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All Forum Posts by: Eric Fernwood
Eric Fernwood has started 52 posts and replied 675 times.
Post: Winning strategies for Southern CA in 2023
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Jordan Futch,
We've operated a one-stop investor services business in Las Vegas for 15+ years and delivered over 480 properties to over 180 clients worldwide. We've also completed over eighty 1031 exchanges with most coming from California followed by Portland, Seattle, Florida, Indiana, Oklahoma, and Texas. My point is that I’ve actively worked deals for several years and been through a few financial cycles.
Today, most of our clients are from California. The most common reasons people choose not to invest in California are:
- Rent control: Rent control laws limit how much landlords can charge their tenants for rent. While this may protect tenants from steep rent increases, it can also make it challenging for landlords to turn a profit. Additionally, evicting tenants who are not paying rent becomes more difficult under such laws.
- Anti-landlord regulations: There are many regulations in California that make it challenging for landlords to operate their businesses. These regulations can include tenant screening requirements, eviction laws, and building codes.
- High property prices: Property prices in California are very high. This can make it difficult for investors to afford to buy properties, and can also make it difficult to sell properties for a profit.
- High taxes: Property taxes in California are notorious for being very high. This can significantly reduce the profits of landlords and make it harder for investors to afford buying properties.
So, the difficult of finding properties that cash flow is not the only reason Californians invest out ot state.
@Jordan Futch - On you comment on real estate crashes.
In 2005 I did extensive research on selecting the right tenant segment to target for income reliability. We've targeted this tenant segment for over 15 years. Our results:
- On average, our tenants stay over five years.
- We've had six evictions in the last 15+ years (over 1,000 tenants).
- 2008 crash - Zero decline in rent and zero vacancies. Properties prices plunged, but our clients buy properties for income replacement, not flipping.
- COVID - Almost no impact
- Eviction moratorium - Almost no impact
So, if you target the right tenant segment, you can achieve income reliability. However, nothing can protect you from national crash events. If your goal is a reliable passive income, you can achieve this with the right tenant segment. If anyone is interested in rental income reliability, reach out.
@Jordan Futch - Airbnb
Short-term rentals rely on vacationers, so occupancy is dependent on the economy since vacations are optional. This is why there is a lot of interest in mid-term rentals. Mid-term rentals solve a business need. For example, traveling nurses.
Another differences between short-term rentals and mid-term rentals is the amount of personal time investment required. One of our team members owned four short-term rentals and described them as, "purchasing another full-time job." She 1031 exchanged some of her properties and converted others to long-term rentals.
With mid-term rentals, there is cost effective property management available. Also, our approach is to purchase excellent long-term rentals and use them as mid-term rentals. This provides a fallback position if the market changes.
Post: Machine Learning to predict comps
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Johann Villalvir,
Congratulations your accomplishment.
Some background: I am an engineer and what I do in our investment services business is primarily data science and software development.
We use data mining software to evaluate thousands of properties based on about 40 behavioral characteristics of our target tenant segment. The software performs the following functions:
- Eliminates all properties that do match our target tenant pool segment.
- Selects sales and rental comps for evaluating rent and return.
- Generates investor analytics. We provide actionable information, not MLS data sheets.
I’ve experimented with increasing the scope of our software. However, despite trying many approaches, I have failed to consistently meet our accuracy and consistency requirements.
Today, we use a hybrid solution. We reduce the number of investment properties to consider by about 99.6% using our data mining software. Then, we match the properties that passed the data mining engine against the specific financial situation and goals of individual clients. Next, we manually evaluate each property. At the manual evaluation step, approximately 60% more are eliminated. Additional software estimates renovation costs and provides actionable analytics. We have never shipped MLS data sheets.
Below are some reasons why taking the next step with software, has not been successful for me.
- There is a lot of inaccurate information in the MLS. A recent example, "How much is the monthly association fee?" Answer in the MLS, "Yes."
- Computers cannot accurately determine whether a property is located in a desirable or undesirable area for a particular tenant pool segment using photos or aerial maps. There are more location considerations. For instance, even if a property has excellent characteristics, it may not rent if there is a significant amount of traffic on the street. This determination can only be made if you know the specific street.
- An onsite evaluation is essential. For example, if there is a barking dog next to a property, it will not rent. How can software determine the presence of a barking dog?
- Zillow and OpenDoor attempted to use software to predict the sale price of properties and their results were/are bad because their software was poor and the inherent limitation of software to deal with subjective data. Zillow lost so much money that they decided to exit the flipping business, while most of the OpenDoor properties we see in Las Vegas are sold at a loss.
In my experience, software can only go so far when humans are involved. Our hybrid approach has worked well. If there is a better approach, I would like to understand what it is.
Thanks for your post.
Post: Do You Understand How Ugly This Is Going to Be?
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Some great horror stories on this thread. And, I believe most are true, or at least representative of reality.
I believe there is a common theme: people decided to do everything on their own. Let me ask you a question. If you needed surgery, would you start medical school? Of course not, you would find a surgeon with extensive experience in the procedure you require.
That is why you need to work with an experienced local investment team. To date, we have delivered over 480 investment properties, and none of our clients have ever been involved in the renovation, maintenance, or management of their properties. Managing properties is not their skill set, and they do not have the time. Additionally, there is another need that an individual investor cannot provide. The only way to have a reliable income is to have a tenant who stays in the property for many years, always pays rent on schedule, and takes care of the property. However, finding such a tenant is rare, and out of over 100 property managers in Las Vegas, I have only met two who possess the skills to consistently select such tenants. You cannot afford to manage your own properties. One bad tenant can cost you more than several years' worth of management fees.
For over 15 years, we have provided end-to-end investor services. Our clients focus on what they do best (e.g. doctor, lawyer, engineer, business owner), while we handle everything else. What sets us apart from other realtors? We are engineers who approach finding, validating, renovating, and managing properties as engineering problems. We use proven processes, not luck or gurus. How do our clients evaluate our performance? Over 90% of our clients purchase two or more properties from us, and our largest source of new business is referrals from existing clients.
You might assume that our end-to-end investor services come with a steep fee. However, in delivering over 480 investment properties, we have only charged a fee 4 or 5 times, and only due to exceptional circumstances. For all other properties, our fees were paid by the seller's listing agent, not our client. This enables you to take advantage of 15+ years of experience and a team of experts, without any additional cost to you.
You can either try to do everything yourself or work with a team of experts. By working with an experienced investment team, you also have the option to invest where you can make the most money, not necessarily where you live.
Post: Looking to do our first 1031 exchange
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Javaras Thomas,
We've completed over 80 1031 exchanges from multiple locations and never had an attorney involved. The primary locations where 1031 exchanges came from are California, Portland, Seattle, and the midwest. The most often stated reasons for clients from California, Portland, and Seattle are high costs and anti-landlord regulations. From the midwest, slow rent growth and appreciation. In this post, I will provide a high-level view of the 1031 exchange process and some considerations.
What is a 1031 Exchange?A 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred.The actual 1031 process is simple and illustrated below. The challenging part is the 45-day identification period, which I will discuss later.
1031 Considerations
Below are some considerations that you should be aware of:You are not allowed to use the proceeds from the relinquished property to pay for renovations. Some of our clients have opted to pay capital gains tax on a portion of the proceeds and use that money for the renovation.Not all purchase contracts include 1031 exchange verbiage. Have your listing agent obtain the correct verbiage from your exchange agent for your state and include it in the agent-to-agent remarks, specifying that the 1031 text must be included in the offer.To fully defer the capital gains tax, you must reinvest all the proceeds from the sale into the replacement property. If there is existing mortgage debt on the relinquished property, it's important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be treated as taxable boot, resulting in potential tax liabilities. Talk to your 1031 exchange agent.Both the relinquished and replacement properties must meet the requirement of being held for investment or used in a trade or business. Personal residences or properties primarily held for personal use do not usually qualify for a 1031 exchange.It's important to understand the state-specific regulations regarding like-kind exchanges. Some states may not recognize or fully conform to the federal provisions. Consult with a tax professional familiar with your state's laws.The Biden Administration's proposed FY 2024 budget includes the creation of “capped deferral” for 1031 exchanges. In this proposal, taxpayers in FY2024 would be able to defer capital gains only up to an aggregated amount of $500,000 for each taxpayer ($1 million for joint filers). Source. If you are considering a 1031 Exchange, 2023 may be the last year to do it
Movement of FundsI get a lot of questions on how to handle the proceeds from the sale of the relinquished property (ies). Below is an illustration of the flow of funds during a 1031 exchange. The funds move from the closing escrow agent to the 1031 exchange agent. When you close on the replacement property, the funds go from the 1031 exchange agent to the escrow company handling the closing. The funds must never be in your hands, or the 1031 exchange will be void.
Our Process
Where things can go wrong is the 45-day identification period. While you only have to identify (up to) three properties as replacement property(ies), I can see a situation where you are unable to close on any of the properties for various reasons. If this happens after the end of the 45-day identification period you would lose the tax exemption.To guard against this situation, we follow a different process. Once your relinquished property is in escrow and all contingencies have passed, we will get the replacement property or properties under contract before the relinquished property closes. This is permissible as long as we close on the replacement properties after escrow closes on the relinquished property. We target to close escrow on the replacement properties within 2-3 weeks after the relinquished property closes.
Using this process, if a replacement property falls out for any reason, we have time to get another property under contract and complete due diligence inspections. Only after due diligence inspections do we know if we want to close on the property.
Cash Out Refinance or 1031 Exchange?When people contact me about a potential 1031 exchange, I ask them why they want to do a 1031 instead of a cash-out refinance. Which is the best option depends on whether you want to keep the property. Because this is a frequent discussion, I put together the following decision chart.
Javaras, I hope this helps. Reach out to me if I can help or if you are undecided on the replacement investment location.
Post: Las Vegas????
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Excellent post Nick!
Post: Newbie with high income - Invest local or long distance?
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Sean Haran,
The most reliable way to achieve a goal is to start at your destination and work backward to where you are today. That is what I will do in this post.
I believe the goal of real estate investing is to create a reliable passive income that meets the following requirements:
- Inflation compensating: Rental income keeps pace with inflation, enabling you to pay inflated prices to maintain your standard of living.
- Persistent income: Your income will last so you will not run out of money.
- Reliable income: Your income continues even in difficult economic times.
Before I continue I want to explain why inflation compensation is the most important factor.
Financial freedom is more than just replacing your current income; it's about maintaining your current lifestyle for life. Inflation continually erodes the purchasing power of a fixed amount of money. What you can purchase today for $100 will require $155 to buy in 10 years if the inflation rate is 5%. The only way to sustain your current lifestyle is if rents keep up with inflation. If rents don't keep up with inflation, your financial independence will be short-lived.
Why Location Is the Most Important Investment Decision
Unless rents keep pace with inflation, you will not have financial security. So, what is the first and most important investment decision you will make? The city where you will invest.
In real estate, prices are dictated by supply and demand. Population growth is the heartbeat of demand.
- When the population rapidly increases, the existing housing inventory is not sufficient, creating a mismatch between the number of buyers and sellers. The result is rising prices. If the population continues to increase, prices will continue to rise.
- When the population is static or declining, the existing inventory is sufficient to meet housing requirements and prices stagnate or fall, relative to inflation.
Rents follow prices.
- Higher prices reduce the number of people who can purchase, increasing demand for rental properties and increasing rents.
- Lower prices enable more people to purchase, decreasing demand for rental properties and decreasing rents.
So, when it comes to selecting an investment location, the critical factor is population growth. Do not invest in any city where the population is static or falling if you want rents to keep pace with inflation.
What are some other location selection criteria? I listed a few below.
- Cities with a metro population greater than 1M**.** Small towns may rely too much on a single business or market segment. Wikipedia
- Both state and metro populations are increasing. Do not buy anywhere if the state or metro populations are static or decreasing. Wikipedia
- Low crime - High crime locations almost always have declining populations. Do not invest in any city on Neighborhood Scouts’ list of the 100 most dangerous US cities.
- Rent control - Cities and states with rent control may prevent you from increasing rent fast enough to keep pace with inflation. This can limit your ability to select the best tenant and can make evictions of non-performing tenants difficult or impossible. Never invest in any location with rent control.
- Low operating cost - It's not how much your gross what matters is how much you net. Choose a location where operating costs consume as little of your gross rent as possible. Below is a comparison of property tax and insurance costs in three popular investment states.
To show the impact of taxes and insurance on net cash flow, I compared overhead costs on a $400,000 property in those three states.
So, if you buy a property in Texas, it must generate a $5,700 ($9,194-$3,494) higher annual cash flow than a property in Nevada to compensate for the higher overhead cost in Texas. (Sources: Insurance - ValuePenguin, State Property Tax Rates - Rocket Mortgage)
Property Selection
Rather than following popular dogma, I recommend focusing on your goal of achieving a reliable income. To have a reliable income, your property must be occupied continuously by a reliable tenant. A reliable tenant is someone who stays for many years, pays all the rent on schedule, and takes care of the property.
Reliable tenants are the exception, not the norm. And, because you will likely hold the property for as long as you live, you will need multiple reliable tenants over the years. The way you achieve this is to buy properties that attract people from a tenant segment with a high concentration of reliable tenants.
You can identify this tenant segment through multiple property manager interviews and research.
Once you identify the tenant segment you want to occupy your property, determine what and where they rent today. It could be multi-family, single-family, condos, or whatever. Your goal is to have a reliable income, so purchase properties that are attractive to the tenant segment with the highest percentage of reliable individuals who are willing and able to rent.
This approach works anywhere because you are making property selection decisions based on your financial goal; the type of property is irrelevant. You just want a reliable income.
The Skills You Need to Succeed
Everything you learn in podcasts, seminars, books, and on real estate websites is general information. It is valuable information but tells you nothing about how to invest in any specific location. What you need is an experienced local investment team. And this is true whether you invest across the country or next door.
An experienced investment team has years of experience doing what you need to succeed. For example, our investment team has delivered close to 500 investment properties to clients worldwide. There is no way you can replicate the years of experience a team of experts already has.
And, there is no reason not to work with an investment team. For example, out of almost 500 properties, we have charged a fee only 4 or 5 times, and all were unusual situations. Other than these 4 or 5 properties, we’ve never charged clients for our investor services. I assume that most experienced investment teams are like us, not charging a fee. So, I ask you this: if you could gain the experience of a team of experts at no cost than working with a realtor, why would you attempt to do it all yourself? For example, if you needed surgery, would you start medical school? No, you would find a surgeon who specializes in the type of surgery you need.
Finding a good investment team is another story. Let me know if you’d like to know how to find and vet a good team. This post is already long.
Summary
Always start at your goal and build a plan back to where you are today. And, always stay focused on your financial goal, not dogma.
Post: August Las Vegas Rental Market Update
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
It’s August and time for another Las Vegas update. For a more in-depth view of the Las Vegas investment market, DM me for a link to our blog site which contains more information on investing in general and investing in Las Vegas in particular.
Before I continue, note that the charts only include properties that match the following profile, unless otherwise noted.
- Type: Single-family
- Configuration: 1,000 SF to 3,000 SF, 2+ bedrooms, 2+ baths, 2+ garage, minimum lot size is 3,000 SF.
- Price range: $320,000 to $475,000
- Location: All zip codes marked in green below have one or more of our client’s investment properties.
What we are seeing:
Overall inventory continues falling in Las Vegas. The chart below is from the MLS and includes all property types and price ranges.
The Charts
The charts below are only relevant to the property profile that we target.
Rentals - Median $/SF by Month
Rents held sturdy from April through July. YoY is flat.
Rentals - Availability by Month
The number of homes for rent continued to drop (since January).
Rentals - Median Time to Rent
The median time to rent is at 20 days, a very reasonable time on the market.
Rentals - Months of Supply
Only about 0.8 months of supply for our target rental property profile. Demand is greater than supply. This will push up the rent.
We saw a similar tight supply in sales as well. Now only about 0.6 months of supply. This will push up the prices.
Sales - Months of Supply
Sales - Median $/SF by Month
Despite increasing interest rates, $/SF is climbing up.
What is driving long-term demand for rental properties in Las Vegas?
Las Vegas Fundamentals
Supply and demand determine prices and rents. What is the supply situation in Las Vegas?
Supply
Las Vegas is unique in that it is a tiny island of privately owned land in an ocean of federal land. See the 2020 aerial view below.
There is little undeveloped private land remaining in the Las Vegas Valley. Any available land in desirable areas costs more than $1 million per acre. Due to the high cost of land, new homes in our targeted locations start at $550,000. The homes that appeal to our target tenant segment are priced between $320,000 and $475,000. Therefore, no matter how many new homes are built, our target housing segment remains almost constant.
Demand
Demand for housing is driven by population growth. Las Vegas is a rapidly growing city.
- The average population growth is between 2% and 3% per year.
- According to CNBC, Las Vegas is the top destination that people want to move to.
- Penske truck rental announces 2022 top moving destinations: Houston is #1, and Las Vegas is #2.
What brings people to Las Vegas? Jobs.
- At the spring job fair, there were over 20,000 open positions.
- According to the Bureau of Labor Statistics, Nevada is the #1 state in the nation for job growth
- Where are California companies moving? Henderson and Las Vegas are adjacent so the total for Las Vegas metro is 3,603 companies moving from California to Las Vegas.
More jobs are coming: there are over $30 billion of large projects currently under construction or in the planning stages, which will create thousands of additional jobs.
Everyone Must Have a Place to Live
No one has to take a vacation, buy a new car, or use self-storage. However, everyone must have a place to live. That is why rental property income is so reliable. Las Vegas is an ideal location for real estate investment because of the combination of land shortage and population growth. This combination almost guarantees appreciation and rental growth for the foreseeable future.
Thanks for reading my post. Reach out if you have questions or would like to discuss investing in Las Vegas.
Post: Single family residential vs commercial
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Carlos Silva,
Great question! My views on both:
Commercial
I mainly deal with residential investment properties, but I also do commercial properties. However, I do not generally recommend commercial properties due to their cyclical nature and the increasing competition in any profitable sector. For example, ten years ago, when I moved to my home, there was only one self-storage facility in the area. Today, as shown on the map below, there are 18. The area population has not increased anywhere near 18 x so the 18 are splitting nearly the same amount of business. Commercial real estate is usually a zero-sum game.
Another concern I have with most commercial properties is that most are not a requirement. For example, while everyone requires a place to live, no one requires self-storage. The same scenario is true with warehouses. There was a shortage three or four years ago and now they're being built everywhere.
Residential
Residential investments can offer a dependable source of passive income if you invest in the right city and buy properties that attract the right tenant segment. While I won't delve into the process of selecting a location for income reliability, I will briefly describe why I relocated to Las Vegas to establish my investor services business.
Why Invest in Las Vegas?
Prices and rents are a function of demand. Where there are more sellers and buyers, prices are low, and rents and prices increase slowly or not at all. Where there are more buyers and sellers, prices are higher, and rents and prices increase rapidly. What is the supply and demand situation in Las Vegas?
Supply
Las Vegas is unique in that it is a tiny island of privately owned land in an ocean of federal land. See the 2020 aerial view below.
Available land in desirable areas costs more than $1 million per acre. Due to the high cost of land, new homes in such locations start at $550,000. The homes that attract our target tenant segment cost between $320,000 and $475,000. Therefore, no matter how many new homes are built, our target housing segment inventory remains almost constant. This differs from metropolitan areas with unlimited expansion potential, where the construction of new homes limits the growth of rent and home prices of existing properties.
In summary, the supply in the $320,000 to $475,000 range is almost fixed and will not increase.
Demand
The driver for housing demand is population growth. The average Las Vegas annual population growth is between 2% and 3%. What is attracting so many people to move to Las Vegas? Jobs.
At the last job fair, there were over 20,000 open jobs available. The average annual income for these jobs is $65,000, which falls within our target tenant segment. Moreover, the number of available jobs is expected to increase in the future due to new developments.
Depending on which study you read, there is between $18B and $26B worth of new construction under development. As these projects come online, they will create even more jobs and attract more people to Las Vegas further increasing demand for the segment we target.
The combination of a fixed supply in our target price range and increasing demand almost guarantees that prices will continue to rise in the foreseeable future.
Summary
No one has to buy a new refrigerator, store things in a warehouse, or have an office. So these are more discretionary than having a place to live. Also, replication is very simple with commercial properties but may not even be possible with residential.
Commercial and residential investments are very different in my opinion.
Post: Anyone in Las Vegas looking to learn more about MTRs?
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello @Allen Duan,
Last year, we conducted a study with a few clients and produced a white paper. If you would like a free copy of this white paper, please DM me.
Below are some of the results of our study:
-
Short-term rentals and mid-term rentals are fundamentally different. Short-term rentals mainly cater to vacationers. During difficult economic times, fewer people tend to take vacations. This is why many short-term rentals in Las Vegas were sold during the COVID-19 pandemic. In contrast, mid-term rentals are primarily driven by business necessity. For instance, there is currently a nursing shortage across the US, and traveling nurses help to alleviate it. Our research shows that traveling nurses usually start with a 13-week contract that may be extended. They require a place to live, which is why mid-term rentals are driven by necessity.
-
The primary consumers are traveling nurses. Hospitals with trauma care levels one and two and neonatal intensive care typically have the most traveling nurses. Properties should be within about 5 miles of such hospitals. However, the property must be in a safe location, which is sometimes further than 5 miles from the hospital. See the map below for trauma and neonatal intensive care hospitals.
-
There are two primary places to market furnished rentals, the MLS and sites like Furnished Finder. Our research showed that furnished properties rented through the MLS have a $.60/SF to $.70/SF incremental rent above non-furnished long-term rentals. On Furnished Finder, the incremental rent appears to be about $1.20/SF.
-
Having a property manager to handle mid-term rentals is crucial. The property manager we work with offers reasonable rates for this service and will take care of inventory management, leasing, maintenance, and overall property management.
-
Always buy a property that would also be a good long-term rental. You need the backup option in case the mid-term rental market changes.
-
Minimizing turn costs and downtime is critical. This requires the right renovation components and speedy make-ready after a tenant departs. A renovation company that has already completed over 350 renovations for us will quickly do whatever touchups/repairs are necessary so we can get the property back on the market.
-
Use electronics to control access and reduce turnover time. For example, the garage door must be remotely controlled so:
- The property manager can remotely open it to allow delivery and service people access.
- Access to the garage will be through an app on the tenant’s phone, no clickers or digital keypads to reprogram. Also, immediately after the tenant leaves, the access can be changed.
-
Minimizing vacancy is critical. We believe the best way to do this is:
- To ensure sustained occupancy, positive tenant reviews are crucial. Providing a simple and easy move-in process can help create the best experience for new tenants. The gateway to tenant resources will be accessible through their phones via a QR code, which will give them access to a property-specific website. This website will include links to download the necessary apps to control the house, QR codes for food delivery and other services, maps to locations of interest, requests for repairs, and more.
- Attractive furnishings. There are multiple companies that, given the dimensions and such, will provide a list of everything you need, down to spoons and salt shakers.
- High-quality photos. The photos must show a bright, attractive, friendly property. For several years we've worked with a commercial photographer so we can get quality photos at a reasonable price.
- Currently, properties are marketed solely with photos. We will create a unique website for each property which will increase its desirability. This website would include a walk-through video, more photos, information on what to do in the area, shopping recommendations, places to go, and things to see. By providing an overall guide to the area, potential tenants will realize that there are many things to do and places to go, increasing the desirability of the property.
This is a summary of the study. If anyone is interested, DM me for the complete study.
Post: 1031 rules 3 properties?
- Real Estate Agent
- Las Vegas, NV
- Posts 699
- Votes 1,477
Hello Joshua,
To date, we have successfully completed over eighty 1031 exchanges. In this post, I will discuss the basics of a 1031 exchange and the process we follow. Also, some proposed 2024 legislation that could end/limit 1031 exchanges.
What is a 1031 Exchange?
The actual process is simple and illustrated below:
Be aware of the 45-day identification period. Although you only need to list up to three potential replacement properties, there is no guarantee that you will be able to acquire any of them. If you fail to do so, you will lose your tax deferment.
Movement of Funds
Another frequent question I receive is regarding how the proceeds from the sale of the relinquished property must be handled.
The following diagram illustrates the flow of funds in a 1031 exchange: The funds are transferred from the closing escrow agent to the 1031 exchange agent. Once you close on the replacement property, the funds flow from the 1031 exchange agent to the escrow company handling the closing. It's important to note that the funds must never be in your hands, as this will void the 1031 exchange.
Our Process
The risk of losing the 1031 tax deferment due to being unable to close on the identified properties is a significant risk. We created a process that minimizes or eliminates this risk.
Once your relinquished property is in escrow and all contingencies have passed, we get the replacement property or properties under contract before the relinquishing property closes. This is permissible as long as we close on the replacement properties after escrow closes on the relinquished property. We target to close escrow on the replacement properties within 2-3 weeks after the relinquished property closes.
Using this approach, if the replacement property falls out for any reason, we have time to get another property under contract and complete due diligence inspections. Only after due diligence inspections do we know if we want to close on the replacement property.
Some Considerations
- Renovations cannot be paid for using the proceeds from the relinquished property. Some clients choose to pay capital gains tax on a portion of the proceeds and use that money for renovation.
- Verbiage related to 1031 exchange may not be included in all purchase contracts. Ensure that your listing agent obtains the correct verbiage from your exchange agent and includes it in the agent-to-agent remarks, specifying that the 1031 text must be included in offers.
- To fully defer capital gains tax, you must reinvest all proceeds from the sale into the replacement property. Any cash or non-like-kind property received during the exchange will be subject to capital gains tax.
- If there is existing mortgage debt on the relinquished property, it is important to consider how it will be handled during the exchange. Any reduction in debt or cash received may be considered taxable boot, resulting in potential tax liabilities.
- Qualified Use Requirement: Both the relinquished and replacement properties must meet the requirement of being held for investment or used in a trade or business. Personal residences or properties primarily held for personal use do not qualify for a 1031 exchange.
- State Tax Considerations: While 1031 exchanges are allowed under federal tax law, not all states conform to these rules. It is crucial to understand state-specific regulations regarding like-kind exchanges, as some states may not recognize or fully conform to federal provisions. Consult with a tax professional familiar with your state's laws.
- The Biden Administration's proposed FY 2024 budget includes the creation of "capped deferral" for 1031 exchanges. Under this proposal, taxpayers in FY2024 will only be able to defer capital gains up to an aggregated amount of $500,000 for each taxpayer ($1 million for joint filers). Source. If you are considering a 1031 Exchange, 2023 may be the last year to do it.
If you would like to investigate moving your investments to Las Vegas, DM me.