Telling brokers about a possible 1031??

Question

When my current tenants lease expires in march of 2018, I plan to sell the property(sfr) and reinvest that money via a 1031 exchange into a small apartment building(12-18units)mo

I've already contacted a few different brokers, to see what kind of opportunities are out there.

Should I be transparent with all of them, and tell them that I'll be using 1031 money. Or is this going to put me in a bad negotiating position, and I should try and avoid this?

Is it also best to let them know that I won't be looking to buy until march onwards, but that I want to work with them now to identify what exactly is my ideal property?

Is there anything else I should know or consider, when doing a 1031and dealing with brokers, and in general?

Joel Owens · Answer

I usually want to know what the penalty is for a clients failed exchange.

They should be calculating this with the help of their CPA, tax professional,etc.

Some states it can as much as 50%! You could have state income tax, depreciation recapture, medicare tax of about 3.8%, capital gains tax,etc.

Now sometimes sellers have unused depreciation to carry over. This is why you need to talk to your tax professional.

If buyers doing an exchange are worth say a total of 3 million net worth and make 300k a year and are selling a small property where the failed exchange is 50k to 100k penalty then they might just pay the fees. To them it might be better than buying a marginal property just to complete an exchange.

I tend to find most 1031 buyers suck at planning. They get 45 days from the sale of their property and then take vacations, screw around looking for pie in the sky properties with super high returns,etc. Then they get down to 2 to 3 weeks and finally ( see the light) that they need to get serious and dampen expectations of what they will buy etc.

Example instead of looking for an 8 cap to start and then with 2 to 3 weeks left buying a 6 cap with proper planning they might have landed close to a 7 cap if they were realistic to start.

A smart broker will ask the potential 1031 buyer where they are at in the process and (how fast) their market moves for the property they are selling.

There is a difference between a seller listed their property for sale, has it under contract with a buyer, has passed contingencies with that buyer and are hard with funds, and the sellers property has closed and funds are now sitting with a QI with 45 days winding down. Much different levels of buyer motivation and intensity level.

If the buyer is going to have a very high tax penalty for a failed exchange the broker knows the buyer is just not (somewhat motivated) but (really motivated) to do something.

For a broker it is just sound business to make a decision where to invest your time. A buyer that has cash but without a 1031 looking for a 1 in 5,000 property for price and yield versus a 1031 buyer willing to buy something good at close to market. For some 1031 buyers yield is not the top priority but quality of the location and level of being passive with ownership.

No legal or tax advice given.

Dave Foster · Answer

@Barri Griffiths, You should absolutely tell your potential buyer broker about your 1031 for several reasons.

1. They need to understand that you will be under a tight time frame and they need to be ready to allocate extra time and energy for you during the initial period to get your replacement under contract.

2. It sounds crazy but 80% of all brokers have at best a passing knowledge of the requirements of a successful 1031 exchange. Not dissing them.  Their job is to sell real estate and work with other professionals.  But you will want them to have access to your QI early on so they can have a resource for questions and guidance as your exchange progresses.

3. Simply asking them about 1031 will generate a response that will give you a basis of comparision broker to broker.  Are they confident or over confident.  Do they have demonstrated experience with 1031 exchanges or have they just heard of them?  Are they willing to be part of a team or do they not play well with others?  Actual experience with 1031s is not that critical but an attitude of team player is.

4. If they know that you will be going through a 1031 when you sell it should make them more willing to do some modeling and due diligence ahead of your sale.  The more they understand what makes you tick the the exact type of properties you're looking for, the more focused they can be when the clock starts.

5. Things like contract language, acquisition size and type, sourcing of funds and lender access are all things that will go much more smoothly if your broker knows about your 1031 and knows enough to work with the QI.

Johnny Borrelli · Answer

Hey Barri.  I have information on 1031s that may interest you. Feel free to message me.  With low real estate inventory it can be a challenge.  In CA it is, not sure about the market out there.  Have you ever looked into exchanging your property for REITS?

William Hochstedler · Answer

Buyers who are looking for replacement properties should be music to brokers' ears.  It means that they have at least some cash and have to close to avoid penalties.

By all means let them know what you are up to.

Anthony Chara · Answer

Hi Barri, besides Frank and Dave's good advice, usually your Purchase Contract on the new property will ask if your purchase is contingent upon the sale of another property. If you lie on that contract and say it isn't and then you back out of a deal due to not being able to sell the first property for some reason, your earnest money could be in jeopardy. There's also some pretty strict guidelines on the properties you choose, when you choose them, timeline to close and the amount of financing on the new property, just to name a few. Make sure you're working with a good and reputable Qualified Intermediary (QI) for both the sale and purchase process. And, yes, you should tell your agent that you're doing a 1031 exchange so they can help you and understand your timelines.

Frank Chin · Answer

There's a lot of moving parts in the transactions you're attempting to accomplish, and a lot of things can go wrong. So if people you deal with have more of the big picture, you can give you suggestions, and be more helpful when things go wrong. Remember, with 1031's, you have a strict timetable to follow.

Take your current tenant for instance. Will they vacate exactly on the end of March. Will they be buying a home, or relocating. Each one of these things can screw up your timetable if they can't move out on time.

I don't know your area, where I am, 12-18 units buildings are not easy to find, especially if you want a good deal. You're right that if people know you are under the gun, they'll ask ridiculous prices, which will negate any advantages to a 1031.

If I was selling a SFH to fund a purchase, I would try to avoid the normal time constraints of a 1031. With reverse exchanges, you need money to fund the up-leg property first, but you gain yourself some time. When I tried it some years back, I considered lease with an option to buy to tie up the up-leg commercial property. If you do this, tie up the next property first, you can even do a simultaneous exchange, rather than the more well known non-simultaneous one. However, with the time frame your considering, it's a bit short.

When I tried it, agents I work with know I'm attempting a 1031. The problem was not in selling, it was a hot market, and people were willing to pay over asking. The problem was acquiring the property within the time frame, when people ask ridiculous prices also in a hot market.

Telling brokers about a possible 1031??

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