1031 Exchanges, Unrealized Gains, Latest News In Build-to-Rent - EP18

1031 exchanges multifamily real estate financing real estate portfolios Dec 28, 2021

"I had chatted with Karen before and she said something that was interesting to me. She said that 50% of people that do 1031 exchanges do not need to do it... I know that there's so much talk about it and it's awesome to get more properties and double your portfolio with a 1031 exchange but talk with your accountant because you may be in a situation where you do not have to do a 1031 exchange and put that pressure on yourself." - Sherida Zenger, B2R Show

"For a lot of these people, the complexities of a 1031 exchange, ultimately aren't worth it. When I have a client considering it, the first thing I tell them to do is talk to your account and find out what happens if you don't. The accountant will email them back. "Well, you're going to owe a tax bill of $8,200" and they'll go, "I'm not going to rush into some deal that I wouldn't do otherwise over $8,200..." - Steve Olson, B2R Show

Episode Highlights:

  • The current state of 1031 tax-deferred exchanges
  • The ins and outs of doing a 1031 exchange
  • Advice to discuss with your accountant about doing a 1031 exchange
  •  Thoughts on being taxed on unrealized capital gains
  • Latest news and updates surrounding 1031 exchanges and the build-to-rent industry
powered by Sounder

If you're in the build-to-rent space, whether it's you, whether it's your investors, you're going to get these questions about 10 31 exchanges. It's such a tremendous source of capital in the real estate world and it's actually always there. Somebody's always doing an exchange, whether the market's pure mayhem, whether it's a little bit slow, these exchanges come up, people got to deploy money, they got to get it out there or the tax consequences are going to be pretty brutal.  

There's been all this talk in some of these new laws getting passed or proposed by the new presidential administration about, should get rid of 10 31 exchanges? " I'm not an expert on it" seems to be the usual banter. It's been dying down a lot. 

They love to bring it up, but I don't know that it's gained any significant traction. Have you guys heard anything on that? I haven't heard anything in a while.  

Sherida Zenger: Nope. I was weirded out.  

Chase Leavitt: Yeah. A big concern. 

Steve Olson: 1031 exchanges appear to still be here. Did you hear they wanted to talk about taxing unrealized capital gains? I don't even have words.  

What would you do? How do you even administer that? They'd have figured out a way to do it terribly and make it counterproductive and crash the economy. 

I looked at my TD Ameritrade account today and I made about $200 and apple stock today. So w when do I pay or how, or what?  

Sherida Zenger: Maybe you could lose it all tomorrow. Is this a yearly thing? Is this a monthly thing? Is this a daily thing? You're going to pay me back when I lose? 

Steve Olson: You know they don't plan on doing that. Are you going to send me a check when I send you my, my statement of loss, the, oh, you lost in your, like, it was not serious. Proposition  

Chase Leavitt: Sounds like a nightmare.  

Steve Olson: Yes, that's correct. I think everybody agrees with that one. That was a stupid idea. You know, if you think it's a great idea, you probably don't listen to this show.  

So 1031 exchanges. Of course, there are many rules and things associated with that. We're not here to talk about that. That's for you, your accountant, your 1031 accommodator. 

Right to go over and make sure that you're compliant, but there can be some unique, uh, intricacies to it that we've found on, on the build for rent side, when it comes to when you close on new construction, what do you actually own? And when do you own it, and how does that apply? Does one of you want to dig into that a little bit and what people should be thinking about there? 

Sherida Zenger: I think one thing that makes us different when you're closing on new construction, you're actually taking title to the. So that's one of the key things in the 10 31 exchanges, you have to take title to that property within that 180-day mark. 180 days of when you closed on the departure property. So the property that you sold, if 180 days to actually close on the property that you're acquiring, you have 45 days to identify a property. 

Chase Leavitt: It gets a little bit tricky when you're buying a new construction multi-family property. You have to time that accordingly.  

Sherida Zenger: We're pretty good with people saying, Hey, if you're going to do a 1031 exchange, talk with us. 

We recommend using our accommodator Karen Weeks at United West Title because she's phenomenal but talk with us because we don't want you to identify something that ends up not being property.  

Chase Leavitt: Does there have to be a CFO in order to 1031 exchange into it?  

Sherida Zenger: No. No, because you're taking the title, and again, you're having the value. Whatever you sold your property for. Less some commissions and title fees. That's what you have to replace it with.  

Usually, most of our investors are maybe buying two or three or four more of our properties because they can take the land value when they close. And then some of the construction, depending on how far we're going to get into it. 

So that's one of those things we always say to people, if you're going to do a 1031 into something that we do talk with us first, let's chat with it. Cause you're not going to be. Sell something for eight 50 and buy our fourplex from us for 900 and fulfill that exchange within 180 days. It doesn't work that way, but we can accommodate exchanges. 

We're just gonna have to split the money out a little bit. Cause you can divvy out how you do your money. I want 30% here. I want 20% here. I want 50% on this other property.  

Steve Olson: As I understand it, it's, it's ultimately about proving like you said, what you owned and when you are. Right. So, I mean, some people take, kind of take a gamble. 

They say I'm going to buy this property for a million dollars. Right. And even though it took 18 months to build it, I'm still claiming the whole million because I'm going to get audited maybe in three years, and good luck. What I owned and when I owned it, but that's actually on you, you've got to prove it. 

I think they're probably just planning on saying here are my closing documents and what I paid. I don't know if that holds water or not. And I prefer to never find out. Right. But the best part is as well, take what you paid. And if you've got copies of approved loans and vertical budgets, you could probably be any reasonable person. 

And, and by the way, like 50 CPA, Have agreed with us on this. You could subtract that vertical budget from your overall price and get to a land value that way. Could you not?  

Chase Leavitt: Have at least a land value. And out of the 10 years, we've been doing this, have we ever had anyone that's done a 1031 exchange into new construction? 

I don't know yet. I haven't personally. I've had some clients. They have not been audited yet.  

Sherida Zenger: And you guys, another thing that can help as a safety net. If they want to make sure they play by the rules, we obviously have bank draws. Right. So if you're kind of trying to get as much out of it as you can, we have monthly bank draws, so you'll be able to say, okay, so here was my land, but I've had five draws that equaled 150,000. 

At this point, my property was worth X. Because of the one value in the dress.  

Steve Olson: I think you're talking about what I've heard referred to as a build-to-suit exchange. And I've heard it called a bunch of other things. There are so many kinds out there and I never know we should get a really good accommodator on the show and interview them. 

Karen. Yeah. I don't think she'd want to be on the show.  

Chase Leavitt: She'd be awesome though.  

Steve Olson: She's great. In this case, you say, the accommodator creates a temporary entity. That takes the title. Right? So you sold your exit property on January 1st. 

So by the letter of the law, you have 180 days. Let's just call it June 1st. You have until then to close on the replacement property. In new construction, the rationale being well, what if I closed on dirt in February? So now I have five more months to do construction and build value into this property above and beyond the actual land value. 

Right. I have that, that period of time. So, but the title company has to take title through that. It's called an E I can't remember what that stands for, like an exchange. Asset tries something like that. There's an entity, a specific time they use. And so then you come in towards the end of May and you actually close at that point. 

That's when chase Levitt shows up on the title cause Chase Leavitt exited title in January shows up again on the new property at the end of May. He's going to take that, that land value, and add up all those banks draws that had just been talked about. And that's the value he claims. Right. And that's that, that holds water. 

Does anyone want to tackle the problem that can create on financing?  

Sherida Zenger: A lot of lenders don't like it. I think we've found two lenders that will do it because most of the time it's held in an LLC. First of all, they don't like that. They want it to be you on the line, not your LLC. 

We're doing one in Idaho for a client of mine. The bank was actually pretty cool with it, but he has already closed on his departure property. He has his funds. He's good to go. I think we're going to eat most of it up just in the first draw alone. I think he's fine, but he had to be on title and the LLC. 

Steve Olson: It seems like it's a lot easier on a commercial finance deal. Whenever you drag Fannie Mae into something, It's going to complicate it.  

Sherida Zenger: And most commercial, most of the time you're doing it in an LLC  

Steve Olson: I think every time it has to be. And then that's the point where you could actually because, on a conventional loan with Fannie Mae, you can't have a reasonable conversation with Fannie Mae. 

Oh, here's what I want to do. And it really makes sense. They're going, they're going through, well, it doesn't say it. Yeah, right. If you're dealing with a robot, but on a commercial loan, you're talking to a loan officer who can talk to a loan committee who can say, we want to do it this way and the other, and they approve it on a case by case basis. 

Right? This kind of situation would be reasonable. They would understand that. So I don't think that you're going to be able to get away with a build-to-suit. I'm not sure anyone ever has on Fannie Mae financing. Do you know anybody?  

Sherida Zenger: Not that I can think of. 

I think the other thing that is out there, you know, it used to be that with 1031 exchanges, it had to be like-kind, and that was such a hangup for a lot of people. 

Well, I sold a condo, so I have to buy another condo and that's not the case either. So you can sell land raw land and then buy a fourplex. You can sell an apartment building and buy some single-family homes just has to be in the same realm. Right. I know that there have been. Again, this is just what I've been told. 

So don't hold me to it. But people have exchanged into houseboats down at lake Powell, 10 31 exchange into a houseboat. So, and I know that they were, I was actually to talk to Karen about a gentleman that I know that wanted to do an exchange into an airplane. I don't know how that worked and what they ended up figuring out, but I know that there was some kind of. 

Chase Leavitt: Can we talk about the numbers just a little bit, let's do an example. Cause I think there are some misconceptions out there on the amount of what people need to exchange that I get asked on every now and again. So let's say investor, Bob comes to you and says, Hey, I sold my duplex for 500,000. Okay. I bought it for 300,000. 

So I ended up making 200,000, right? How much would investor Bob need to exchange? Because oftentimes they have that investor that they'll come to me and say, okay, I need to exchange 200,000. Is it the 200,000 that the 300,000 that he owed on it? Is it the 500,000? Let's just talk about that real quick. 

Sherida Zenger: So my understanding is it's whatever you sold the property for. So the 500,000 fewer title fees and commissions are what he would have to replace. There is a big misconception because people say, oh, it's only on my gain. It's not, it's. What you actually sold the property for, you have to then replace that value. 

Chase Leavitt: Let's say commissions, let's say ends up 4 75, 4 75. So he needs to find a nut. You're telling me he needs to find another property for 4 75 or more. Correct. And it's easy when the property is already built. Right. Cause you know what you're going to purchase that property for. So I think is what we've been talking about here is the new construction. 

And figuring out what the costs are. So basically that is what you need to do. You can 1031 exchange into new construction. We went over this what five, 10 minutes ago, just find out what the land value is and that construction value, and it needs to equal for investor Bob, at least the 4 75. At the time of his hundred and 80-day mark  

Sherida Zenger: He could split it into two. 

So sometimes we'll say to an investor, Hey, you may want to buy two fourplexes because we can tie that value upright on that first draw loan with the land value. 

Steve Olson: As long as you get to that overall exchange amount that needs to be achieved.  

Sherida Zenger: And here's another thing when you're, identifying a property. 

You have to identify, you can identify up to three properties, right? Yeah. If you identify four, you have to buy. If you identify three, you can buy one, two, or three.  

Steve Olson: Because you have to identify within 45 days of your exit and that's there so that people don't say, and I identify the whole world. 

You can't prove you're in good faith. Try and do a 1031 exchange. Yeah. Okay.  

Chase Leavitt: Plan ahead. I think the biggest thing is to plan ahead. Understand what you're going to sell the property for. Even before that, understand what you want to go into, and if it's new construction understand your timeframes and your deadlines know that you need to take title right. 

And understand when that's actually going to happen and maybe plan for a little bit of buffer we've been talking about on our episodes lately, that there's a lot of delays going on. Maybe give it at least more than probably one to two months, maybe three or four in case. Fall behind a little bit. And you can't take title when you were planning on it. 

Sherida Zenger: I know one thing that we've done because our contract says it will be completed within 12 months. Right? So we've gone over that, but we've had some people that have said, Hey, I have my 1031 exchange. I have to close by my hundred 80th day deadline. You guys aren't quite ready for me to close. So can we work something out? 

And usually, we've said, okay. Yes, we'll let you. But we're going to write an addendum to your contract that says your 12 months, right? Our builder's not going to be responsible for any Glocks, not taking exactly. It doesn't click until the building next to you starts construction. The other thing that chase had brought up with, Hey, this works for new construction. 

It works for new construction. If you're taking title to the property, cause there's a lot of new construction out there, you know, the average home. Yeah, you can put it under contract, but you're not taking title to the property. Once you go under contract.  

Chase Leavitt: A lot of times it's a certificate of occupancy.  

Sherida Zenger: Our people are carrying the construction loan. So that's what makes it unique and makes the 1031 work new construction with us.  

Chase Leavitt: Sooner than later.  

Steve Olson: Well, this is something that you talked about a couple of episodes ago when we were talking about valuing a deal, right? Wha what was somebody willing to pay for a deal? What is it worth? 

And one of the big points is that. They could have a huge tax consequence. So the uncertainty of new construction in a build for rent deal, uh, sometimes isn't worth it on a 10 31, you're saying I'm going to have a $300,000 tax bill. If I don't close by day 180, you know what that attractive cap rate that comes with brand new construction may not be worth it to you. 

You may say I'll take a four and a half cap rate because I know I am saving that giant tax bill and I get a moderate return on my money. Along with it. Right? So when you're doing that build for, you got to consider it all these logistical, the supply chain, these labor things it's harder and harder and harder. 

I think they should link them to the time period for a 1031 exchange. I dunno, maybe I'll go pick it on the steps of Congress or something with literally everybody else. I think everybody's there right now.  

Sherida Zenger: Give us a little more time, especially right now in the climate we're in. Right. Everything's taking longer. 

Steve Olson: I think did that at the beginning of COVID didn't they? Yeah, they extended some, I think they pushed 1030 ones out. They gave everybody a little more time, which was cool. I think that was a good idea. It really helped them. Mark. Just increasingly six months doesn't seem to be like enough, enough time. 

Sherida Zenger: We've been pretty flexible with people as well saying, Hey, let us know and wait to close on that departure property. You can put it under contract, just make your close of escrow, close to the wind. You're going to close on one of our properties, right? Because we want to give you as much of that 180 days as we can. 

I know that doesn't always work out, but again, talk to us, we can help walk you through this.  

Chase Leavitt: Yeah. If someone came to me with the 10 31 exchange and said, Hey, I want new construction. I'd say it's probably not going to happen. You're not going to start sooner next time.  

Sherida Zenger: Or are you flexible? Can you wait a year to sell your property? 

Chase Leavitt: But if it's already sold, saying I have money in my bank or with the accommodator yeah. Let's find something that's already existing then.  

Sherida Zenger: And it may be just something I know chase had mentioned this in another episode, Hey, maybe this is just something as a placeholder, right? I'm going to put my money here. 

It's an okay investment. Maybe I'm getting a return. Maybe I'm breaking even exactly. And I'm not having to pay the capital gains on it till the next property comes available. Right. Something else that I can put my money into again, you have to be smart, but you may just want to play.  

Steve Olson: If the government wanted to facilitate more new construction and especially affordable housing, which has so many strings attached, it can be difficult. One possible way to do it, I'm getting a little academic here is lengthening the exchange period. If you're buying that kind of. You know that that would move a lot of this 1031 money, which we talked about at the beginning of the show is always out there circulating. 

You could push a lot of that in the right direction of whatever kind of housing you wanted to create. And should I handle that at the Capitol when I go there? Yeah.  

Sherida Zenger: Okay. Make a few cents for that. I had chatted with Karen before. Just cause I usually like to put clients in touch with her and she said something that was interesting to me. 

She said 50% of people that do 1031 exchanges do not need to do it. So that's one thing that I want to just say, Hey, I know that there's so much talk about it and it's awesome. And you know, you can get more properties to double your portfolio. However, you want to do this with a 1031 exchange but talk with your accountant because you may be in a situation where you do not have to do a 1031 and put that pressure on yourself. 

Steve Olson: We need to get them on the show, but I've had that very same conversation with Mark Kohler. Who's the most entertaining CPA there is, right? He's the only guy that can make taxes. But he told me that same thing, that like a lot of these people, the complexities of a 1031 exchange, ultimately aren't worth it when I have a client considering it. 

The first thing I tell them to do is talk to your account and find out what happens if you don't. Yeah. And the accountant will email him back. Well, you're going to owe a tax bill of $8,200 and they go. I'm not going to rush into some deal that I wouldn't do otherwise over $8,200. Yeah. Right. So it's, that's, that's a good point. 

I should point out that Karen is a real person. She is our title company and 10 31, her, she is not the stereotype. That emerges of the naggy lady who wants to enforce the rules on everybody. 

She's the good Karen. I mean, some people are saying like, Karen is like a new racial slur almost. 

I mean, it's a, it's quite the insult to be called a carrot. So I've had this conversation with her. She hates that. That's her, that's her name right now who chose that? She's the best. Yeah. I just kind of a funny tangent along with this, but this topic, I was talking to a client, this is like six months ago. 

And they kept saying, yeah, I've got to do this 1033 exchange. And I just kind of let it slide. And they kept saying 1030. I'm like thinking you don't know what numbers are. Right. You don't understand. Oh, no, I don't understand. I learned all about a 10 33 exchange. And if you go at starting at section 1030, there are all kinds of exchanges. 

1031, 1032 to 1033, 1034. For our weird trivia, 1033 is what happens in the event of eminent domain. Oh, if you, if your, if the government says, Preston, we are taking your house, it is in the public interest that we need to put a power line here. We own your house now, and we're going to pay you fair market value, which rarely has, has somebody who has been on the receiving end of this thought they got fair market value, right? 

That's a big topic. Now here's this money. He actually has a lot longer than the timelines for exchanging in 1033 are much more generous than in 1031.

Sherida Zenger: That's interesting. I wonder if that's the same thing. I had a client that was talking to me about the fires in Paradise, California, a couple of years back. 

And she had said, I think she had. Yeah, like it was, and I kept thinking, does she know what she's talking about? And then I looked it up. So I wonder if it was also the if it's 1033 exchange. That's the same.  

Steve Olson: Eminent domain. So it's condemned or disposed under threat of condemnation, is probably that if not, it's going to be 30, 1034 is the sale of stock. 

I learned that if you're a nerd like us, you might enjoy reading about that.

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