REIA 66 Justin Kehne: The Advantage of Advanced Capital Gains Tax-Deferral Strategies

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Enlightened Investors. Nobody knows more about investing than institutional investors. Today, we explore how we too can invest like an institution and like the big guys, take advantage of advanced capital gains tax deferral strategy. Our guest, Justin Keeney, along with his team of licensed financial professionals, provides investors access to fractional ownership of institutional quality real estate assets. They are experts at structuring passive tax-efficient portfolios through 1031 exchanges and opportunity zone investments. They've gained vast knowledge through the experience of executing over $250 million in 1031 exchange Delaware statutory trust transactions. They hold claim to the largest single Delaware statutory trust transaction in the history of the industry. So Justin, before we get into the finances of institutional investing, share with us a memorable experience from your formative years that helped you to be the person you are today.

Yeah, absolutely. Thanks, Allen. Really looking forward to the conversation here and we'll get into kind of the meat and potatoes of that whole word salad that you threw out there. But in terms of formative years, and you mentioned one memory, I'll give you multiple. I'm 30 years old. So for me, formative years is, you know, maybe as a child growing up, In my teens, probably. I was an athlete, always an athlete growing up. I played just about every sport under the sun, but lacrosse, growing up in Annapolis, Maryland, which is kind of a hotbed for lacrosse, lacrosse was my primary sport. And it's not any one experience. I'd say it's sport in general and a lot of failure, a lot of missed shots, lost games. Can't tell you how many times I've been cut from teams, but it was something that I enjoyed and it was something that Specifically the sport of lacrosse, was something where you could learn to put in effort, show up every day, really work at something, and it forced you to delay gratification, and it forced you to accept failure because you weren't going to win every game, you weren't going to make every shot, sometimes you were going to get cut. And if you threw in the towel and gave up at that point, you didn't get to play the sport that you loved anymore. I presented the other day. Somebody asked me my 3 keys to success. I said consistency, effort, and a short memory. And I think that applies here. And I think I learned that through my experience in athletics. You fail, you get a no, a deal falls apart, you lose money. You have to have a short memory and keep trucking and keep moving forward.

Well, explain just a little bit. What do you mean by short memory?

So you don't want to forget your failures, but you don't want to let them shake your confidence, right? So you want to learn from your mistakes, And they talk about it in football all the time. Quarterback comes out and throws an interception. The next offensive possession, they talk about quarterback has to have a short memory, right? If he's dwelling on the interception that he threw in the previous possession, if you're dwelling on your recent failure, it's going to negatively impact your performance moving forward. Again, you don't want to forget your mistakes. You don't want to— you certainly want to learn from those mistakes and kind of make sure that you evaluate what went wrong. And you can avoid those things in the future, but you can't dwell on those mistakes. And when I say short memory, that's what I mean. You can't let that rattle your confidence.

Yeah, excellent advice. It is so easy to dwell on and to focus upon our shortcomings rather than to look to our successes. So yes, good advice.

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Well, Justin, before we jump into our discussion on 1031 exchanges, you are involved with the Securities Exchange Commission, and you wanted to let our viewers and listeners know a little bit about what the limitations are in terms of what you can and cannot do for them. So give us your disclaimer. Absolutely.

I have my securities licenses. I'm a financial advisor, investment advisor. Our industry is highly regulated and we always need to be very transparent. And so the disclosure that I'm asked to read in situations like this, I'll keep it brief, but this is for informational purposes only, does not constitute individual investment advice, should not be relied upon as tax or legal advice. You'll hear me say that a few times. I'm not a CPA. I'm not an attorney. Rely on your proper tax and legal advisors before making any sort of significant decisions. So please consult those appropriate professionals regarding your individual circumstances. Investments in real estate carry risk. DSTs, which are Delaware Statutory Trusts, are speculative, illiquid, carry a high degree of risk, including the potential loss of the entire investment. Investors should read the risk section of the private placement memorandum for a full disclosure of all those risks as it pertains to individual deals. Potential cash flows, returns, appreciation are not guaranteed, could be lower than anticipated. And securities that we deal in are offered through Concord Investment Services, LLC, member FINRA, SIPC. I'm with Fortitude Investment Group, which is independent of Concord Investment Services. So with that done and out of the way, we can get into the more interesting and fun stuff.

A little bit boring, but good advice. It's always good advice.

Necessary, necessary.

Yes, indeed. Well, break it down for us. What is a 1031 exchange? And just put that in layman terms as best as you can so we can understand exactly what that is so we can take advantage of 1031 exchanges. Sure.

So a 1031 exchange refers to— it gets its name from Section 1031 of the Internal Revenue Code. It's codified in IRS rules in our US tax code. It refers to what's called a like-kind exchange. And it's a way that you can defer capital gains taxes on the sale of real estate. So it applies to investment or commercial business real estate. It does not apply to your primary residence. There's a different section of the tax code that allows for most people to not pay capital gains taxes when they sell their primary. But when it comes to selling highly appreciated investment real estate, whether that is a single-family rental home, a condo rental, or a $15 million warehouse distribution center, if you sell that and don't do anything about it, and it has appreciated since you purchased, you will owe Uncle Sam capital gains taxes. Depending on where you live, where you sold, you may owe your local state capital gains taxes as well. Being a savvy investor, being in real estate, trying to build wealth and income through real estate, you'd obviously like to keep as much of your money in the investments and working for you as you can to enhance your returns, potentially enhance your returns. And so a 1031 exchange allows you to sell one piece of property, reinvest the proceeds into another piece of real estate, and as a result, not have to pay capital gains taxes Today. It's not an elimination. It is a deferral. If you ever sell a property, you do one 1031 exchange, you sell one, buy one. If you sell that replacement at some point in the future and don't do another 1031 exchange, you will ultimately have to pay those taxes. That's why it's a deferral. It's a very important distinction. But what we see often is guys that build their wealth through real estate, whether passive or active, They're able to sort of use the 1031 exchange to sell one property and kind of upgrade to something bigger or better, or sell one and buy multiple to diversify a little bit. It's kind of like a 401 in that it allows you to invest pre-tax.

So it's a like-kind exchange. And if I am correct on this, like-kind means that it is real estate to real estate. And in other words—

That's correct.

You could have a single-family home and you could exchange that for a shopping center. As long as it's real estate, it's like-kind. Is that correct?

That is. That's a great point. It's a common misconception. Folks call me and they say, hey, Justin, I sold my multiplex, my fourplex. I want to do an exchange. I have to buy another fourplex, right? I have to buy another piece of residential property. It's not true. You sell real estate, you can buy real estate. The term in— not to get too technical, but the term is real property, which actually also includes things like mineral rights and air rights. If you're in the Midwest, mineral rights as it pertains to oil and gas. Folks in maybe Manhattan or Miami are familiar with air rights, which is essentially rights to build in the space above a building, which in a big city, lots of skyscrapers can get contentious and have significant value. But for most folks, it is real estate for real estate. And again, it has to be investment or commercials/business real estate for the same.

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And if I am correct on this, the exchange has to be of greater value than the property being sold. Is that correct?

It is. So there are some rules around the exchange. You are correct. When you sell a property, hypothetically, let's say you sell a property for $500,000 and you want to exchange with those proceeds, The next property that you buy has to be at least $500,000 equal or greater value if you would like to defer all of the capital gains taxes associated. We see partial exchanges where you defer most of the taxes, but not all, and that's certainly an option. We call that taking boot. The portion that you do not reinvest is considered boot. So that's a big rule. And then another rule is the timelines involved. So the entire exchange has to be completed in 180 days. From the sale of your, what we call the relinquished property, the property that you're selling. So you have 180 days to complete the purchase, the closing on the replacement property. And even within that, you only have 45 days to identify one or multiple potential replacement properties. And so if you're in a situation where, and we see it all the time unfortunately, you're in a situation where it's day 40 following the sale of your property and you found something local that you like, that you think you wanna buy, and you have a contract in, on it, you identify it, and that sounds nebulous, but there are people that record these things. You identify it in terms of writing down the address and a description. You identify it and then day 45 passes. Now we're day 50. Now we're day 60. We're doing our due diligence. Now we're day 70. And for some reason, the deal falls apart. You're up a creek. You've only identified one property, this one property that you had a contract in on, and that deal has fallen through. And so now your exchange We call that blowing the exchange. And there are no real negative repercussions other than you're not penalized, but you now will be forced to pay those capital gains taxes when you file your taxes at the end of the year.

So there lies the rub with the 1031 exchange are really those timeframes. And there's no flexibility.

That's correct.

They are laid in stone.

Christmas, New Year's, 4th of July, doesn't matter. It's not workdays, it's calendar days. And so, We sometimes deal with clients in the 1031 space. We work closely with qualified intermediaries, who are the folks that sort of facilitate the 1031 exchange. Sometimes you're working on Saturdays and Sundays, and the deadline is, it's midnight on Saturday, or it's midnight on Sunday. And so if a client's not prepared, sometimes you do have to field those phone calls when you'd rather be doing other things.

Well, 1031 exchanges have been around for a long time, but there's something relatively new in the investment environment, and it is these Qualified Opportunity Zones. What are Qualified Opportunity Zones?

So Qualified Opportunity Zone legislation came about in 2017 with Donald Trump's Tax Cuts and Jobs Act. And an interesting thing about QOZ legislation is that it was a bipartisan effort. Senator Cory Booker was the one that was heavily involved on the Democrat side. Sean Parker is a private individual. He was the first president of Facebook. Some people may know him as the guy that founded Napster back in the day, but Sean Parker was a lobbyist, a big force pushing for this legislation because he personally had significant amount of Facebook stock. We call them paper gains, huge amount of appreciation on that stock. But essentially for someone like that, that's locked away because if he were to sell those shares, the capital gains would be inordinate. So in 2017, the Tax Cuts and Jobs Act established what they call Qualified Opportunity Zones. And these are census tracts that meet certain criteria. Generally speaking, they use 2010 census data, and it was certain median income thresholds or certain relative income thresholds relative to nearby areas. There are around 8,700 of these in the US, and they were identified for tax deferral benefits.

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So the intention here is to motivate private investment in some of these areas. Realized capital gains can be invested in these Qualified Opportunity Zones through certain mechanisms. We call them Qualified Opportunity Zone funds. I know that's very original. by the number of tax deferral benefits. And us being in the 1031 exchange space, where lots of real estate investors are looking to defer those capital gains, we're very familiar with tax strategy. And so when this came out in 2017, many of the groups that we work closely with sat up and took notice and took action. So there are some slight differences between the 1031 exchange and the Qualified Opportunity Zone legislation, though both are geared towards capital gains tax deferral. So in the 1031 exchange, as I mentioned, You're limited to real estate. And when you sell a property to get a full tax deferral, you have to reinvest all of the proceeds, equal or greater value from what you sold. Qualified Opportunity Zones and the Qualified Opportunity Zone funds apply to any sort of capital gain. So I have a client at the end of 2020 who invested $7 million in short-term capital gains from the stock market, from trading options. We see real estate investors Use the Qualified Opportunity Zone legislation as sort of a backup for those scenarios that I mentioned where you've blown an exchange. We see folks do it with the sale of artwork, your Beanie Baby collection. It really doesn't matter. Anything that's a capital gain can get the deferral through Qualified Opportunity Zones. The difference is you only invest the gain. You don't have to invest the full proceeds amount. You get a deferral. So there's 3 parts to it. We call it easy to remember, think Dr. Dre. Okay? So deferral, reduction, elimination, DRE. Okay. So, the first part is deferral. If I were to sell stock, bonds, art, real estate in the year 2021, and I were to reinvest those proceeds within 180 days into a Qualified Opportunity Zone fund, I would not have to pay those capital gains taxes in tax year 2021. Okay? That's the deferral. I do have to pay those capital gains taxes in tax year 2026.

Okay.

So that's generally end up paying them in 2027, but it's tax year 2026. However, you get a 10% reduction on what you owe. So that is the reduction. So we're at number 1 is deferral, number 2 is reduction. The 3rd piece of this legislation and the piece that's really sort of the meat of the legislation, the real opportunity here, no pun intended, is the elimination. So I sell a piece of property in 2021, it's highly appreciated. I reinvest the gain. Within 180 days, and then I keep that investment, I hold that investment, one of these Qualified Opportunity Zone funds, for 10 years. So now it's July of 2031. Any growth that I've seen on my investment over the course of those 10 years comes back to me totally capital gains tax-free. And so if I invest $500,000 in gain, and most of these, from what we deal with and what we see, are ground-up development projects in the real estate space, Due to some of the rules around the legislation. If my money doubles, nothing's guaranteed, potential for growth, just talking hypothetically here, but if my money doubles over 10 years, that gain at the end of 10 years all comes back to me totally tax-free. So when you run the numbers on these things, it adds not an insignificant amount of potential return. That being said, you never want to let the tail wag the dog. Tax deferral on no gain is easy to come by, right? If you don't make any money, It's easy not to pay taxes. So, and the deal has to make sense outside of the benefit, outside of the tax incentive, but it's a really powerful piece of legislation for folks that do have significant capital gains.

Yeah. Significant incentives, but high risk because these opportunity zones are not in the best neighborhoods. I mean, that's the reason they did them was to develop declining areas. I think most of them are in urban areas, are they not?

There's a lot of urban and rural. What's interesting though, and that's a great point and sort of a common point that is brought up, so they used 2010 census data when they were drawing these lines. And so what you see is there are a lot of areas where it is exactly what you described. It's industrial, it's sort of downtrodden, maybe it's rural, maybe it's out in an airport, but because they used 2010 census data and this legislation was passed in 2017, at the end of 2017, what you saw in that 7-year span is that approximately 2/3 of these areas have gentrified significantly since 2010. And so there's certainly some areas where outside of the tax benefits, they're attractive areas to invest in. And believe me, so I'm down here in kind of the Palm Beach area, West Palm Beach, Fort Lauderdale, and there are some areas nearby where if I mentioned it to the locals, they'd say, why would I put any money in Riviera Beach? Right? It's industrial, it's a poor area, it's going to be a black hole, right? That being said, there are some very nice areas that fall into these Qualified Opportunity Zone designations that have seen significant growth, that are gentrifying significantly. And there are some areas where a deal totally outside of the benefits does make a lot of sense.

Yeah, you do need to do your homework, do your due diligence.

Absolutely.

In any investment.

Absolutely.

But these Opportunity Zones could be good, and who knows? Sometimes they're a gamble, but gambles can turn out good sometimes.

One more piece in that regard. These are generally ground-up development projects, right? And I mentioned that because of the rules of the OZ, you know, development's always going to be riskier than acquisition. You know, a lot more moving parts, requires a different set of skills, and there are risks in any investment. That's absolutely true.

Well, where can we get started in this 1031 or these Opportunity Zone opportunities?

And that's where Fortitude comes into play. So we deal with 1031 exchanges on a daily basis. We deal with Qualified Opportunity Zones on a daily basis. Our niche, I am a financial advisor, investment advisor, but we don't build your stock and bond portfolios like your traditional guy at Merrill Lynch or Morgan Stanley. We really focus on the real estate portion of people's portfolios. Most of our clients are real estate investors that have owned real estate for a long time, highly appreciated, looking for some tax strategy. or they're successful professionals who have a high salary, they have their traditional money guy, and they're looking for some real estate exposure and the potential for some passive income. So what we offer to folks outside of just a ton of education, webinars, we're getting back to in-person events, but over the last year and a half or so, we've done a ton of webinars. But what we offer to folks is the opportunity for ownership in a variety of different real estate investments. Most of our investments are suitable only for what's known as accredited investors. The SEC defines an accredited investor as someone that has $1 million in net worth, not including their primary residence, or meets certain income thresholds. But through the 1031 exchange, we offer some of these fractional investments. And so a lot of our clients are guys that no longer want to manage their real estate. They want to accept an offer because it's a hot market. They're 50, 60, 70 years old. They want to spend more time with the kids and the grandkids. And so they're able to When suitable, they're able to sell the property that they've actively managed for a number of years, perform a 1031 exchange, defer those capital gains taxes, and reinvest into fractional ownership of a $100 million multifamily property that's going to be managed for them by a billion-dollar institution, or reinvest into an industrial distribution center with a top tenant on a long-term lease in a growing market, again, with a billion-dollar sponsor that's going to manage that for them. And it offers them the potential for cash flow. It offers them the potential for Real estate appreciation. Similar vehicles on the qualified opportunity zone side, again, accredited investors, at least with what we deal in, but ways for the client I mentioned invested short-term stock gains. He's a successful mortgage broker. We have doctor clients, attorney clients, folks that have gains from one place or another and are looking for the potential for growth and looking for that tax-efficient strategy. And so that's really where we come in. On the 1031 side, to make the quick distinction, anybody that owns investment real estate can perform a 1031 exchange. Just what we offer within the 1031 exchange is suitable only for accredited investors.

Well, what is a Delaware statutory trust and how does it apply to the 1031 exchange?

So that's kind of what I touched on there. Delaware statutory trust is a vehicle that was created in 2004. For those folks at home that have itchy fingers, you know, you can Google Revenue Proceeding 2004-86. It established the DST as a viable viable solution or potential solution in the 1031 exchange. It is fractional ownership. It's known as beneficial interests in a trust, and the trust owns a single piece of property or a portfolio of properties. These are not real estate investment trusts. They're not REITs. REITs do not qualify for the 1031 exchange. These are not partnerships. Your standard sort of limited partnership investment does not qualify for the 1031 exchange. This is a vehicle that's specifically geared towards the 1031, and it allows folks to access ownership of, fractional ownership of, some of these institutional-quality assets. And so, like I said, most of our clients in the DST space are folks that are selling real estate and are open to being passive investors on the back end of the 1031 exchange.

Well, there has been a proposal to modify the 1031 exchange and even Some discussions about eliminating the 1031 exchange. Those of you in the profession and look at these things every day, where do you think this is going to fall out? What's your take on that?

That's the million-dollar question. So it's interesting. I mean, it's up in the air. I'm not an attorney. We speak with folks all the time, obviously in the space, in the industry. There are a number of groups lobbying against that. They obviously believe that there is material benefit to the individual middle-class taxpayer to maintaining the 1031 exchange. I saw some statistics the other day. 1031 exchange creates between 500,000 and 750,000 jobs. It drives additional tax revenue for state and local municipalities through transfer taxes that are paid at the time of exchange. It helps to inflate real estate values in markets, and for most areas, School funding, public school funding is tied to property taxes. Higher real estate values means higher property taxes. Most exchanges are not done by the Donald Trumps of the world, the massive corporations. Most exchanges are done by small businesses, the individual taxpayers. Most of the exchanges that are performed are one-time events, and then the next time they sell, they pay taxes. at a higher rate and a larger tax bill because they were able to keep that money working for them. There is some conversation around eliminating the exchange or limiting it. I can't speak to it. I do know that people in the industry have taken notice. National Association of Realtors is a group that is lobbying against that. Federation of Exchange Accommodators is a group that's lobbying against that. Many of the larger real estate sponsors that we work with are pretty tied in as well. If I had a crystal ball, I'd be a wealthy man. That was sort of a non-answer.

My speculation is it's not gonna change much, but we'll see in the end.

Those are your words, not mine.

Yeah. Well, I'm not gonna bet on it, but I'm speculating not much is gonna happen.

Sure.

Well, Justin, how can our viewers and listeners get in touch with you?

We have a couple of websites, 1031dst.com, 1031custom.com. Both have a plethora of educational articles, educational content on 1031 exchange, Qualified Opportunity Zone funds, and real estate investing in general. If you are looking to read up on potential legislation changes, there's definitely some information there for you. Alternatively, you're free to book a consultation, book a call with me. I've given Allen a link where you can schedule a meeting with me. Happy to be a resource. Happy to talk real estate investing in general or answer any questions that you have on either of these topics. A lot of folks come to us and say that 1031 exchange sounds confusing. It sounds difficult, or they've had a bad experience. If you have the right team in place, it can really be a pretty seamless, stress-free— not stress-free, I can't promise that, but it can really be a pretty seamless transaction if you're relying on the right professionals and have the right team around you. We're always pushing for that. And it's really about education and preparation. And so if you ever have a need for a resource, wanna ask some questions, wanna initiate some of that preparation, click the link, visit either of the websites, 1031dst.com, 1031custom.com.

And those links will be in our show notes. So take advantage of that, our viewers and listeners. Our last question of the day, Justin, is share with us one of your most difficult setbacks in life and how did you come through that time And what did you learn from it?

You're really asking the hard-hitting questions here, Alan. I like it. So I used to be an engineer. I studied in college. I, for a moment, I was a nuclear engineering major, then ended up getting degrees in physics and biology. I went to the University of Florida initially to receive a PhD in aerospace engineering. I was there 2 years, got a master's degree, and decided I wanted to try my hand at the whole, you know, working for a living thing. As opposed to living in a perpetual college town. So I moved down here to South Florida. I worked at an aerospace engineering company for a few years. And I joke, I say it took me 10 years to realize that engineering wasn't for me, which was difficult because— and this may sound privileged because I'm not here telling a story about the time that my house got foreclosed on or I couldn't pay my bills or whatever it was. So there was certainly some penny-pinching at times, but making the decision that Something that you've spent 10 years of your life working towards, making the decision that that thing is not for you, that that thing is not the right choice for you, especially when such a large part of your identity is tied up in that goal or tied up in whatever that was. I was a scientist. I was an engineer. I was just an engineer. That's who I was. And so coming around to the idea that this was not the right fit for me and I should be doing something else, It was a crisis of identity. And I talked about rattling, trying not to lose your confidence, trying not to get rattled. Crisis of identity is something that will really rattle your confidence. And so that was a difficult thing to wrap my— from a mental perspective and a mental wellbeing, mental health perspective, that was a very difficult thing to wrap my head around and a difficult change to make. And having done that, very happy that I did. I'm in an industry and in a profession that is much more a fit, much more interesting to me. And on top of that, I viewed that as a failure initially, being in this profession, this industry where it wasn't a fit. And now looking back on that, that is one of those failures where you tried, it didn't fit, it didn't work. You dust yourself off, you move on, you try something else. So I, if for some reason, if for example, this is timely, if the 1031 exchange goes away and that's no longer a part of our business, you know what? That's okay. You dust yourself off, you go in another direction and you find something else that's going to work for you. And it no longer is a scary proposition. It no longer is this big, thing that seems formidable because you've dealt with that before, you've changed direction before, and so you've learned yet that you have the ability to do it.

That isn't a trivial thing to go through. That's a difficult thing to transition through a crisis like that, particularly when you've built on that. Well, you were probably in school and working on that for 10 years, probably through adolescence you were even looking towards that field and that degree. So that was Major life transition. Never easy to make.

And I was fortunate, you know, I was fortunate I was in my 20s. There are folks, very successful folks that I know, that, you know, made a transition like that in their 40s, 50s, 60s. It's never too late, but it's also— it doesn't— it's not an easy thing.

No, it's not. But you learned a lot from that, and rather than it actually being a failure, it was actually A success story, so that's good.

Better for it, I hope.

Yes, much better for you to have made that transition than to have stayed in a profession that was not satisfying for you. Well, Justin, thank you so much for being on the show. Very enlightening show. You have a real knack for making these things understandable, so I appreciate you doing that for us.

I appreciate that, and I appreciate the opportunity here, Alan. I've had a good time, and it's not even 9 a.m.

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