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