The Magic of 1031 Exchanges Script
Intro to 1031 Specialists
We are a Qualified Intermediary that facilitates 1031 exchanges for clients all across the country.
In this presentation, we’re going to share with you how you can use the 1031 exchange as a tool to defer real estate taxes and build more wealth via real estate.
What We'll Cover
Here is a quick rundown of what we’ll cover. First, I’ll give you a quick overview of 1031 exchanges. Then I’ll show you the real magic of using the 1031 exchange to compound your real estate gains, tax free. And finally, we’ll share best practices so you can have a successful exchange.
What’s A 1031 Exchange?
A 1031 exchange is the swap of one investment property for another like-kind property without paying tax. 1031 exchanges have been around in the US for more than 100 years.
A 1031 exchange transaction happens just like any normal real estate transaction except for a couple key differences:
- You must use a Qualified Intermediary like 1031 Specialists – Qualified Intermediaries are independent 3rd parties required by the IRS to facilitate 1031 exchanges.
- You can’t take constructive receipt of your funds.
First, you’ll sign an agreement with a Qualified Intermediary like 1031 Specialists. We will direct your proceeds from your relinquished property to a partner bank where your funds will sit for the duration of the exchange. When it’s time to close on your replacement property, we will direct those funds from the bank to the seller of the replacement property you are buying, successfully completing your 1031 exchange.
Types of Exchanges
There are 3 primary types of 1031 exchanges: the Forward, the Reverse and the Improvement or Construction exchange. There’s also a simultaneous exchange, but those are less and less common today. The vast majority of 1031 exchanges done today are Forward Exchanges.
In a Forward Exchange, you sell one investment property and buy another within 180 days.
The Reverse is opposite of that – you buy first and sell one of your properties to satisfy the exchange. We see a lot of well capitalized family office clients do Reverse Exchanges.
Then there’s the Improvement Exchange, which is when you invest equity to improve your replacement property.
Which exchange you chose really boils down to your investment objectives, capital and timing.
Nearly Infinite Exchange Options
You can exchange raw land for a rental home, an apartment complex for a shopping center or diversify from an office building into multiple rental houses. There are more than 16 types of real estate that qualify for 1031 exchanges. And you can exchange any of these types of property inside any city or town in the US. So long as all property is held for business or investment purposes, you have nearly infinite exchange options.
Do I Qualify?
First, you have to qualify, or rather, not be disqualified from leveraging Section 1031 of the tax code. You must pass three basic tests to qualify for a 1031 exchange:
- “Who You Are”: You can’t be a flipper or developer
- “What You Own”: It must be US real estate held for business or investment purposes
- “When You Bought It”: >2 years ago
The 1031 exchange is the 8th wonder of the world. It is a gift given by our Government to real estate investors.
The true power of a 1031 exchange is the ability to meet your investment objectives without losing equity to taxation. With more money, you can buy larger, multiple, or more productive properties.
Here’s an example:
Consider a scenario where you have $500,000 in equity in an investment property you are selling.
When you do a 1031 exchange, you defer your taxes and don’t pay capital gains tax; if you don’t do a 1031 exchange, you’ll take a $65,000 capital gains tax hit.
When it comes time to reinvest, you have a lot of less equity: $500,000 for a 1031 vs $435,000 for not doing a 1031!
Now let’s assume the equity remaining represents a 20% down payment.
With a 1031, you’ll be able to afford a $2,500,000 property. But if you decide not to do a 1031, you’ll only be able to buy a $2,175,000 property.
The difference in a single transaction is $325,000. This $325,000 buys you more property, more diversification, more bonus depreciation, and more cash flow.
The Magic of 1031 Compounding
As you can see, there’s a lot of benefit in doing just one 1031 exchange. But what if you do multiple 1031 exchanges during your lifetime and just keep exchanging?
The table on this page demonstrates the impact of taxes on compounding. The same transactions, the same returns each time (50% return on equity). The only difference between the middle column and the right column is deciding to 1031 versus not.
If you do ten 1031s in your career, you will have turned $100,000 of equity into $5.766MM.
If you decide not to utilize a 1031 and pay 30% taxes each time, after 10 transactions you’ll take home just north of $2,000,000.
You’ll be $3.75M richer by doing a 1031 exchange.
What if you did 20 transactions in your career?
As you can see in the dark grey box at the bottom, you will be $292 million dollars richer by choosing to utilize the 1031 exchange versus not doing a 1031 exchange.
This is the power of tax-free compounding. This is the magic of 1031s.
Swap 'Till You Drop
There is no limit to the number of times you can 1031. That’s why 1031 grandmasters just keep exchanging.
While you’re alive, 1031 exchanges allow you to buy property with higher basis, benefit from more bonus depreciation and build a bigger real estate portfolio that generates more cash flow.
And when you pass away and your kids inherit your portfolio, they’ll get a step-up in basis and won’t pay a dime on the lifetime of appreciation you made happen. You will have avoided taxes altogether.
This is what we mean by Swap ‘till you drop.
Planning to Win
Let’s assume you qualify; you have a property you want to exchange and you’ve hired 1031 Specialists as your Qualified Intermediary. What next? Now is the time for Planning. This is where you win.
The Challenges of 1031s
It’s not all roses – there are some challenges of 1031s. There are generally two objections we hear from 1031 naysayers.
- “It feels like I have a gun to my head as far as the timelines are concerned.”
- “1031s cause you to overpay for your properties.”
Let’s address each.
The Clock is Always Ticking
The main challenge with 1031 exchanges is the limited amount of time you have to find and close on a replacement property.
The clock starts right on the closing of the sale of your relinquished property.
You’ve got 45 days to identify your replacement property and have to complete the transaction within 180 days. These deadlines are FIRM, regardless of whether the 45th or 180th day fall on a Saturday, Sunday, or holiday.
Planning to Win
Planning is the solution. The more you plan, the more you mitigate the timing risk.
Before the 45-day clock even starts to tick, you can:
- Have your broker shortlist 10 properties for you
- Identify replacement property or properties
- Enter into an option contract to buy a replacement property
- Put your target property or properties under contract (assuming they aren’t going “hard” and putting their money at risk)
- Do a Reverse Exchange
I recognize that finding a suitable replacement property is work. But the alternative is paying 30% in taxes and taking a HUGE hit. So why not do the hard work, and compound tax free?
Tell No One
For those that think 1031 buyers overpay, I have some advice. Tell No One.
Almost no one needs to know you’re exchanging. You don't need to tell anyone other than your QI and your legal advisors. There is no provision in the 1031 rules that states that you have to publicly disclose that you're exchanging.
There’s a misconception that you are over-paying because you are a 1031 buyer and that’s false... because no one should know you’re a 1031 buyer in the first place!
Tell No One.
Wisdom from Our Experience
Some investors who utilize 1031 exchanges overpay because they are disorganized and undisciplined. But 1031s aren't structured in a way that inherently makes you overpay.
So, here’s our advice…
- Plan ahead, smartly
- Have a process to identify opportunities
- Never let the tax tail wag the dog – if you’re overpaying a ton to save on taxes, you’ll be inflicting significant financial damage to your portfolio… it’s probably best to opt out and pay the tax
Here to Help
We’re here to help and have all the resources you need.
With our 1031 exchange calculator, you can dive deep into the nuance of 1031 exchanges, from capital gains calculations to 1031 tax deferment to detailed scenario analysis of different 1031 replacement properties. And it works in a way that’s simple to use and easy to understand.
Our e-book, the 1031 Bible, has everything you need to know about 1031s.
And of course, if you have specific exchange questions or are ready to do a 1031, just email me.