EVERYTHING You Need to Know about 1031 Exchanges! - YouTube

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.