The grand exit! 1031 to the afterlife?

Question

As someone wobbling before their 1st investing baby steps this question isn't a top priority, but following 'begin with the end in mind' (and because I like to follow odd tangents)...

Everyone has their personal plan, a unique goal. When it's time to give up the calculator. Hang up the spreadsheet. When it's time to ride off into the sunset on the back of your trusty portfolio... what do you do?

Is there an end?

Are you giving this headscratcher to the kids as part of your legacy?

Dave Foster · Answer

@James McKay, You can see from my profile that I live in the world of 1031.  So you've got to take what I say with a grain of salt.  But it comes from the background of 1000s of transactions and years before I started working as a QI  when I got so fed up with the tax on a flip I did in 1996 ( www.the1031investor.com) that I learned about 1031s and started doing them myself personally.  So hopefully you'll forgive me if I disagree with the fatalism of you and @William Jenkins.  I'm going to go out on a limb and say that anyone using 1031s as a deliberate thought out strategy who ends up in worse shape at the end of the game has a problem with execution and use of the tool.  the tool is not the problem.

There are a myriad of strategies to use 1031 to not only exit the game effectively but to enhance your net worth significantly as you go.

1. Diversify - Grow your portfolio selling with the 1031 and buying multiple replacements and by doing it that way tap into 100% of your equity instead of the limits in a refi.  And allow yourself to stay within the price range of property that maximizes your noi

2. Consolidate - Sell multiple high maintenance properties and purchase one larger but higher returning property that provides less management.

3. Move geographies - Get a lot of appreciation in SOCAL the last few years? - Awesome.  Sell and 1031 into cash flow in one of the turn key markets.  Can't get a contract fast enough in Seattle? - take advantage of that and sell and go into an area that is farther back on the recovery curve.

4. Move classes - Doesn't matter the type of real estate, theres good times to buy and not so good times to buy.  What did Warren Buffet say - "Be greedy when others are fearful and fearful when others are greedy".  Is every investor trying to buy your MF for ridiculous prices?  Then sell and go buy under priced ag land.   Or if commercial is overbuilt and Amazon is flexing it's muscle then sell commercial and buy residential.  Time for a warm sunny vacation?  Sell your your show shovel requiring Albany 2 flat and buy a vacation rental on St. Pete Beach.

5. Slow your life down and move from active to passive.  Use consolidation and changing classes to end up with truly passive real estate investments like the DSTs that @Matt K. referenced or TIC projects - All passive.  All 1031 compliant.  All let you keep the unpaid tax working for you.  What does $200K in unpaid tax represent to you after a few years?  If you can generate 7% off your investments that 200K of govt money means $14K in your pocket every year as long as you keep it.

6. Eliminate the tax slowly - yes eliminate it!  Using a combination of sec 1031 and sec 121 you can slowly over time convert rental properties into primary (retirement?) homes and actually eliminate a good chunk of the tax so the profit is actually tax free.

7. Die - Yes I put this one last because its the least preferable but the most effective.  Your heirs get the step  up in basis and the tax disappears.  And if the properties have been put into an estate planning vehicle of sorts and transitioned from active to passive then it doesn't matter whether your heirs are astute real estate investors or not.  The legacy of your smarts will provide income to them for years.  I used to worry about this as well - what if I die with a bunch of projects unfinished.  Can my sons carry on?  Unfortunately I've got an engineer, a Dr., an optometrist, a vagabonder and an adventure junky.  Far better for me to position assets for them to benefit from at arms length than to saddle them with their dad's passion.

Bottom line I am a huge fan of the 1031 used well.  Dabbling without direction probably won't get you where you could go with it.

Dave Foster · Answer

@William Jenkins, I understand your personal preference but you're making some pretty broad statements that just don't jive with reality.  Again, of course it's the application and not the tool that makes success.  And nope a 1031 is not right in all circumstances.  But the reality is that hundreds of thousands use 1031s successfully every year.

You did get me curious though, so as Jimmy Buffett would say "I took some time off to try and recall the whole year".  I've had 4 clients fail to complete exchanges this year to date.  We have a couple more in the pipeline that won't complete.  But those are for a completely different strategic reason which the 1031 process is still an integral part of their strategy.  That is such a small % less than a fraction of 1% of the exchanges we've done as  to be grossly statistically insignificant.

Yes I get the whole "dark art" perception that comes with the 1031 exchange.  For decades they were incredibly tough to accomplish.  Then there was the whole sequence of massive law suits resulting in the new tax code adjustments which were only finalized in 96.  And then I blame our industry as well.  Although the code required that you use a QI the industry prided itself on making the process seem as difficult as possible.    Some of your personal perceptions may come from this background.

Some of the factors making 1031s easier than ever to successfully accomplish are:

1. Commoditization - Real estate is a commodity now a days.  Just like orange juice or wheat or pork bellies.  What is available at the investor level today will be available in 45 days.  It just may have a different address.  so unless you're the kind of investor who falls in love with an address or paint color you can almost always find the returns that meet your needs within the time frames.

2. Globalization - They make me dizzy, but I have bunches of clients looking at multiple markets.  No longer do 1031 investors sell in Denver and buy in Denver.  They sell in Honolulu and buy in Indianapolis (or wherever).  And along the way during the 45 day period they have boots on the ground in Cleveland, Memphis, and Jacksonville.  The world is a much smaller place and markets easier to identify and investigate.

3. The rise of mass marketing and the wholesaler.  Boots on the ground with pocket properties can be found all kinds of places.  Again helping mitigate the perceived risks of the 1031 timelines.

4. Passive replacement properties.  The DST and TIC as back up replacements has been around for quite a while.  But only in the last little bit has appreciation caught up with minimums and the practice started to become popular.  Trouble finding that perfect replacement?  No problem, pick a TIC.  And the returns do not have to be substandard to the real returns folks are getting on the street.

5. Contingencies - Whether it's buyers market and you want a contingency for you selling your old property.  Or whether it's a sellers market and you want a contract contingent on your finding a good replacement, strong creative contracts can also be used to mitigate the time periods.

6. Reverse exchanges - For those in special need and with the right amount of profit a reverse exchange takes all the pressure off finding your replacement property.

I think you and I probably agree that the timelines can cause issues.  And we both agree that 1031s aren't the be all end all for everyone.  But we disagree on the significance of the number of 1301s that are problematic and how many times the time frames actually cause an issue.

I think your sample size is way too small to make the umbrella conclusion.  It really harshs my mellow when I do an exchange for a client and they say "This is easier than I thought. I wish I would have done this years ago".

William Jenkins · Answer

I am not a big fan of 1031s.  In theory they are great, I mean who wouldn't want to defer capital gains.  In practice I always feel like the transaction is forced (either or both asset sold and the asset bought).  I have seen many peopole get into a 1031 and end up in a worse position (asset quality, ROI, etc.)  then when they started just because they "had to do something."  Your best deals are made when you don't have to buy or sell anything.  The ability to walk away is key and a 1031 in most cases (not all) hinders that.  1031s have a place, but they are not the end all be all that some would like to claim.

William Jenkins · Answer

The best tax move you can ever make is to die!  Sad but true.

Answer to your question... I don't think I will stop acquiring (good deals only) until it is not fun anymore.  In terms of a 100% cashing out, that question is tougher to answer.  Real estate is hands on regardless of what anyone says and leaving RE assets to family that does not know anything about them is a recipe for disaster.  Later on in life, if I believe my heirs would be able to responsibly manage my estate then I will likely never sell 100%.  If the opposite is true then I will try to pair my holdings as best as possible to leave the smallest mess possible.  I am hopeful that this decision is a long time in the future for me.

At the begining stage you shouldn't even be worrying about this, but there you go.

Matt K. · Answer

if they inherit it'll step up the cost basis and then they can get rid of your life's work and have a party w/ less taxes.

or

https://www.thebalance.com/delaware-statutory-trust-1798719

JD Martin · Answer

I think my plan is to put everything into trust so that it can create cash flow forever - well, not forever, but for a while long enough that the people I knew get off the planet. I don't have anyone following me, as best as I can tell, that will be likely to not burn through the cash in a month or a year, so if I can set it up where it pays out cash dividends for long enough that they're not living on the streets, that's good enough for me.

Remember the old saying: from shirt sleeves to shirt sleeves in 3 generations.

William Jenkins · Answer

@Dave Foster , I think you misunderstood my point.  1031s can be very powerful but it is not some panacea into never paying capital gains.

I am simply pointing out that it is very RARE for a great exit to line up with a great acquisition in the time frame allotted for in a 1031.  I have personally seen people get so caught up in a 1031 that they sell an asset, scramble to find a replacement, and then overpay on a purchase to avoid paying taxes....

Where I see the most success in a 1031 is where a seller holds a VERY liquid asset where he/she can control the timing of the sale.

Dave Foster · Answer

BTW - @James McKay, if you hit the @ key followed with the ? key a list of all posters on this thread pop up and you can tag.  Otherwise you can simply type the @followed by a name and you can tag your colleagues.

The grand exit! 1031 to the afterlife?

Most Popular Reply