EP 021 1031 Strategy Stacking with Dave Foster

Come checkout our live and interactive webinar where we discussed how to align different 1031 Exchange strategies with your business/investment goals and tax strategies. Together with Dave Foster, Founder and CEO of The 1031 Investor, we shared the many different creative ways we have used the 1031 exchange to help our clients build their businesses and minimize taxes.

If you're interested in learning more, email: info@markperlbergcpa.com

Transcript

Title: 1031 Strategy Stacking with David Foster 

 Description: Join David Foster & Mark Perlberg CPA as we discussed how to align different 1031 Exchange strategies with your business/investment goals and tax strategies. Together with Dave Foster, Founder and CEO of The 1031 Investor, we shared the many different creative ways we have used the 1031 exchange to help our clients build their businesses and minimize taxes.

Youtube link: https://www.youtube.com/watch?v=AYXcWLxiaQw&t=3612s

Podcast Link: Coming Soon! 

Mark (00:00:10):

All right, guys. Welcome to tonight's presentation on 1031 strategy stacking. Now, there so many valuable and potent things that we can do with the 1031. And obviously as you know when we do a real estate tax plan and tax plan for all sort businesses, not just real estate investors, factors and opportunities, and the 1031 is one of those things. And we also want to see how that will align with your investment strategy. So we're going to talk about all different scenarios and how those can play out based on your situation. And I'm joined by David Foster. David Foster is a founder and CEO of the 1031 investor. He's an exchange intermediary. When I find an opportunity to do 1031 exchange for my clients, I usually will say, "all right, we're going to do 1031, talk to Dave." He makes my life and my job easier. And when someone does that and helps me save my clients hundreds of thousands in taxes, I usually like to have that person on I as a guest on our webinar.

(00:01:23):

So before we get Dave started, I want to just do talk about one thing that is extremely important about before you do a 1031 exchange. Hold on. Am I showing? Can you guys see the screen as well? You can see the file? Okay. So the first step, talk to your accountant. Because we don't know the 1031 exchange is necessary. There may are all sorts of variables to consider, your current tax rate, other losses, suspended losses, other opportunities, where you're headed and what you're doing before we can decide that 1031 is appropriate. So you want to get the accountant involved and to collaborate with you. You need a CPA who is aware of the strategies and implications and who can really collaborate with you. And their business is designed to do that type of service. So a lot of accountants are what we call 1040 factories and they really just focus on telling you what you owe at year end.

(00:02:27):

You want to be proactive. So that is the very first step. And if you think that you can do a 1031 after you have sold the property, you're too late. So you want to talk to them as soon as you can, as soon as you think about selling a property, you want to do some capital gain planning. So we're going to talk about some 1031 strategies and how all the different goals and scenarios will apply. And I'm joined by my awesome guest, David Foster. David, do you want to give just a quick introduction about yourself and then we're going to go into some scenarios and just riff on them?

David Foster (00:03:05):

Sure. Yeah. Well I'm really happy to be here tonight. I live in the world of strategy. When you talked about 10 40 factories, that really resonated to me because the 1031 exchange is really primarily a paperwork process. But inside of that are so many opportunities to shape strategies that can build lifelong and actually generational wealth that, but you've got to tickle those out. And so yeah, someone can fill out papers, but it's the accountant that understands your whole picture. It's the qi that's the parlance for qualified intermediary for the 1031. It's the QI that can see where you're trying to get to and work with you. But all of that assumes that you've got to be starting that before it's too late. And you're absolutely right. I get those calls every month from someone that just closed on a piece of property and said, I want to do a 1031.

(00:04:07):

Well you can't. I'm sorry. So I weep with them, but there's nothing that we can do. But yeah, I love that first step because you truly are the only person that knows their whole situation. Someone can call me up, I got one last week, I've got a rental, I'm going to sell it, I've got to do it. 1031. Well, it took us about three or four days to realize that that person was a rental, but they had already lived in that property until 2018. And so the calendar was lining up so that they were actually going to be able to sell it tax free because the primary residence, that's not something I would ever know. It's something that their accountant knew immediately. So they saved a lot of money by not having to hire me, which now that I think about it, maybe you shouldn't talk to your accountant, just do the 1031. We'll talk to them later. Now that's absolutely the very first step you got to do.

Mark (00:05:08):

Yeah. And another detail, I just want to backtrack and add in here, for those of you who are maybe less familiar with the concept. At a high level, what you're doing with the 1031 is you have a property that you're going to sell at a profit. And instead of paying capital gains on it, you roll your gains into a replacement property and that defers the capital gains on that property indefinitely. And if you were to pass away as of right now, you would get a step-up basis to fair market value and that depreciation on that property eventually will be increased in the future. But if you hold onto this property for the remainder of your time, there will be no capital gains on that transaction.

David Foster (00:05:56):

A Couple of things that I would add on to that. So the 1031 exchange is it takes a village. The qualified intermediary is simply a required component by the IRS that is added on to the role that everybody else is playing. So when you do a 1031, you are still using and accessing the expertise and services of your regular accountant, realtor, title company, attorney, cost segregation specialist, everybody that you normally use.

(00:06:31):

And then the QI is added onto that. And so that's why we love being a creature of statute. "You have to use me, the IRS says you do." So it's really a question though of fitting in with all of those other vendors and people that you work with normally. So what that leads into, and where Mark is going to take us tonight, that's so fun, is if I could just introduce the 1031, it's what he said. It's a sale of an investment property followed by a purchase of an investment property. And by doing so, you will be able to take advantage of what I call the four D's of 1031 investing. And those four D's are: "defer, defer, defer, and die." And what we're going to see, as we go through this slide deck tonight, how by following those four D's, you will never have to pay a penny in capital gains tax on real estate sales. So I'm excited to jump into those with you.

Mark (00:07:43):

Swap until you drop. OK, so let's get started on some of these strategies. Let's have some fun here. So first one, changes in our business and investment goals. And I'll tell you one first that actually it's funny, because I met Dave on the BiggerPockets forum. He's pretty prevalent there. But I actually found out that he had done some exchanges for some of my clients. So I had a client who had a convenience store and went to shift into real estate investing. We exchanged one convenience store for I believe two or three vacation rentals. I don't remember the amount, but you probably do Dave. So that was one way we were able to take advantage of the increased value of this convenience store and roll those into an entirely new business model, was vacation rental.

David Foster (00:08:41):

Yeah, that's exactly right. And the key to this in the 1031 is that the 1031 exchange is only for real estate. So if you are selling in real estate, Mark, I think you use the same terminology I do. There's really three components to it. There is the land and buildings, the real estate. There is the FF and E, the furnishings, fixtures and equipment. And then there's the goodwill or the blue sky, or the business value. And of those three, only the real estate component can be sold at 1031.

(00:09:18):

 So one of the accountants' jobs, and the job of negotiating, in the contract for sale, is if you want to take advantage of tax deferral, you want to try to minimize the value of the FF and E down to its adjusted basis. So that there's no recapture of depreciation or there's no profit seen on no sale. You want to minimize the value of the blue sky because you're going to have to pay tax on that regardless. And try to put all of the value legitimately that you can into the land and building. Because then you're going to 1031, buy new real estate, and voilà, you've absolutely minimized your tax burden.

Mark (00:10:02):

Yeah, that's a fantastic additional comment. And with the convenience store, another thing we had there was inventory. The 1031 on that was probably done, I believe it was actually after I had entered. But one of the responsibilities there was valuing the inventory of all the stuff on the shelves as well and separating that out from the real estate. Because that is another thing that we are actually disposing of and giving to the next purchaser of that property.

David Foster (00:10:41):

And then the other thing is, I remember, I think that the convenience store it was up north, was it Maine or New Jersey?

Mark (00:10:50):

It was Vermont.

David Foster (00:10:52):

It was where?

Mark (00:10:53):

I believe it was Vermont.

David Foster (00:10:54):

Yes, that's right. And they exchanged that for vacation rentals in Gulf Shores, Alabama, and the panhandle of Florida. So the illustration again is it's real estate for real estate. But as you start to see the national market develop and grow, you can use the 1031 to move it geographically anywhere that you want. So not only can you change sectors of real estate from commercial to residential, from land to industrial, but you can also change where it's located. I'll bet that there's more than a few people listening tonight who wish that they would've started buying property near Austin, Texas about seven or eight years ago. Who knew, right? But when you start to see those things developing, you start to see the places, I like to call them cones of investment. There are places where either the federal government or private industry are starting to focus their investment and the best thing a real estate investor can do, join the crowd. But join in while it's still a small crowd. And that's what the 1031 can let you do.

Mark (00:12:09):

And those are all great points. Here's another idea for you. So let's say this convenience store was going to be turned into something of an entirely different purpose. So let's say they were going to turn it into a yoga studio. You got all this inventory here, they don't need it. What do you do? You can maybe find a way to donate some of this to charity and then you get a deduction equal to the fair market value of those items if no one's going to use them, get the right off of the charitable donation. And also Dave as we go through these, if you have any great stories or anything that you want to just throw in there, give some cool examples. And I'm sure you've seen a lot of stuff. Feel free to just put those in there as well.

David Foster (00:12:57):

I get to do that "I knew a guy," shtick. That's awesome. Love it.

Mark (00:13:03):

Cool. Another concept here to another one of the D's here, create new depreciation. Usually we can leverage our gains into bigger properties. And especially if this is an older property, let's say we're getting to a profit margin where perhaps we don't have enough depreciation to offset our profits yet, we can create new depreciation.

David Foster (00:13:31):

Yeah. Now this one's a little tricky because you've got to coordinate with the 1031 rules. And so in order to defer all tax, your responsibility is to purchase at least as much as you sell. The depreciation clock does not simply reset when you buy the new property. So if you have a property that's been fully depreciated out, say you're selling it for 500,000 and you go buy another $500,000 property, you will defer the depreciation because you're doing a proper 1031, but you're not creating new depreciation. Now if you take that $500,000 and you go buy a property for $700,000, or you go buy two properties for $350,000 each, now you just created an additional $200,000 of depreciable basis. And that's how you can buy that new depreciation. And yeah, actually this last month we did a beautiful one. I don't know if any of your listeners are going to be familiar with Delaware statutory trusts, but they're a quirky little passive fractional ownership model that qualifies for 1031.

(00:14:58):

But you're not actually buying real estate, you're buying an interest in a Delaware trust that happens to own the real estate. And you guys call Mark and ask him about these, call me about these. Here's what's cool about them, is that if you're selling assets that you don't have any debt on and you're depreciated out and you want new depreciation, Delaware's statutory trust always come with institutional debt already attached. So you may buy a part of that Amazon distribution center and you're buying just a small part of it, but it is 50% leveraged. So you have a property you sold for $500,000 in cash, when you buy that DST, you are spending all $500,000 in cash. But what you're actually getting is a million dollars worth of the DST. And that's $500,000 of new depreciable basis. So instantly with non-recourse institutional debt, you're getting a truckload more of additional depreciation.

Mark (00:16:15):

So I didn't realize that you helped with coordinating those contributions to Delaware statutory trusts. That's really good to know.

David Foster (00:16:23):

Yeah. Well at this point in the market we get a lot of people asking for it, so we know who to send them to and to talk to people about them if they've got questions. Again, it comes back to go back to your financial planner, your accountant, but it's quite a hot little topic these days.

Mark (00:16:43):

Yeah. And DST's are really good for, if you want to kind of move more into a passive role with these Delaware statutory trusts, I believe the really common for people towards the end of their investing career. Another thing we want to think about, another example I want to give, I have a client who purchased a property in [inaudible 00:17:04] North Carolina, lower income community, but gentrifying area, put some work into it. And the market value, he bought for 175 and the market value is going to be around $300,000 about two and half years later.

(00:17:21):

And so if he sells it for $300,000, he can now leverage that profit and that equity into a much bigger deal. So now we're thinking about when we think about our down payment, which includes the money that we get from the sale. We now have, in our equity that we have in the deal, we can now leverage it into a far larger property. So we can potentially get over a million dollars of real estate now. So we start off with this small piece of that of an asset and now we can leverage it into a far greater asset and have a much larger depreciable basis and more profit.

David Foster (00:18:02):

And if you are a spreadsheet junkie, you can do these for yourselves. But what this is illustrating, and we'll hear this come out several times during tonight's talk, but the concept of compound interest, which Albert Einstein said is the eighth wonder of the world. And we throw out an example all the time of two people with a hundred thousand dollars gain, just like this guy. And if one of them chooses to pay the tax, they're going to spend around $20,000 between federal and state that's going to the government.

(00:18:40):

 That's no longer theirs to use. If the other investor, compared with them, simply does a 1031 exchange. That $20,000 of tax stays with them. Now that's cool, right? I've got $20,000 more. But what it does is what Mark just illustrated. That means now that one investor has a hundred thousand dollars that he can go buy a property with. At 20% down, he can buy a $500,000 property. The other investor only has $80,000. So what can he buy? $400,000 property. So in the very first move, they're now starting to be miles apart in what they're buying power is. And if you carry that illustration out, literally just four or five sales, you'll end up with one investor owning almost 12 million of real estate and the other investor owns three and a half, which isn't bad, we're not going to complain, but I know which one I'd rather have.

Mark (00:19:49):

And if you really want to take advantage of leverage, second home mortgage, 10% down, a lot of clients doing that.

David Foster (00:19:55):

We didn't even put that down as one of our strategies, but holy cow, yes. And here's why that's so key, because the second home mortgage gives you primary residence rates and terms are very, very favorable. And the only requirement is that the property usually be a hundred miles or more away from your current primary residence. And that you agree to use it for investment purposes, or for yourself, for two or three weeks a year. Which leaves the entire rest of the year for that property to be used for investment

Mark (00:20:39):

Open for business.

David Foster (00:20:39):

So there is no problem at all qualifying back as an investment property for our 1031 purposes.

Mark (00:20:46):

And so imagine this, you put some money down and then you get some gain. Let's say if your equity and your gain can combine to at least a hundred thousand dollars, now we're talking about a million of real estate we can get with the second home mortgage. And our clients, someone may say, "well, what am I going to get for a million dollars? We want to do multi-family." So what a lot of our clients, their investment strategies in those instances, are the higher end of short term rentals, which give fantastic margins, obviously a different business model, but very lucrative.

(00:21:22):

Let's talk about cost segregation in 1031 exchanges. Now here's another opportunity for strategy stacking and also potential tax traps that we want to watch out for as well. We could probably just talk, there's tons of articles and I've heard different viewpoints on how these interact. But we could go on for ever. At a high level, the traps are when we do the cost segregation, we identify property that is non real estate, we can write it off right away. So we do a 1031, we might have to worry about some depreciation recapture. And that is taxed at your ordinary income rate.

David Foster (00:22:08):

Yeah, that's exactly right. That's a gotcha that a lot of people don't realize. When Trump instituted the new rules on advanced depreciation, there was some hope that it was going to evolve to allow you to still include it as real estate when you sold. But I think that ship has pretty much sailed. So again, we go back to the very first slide. You need to be talking to your accountant. Because sometimes recapturing depreciation isn't a bad idea, if you've got some built up losses, some operating losses, some ways to offset it. Because of the pop you get from doing it initially. Did you have a windfall this year? Let's offset that with some bonus depreciation. Are you anticipating a reduction in your income next year? But who's going to know that? Mark is, every day.

Mark (00:23:07):

Absolutely. And some other things we can do to offset this. Let's say we're having a good year, obviously we can bring down the tax rate on our ordinary income with things like SEP IRA contributions, cost segregation studies again to offset the depreciation recapture. And we do cost segregation study on the replacement property of the excess value.

(00:23:35):

 We can even, there are different ways that we can actually, believe it or not, do a cost segregation study on the replacement property. There are two ways that we can look at that replacement value. We can elect to treat all the replacement property as brand new and run the cost tag on that new replaced basis. But there's another election where we carry over that prior year's depreciation and it won't qualify for both appreciation or cost segregation. So there's some analysis that we want to do here based on your scenario on how we are going to carry over and report your new depreciable basis. Another thing that we can do to mitigate the depreciation with capture is evaluating the fair market value of this property that's going to see depreciation recapture. Maybe get your cost segregation engineer involved in this and analyze what's fair market value of this property that we fully wrote off. Maybe if we can cut it in half, to minimize the depreciation recapture.

(00:24:40):

Cool. Let's talk about house flipping. Okay, so I bet you get asked this question all the time, "why are all these idiots paying ordinary income tax on their house flips? Why don't they just do 1031's, right Dave?

David Foster (00:24:53):

Look at it again. Flipping is a four-letter word, or at least flip is. It's the worst of the four-letter words. Yeah, and here's why.

PART 1 OF 4 ENDS [00:25:04]

David Foster (00:25:02):

That's a four-letter words. Yeah, and here's why. Because again, one of the requirements for property that qualifies for 1031 treatment is that the property be property you purchased with the intent of holding for productive use. If your intent is primarily to resell it, the fix and flip model, then it does not qualify for 1031 treatment. You will pay ordinary income on that profit. So not only can you not defer it, but you're going to pay more in tax. And that just breaks my heart every time.

(00:25:43):

I mean, I do get it. There are a lot of people out there that depend on flipping as their source of income, and so they've got to do that. But even then, there's other ways that we have of fixing that. What I talk to people about doing is, flipping on its head. Change the model ever so slightly. And here's how it would work. So instead of buying a house and flipping it, we use a concept that the folks with bigger pockets came up with. They called it... What they call it, Mark? The-

Mark (00:26:17):

Loose Option?

David Foster (00:26:18):

The BRRRR Method.

Mark (00:26:20):

Okay. Yeah, [inaudible 00:26:22]. Yep.

David Foster (00:26:22):

It's called the BRRRR Method. It stands for, instead of buying, and fixing, and flip it, you buy it, you rehab it, you rent it, and then you refinance it. So by doing that, first of all, you changed your intent, so that if you ever do sell that house, you can now 1031 Exchange it and defer all the tax. But what you did was by buying it, rehabbing it, and renting it, you now have income from a tenant. The tenant is paying the amortization on your mortgage.

(00:27:03):

That's something a lot of people overlook. That loan being paid down isn't being paid down by you, it's being paid down by your tenant. And what did you do? You refinanced it, and that freed up cash that is tax free. So if you're one of those folks that makes a living doing that, you can use the tax free cash to live on. But here's an even better accelerator. This is gasoline on the fire. You take the cash-out refinance, and go buy another property just like that.

Mark (00:27:39):

Yep. Again, this is actually the compounding of interest.

David Foster (00:27:42):

Bingo, bingo, bingo. In the course of a year, you've all of a sudden got four or five properties. I had a guy who's in the Orlando area that literally does 30 or 40 exchanges a year with us. And for the first year he was doing it, every time he called, I would say, " Hey, are you sure this is not just a flip?" He said, "No." And then, he showed me his portfolio. And then, when he was never selling a property that he had owned less than a year. But because he had built up so many using refinance, now he was just like clockwork. He was an engine.

Mark (00:28:22):

Such a powerful strategy. And again, even though you're taking out a lot of the cash, and it's really favorable from a tax and cash flow perspective, you still run the [inaudible 00:28:34], and get some write-off there as well. Another idea is you can present a lease option purchase to prospective buyers. So instead of just having an instance where you have... Well, again, our intent has to make this to be a landlord, right? You have to market it as available for rent.

(00:28:56):

But if you have the opportunity to say, "Hey, try this out as a rental, and we'll give you the option to purchase it." You may have the opportunity now to change the nature of this transaction from one as broker-dealer to one that can be treated for capital gains, because, first, they were your tenant. The intention for them to be a rental. And now, if we were to sell it, obviously you'll get that favorable capital gains treatment. But you want to do a little bit better. Call David. Now, you can do a 1031 into another property. Now, that property also has to be a rental property. Or not just a rental, but an investment fixed asset, not one with-

David Foster (00:29:37):

Yes. Sure. That's right. Correct. Yep. Yeah.

Mark (00:29:40):

And another incentive here is, if they are considering buyers in the future, they're going to be good tenants, because they don't want to mess up the property. You can even take a portion of their rent and put that towards their down payment, so they become invested. And if they decide not to buy it, well first of all, that down payment towards the purchase untaxed, because it's a liability. And also, it just gives you a little bit more cash to come in to your pocket.

David Foster (00:30:06):

Yeah. And here's actually a great tweak on that strategy. This is one of my favorite purchases of all time. So we changed that model a little bit, although it's a great one. Particularly if you have a heart for helping people bootstrap themselves up. Instead of giving handouts, you're giving hand ups. And a lot of times, people are great tenants, but they don't have the cash or the credit for a down payment. And for a little bit of money that goes into your pocket, hey, who's going to turn down profit? Right?

(00:30:37):

You can sell to them an option that will let them purchase that property once their credit has healed. I love that. But Mark, this was fun. Here's where we change the model. Back in Denver in the early 2000s, I changed it so that I developed a search and purchase lease option business for corporate executives. So they would be moving into Denver, and we would get in contact with them. And they weren't sure they were coming in to work for AT&T or Quest. The telecom industry was huge. They weren't sure where they wanted to live.

(00:31:17):

So we would say, "Well, here's the deal. Go pick out a house you think you might like. I'll buy it. And I'll lease it to you for three years. And I'll give you an option to purchase it anytime you want." At plus 10% in year one, plus 15 year two, plus 18 year three. So they could exercise that. If they loved it, they could buy it at any time they wanted. What did I get? Guaranteed lease increases. And then, we would get the option strike, so that went right into our pocket. And guess what? These were people that had plenty of money. It was just a question of where they wanted to live. I never had to change a toilet or a valve the entire time we were doing it.

Mark (00:32:08):

That's awesome.

David Foster (00:32:09):

And the favorite house that I ever purchased for one, they picked it out. And when we closed on it, I drove over to do a handoff. Back then, you did the handoff of keys with the seller. And I drove over there, and there was this 45-foot RV with a matching truck in the circle drive, and it was the sellers. I went, "Holy cow. What is this? I didn't pay you that much." They said, "No. We actually won the lottery. And we were selling the house, so we could go in our RV. But we didn't want you to know, so you could negotiate us down."

Mark (00:32:49):

That's good. I like it. That's a good story. That's really cool. Again, there's so many ways if you're resourceful and creative that you can look at this and leverage the 1031. And let's say, these tenant don't decide to buy the property, right? Just sell someone else the 1031. Lots of opportunities there. Very cool story indeed. Talk about the next strategy here.

(00:33:15):

I wanted talk about this one, Dave, because I am starting to work with some property developers and some bigger projects here. And there might be some opportunities here. And I just love the possibility of this. And I figure you could probably give us greater insight on this based on your experience. And I'm going to send this to some of the people that I'm working with. So let's talk about development or construction 1031 Exchanges.

David Foster (00:33:45):

Yeah, boy there is. Oh, my gosh. That sound you hear is all the attorneys in America flying in and out of the room in anticipation of the business they're going to get from this. These are a very gray, and yet at the same time, tight-knit area for 1031 Exchange on a bunch of different levels. Let's just start throwing some scenarios out, because they're going to be developed a whole bunch of different ways. Give me a scenario regarding the construction side of things first. And we'll back into that. Tell me what you got.

Mark (00:34:25):

All right. So let's say we have a group of investors. Well, let's just say, we have an investor here, and they're selling. They have, let's say, a multifamily. They're going to sell at a massive profit. And they want to build something up from scratch. And they're looking at plots of land to 1031. But they're saying, "Hey, the value of this land isn't nearly as much as the value of the land and building that we're selling. So we want to find an opportunity to potentially include in this value the future purchases of this development. We're going to make a 30-unit multifamily development on this plot of land."

David Foster (00:35:08):

Yep. So, now, when you talk about a 30 home development.

Mark (00:35:15):

That probably wouldn't work, I'm guessing.

David Foster (00:35:17):

Well, there's ways. Don't temp me. There's ways.

Mark (00:35:20):

Yeah.

David Foster (00:35:20):

And that's what I'm excited to get to. But remember the 1031 is for property you intend to hold at may be an easier to understand level. Let's talk about somebody who's selling an asset, and they want to purchase a new headquarters for their corporation that doesn't exist yet. They know the tract of land they want. And they want to build a corporate headquarters on it, or a restaurant for their restaurant, whatever. But it's one building that they're going to hold it. Now, that would qualify for 1031, wouldn't it? Because I'm intending to hold it. But the problem is going to be twofold. First of all, you can't exchange into property you already own. So if you buy the land, you can't exchange into it anymore. Secondly, you can't exchange into the improvements on land you already own.

(00:36:21):

So you couldn't buy the land, and then exchange into the building on it. And then thirdly, from the day you close the sale of your old property, you only have 180 days to take title to the new property. So there's your threefold problem right there. I can't build soon enough. I can't take title to the land and start building. And I can't exchange into the improvements once I own the land. So there is, depending on which one's the worst problem, a construction 1031 Exchange might work, where we as the 1031 QI take title to the land. So it's bought with the client's money, but we're the ones that take title to it. And while we are holding that, then they start building on it. And it becomes a question of, how much construction can they get done in 180 days? Because the construction exchange also has 180-day calendar.

(00:37:33):

You have 180 days from the day that we take title to it, to complete and take title to the new property yourself. And for those of you out there, this is a twist on also what we call a Reverse Exchange. It really doesn't allow you to reverse the process, but it makes it look like you're purchasing first. And there is a safe harbor from the IRS for this, but it's a very specific process. But if you can't get enough value. Let's say you're selling a $500,000 asset. So you need to buy 500,000. The land that you need to purchase is 250. And the building is going to be another 750. Well, all you've got to add is another $250,000 of value. And you'll now meet that $500,000 requirement, right? So we would take title to the land, then you would put $250,000 of improvements into it. And then, we shift ownership to you. And that completes your 1031 Exchange. And then, you simply complete the construction at your own pace after that. Makes sense?

Mark (00:38:58):

Now, here's a tricky part of this is, at what point does the pipes and the lumber materials become a part of the real estate? I imagine it has to be in place, and part of that plot of land, and fully installed before we can say that these are bricks as it becomes materials, as it transitions from being classified as just materials into being classified as actually part of the building, right?

David Foster (00:39:25):

Yeah. Well, that's exactly right. And this is where we go back to number one. I love that first line. Talk to your accountant. Because I am the worst property manager and construction manager in the world. You tell me that $500,000 of paving was done, I believe you. You tell me the kitchen cabinets are in. I don't know whether they're ordered, in the garage, or on the walls. That's where you've got to work with your accountant, to see at what point did we transition from it being materials into part of the real estate.

(00:40:07):

But that's the beauty of it. So that's one twist is the ability to build something that doesn't exist. Now, improvement exchanges are even easier than that. You buy a property for $300,000, needs $200,000 of improvement. You can generally get that done in two or three months. So we take title to it, while we hold it, you improve it. And you not only sold a property for 300,000 and deferred all the tax, but you just bought yourself a brand new basically property that's been improved and renovated all with your 1031 dollars.

Mark (00:40:49):

Yeah. So like I said, I haven't had the opportunity to do one. I presented this to clients. It's hard. A lot of our clients aren't really into the development and building. But I'm keeping my hopes out there that we'll have a chance to work on this. This will be a tricky one to implement, but such a cool idea. So it's out there, and we'll be willing to help you out if we get the opportunity.

(00:41:14):

Let's talk about multi-asset investments. So let's just say multi-assets here, multiple assets. Earlier, one of our guests, John S, he has a portfolio of properties that he's going to sell all at once. And how does that work? If we're going to sell one property, if we want multiple properties, there are ways that we can do this as well. So fill us in on that whole process.

David Foster (00:41:42):

Yeah. There's a couple different ways depending on what the market is telling you. So first of all, it is possible to sell an entire portfolio as one sale and one 1031. That's not a problem. And when you do that, you then only have one 45-day timeline that you have to worry about. You only have one 180-day timeline. So you could sell that portfolio of properties, 10 properties, for $200,000 each for $2 million, and go and buy as many replacement properties as you want. And the ease of that is because you only have one 45-day identification period to worry about and 180-day period. And so, you would set about during that 45-day period of identifying 10, or 15, or 20 properties that you want to buy in that price range. And that can work very nice.

(00:42:44):

Downsides to a portfolio sale obviously are that the sharks swim in that water. And so, it's hard to sell an entire portfolio without taking a bit of a haircut on the price of them. So you can also sell them as individuals. Now, if you happen to own those properties all in LA County, California, or maybe Sevierville, Tennessee, or Seattle, they're probably all going to go under contract, and sell within one day of each other anyways, because that's what the market is. And so in that case, what you've got is 10 sales or 20 sales each with their own 45-day deadline and 180 days. But there's so much overlap, that you could then set about identifying multiple properties that will each be used for maybe a couple of your exchanges.

(00:43:53):

Actually, this is the reverse of multi-asset purchasing. This is what we would call a Consolidation Exchange. So you take two of your $200,000 sales. But because the timeline's overlap enough, you're purchasing one $400,000 replacement. And where this becomes beautiful is when you're wanting to really ratchet up your portfolio in terms of its value, because you see at a higher ROI. Or because you're going from single family to multi-family, and you can get more dollars per door of rental. Whatever the reason is, as long as you can make the timelines overlap, so that the property you want to purchase can go on both 45-day deadlines, it can be purchased within 180 days of when the first property sells. You're golden. Consolidation Exchange is great.

(00:44:54):

The opposite of that, I think where we started was diversification, selling one and buying multiple. And that is easy enough to do as long as you purchase in total at least as much as your net sale. And you use all of the proceeds from the sale to do that, you'll defer all tax. So I think my poster child for that are the people that say they buy a property for, gosh, I used to say a hundred thousand dollars. You can't even buy that anymore. But let's use the example. You buy a property for a hundred thousand dollars. You fix it up. You put a renter in it. It's a couple years later, and all of a sudden that thing is now worth $200,000. Awesome. So you want to sell it and take advantage of the 1031, but here's the problem. You're very comfortable in the hundred thousand-dollar demographic. You know that.

(00:45:59):

You know exactly what kind of flooring is needed, exactly where to advertise for tenants, exactly how to market it, what kinds of countertops it needs. You're not so sure at 200,000. Is that Corian? Or is that laminate? Is it carpet? Is it tile? I don't know what to do. I'm scared. I'm scared of those people. But why not take that $200,000 sale and go buy two hundred thousand-dollar properties? You live in that world, you love that world. Fix them up, rent them up, and when those are each worth 200,000, what are you going to do? Sell them and go buy four hundred thousand-dollar properties. And then, one day you're going to wake up, Mark, and you're going to be tired. And you'll wonder why. That person's going to wonder why. And they're going to call you, and say, "Why am I tired?" And you're going to say, "Dude, I'm tired too, because we got 40 properties we're trying to report on your tax returns."

Mark (00:47:06):

Yeah, I've got one right now. It's just brutal right now.

David Foster (00:47:09):

Yeah. And so, what are they going to do? They'll start to sell those and consolidate into fewer. And that's what I call the ebb and flow. When the market speaks, you expand. When the market speaks, you contract. And you could do it all with the 1031 without ever paying tax.

Mark (00:47:34):

Question on this. So let's say, we have a portfolio of 10 property. What are our rules if, let's say, if it was one transaction, 10 property. What are our rules for identifying replacement properties in that? Does this still going to be-

David Foster (00:47:55):

Let's say those are $200,000 properties, okay? So the sales can be two million bucks. So as far as identify them, you have 45 days to identify your potential replacements. At the end of that 45 days, the list is set in stone and cannot be changed. So that's number one. You got to know, that's all the time you've got. But leading up to that, you can close on any properties you want during the 45-day period. So I want everybody to keep that in the back of your mind. Here's the identification rules. If you're trying to go to a larger asset, you want to sell that $2 million portfolio, and go buy two or $3 million multi-families. Perfectly fine.

(00:48:50):

But as long as you name three or fewer replacements on your list, their price doesn't matter. So sell for 2 million and name three $5 million apartment complexes. That's perfectly fine. But if you're wanting to go the opposite direction and buy many smaller properties, then here's what comes into play. If you name more than three potential replacements, their total value cannot be more than 200% of what you sold. So you sell for two million, you can name 50 potential replacements, as long as the total aggregate value isn't more than $4 million. Make sense? Here's the last exception of that though, and why I started out during the 45-day thing. The one exception of that is if you actually purchase-

PART 2 OF 4 ENDS [00:50:04]

David Foster (00:50:02):

Is if you actually purchase 95% of the value of the list. So what would that be? If you actually purchased $1.9 million of the list, it will still qualify. How do people do that when they're trying to buy 50 properties? Well the answer is, they already have them under contract before their sale closes, and they close on all of them during the 45 day period. So that when day 45 comes, their list is limited to the number of properties they've already closed. And that's how they can do it.

Mark (00:50:46):

Yeah. So some other ideas we can think about here, as far as strategizing here. We can actually, I think we're going to talk about it here, but the reverse 1031 exchange. So let's say we know it's going to be a struggle to identify the replacement properties. We have a seller locked in who's patient. The hard part is identifying the replacement properties.

(00:51:09):

So what we can do is, we'll actually instead, we're going to maybe lock in the replacement property first. Because that's going to maybe take a little more adjustments and more search and a little bit more due diligence, and we don't want to be under the gun. Let's say we know it's going to take more than 45 days, we don't know how long it's going to take. So we identify the replacement property first, and then we sell to the seller.

(00:51:34):

One of the advantages of this, of doing the reverse is, unlike the traditional 1031 where you sell your property, you have 180 dates by the replacement, you have the dead time with no property, no revenue. When you do the reverse, you have two properties generating cash, cash flowing into your pocket as you are performing the 1031 exchange and you're a little bit less under the gun to find the replacement properties.

David Foster (00:52:03):

Yeah, absolutely. And that's our reverse exchange, what we talked about earlier. But there's no development and no construction needed. We simply take title and hold that property until your old property closes.

(00:52:17):

But you're right, that's a great theorem, maxim for life: Do the hard thing first. And when we're in a market like this, the hard thing is not selling your property. The hard thing is finding the new property. So, some twists on that, that can save you the high cost of a reverse exchange, are to locate the new property first and get it under contract before you close the sale of your old property. That's perfectly fine. So then we don't even have to do the reverse round, but you've already got your property locked up and it's waiting for you. And especially if you've got a friendly buyer who's willing to wait, that's awesome.

(00:53:02):

But what else can you do to entice those sellers to work with you? Offer them a bunch of earnest money. Offer them earnest money that may even be releasable if you are certain that your sale is going to go through. Because when you go to that purchase, the 1031 money can all go forward, and part of that can be used to repay you for the earnest money that you put out in the buying process. So even though it may involve some expense from you at first, that can come back when you close your purchase.

(00:53:42):

And I'm always fond of telling people too, especially if you're buying a larger asset, that LOIs are a wonderful thing, letters of intent. Because generally you get a longer due diligence period, a longer finance contingency period. Use those to your advantage. Get it under contract, at an extended period as you can, and then go sell your property. And like I say, if you're in San Francisco and you don't have 10 offers on the day you put it on the market, it may be over-priced, I don't know.

Mark (00:54:23):

Yeah. And make sure the contract is assignable, so we can assign the exchange intermediary. And also, you might want to not show all your cards. They don't need to know that you're doing a 1031 exchange before you get it under contract as well. So they might say, "Oh, well this guy's under the gun, he needs to close something fast. We can really take advantage of this." You may want to just not show all your cards in the negotiation process.

David Foster (00:54:51):

Yeah, that's a great point. And you're right, simply using assignable contracts solves all of that. So that's always an encouragement they have. Let me leave this part of the topic with, when we talk about multi-asset, it just occurred to me, that does not necessarily mean the same type of asset.

(00:55:11):

And so again, as you're going through your investing career, at different stages you may want to invest in different things. And I will frequently have people who are starting to look towards slowing down. They've had a good long investing career. "What am I going to do, Dave, just sell and keep buying single family homes? I'm tired." And that's when we talk about moving into larger, different class assets.

(00:55:42):

But the other thing that I hear right along with that is, "My spouse is even more tired. And he or she are wanting to start enjoying some of this money. When do we get to enjoy the money?" Because in the 1031 exchange it all has to go forward.

(00:56:02):

So there's two times that happens. Number one, don't ever forget that when you do the 1031, the opportunity to refinance and take cash afterwards is huge. Because you can pull the money out tax free, you use it for whatever you want. Now, depending on what you use it, there's going to be some implications on, are they going to be able to take the interest deduction. Correct?

Mark (00:56:34):

Mm-hmm. Oh and another thing is, so let's talk about the timing of when we refi, right?

David Foster (00:56:42):

Yeah. If you refinance before you sell, which is many times a temptation, the IRS has a tendency to look at that as you trying to pull profit out ahead of a 1031 exchange. Well, guess what? That's exactly what you're doing. So they're right. And when you do that, they're going to want to disallow your exchange because of that.

(00:57:09):

But when you refinance after a 1031 is complete, even if it's one day or the same day, you're no longer taking profit. What you are doing is borrowing someone else's money, but it is secured by the equity in your property. And that is perfectly allowable. So do it afterwards.

(00:57:38):

And then, depending on how you use the money, you may or may not be able to get the mortgage interest right off, but your tenant is still going to be making the mortgage payments for you.

Mark (00:57:51):

Well, think about this. Also, for some of the accountants out there listening in, when you [inaudible 00:57:59] the document, this multi-asset 1031 exchange, and on the 8824 it is a brutal document, so this is for the accountants in the audience. They actually require that you provide a separate work paper documenting how you calculated the deferer's gain. So you actually have to do some workarounds on your tax software because they say actually, they specify the instructions to not fill out certain lines and actually do it manually.

(00:58:23):

And so I spent a lot of time developing that work paper and scrutinizing myself. And it was a challenging process. But any of you accountants in the group, everyone [inaudible 00:58:37] connect on this, we'll talk and I can show you what I've gained through that process.

David Foster (00:58:41):

Yeah, that's actually a great point. Because you have to allocate the basis of that old property amongst the assets. And so there's got to be a rationale for that.

(00:58:54):

Now the other side though, because I think for the spouse that wants to enjoy, you got the cash out [inaudible 00:59:02] you also have the opportunity to spend, say, from a multi-family portfolio or a large commercial portfolio, into maybe some vacation rentals where you can start to enjoy them yourself.

(00:59:21):

So you can start to use the 1031 to position yourself to get free vacations. Or maybe ahead of retirement. So that when you retire, what you do is, and I don't know if we got a slide for this later, but you actually decide to end up converting that property from investment-

Mark (00:59:41):

Love this strategy.

David Foster (00:59:42):

Into your primary residence. And that's another one of the Ds. Because as long as you don't sell it, if all you do is convert the property, you'll still never pay the tax. So, you sell your property in Cincinnati and you move into your vacation rental in Destin, Florida. Not a taxable event. It simply changes where that property is reported on your tax return.

(01:00:13):

But when you did that, the sale in Cincinnati was tax free as your primary residence, put the money in your pocket and have fun. Move into the property in Destin, and as long as you live there, you'll never pay the tax.

Mark (01:00:30):

I love that. And also, just as a heads up, you can only exchange US property for US property. So if you want to have vacation rentals in Costa Rica, that's great, can't do it. [inaudible 01:00:42] the 1031 for the US.

David Foster (01:00:48):

Ooh, pick me, pick me. Guam and the US Virgin Islands also qualify.

Mark (01:00:51):

Oh, good to know.

David Foster (01:00:52):

As US property. Oh yeah, and the Northern Marianas, if you can find it on a map. But we have people that will go into, there's some beautiful places on the island of St. John's. It's 75% National Park. It's everything that the Dominican Republican and Costa Rica can ever offer. But it qualifies for 1031, from a US property.

Mark (01:01:19):

So I didn't know that, so there are some foreign properties that will qualify. Okay.

David Foster (01:01:24):

Yeah. But I know someone's going to ask in the chat box, "What about Puerto Rico?" Puerto Rico does not. Ask me why, I tell you, "I don't know." It has something to do with how the treaty was set up when they became a territory. So it's got to be a very specifically set up treaty that turned it into a territory. And that's why we know Guam and the Marianas, and the US VIs count, but not Puerto Rico.

Mark (01:01:52):

Yeah, very interesting. I'm sure there's an interesting story behind it. And Puerto Rico has an interesting way, their capital gains are treated entirely different on Puerto Rico. I haven't had any investors there.

(01:02:07):

And also, so when you refi, people say, "Well, I want to do a cash-out refi for my rentals. But do I have to buy another rental property?" or whatever. If you're doing a cash-out, if you're refinancing and taking cash out of your rentals, you can do whatever the heck you want. You can buy a new Mustang. It doesn't have to be business because it's just money that you're borrowing against the equity in your property. However, if you are-

David Foster (01:02:36):

That's where you buy the property in Costa Rica with.

Mark (01:02:39):

There we go, exactly. And then you [inaudible 01:02:41] the 1031 into the mountain cabin in Colorado. However, if you [inaudible 01:02:50] to borrow from it against the equity and that interest is for business purpose, then that interest would be, in that instance the interest you would be able to deduct against that business activity. Let's see what the next topic is here. We already talked about reverse 1031s. Anything you want to add on this?

David Foster (01:03:15):

No, I love, you've got to start working on these early because they take a lot of coordination. Between a CPA, between the lenders, and between the QI. So they're not cheap, and they're not easy, but with enough planning they can work for you pretty awesome.

(01:03:35):

A reverse exchange. For just a regular property, [inaudible 01:03:42] one might cost you $850 or a thousand bucks. You can always [inaudible 01:03:46]. When you do a reverse exchange, something even that small is going to add $6,000 to $10,000 to the price. And you can imagine on bigger projects what that's going to be.

(01:03:56):

But here's what people forget. And that is that, while you still own your old property, you're generating all the income off of that. You're getting all of the tax breaks on that. While we hold title to the new property, waiting for your old property to close, you are making all of the income off of that property.

(01:04:25):

So by the time you look at that as a form of double dipping, for that six month period, [inaudible 01:04:35] always the amount of extra income you get will offset the cost of the reverse exchange. So although they're expensive, there's some ways to mitigate that to your benefit.

Mark (01:04:48):

Awesome. Great insight right there. Let's talk about, this is one of my favorites, and this is actually how I met Dave. Because I couldn't find an answer. I had to go to the forum. House hacking and primary residence and 1031 exchanges. We could probably do a whole webinar on just this.

(01:05:07):

But let me tell you the story about the deal that I was doing that led me to Dave is, we had a client who was selling a property with about maybe $80,000 of capital gain. And the client also went to do a house hack with FHA financing, 3% down or 3.5% down. And you can leverage that into a multifamily unit. And this client eventually purchased, or was planning to purchase roughly, I think it was an $800,000 FHA leveraged house hack where the client was going to live for free for the remainder of the time there. And it was a beautiful place on the lake, wonderful place. Just amazing.

(01:05:51):

And then I thought to myself, "Well hey, wait a second. Majority of this property is going to be business. Even though we're using FHA financing and living in it, we're still buying business property and we're still selling business property." So that's when we looped in Dave, and we actually did the 1031 exchange from the short-term rental that she sold into a multi-family unit where she lived in, and then we leveraged FHA financing to really maximize the amount of real estate that we were able to get in this transaction.

David Foster (01:06:23):

Oh yeah, this one's close to my heart because I think for every American out there, this is the absolute best way to build your wealth that exists on the planet right now. As well as being the most healthy I think for your personal life.

(01:06:44):

And let me wax eloquent for a moment here. My wife and I figured out a while back, we were simply doing some math. We have had people living with us as renters in our houses, whether they were vacation rentals or whether they were our primary residence, or whether they were the other half of a duplex, for 28 out of our 32 years of marriage. The community that you get in building relationships by doing life together is massive.

(01:07:21):

Now, that could be as simple as buying a single family house and renting out the rooms. That's a house hack. Now, when someone does that, Mark, and you verified this for me, when they go to sell, if you have not allocated out the individual bedrooms as investment, if it's simply part of this shared living space, they do need to declare the income, but there's no depreciation taken. And when they sell that, they get the entire primary residence tax-free benefit. Correct?

Mark (01:08:03):

Yeah. So this is a tricky one of house hacking, and I have a video on my YouTube page, a quick one on this. So let's say I live in a house with two roommates. The only portion that will actually depreciate is the portion of which that is fully dedicated to the usage of our tenants. So those individual bedrooms that we don't step foot in, those will receive depreciation or treated as business properties. So those two bedrooms of the three bedrooms will not qualify for that Section 121 gain exclusion.

(01:08:35):

So the remaining amount that we share, the kitchen and the bathroom and the living room, all of that which is shared, and the land and the driveway, that will qualify for Section 121 exclusion.

David Foster (01:08:48):

Right. But because you've depreciated those other rooms, you get the depreciation benefit. And because that has been set aside as investment real estate, guess what? When you sell that property, you can take the allocation towards the primary residence tax free, and do a 1031 on the rest. And that's what's beautiful. So part of it's tax free, the rest of it's all tax deferred.

(01:09:18):

And the thing that I love best though, the application for this, we're doing this right now with my children as they get out of college, and all my nieces and nephews. Is that we are working with them to buy a multi-family at the location of their first job. And the reason why we're using small multi-families is exactly what you said, because both FHA and conventional financing will let you purchase a property that is four or fewer units, duplex, triplex, quad. And you can get primary residence financing for those even though you are renting the other units.

(01:10:05):

So my electrical engineer that just graduated, we're looking for a duplex for him right now. His mortgage will be free because we're renting the other units. But he only has to put three and a half percent down. And when he sells that property, he will get the primary residence exclusion on the half he lives in, and the other half he will 1031 into, I don't know, maybe another multi-family.

Mark (01:10:41):

Yeah.

David Foster (01:10:41):

Three and a half percent down. And as long as the part of the property that's going to be used for investment is equal to the amount that he sold that was used for investment, he can live in the other half. So the 1031 will actually be able to buy his next primary residence.

Mark (01:11:09):

Love it. Such a powerful strategy. And we think about, our mission is to help real estate investors and business owners achieve financial freedom. And when we think about what we were able to do for that client where she eliminated the burden of paying mortgage and taxes and insurance, we eliminated that overhead. And this is in New York, where it's hard to afford where you live.

(01:11:31):

Not only did we upgrade the quality of life for our client, where she lives on this beautiful place on the lake, we've eliminated her housing overhead, and now she has the opportunity to take more risk and invest in more property. And maybe if she wants to leave her day job sooner, that opportunity is available, have that financial freedom. We've just accelerated the process by which we can do it. And we paid zero dollars on the gain of the short term rental, which gave us access to more equity and cash.

David Foster (01:12:05):

Yeah. And since we're on the topic of primary residences, let me give you one other really powerful retirement plan for you.

(01:12:14):

So almost everybody goes into retirement with an idea of, "If I run short, I can deliver pizzas, I can go bag groceries, make a little money to come in." Remember us talking about the conversion of the investment real estate into your primary residence? I have a client in St. Pete Beach here, who's a realtor, who owns three identical, they're on the same floor, condos beachfront. He rents them out right now, they're investment.

(01:12:51):

When he is ready to retire, he's going to sell his primary residence. That money will be tax free. That's the start of his retirement nest egg. He's going to move into the first one of his investment properties. Well, that's no longer investment. Now it's his primary residence. When you convert a property into your primary residence, you're still going to be able to take a partial exemption.

(01:13:25):

Now here's the way that it works. If the property was the product of a 1031 exchange, as opposed to, let me back up. To qualify for the primary residence exemption, you must have bought a primary residence, lived in it for two out of the five years prior to selling it. And as a married couple, you will get the first $500,000 of profit tax free, $250,000 if you're an individual. Now that's profit, not sales price.

(01:13:57):

When you convert a property from investment into your primary residence, that was once the product of a 1031 exchange, before you can sell it, you have to have owned it for five years, you have to have lived in it for two out of the five years prior to selling it. That's sounds familiar, right? You have to recapture all depreciation. Since 2008, I think it is. But when you sell, you get to prorate the rest of the profit between the years it was used as your primary residence and as investment.

(01:14:41):

So let's say he happened to buy it, rented it for three years, and then he moved into it and lived in it for two. Did he own it for five? Yep. Did he live in it for two out of the five prior? Yep. And when he sells it, he'll get 40% of the profit tax free.

PART 3 OF 4 ENDS [01:15:04]

David Foster (01:15:02):

... Of the profit tax free.

Mark (01:15:04):

Awesome.

David Foster (01:15:05):

Where is he going to move?

Mark (01:15:09):

Multi-family unit, hopefully.

David Foster (01:15:12):

Next door into the next one. Dude, so instead of having to deliver pizzas, his retirement job is every five or six years, he moves into a different beautiful condo. Is he going to pay some tax? Sure. But, he was going to have to pay tax on his tip money from the pizzas. So, why not pay a little bit and shelter everything else out? And remember the end game, he still owns those, his last property when he dies, his heirs get it, and all of the profit and depreciation disappear. And, his kids bury him with a smile.

Mark (01:15:54):

There we go. I love it.

David Foster (01:15:56):

And I'm not sure that's really a... Hopefully it's a smile of fun and not anything else, but yeah.

Mark (01:16:04):

I like that, very funny. Let's see what else we have here. Okay, so let's say that we are active investors. We're self managing, and we want to phase out our participation in our rental properties. And, we want to maybe have a more passive role here. Maybe we're thinking about being cash partners, syndications, things of that nature, how can we do this and what are some strategies that you've seen?

David Foster (01:16:33):

Sure. Well, first of all, you want to work your way down the scale of where you're going to be comfortable. Because going from active to passive might simply mean going from managing your own properties, to hiring a management company. And so, you're trying to do your 1031 to position yourself with enough of a better cash flow that it will sustain then hiring a management company. So that's number one. Number two though could be going from say, single families that are heavy hands on, to a multi-family where you can have one unit that's on-site management. Or again, managed by a company. That's going active to passive using the 1031 exchange. It might be going from residential into what is called triple net commercial, which the triple net, the and, and, and, simply means that the tenant is responsible for all taxes, insurance, and maintenance. So you truly, at that point, only have to manage the signing of the lease and you got to walk to the mailbox to collect the rent checks. So, that's active to passive.

(01:17:53):

The Delaware Statutory Trusts that we talked about earlier are fractional ownerships. Those are absolutely passive. You pick them out, you buy them, you have nothing to do with management. You collect what we call mailbox money. That's active to passive. Buying vacation rentals, you can put them into either a community [inaudible 01:18:20], like a lot of the Colorado [inaudible 01:18:23] is. Or, it could be something where you hire a management company. Again, that's a form of active to passive. You mentioned syndications, which is an interesting animal. [inaudible 01:18:36]-

Mark (01:18:36):

And that's going to be a tricky one.

David Foster (01:18:37):

... which is really simply... What's that?

Mark (01:18:40):

That's a tricky one because tenancy in common, but I'll let you...

David Foster (01:18:43):

That's exactly right. Yeah. Truly, a syndication is just a bunch of people getting together to buy a piece of property. A Delaware Statutory Trust is a form of a syndication, but it's a form that the IRS has specifically blessed. The typical syndications that Mark and I are talking about are LP or general partnership syndications where what you may be buying is not real estate, but you may be buying a membership interest in an entity that holds real estate. And, that does not qualify for 1031 because the 1031 has to be used, it has to be the sale of real estate, and it has to be the purchase of actual real estate. So the quick answer, and then, Mark, I'll let you expand on that, is that that syndicate or that partnership has to be able to sell to you a tenanted common interest in the asset itself. And then, that will qualify for 1031.

Mark (01:19:54):

Exactly. So, you want to work with flexible people here who will allow for that type of arrangement. And also, of course, coordinate with your accountant to make sure that you, and people like this, make sure that you can make this happen. So, before we go into questions, let's do one more which is legacy wealth building and how does a 1031 play into that?

David Foster (01:20:16):

Yeah. I have a family right now that we did our... Well, we did Grandpa's last exchange. And, when Grandpa passed away, his entire estate of portfolio of properties went to his son. When his son inherited those properties, the tax disappeared because of the step up in basis. That gentleman passed away several years ago and the money went to the children... The properties went to two children who, again, inherited now a much more expanded portfolio, but again, tax free. And they are now in the process of building on top of that portfolio. And that truly is the final D of the 1031 investing. Remember, as long as you never sell a property, you never pay a tax. As long as any time you sell a property you do a 1031 exchange, you never pay the tax. As long as any time you convert a property and live in it, you never pay the tax. And finally, as long as you die owning your real estate, your heirs will never pay the tax.

(01:21:38):

I can't imagine a more powerful strategy if you like your children. And if you don't, my advice to you is be very careful that they don't learn about this and decide to go into the medical field just so they can learn how to shut machines off.

Mark (01:21:58):

Yeah. Yeah, and so, another thing that we were talking about here is we have the four Ds, but then after you die, maybe try to do just some more cost segs in there if you can, and you'll see the benefit if it's worth the energy. Because, even though you're going to get all this depreciation and shift into that year, if it goes straight to the heirs, it gets stepped up to fair market value anyway, and then we don't have to worry about any recapture of that 1245 non-real estate property. That gets stepped to fair market value basis as well.

David Foster (01:22:29):

Yeah, I mean, I'm still shaking my head [inaudible 01:22:32]. You know what? And what's funny is I was literally, just last week, we've been doing some work on our 401Ks and it doesn't matter whether you're red or blue, or whatever, the thought that you're actually going to be in a lower tax bracket when you start drawing your 401K down is almost laughable. Because, Congress has never met a tax that they don't like. So, why would we think taxes are going to go down in the future? And if they don't, and you have to start drawing on your 401K, guess what? You need Mark there to help you start to offset that by changing some of your depreciation status. Absolutely.

Mark (01:23:23):

Yeah, absolutely. And another thing that we are doing with some of our clients, so we have a client who's inheriting a lot of properties. They got stepped up to fair market value. And, this client had to quit her job to oversee all these properties. A little bit overwhelming for her, but here's some opportunities. We have all this stepped up depreciation and from her old job, she has all of these 401Ks and IRAs. And what we are going to do, we are going to take advantage of all of this elevated depreciable basises, and we are going to roll the IRAs and the 401Ks into a Roth IRA, where we can take advantage of all of these losses and her now having the real estate professional tax status. We offset all the taxability on that distribution. We're taking advantage of her being at a very low tax rate.

(01:24:07):

And now, at least as of right now in which it is allowable, it is October 7th of 2021... We don't know what Congress is going to say. But we are, she could self direct from her Roth IRA into cryptocurrency, which she's really interested in. It grows tax free, she can take the money out tax free. There's another way, strategy stacking, thinking about elevated basises and cost segregation, and retirement account utilization, and then the crypto strategy.

David Foster (01:24:39):

Yeah, and where did we start with? It takes a village. There's a whole bunch of people that have to be involved to really create that kind of strategy.

Mark (01:24:50):

Awesome. So, these are things that... We could probably, there are so many other things that we could talk about. We could probably have a multi-series and talk for hours on all the different things. Some honorable mentions that we didn't get enough time to talk about, even things like qualified opportunity zones and combining that with 1031s, where you could roll just your gains into that. There's just so many other things that we can do here. We can offset our gains by rolling it into the QOZ and then the depreciation capture with 1031. There are tons and tons of other ways that we could look at this. We've already been talking for a decent amount of time and I want to get to everybody's questions. But, based on your circumstances, who knows what kind of opportunities we will find.

(01:25:34):

So, what I'm going to do now is I'm going to read through the chat and the questions, and see what kind of questions we got, and how we can answer them.

David Foster (01:25:41):

Fantastic.

Mark (01:25:44):

"Is there a best legal entity for 1031 exchanges?"

David Foster (01:25:49):

No, there's really not. The 1031 exchange can be done by any tax paying entity. So, this is where we defer to your legal and finance counselors to say what's going to be better from a liability perspective or from an operational tax mitigation perspective. Any entity can do it. The simplest one to 1031 from is tenants in common because then all of the owners can separate, but that's the only advantage at all, really.

Mark (01:26:23):

Yeah. So, but there are some things that we got to watch for here. We have a client who, I think we dodged a bullet because of the transfer didn't come through, but if you go from... If you do the 1031 into tenancy in common, but then let's say we want to turn this into a partnership LLC, we have some challenges now because now it's considered owned by an LLC. And it's almost as though we kind of didn't transfer it into something that we are going to own, we kind of moved it into this other entity, and that can raise some challenges here, right?

David Foster (01:26:59):

Yeah, that's exactly right and that's why you've got to work hand in glove with your accounting team. Because, there's ways to overcome it, but it all depends on what your goals are. So, but the rule for us is that any tax paying entity, corporation, partnership, trust, [inaudible 01:27:17] can do a 1031 exchange.

Mark (01:27:21):

Yup. Let's see what we have here. "I went under a contract in early May of 2021 on a new construction cabin for $600,000 dollars. It won't be ready until we close, until late November. In between those two dates, I'm planning on selling one of my homes for about $230,000 dollars, hopefully in October of 2021. I'm hoping to figure out on this call if I can 1031 exchange here." Now, if you say home and we're talking about primary residence, you don't have to worry about capital gains on your first $250 or $500,000 dollars.

(01:28:01):

So, when you say home, if you're talking about your primary residence, the 1031 likely is not necessary. But, let's say, by home you mean your real estate investment property, how would we answer this?

David Foster (01:28:18):

Yeah. Well, did I hear that it was going to be done in 2021?

Mark (01:28:22):

Yes.

David Foster (01:28:23):

Oh, okay. There's your answer right there. So, first rule of thumb, nobody ever buys a vacation home. That is not the phrase you should ever use. What you're buying is a vacation rental or an investment property that you're going to use some for personal use. Because, a second home or a vacation home that has no investment intent doesn't qualify for 1031. But a property that you're buying with the intent of using some for investment is perfectly to 1031 into and there isn't a prohibition against some personal use. So first of all, what you're looking to buy, what you're having built is an investment property you're going to use some for personal use.

(01:29:19):

Now, the second thing though is, absolutely, this is awesome. Remember the timelines of the 1031. You've got 180 days to take title to your new property. Problem with new construction, if you sold your property, but you wanted to buy new construction, you almost can't do it because they couldn't get it done in time. But because you went under construction back in May, it's going to be done in November. So, the opportunity for you to sell your property in October, do a 1031 exchange, and complete it with the purchase of the new property in November, absolutely. Awesome opportunity to do it.

(01:30:06):

My caution would be, not so much in your case because I think you'll be fine, but for those people who are looking at, "I'm going to sell my property this month. My builder tells me it's going to be done in four months," every builder in America thinks that there's 45 days in every month.

Mark (01:30:26):

Yeah.

David Foster (01:30:26):

Just be careful.

Mark (01:30:28):

Well, also, quick question on this as well. So, the person asking the question says they're under contract for a new construction cabin. So, also, as far as the procedure here, first, you got to get engaged with someone who really knows his stuff as well. Talk to your accountant. But also, I believe that we would want to assign that contract to the exchange intermediary because this is going to go under contract and it's going to go under contract before the sale of the property. So, in that instance, wouldn't we have to start getting that procedure going under way? Because, if he were to purchase in his own name, now we lose that opportunity to 1031.

David Foster (01:31:14):

No, that's right. Now, we can be very, very flexible. There is no reason to assign it to the QI prior to closing. The assignability is simply part of the mechanism by which we transfer the title. So, going into contract for it was perfectly fine. Right before they take title to it, there will be an assignment that's part of the escrow. So, that's not such a big deal. But, there is one other question that you'll want to look at. And that is, did you have to buy the lot? Because if you took title to the lot, you can't exchange into the improvements on it and you can't exchange into improvements on property you own. But it's very, very interesting. Different parts of the country have different conventions. In Southwest Florida, the builders will almost always make you buy the lot and then they'll contract with you to build on it. That negates the opportunity to do a 1031. And you mentioned cabin, so I'm thinking this might be Gatlinburg, Somerville, some place like that. In the Smokies, it's very common for these builders to have their own inventory of lots. They bought a bunch of acres when they were young. And what they go into, what they're selling to you is a lot and a house on it. Now, you may be directing the finishes and you may have put a lot of money down on it, but... Somerville, exactly.

(01:32:47):

So, the lot and the builder is one. Scott, you're in good shape. Give me a call... Or Pamela, whoever it was, give me a call, we'll get you fixed up with that 1031 because that's perfect. Yup. And that earnest money... This is great, these questions are coming in real-time. That earnest money that you put down, we can give that back to you at the time of closing. We simply put a line item on the settlement statement called Return of Earnest Money. And, the 1031 money goes to the title company, the title company writes you a check for the $5,000 dollars, and that's not taxable. And then, the 1031 money replaces it.

Mark (01:33:28):

Awesome.

David Foster (01:33:29):

Bada boom, bada bing.

Mark (01:33:31):

Beautiful stuff. I've got another question here. "Wouldn't the inventory have a purchase price, so if you sell it as part of a sale at the same price, less you bought it for, then why would there be a tax bill?" Well, that's a good question and this is a tricky part here. And, so the fair market value of the inventory that we are selling to the buyer, that's what we would determine as the basis in the inventory. But, now there comes the tricky part on, now how much did the buyer purchase of the property versus the inventory? And where are the values here? So, that would take some deeper analysis. I can't really tell you exactly what would be the recorded profit on that inventory. So, that is a tricky one. And in that instance, we really have to look at the individual situation.

(01:34:21):

And you may want to also evaluate, and see how we interpret the intent of the buyer, and what the usage is, and if they have any desire to purchase the inventory. In the purchase contract, did we assign a value to the inventory here? So, there's just a lot of items here that are really open to interpretation and analysis that we would have to evaluate on that individual instance.

(01:34:51):

Here we go, and so, "Yes, it is a vacation home. Good to go here." Okay, I think we have answered all the questions here. Before we wrap up, does anybody have anything else before we wrap this thing up? Okay, great. So, for those of you who missed this, you're going to see the recording on our YouTube page and also on the website at markperlbergcpa.com, and anyone who's registered, you'll be sent the recording. I hope you get... Dave, thank you so much for giving us your time today. This was really fun and I learned some new things today. And, I always love talking to people who are really great at what they're doing and help my clients out.

David Foster (01:35:32):

Well, and I love what you gave to me tonight. That was awesome to get that give and flow going, because that's where creativity can really come into play. So, that was awesome. By the way, anybody that wants to I know can get to me through you. Or you can also go, we've got about 30 1031 YouTube videos at the1031investor.com.

Mark (01:35:54):

Awesome. And, anything else you want to tell to the guests? If you have a call of action that you want or you want to give them your information, anything you want, now's your chance to just say whatever you want to say here.

David Foster (01:36:06):

Justice Learned Hand was the Supreme Court Justice on the bench when the tax code was originally placed. And what most people don't know is that the 1031 exchange was one of the original parts of the tax code. And Justice Hand said, "No one should be forced to pay tax more than they are legally required. Taxes are an obligation, not a contribution." So, the idea of using every legal strategy to minimize your taxes is absolutely appropriate. And what I love, my gosh, this one is still [inaudible 01:36:50] in my brain because I heard this from a mentor of mine a few weeks ago. He said, "Dave, the tax code is not a way for the government to make money. The tax code is a way for the government to incentivize your behavior. Because, the impact of your behavior is what generates income for the government."

(01:37:17):

They put 1031 in play so that farmers could transfer property without paying tax, so that painters, appraisers, accountants, and QIs could all generate income and pay tax on that income. The 1031 exchange, I think, is the greatest thing out there. Use it.

Mark (01:37:38):

Yeah, and that's all fantastic stuff. And, I'm probably going to do a whole video on just that concept that the code encourages us to be innovators and to really pursue our passions, and take risks because there are financial incentives to encourage those behaviors, and to go out there, and fulfill your dreams, and really build something. So many tax saving opportunities when you become a business owner. And, it really encourages innovation in so many ways. So, that's the way I like to talk about taxes. And, I love it. I love talking about all these opportunities and the ways that we can utilize tax code to build wealth, and provide more value to society by growing our businesses.

(01:38:16):

One last thing before we close out, what's the best way to reach you if anybody wants your guidance or help with the 1031?

David Foster (01:38:26):

Yeah, actually, the1031investor.com gets you right to me.

Mark (01:38:31):

Fantastic. Dave, again, thank you so much for this experience and giving us your time tonight. And also, for helping out all of my clients and making my job a lot easier, because we solve some complex problems here and I always know we're in good hands when we use your help. So, thanks for everything. And, everybody, I hope you enjoyed this. And, to all of those, just hit subscribe down below when you receive the recording. And, best of luck to everyone and we'll keep in touch.

(01:39:03):

And one more final thing, if you are interested in our tax services, just shoot an email to info@markperlbergcpa.com and you will have to fill out a survey so we can evaluate the value that we can provide to you as an investor. We might give you some quick tips along the way. And, that'll be the first process and then the discovery session. And also, we are hiring all the time. So if you know someone or you're listening and you're interested, we are seeking out talent. The demand for our services exceeds our capacity, so I am searching for quality tax professionals and offering referral fees. So, if you or you know someone interested in implementing some of these awesome strategies, let us know. Again, thanks again, Dave, for your time. Everybody, have a wonderful night. And, more stuff coming your way. Let's keep in touch.

PART 4 OF 4 ENDS [01:39:55]