All Forum Posts by: Sean Ross

@Ryan Fox, it's a consensus here.  A 1031 exchange would likely only cost you a fee, plus impose rules on how to use your sale proceeds and when, without providing a tax benefit. 

As @Michael Plaks points out, the way that you speak about the "gain" from sale means that you're likely confusing capital gain with net equity after expenses.  I can't be sure, but it's an easy mistake to make at first glance. 

Work with someone to calculate your actual gain from sale.  If your actual capital gain (net sales price minus your adjusted cost basis) is going to be larger than $131K, then we can have a conversation about a possible 1031.  I think that's probably unlikely given what we know. 

Quote from @Dominique Coffin:

Looking for some insight on the topic of doing a 1031 exchange into properties that the owner would want to do seller financing. Does anyone have any experience in this? Looking for certain things I need to watch out for or any advice that would help. Thanks in advance!

@Dominique Coffin,

This is much more common in our current interest rate environment. 

There are a lot of possible issues with seller financing while doing a 1031.  It's possible!  But you want to be careful.  A direct attempt at seller financing will result in taxes being recognized for the value of the carryback note (making the exchange less efficient). The carryback note is not considered a valid asset to receive in an exchange. For example, if you sell a $750K property with $500K in seller financing...well, the $500K will be excluded from the exchange and capital gains taxes will be recognized as payments are made.  Even worse, all of the depreciation recapture taxes allocable to the $500K will be recognized and due in the year of sale. 

(There are even some who believe that the seller providing a loan to the buyer will disqualify the exchange entirely, but that's not been our experience.)

The most straightforward solution is to have the seller provide a cash loan to the buyer outside of closing.  This way the buyer can come to closing with all of the necessary funds to allow for a normal 1031.

  If the seller is not liquid enough to provide a loan, they could attempt to find another financing option for the buyer.  If this doesn't work, then the seller can have the carryback note made payable to their 1031 Qualified Intermediary.  The Intermediary can then sell the note to any party, including the seller or a seller's family/friends.  Any proceeds from the sale of the note can be added to the 1031 exchange account to allow for more tax deferral. 

The issues get a little deeper, but the key takeaway is that careful planning is very, very important.  A lot of my company's clients are trying to do this in 2024, with mixed results. 

Happy to answer any questions you have. 

Quote from @Josie Sevilla:

I have a single rental property in CA which is paid for. Will it make sense to do a 1031 exchange to condo/condos in Honolulu? Zillow shows it’s estimated at $772K. I’ve checked Honolulu and seen condos as low as 250k  ( studio/condotels) to 700k. Will really appreciate any advice/feedback. Thank you much! 

 Thanks for posting Josie.  

How is your property in CA performing for you? Are you set on selling it?

You certainly can 1031 exchange from CA to Hawaii, although the California Franchise Tax Board will make it a little more annoying by forcing you file a new form (Form 3840) each year after you sell...failure to file the form will result in taxes owed. 

And in any 1031 exchange, you only get full tax deferral if what you buy is worth at least as much as what you sell.  If you sell for $772 (let's call it $740 after closing costs), then you'd want to buy a replacement worth at least $740ish in Hawaii.  Alternatively,  you can buy multiple smaller properties in a 1031 that combined add up to your initial sale value.  

My company, 1031X, is a nationwide 1031 provider. We've been in the business for 31 years and have the highest client satisfaction ratings. I am always happy to give you a 100% free consult IF you decide to do a 1031.  

Quote from @Nathan Frost:

Hi, I have two properties that I am looking to sell but once to use the profits wisely. My plan is to buy 1 STR and 1 LTR. How can I go about doing this either with a 1031 or what is the best method to attack this? My plan is to sell one in May and the other in July.

@Nathan Frost,

Thanks for posting.  If you are selling two properties that have appreciated (or have taken significant depreciation), then a 1031 exchange is almost certainly a good route since you're looking to reinvest. 

As @Erica Calella mentioned, planning in advance of the 1031 is very important, particularly if you're not terribly familiar with the rules and flow of an exchange. 

A few rules to keep in mind as you get started:

 - To get full tax deferral, you have to replace the full value of what you sell.  If you sell two properties at, say, $700K and $300K respectively, then you can either combine those into a single exchange and buy at least $1M of replacement properties OR you can split them and have one exchange trade for at least $700K and another for at least $300K. 

 - To get full tax deferral, you have to move all of your equity over into the new properties as down payment. 

 - You only have 45 days from your sale date to come up with a list of properties that you might want to buy next.  This rule is ironclad and can be tough to navigate. If you're combining your two property sales into a single exchange structure, then the first sale date in May will start your 45-day clock for both properties. 

 - You have to work with a Qualified Intermediary; the IRS won't let you complete a 1031 on your own.  My company, 1031X, has been in the business for 31 years nationwide, and we have the highest client satisfaction rating in the US.  Our consultations are 100% free if you want to brainstorm about the best method to attack your exchange. 

Quote from @Annette Homewood:

Hi, @Sean Ross. Thank you so much for your reply. I appreciate your insight.

I randomly called a 1031 exchange off Google & the man I spoke with also mentioned NNN/TIC's. I guess I could do some more research on these. But what it sounded like to me on first impression is that I would still, ultimately, be the landlord. And even though the leasing business would have liability insurance, I get the impression that that would be one barrier, but something catastrophic could still go wrong & I could be held liable. Furthermore, isn't there still the possibility of broken leases or other possible landlord headaches? Bc I would still be the owner, right? I guess I don't understand the difference between being a landlord & having a manager run a rental, and this.

Annette

 @Annette Homewood, if you're looking at an NNN/TIC, you're going to be an owner of some % of the fee interest in the property, which means that you're also a borrower and that you have a vote on all major investment decisions for the property. Almost all large industrial or commercial TIC structures involve a management company run by or hired by the sponsor, so you're not making day-to-day decisions.

The DST is different in that it's a separate fee owner of 100% of the property and is the sole borrower. You're making no decisions at all. Some investors like this, others don't.

If you are really concerned about liability and management exposure, DSTs exist in a bit of a separate world technically (though not always practically). 

What variables do you feel like are most important to you?  Cash flow? Limiting liability? Diversification? Limiting fees? Investment minimums?

Quote from @Ed Ma:

@Sean Ross  Yes, if outside of CA minimal management.  And yes cash flow needs to be better. Anything, except on the East coast

@Ed Ma, I'll send you a PM.  First step is to see what options you have to land on.  Once you have something to compare against, it'll be much easier for you to determine if 1031 exchange is worthwhile. 

@Michael Whiting,

To proceed with a 1031 on your portfolio of rentals, you need to partner with a Qualified Intermediary to act as your 1031 accommodator (the IRS requires this).  My company, 1031X, is 31 years old and is a top-rated national 1031 firm.  I'm happy to walk you through a free consultation. 

Since you're selling 8 SFRs, this could break up into multiple distinct exchanges (most likely), but you have the option of combining multiple sales into single exchange purchases.  You have to line up the timing and valuation properly. 

Are you already listing these SFRs or have any of them under contract? Or are you simply in the preliminary stages right now?

Quote from @Bill B.:

1) with a CRT you are giving the money away. Irrevocably. So do you want to give that money away?

2) lets use your 1031 exchange example. You’re selling one property for $200k that you paid $50k for. You buy 1 x $100k property but not the other. So you give $100k away to a charity and you have a $50k cost basis on the remaining property. (Mostly what I’m doing here is confirming you know at you have to spend all the sales proceeds, not just the profits, since you stated such low numbers.) then you would owe no taxes, but you have given away half your money. 

3) the good news is you gave the charity $100k not $100k minus taxes. The bad news this might/probably had to be done at the time you sold the property? It’s certainly not going to make your 1031 valid.

You’re probably going to need a charity you want to give the $100k to, a good cpa and a great 1031 QI. @Dave Foster have you ever combined a 1031 with a CRT? Anyone else want to weigh in?

We see CRTs as an end game for some investors who have already competed one or several 1031s. 

Basically, the charitable remainder trust is, as Bill pointed out, irrevocable, and will pay you an income over your lifetime and distribute the remaining funds to whichever charity you like upon death. Using a 1031 exchange property to fund a charitable remainder trust will let you keep deferring capital gains (as no tax will be due on the sale of the property by the trust) since it's a charitable entity. Rather, you'll receive an income for life and then a charitable deduction in the amount of the expected remaining balance given to the trust. 

If you are OK not leaving the balance left over to your family, This is a very good tax efficient option that can aid a cause you care about. 

Quote from @Ed Ma:

Yes, loan balance is about 118k @3.5% and property taxes are low due to Prop13.  I'm just worried if I sell it will be a huge tax hit. The 1031 seems like an option.

I'd also have to find a property outside of CA too.

 Ed, your top priorities for a potential replacement property sound like

1. Cash flow
2. Less or no management

?

Are there areas that you're intuitively attracted to?  Or does geography not matter to you?

@Annette Homewood,

I sympathize completely with your predicament. It really sounds like you've got stressful assets and aren't clear about which step to take next without making a mistake. 

You've also clearly done some homework already on DSTs, which is more than a lot of investors do (unfortunately). 

Let me take a whack at some of your "don't know" issues:

Will there by surprise fees? Possibly. Not all DST sponsors or brokers are comfortable breaking down their fees in clear, simple, direct language. DST fees include (1) typical escrow/title/appraisal/legal fees (as with any real estate transaction), (2) capitalized reserve fees that are typically paid upfront since DSTs can't use capital calls or borrow new money, so there are fees that help pay for the DSTs to raise all of the money it needs at the beginning, (3) selling commissions especially if you're using a DST broker, and (4) offering expenses for purposes of running the DST marketing and legal costs. Ask any DST provider/broker to list out these fees and how they impact your return.

Extra fees to cut into your equity? Over the life of a DST, sponsors will take asset management fees and they'll also often take out disposition fees upon sale that might not be subordinate to your investment...which will have the practical impact of cutting into your return on equity.  However, unlike a normal property that you manage, all of the costs and fees are "baked in"...you'll never come out of pocket to pay anything with a DST after you've invested.  

What else you should look out for? Yes, but I think the most important is to broaden your potential search a little. DSTs are useful in some circumstances and are extremely well advertised, but they aren't the only passive investment game in town for you if you're looking to 1031 exchange out of your headache properties. There are other NNN options, although there aren't any options that are going to come with mutual fund-level low fees. This is real estate after all.

Some alternatives to DSTs:

- Any property you buy could hypothetically become a triple net lease property. 

- A NNN tenants-in-common (TIC) property, which is in many was the structural predecessor to DSTs. There are meaningful differences, but they're still passive and often a good route if you're boxed out of accredited investor-only assets.

 - Oil/gas or other mineral rights, which will provide a passive income stream and are 1031 eligible

- There are other syndications out there that aren't structured as a DST, but a lot of them are going to have accredited investor requirements.

Let me know if you have other questions here. I think right now you're on the right path in terms of trying to evaluate the landscape for potential exits.  Be alert -- and I'm sure you already are -- that everyone tied to a company (myself included) is going to be incentivized to give you advice that leads to their service or product.  Ask around.