All Forum Posts by: Dave Foster

@Stacy Tring, Kudos to you for those calculations.  You did some good spread sheet work.  But you're double dippin your tax in several cases.  It's not as bad as you think.  We have a calculator on our website that can help you compare the 1031 vs no 1031 options.  @Jon Taylor, is also awesome at walking you through the calcs.

@Craig A., It is fine to sell a % ownership and do a 1031 exchange. But you must be selling real estate and not a membership interest in an entity that owns real estate. If that property is owned by you and your partners as tenants in common then you own real estate. But it sounds like it is owned by an LLC and you are a 22% owner of that LLC. You do not own real estate right now. You own a membership interest in an entity that owns real estate.

The process of a drop and swap would allow you to sell your 22% interest and do a 1031 exchange. Because the LLC "drops" the property and quit claims it into the members personal names as tenants in common. Once this is done you could sell your 22% tenants in common interest to one of the other owners and do a 1031 exchange. That would be fine. But I doubt that would work unless the rest of the owners could decide on how they want the ownership to go forward.

The drop and swap would probably work better if it was done as a pre-cursor to selling the property entirely.  Once the drop occurs the property can be sold.  and each former member now tenant in common owner, can do their own 1031 exchange on their %.  Or take the cash for their % of the sale without impacting any of the other owners.

@Eugene DuShawn Smith, Neither of these are a bad option. But the thing you need to consider, if cash for down payments is tight, is that in a refi you will not get access to all of your equity. This could limit your ability to use the refi as down payments on two properties. However, a sale would let you get access to all of the equity in the property. And since it is an investment property, you would qualify for a 1031 exchange. A 1031 exchange would allow you to also use all of the tax to invest into nicer property/properties.

This is what is called a diversification exchange, where you sell your relinquished investment property to acquire multiple replacement investment properties. It would be the most cost effective way for you to expand your portfolio. But Id also look at how good your return was on the townhouse first

@Michael Dahl Because of the reinvestment requirements, you couldn't take any of the proceeds without taking a bit of boot like others here have stated.

However, if you completed your 1031 exchange then immediately did a cash out refi, that would allow you to defer all of the tax and depreciation recapture, but also give you access to some cash that is tax free.

@Elizabeth Scala, The IRS requires that the taxpayer for the new property must be the same as the taxpayer for the old property. The most accurate way to find the tax return that is reporting the activity of the property. If an LLC has only one member and elects to pay taxes as a sole proprietor then it is a disregarded entity. All of the property's activity is reported on the member's tax return.

In the case of the series LLCs the child LLCs are generally disregarded entities to the parent LLC. Their only member is the parent LLC. And they don't file a tax return. This means that right off the bat you could sell as a child LLC and buy as that LLC or as another child LLC or as the parent LLC. In all of those cases the activity of the property will still be reported on the parent tax return.

But what if - The parent LLC only has one member (you) and also elects to file it's taxes as a sole proprietor. That would mean that the parent LLC is disregarded to you. And in that case, you could sell as the child LLC and buy as that LLC, or another child LLC, or as the parent LLC, or as yourself (because it is your tax return that is reporting the activity of the property.

Series LLCs can make the 1031 process that much easier.  But you have to be able to track down who the taxpayer really is.

@Brian J Allen,@Henry Clark hit on the greatest solution that's already in place.  And works perfectly with natural aging.  Many people want to down size transitionally as they age.  The 6 bedroom house is too big.  but there's so much gain in the 6 BR house that they would owe a lot of tax over the $500K primary residence exclusion.  This is where a 1031 exchange can bridge the gap.

First they have to convert that property to an investment property.  This would require that they find their next house first and move into it.  A year later they sell their old primary residence and do a 1031 exchange because it is now an investment property.  They still get the first $500k tax free.  And the 1031 exchange defers the rest of the tax.  The 1031 doesnt have to buy bricks and mortar that would require management.  It could buy Delaware Statutory Trusts, or oil gas interests, or real estate syndications that would allow for tenants in common.  All of these are passive and don't change their life negatively.  But they all require that they give up control.  And I find that is the biggest hindrance from more mature folks 1031ing into passive investments.  

I've talked to a lot of people over the years who would rather pay $300K in tax and have $1.2 mil left in cash than go through the work of eliminating that $300K.  It's a trade off.  But the mechanism exists right now.

Thanks for that shout out @Bill B..  I'm not sure we're all understanding your situation @Owen Boller.  Yes, any QI should be able and usually can get your exchange put together in a few minutes or a day.  If we're bragging,  our record is 22 minutes for an in seat closing.  And gave me every gray hair I have.

But that's not the issue here I don't think.  If this is a purchase by you then the issue is that you already have an exchange going.  And for some reason the attorney closing your purchase doesn't think there's enough time.  Then that really doesn't jibe. Because if you already had an exchange going.  And just now the attorney is getting notice of it - that's kind of on you. And, if you gave your attorney's information to your QI and they failed to follow up promptly then that's totally on them!!!  I can't imagine a scenario where a purchase to complete a 1031 exchange could ever be a surprise.  That doesn't add up.

Again, we would all say that even in a purchase where funds have to be wired the QI can work nimbly enough.  But you are in an attorney closing state.  And a lot of real estate attorneys  tend to be one-person shops.  It's their time that they are really talking about.  You have an attorney.  And the seller has an attorney.  And they talk to each other and you only get the filtered final package of what the attorney wants.

It's unfortunate.  And you may have a shot given the market to play some hard ball and threaten the closing and find another attorney.  If you put a cooperation clause in the contract then by law they would have to work with your 1031 exchange.  

The exception to all of this would be if you are attempting to do a 1031 reverse exchange and buy the new property first.  In NY there are several posting regulations and time needed to create the Exchange accommodating title holder.  That does take some time! 

@Steve Schaeffer, Like @Jon Taylor said, the depreciation (via the basis) will be carried forward into the REIT. But once you've converted into the REIT you now own an equity and not real estate. Any time you sell a share of the REIT you will be paying tax on all deferred gain and the depreciation. That's the down side to the 721. REITS are generally not something that folks stay in forever. So the probability of paying the tax you've worked so hard to defer over the years is pretty high with this conversion. There ought to be a way to sell your interests and 1031 into a different DST or back into bricks and mortar. You may have to ask. @Jon Taylor, might that be a viable option?

@Yael Fuerst, if you choose not to do a 1031 exchange, you would also have to recapture all of the property's depreciation as well as capital gains tax when you sell. 10 years of depreciation on a $100K house ($80K of structure + $20K of improvements) You'll have an additional $9-$10K of tax on the depreciation. All told you're looking at $15K ish for a tax bill.

It's been a couple of years since we did an exhaustive study for BP - https://www.biggerpockets.com/blog/1031-exchange-cost. ... prices have gone up. But I know that you can still get a good exchange at this level for less than $1k. And not have to go with one of the free firms, who invest your exchange proceeds in lieu of collecting exchange fees.

Bottom line - Is spending $1K to save $15K worth it to you?? Some would say absolutely. Some would say no. I wouldn't let the time requirements of a 1031 exchange dominate your thinking at this stage in the market. There's a good balance of inventory. And if you're being proactive and shopping before you close the sale of your old property you can actually extend that 45- day window to 90 days. And unless you're shopping for a unicorn property, 60-90 days (even 45) is usually plenty of shopping time. Even at the height of the seller's market in this cycle, 92% of our clients were still completing their 1031's satisfactory replacement properties.

A 1031 exchange is pretty seamless for you. But it is a couple of phone calls, some focused shopping, and some signatures. You've got to weigh that against the $15K tax bill.

By the way - using your 1031 you could actually do both. Purchase a small multi-family and use the deferred tax and a few more dollars to buy a small tract of land. That is the power of the 1031 - Your deferred tax works for you - not the government.

@Amber G. You could do what we call a consolidation exchange.

A consolidation exchange is where you sell multiple investment properties to acquire a larger investment property or several newer properties in a 1031 exchange.

This strategy would remove the hassle of managing multiple properties and allow you to defer all of the tax and appreciation. And if you purchased multiple smaller but newer properties, you'd eliminate the Friday night phone calls and the unexpected expenses that negatively impact cash flow.

When doing a consolidation exchange, you should be mindful of the time frame requirement of the 1031 exchange and your reinvestment requirement.

You have 45 days to identify your potential replacement properties, and a total of 180 days to complete your exchange, so you want to focus on getting those properties sold before you have to take title to the new property and the end of your exhcange period.

One way to make this process go smoother is to find a single buyer and sell them as a portfolio, Sometimes though this requires a substantial discount over selling as individuals. So, you could try to sell them all separately but close together. And even if you didn't sell all of them to combine together. You might sell 2 or 3 bunched close enough to combine.

Although it can seem a bit intimidating, This shouldn't present any tremendous problems in this market.