay, all
right. So there's your rental real estate, and this could be a single-family home. This
could be an apartment building.
This could be a shopping center. This could be a mixed-use building. Anything, any type
of real estate, even land. It could be any type of real estate that you own. Check on
that land thing, by the way. I'm not sure because land I'm not sure if it qualifies
for investment intent. So put an asterisk next to that one, but I have done 1031 exchanges
for smaller properties, duplexes, and small, midsize multi as well. So let's stick to that,
but it can be commercial as well. The purpose of a 1031 exchange is selling this property
and keeping all the proceeds from the sale and rolling it into a next, a purchase up,
into a bigger property. Because if you don't do a 1031 exchange, you're going to pay income
tax on the sale of the properties. Let's say you bought this property for a 100K, you held
it for five years.
You held it for however long you did, and you can now sell it due to market improvements.
And because you're an awesome landlord and you've increased the revenue for the property
and somebody's willing to pay you a higher price, be it on a good market cap rate for
the property. And because you've increased the profitability of the deal, it's worth
more. So let's say you're going to sell it for 200,000. Okay? So you also... That that
gain right there of a $100,000 is taxable and it's taxed at fairly aggressive rates.
So you'd rather not have to pay that tax I'm sure. And just transfer all that money into
your next deal. There's more tax involved in a 1031 exchange as well. Because, as some
of you know, as you hold real estate, you get to depreciate it. So the IRS is going
to say, "Okay, you started out at a hundred. We're going to allow you to write off value
of that property every year, to where on your books, after just a couple of years, it's
only worth, let's say 85K."
So That $15,000 is depreciation that you've gotten to right off your books. Every couple
of years, you get to reduce the value of your investment by a couple of thousand a year,
which is really great because if you made a couple of grand, but you get to reduce the
value by a couple of grand, you make net zero or even net negative from a tax perspective.
Depreciation is a great, great thing. But when you go to sell the property, the IRS
isn't stupid. They realize, "Hey, wait a minute. He sold it for 200,000. We only have it on
his books for 85. So he has to pay gain, not on just that $100,000, but on this depreciation
you got to write off your books, but you actually didn't lose the value of the property." You
actually have to pay up for the depreciation that you got to write off.
It's called depreciation recapture. Okay? So these are all things that you would want
to avoid. So that's why a 1031 exchange is even something you would want to do. Okay?
So here's what a 1031 exchange is. Here's the nuts and bolts of it real quick. So you're
going to sell this property and you are going to, like I said, transfer all of these proceeds,
all of them, you can't take a dime and put it in your own pocket and you're going to
go and buy a bigger asset over here. I'm going to make it physically bigger so you can see
that it's bigger, right? It's got even more windows and it's still got a little smokestack
at the top. It's got a couple of doors on it. Okay? So you're going at... My very first
1031 exchange we sold a duplex and we bought a four family a building. That was our very
first one.
So let's pretend that's the same thing here. Now, here are some of the rules for 1031 exchanges.
And I use my awesome art drawing here to implement it, to tell you about this rule. So the first
thing is it has to be a qualified deal. That's the first thing. So for all you fix and flippers
out there, you're like, "Oh man, this is awesome. I'm just going to do 1031 exchanges every
time I flip a house." No, you can't do that, because a 1031 exchange, this very first property
has to have investment intent. You have to be able to show the IRS that you had investment
intent the whole time when you were involved in the property. So that means that you might
need to show leases, rental income, that you improved the property.
Of course, you can show that you invested in the property and you fixed it up, but you
also have to show that those investments were made for investment rental income, passive
income, intent on the property. Not value add so that I can sell it. Now you can go
out and buy a vacated or a dilapidated duplex and do the BRRRR strategy, the BRRRR, right?
You can go and buy a duplex and fix it up and make investments in the property and then
put tenants in and then go and sell it. And in the back of your little head, you might've
intended to do that the whole time, kind of like flipping a rental property, which is
something common that people do. But the things that you did on the property were always investment
intent. If you're going to do something like that, if you are going to go flip a small
multi, I highly recommend that you hold it for a little while, a couple of months with
tenants in there so that you can qualify for a 1031 exchange when you sell it.
So again, it has to be a property that has straight investment intent, and you can change
your mind later and decide to sell it, but it can not be a property that you went out
and bought and renovated and sold, and you never leased it. No evidence of any passive
income intent on the property ever. So that means if it doesn't fit those, and if it's
just an investment deal, then it's a qualified deal. That's number one, it has to qualify.
Number two, the owner of this property has to be the owner of that property. That sounds
silly, but here's what that really means. When my wife, Liz, and I first bought our
duplex, we bought it. We were actually dating at the time. So we bought it in her maiden
name and my personal name, because we were awesome and didn't have an LLC set up at the
time.
And there wasn't anything like bigger pockets out there to tell us what to do, right? So
we bought it in our personal name. Well guess what we had to do over here? We had to buy
that in our personal name too. It has to be held in the same title. It also has to be
held the exact same title. So for years we owned a four family with my wife's maiden
name on it, even though we had been married for years at that point, right? Because it
has to be held in the same title as this property. Now after the 1031 exchange settled. And we
decided we wanted to refinance the building years later. And so we did a quick claim deed,
which is a whole nother conversation, which we're not going to have here, but we quick
claim deeded it out of our personal name into an LLC later.
But bottom line, this ownership entity has to be the same as the ownership entity that's
buying that property. The exact same. So you can't have one, two, three LLC that's going
to sell this property and then invest in a fund or syndication or something larger that's
with another owner or other people or whatever it is. It has to be the exact same owner.
Okay, got it? All right, good. Now, here's the timeline for a 1031 exchange, and this
is where people get tripped up. And this is where a lot of questions happen. I'll do my
best to explain this to you guys very clearly. So when you are considering selling this property,
first of all, you should, I highly recommend you engage a third party called a qualified
intermediary. Some people also call them 1031 escrow agents. Some people call them just
account holders or custodians.
But the correct term, that I've heard, is qualified intermediary for a 1031 exchange.
This QI comes in and when this property sells, none of this money even touches your pocket.
It goes from settlement into the pocket of the QI, who is a qualified intermediary. And
they can talk you through the whole process and they hold the money. And then when the
money comes and the money needs to go invested into this deal, the qualify intermediary comes
to closing or wires it to the title company for this deal. So the money actually never
touches your pocket. It just goes to the intermediary. That's rule number one. Here's the timing.
In 45 days from you selling this property, it's 45 days from closing, you have to identify
through the qualified intermediary and through them to the IRS, you have to identify up to
three potential purchases that you're going to make.
45 days is like a blink of an eye in real estate time. Okay? Like seven years in dog
years. Well, in real estate time, that's like nothing. 45 days. But I recommend if you guys
are going to go selling property, you better be thinking about what your potential properties
you're going to be buying are before you even put this property up for sale. Right? Most
people that I know that do 1031 exchanges, the day they put this up for sale, they already
had this under contract, right? If you really want to play the game the right way. Now,
let's say you don't. Let's say that you have an unexpected buyer of this property and you
decide, you want to do a 1031 exchange late in the game. Then you have to abide by this
calendar.
So 45 days from here, you have to identify potential purchases. Okay? You don't have
to buy the exact property, but you have to identify potential purchases and you have
to buy at least, this property has to be one of the potential purchases and you're allowed
to identify three. What I mean, what I'm kind of saying in a roundabout way is that it doesn't
have to be number one, doesn't have to be number two, but it better be number three,
if it's not number one or number two. So they could all be possibilities of purchases. Now
the rules get a little more complicated. I'm not going to get into it right now, but you
can also say, "I'm going to take the proceeds, this $135,000 in proceeds and I'm going to
buy this property, this property and this property." You're going to break the money
up and buy multiple properties.
You can do that. There's more rules around that too. Which again, beyond the scope of
this video. But today, what I'll tell you is you can identify one, two, or up to three
potential purchases of which your final purchase has to be one of those three. Okay? Now here's
the other calendar. In 180 days, you must purchase this property, the new property,
which again has to be one of the ones you identified. Okay? So you have to close and
own it in 180 days. So people are like, "Well, what if I don't buy it? What if I don't close?
Can I get an extension?" No, the IRS is very tight about this. You can't get an extension.
You cannot extend this out. If it goes to 181 days or longer or whatever it is, you
can't file for an extension.
I can get an extension on my taxes now. For some reason or another, they're not giving
anything on this. So if you go past that date, you pay tax on this money. That's what it
is. That's the way I understand it. Now, I'm sure I'll get some comments below in ways
you can circumvent the 180. I welcome those comments and those conversations, but the
way I understand it is this profit here becomes taxable, if you go past 180 period, the end.
Now, for those of you that are asking, "Well what if you fall through?" Well, here's what
you do. Here's your backup plan. You got to put it back. Here's maybe the little secret
here that some of the bigger folks in this business have taught me is yes, you identify
properties and just don't be silly.
You start your search for the new property here. Okay? Before you sell this property
and you don't close the sale of this property until you have this identified. That's number
one. So you know where you're going before you even close this thing. So you could identify
the new property right after closing. Okay? That's the best way to do it. Now, you also
can build yourself in a safety net in that 45 days, and in the properties that you identify
are potentials. And there's something called tenants in common. Tenants in common investments.
And they've got kind of a funky reputation out there. They're very complicated. But in
general, what tenants in common are, is you and a collection of other people get together
through an organizer, a syndicator of a tenants in common investment, and you go out and buy
the Empire State Building. Something enormous, like a big office, complex, a big shopping
mall, something like that.
And you, along with these other people have undivided interest in that property. And so
you get your own little deed that says you own 0.3% of the King of Prussia mall, congratulations,
or 0.2% of the Chrysler Building. Awesome, here's your deed for the Chrysler, but for
0.2% of the Chrysler Building and that's all yours. And you can actually liquidate your
1% ownership, that 2.2% ownership. It gets squirrely. And a lot of people don't like
them because there is a relation you have to have the other people and it has to do
with who's managing the property. And it's very hard to change the direction of those
kinds of properties, if you find they're not being run very well, because you only have
0.2%, but if you find one that's run really well, you can do a 1031 exchange into a tenants
in common investment.
Okay? What you want to do is have that as your backup plan. So, that is your safety
net. You want to have like awesome multifamily building that's going to produce of cash for
yourself or the strip center or the smattering of single family homes or whatever it is a
that's your A, number one priority. And then just have your backup plan here. Always have
a safety net built into your 45 day identification. Okay? That's what you want to do. Because
a lot of people ask me, "What do you do if your 1031 falls through?" The people that
know that you can't go past this 180 days, it gets a little scary to figure what kind
of tax you might have to pay. Because some of these folks are selling properties that
they've owned for a very long time. And they might be looking at a way larger gain than
a $100,000. They could be looking at millions of dollars to be paying on sales proceeds.
Another thing people get themselves into outside of tenants in common, are triple net properties.
Triple net is like buying a Walgreens, buying the building that a Walgreens is in or buying
the land underneath a Kentucky Fried Chicken or something like that. Something that's leased
by an enormous company, that's never going to go anywhere and you've got the corporate
company on the lease. So you're good to go forever. You could do a triple net, if you've
got a large amount of money your going to do a 1031 exchange into. But I would look
for like a good premier asset as the number one thing you want to get yourself into. And
if that falls through, then maybe fall back on a tenants in common or a triple net.
So I hope I didn't glaze your eyes over or make your head spin. I know it's a little
longer video, but I hope it was a value. This is 1031 exchange. This is a great way to leverage
your sales on properties. We've done them a few times and we've always been able to
trade up into way larger assets when we do them. So this is a great vehicle. I hope it
made sense. I hope you guys, my awesome pictures up here illustrated the whole thing for you.
As always, as you guys know, I love comments down below. So leave comments. Let's get some
chatter going on, on these things and please feel free to expand on some things that I
said or even refute it, challenge it. I love to be challenged. It's okay. We'll have a
little conversation about those things. So as always guys, I really appreciate you. Thank
you for watching and have a great and profitable week.