539: Population Density, ‘Federal’ Reserve & The Economy, 1031 Exchange Alternative

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Welcome to the Holistic Survival show with Jason Hartman. The economic storm brewing around the world is set to spill into all aspects of our lives. Are you prepared? Where are you going to turn for the critical life skills necessary to survive and prosper? The Holistic Survival show is your family's insurance for a better life. Jason will teach you to think independently, to understand threats, and how to create the ultimate action plan. Sudden change or worst case scenario, you'll be ready. Welcome to Holistic Survival, your key resource for protecting the people, places and profits you care about in uncertain times. Ladies and gentlemen, your host, Jason Hartman.

Thank you for joining me today. I hope everybody is safe and well and not going crazy cooped up in their home. We have listeners in 189 countries and I never thought I'd see this or imagine anything like this, but most of the planet Earth is on a quarantine of some sort. Whether government imposed or self imposed. These are truly amazing times in which we are living. And I don't mean that in the typical sense, because you know my somewhat moderately famous quote, which is, it's an amazing time to be alive. Well, I guess it is an amazing time to be alive. This is not what I meant by it, but hey, we'll get through it. We'll get through it. So be safe, take care of yourself, take care of your family, and wash your hands 97,000 times a day. Yeah. Oh, boy. This is a new world, folks. This will change so many things for so long. Of course we'll get through this. It may be a bigger or smaller deal than we might be imagining. That remains to be seen. But either way, we'll get through it and life will go on. We now live in the world where the largest central bank on planet Earth, of course, the United States Federal Reserve. Federal being in single quotes because it's not really that federal. They are now taking the role of Buzz Lightyear. To infinity and beyond. To infinity and beyond. The Fed has now said publicly that they will provide unlimited asset purchases and an unlimited stimulus to support markets that they pledged that there is no limit to what they will do to prop up the economy. And some there's a case for this, no question. Some say, well, it's not going to help very much. Well, that's not true. It is going to help, but it's not everything. Okay, the Fed certainly has a lot of power, but they're not omnipotent they can't solve the supply and demand shock problem. So one of my many predictions that has come out of this is that we will enter a phase of stagnation where the misery index will be something that most people really suffer from, sadly, where we will see relatively high inflation ultimately, and we will see a more stagnant economy. Now, the question is always compared to what? Well, two things. Number one is compared to the rest of the world, if we're talking from a US perspective, and again, we have listeners all over the world in almost every country on earth. But since the US Is the largest economy and that's where we're talking about real estate investing, it matters in a big, big way. So we will see this period of stagnation. It usually is infectious. And when the US has an economy a certain way, the rest of the world typically kind of follows it to one degree or another. So that's complicated. But the compared to what? Question is, number one, compared to this economy, to all the other economies in the world, and then the global economy as a group, and then also compared to other people in the economy, other players. Right? Because like I've taught you many times before over the years that economics is a relative game. And good old Charlie Sheen, remember him when he embarrassed himself several years ago and he said, winning, winning. You know, Charlie Sheen, there's hashtags all over social media, winning. And here's how you win, okay, look, it, it's a relative game. It's like the bear in the woods, right? You've all heard that story, probably where two people are hik and they encounter a bear and the bear starts to run toward them and they become very worried. And one of them tightens his shoelaces. And his buddy says to him, man, what are you doing tightening your shoelaces? You can't outrun a bear. And he says, I don't have to outrun the bear. I only have to outrun you. And that is true. That I don't want to say it's a funny story, but it sort of is. That is true. That's the way economics works. All you have to do in this type of economy is get ahead a little bit, make incremental gains, or even tread water, and you will be ahead of most other players in the market. That means your neighbor, your friends. Okay? You just want to get ahead of the relative PI. Okay? So, you know, there's that old saying, a rising tide floats all ships. Well, not really. Okay, it floats some ships that float better than others. Right? And I want to help you float better than the other ships. And that's the purpose of what we do@jason hartman.com and on this show and with working with our investment counselors. By the way, our guest today is going to talk about 1031 tax deferred exchange alternatives. And many of you have been asking for me to do a show on this. So we'll get off the topic at hand. We won't talk about the Cerveza sickness or, you know, the China virus. That term's received a lot of criticism and I'm not even going to call it what it is, okay? So I'm just giving it some other names that are circling out there around. So. The cerveza sickness. Boy, people in Mexico must be really upset about that. That's just so discriminatory to call it that. Or do you know, by the way, listeners, that sales of Corona Beer. I read an article about this a few weeks ago. I don't even know what the update is to it. That sales of Corona Beer have sharply declined because of the. And I'm gonna say it now, the coronavirus.

Isn't it weird that people would make that connection? Well, if I buy Corona Beer, I might get the virus. Oh, people are weird. Okay. I mean, strange connections, but sad for Corona Beer. You just don't have the right name right now. Anyway, so our guest today will talk about the 1031 tax deferred exchange alternatives. I think you'll find this to be really interesting and we're going to have a little follow up on it probably tomorrow to discuss one more aspect of the alternative. This is a great thing, of course. Check with your tax advisor. We always say that. And I have to now say, because we've talked about some of the public health issues. Check with a medical professional about anything we say as well. If you need legal advice, check with an attorney. Okay, so that out of the way, all my disclaimers. We have the no limit Fed. Check with an economist. Hey, maybe you're listening to one. You be the judge. We have the no limit Federal Reserve, which is absolutely a crazy statement that means inflation will have no bounds. My prediction is mass migration to lower density living styles that will benefit you who are following our plan because we've been recommending that for years. By the way, Evan, our client who's been on the show a few times, shared with me a good quote from the New York Times. Listen to this. You're going to like this. You've been following my plan for the past 16 years you've been investing where I tell you to invest. You've been going to jasonhartman.com properties. You've been talking with our investment counselors and buying up these great properties that already fit right into this new migration trend that is going to benefit you in a huge way. All right, New York Times says density is really an enemy in a situation like this, said Dr. Steve Goldman, an epidemiologist at Stanford University. Quote, with large population centers where people are interacting with, with more people all the time, that's where it's going to spread the fastest. Referring of course, to Coronavirus COVID 19. So there you go, folks. After the quarantines blow over, and they will. Trump says he wants to reopen America. I never thought I'd see a headline like this. He intends to reopen America in a matter of weeks, not months.

Reopen like implying that America is closed and it really is. Strange times we're living in. I never thought I'd see a headline like that in my entire life. Wow, talk about a black swan event. We are in a black swan event right now. So there will be a mass migration from high density living to lower density suburban living, which is the investments we've been recommending all along. There will be a push toward digital currency. Remember, cash is dirty. And I've already read articles on how the Chinese are cleaning their money. Cleaning the money, Right. Money laundering. I guess that gives whole new meaning to money laundering, doesn't it? Yes, it does. I guess the Chinese government is now money laundering. Okay, there you go. Jokingly, of course. But yeah, cash is dirty. So we need a cryptocurrency. Now the cryptocurrency is going win. The game is not going to be Bitcoin. Hate to break it to you, but I've been telling you this for years. And remember I host a podcast on this subject called the Cryptocast. Almost ought to be called the anti Crypto cast because I've never been much of a believer, although I'd like to be wrong about that. But the cryptocurrency that's going to win the game is the one that is backed by the US Government and the Federal Reserve. And the same will be true in other countries that move toward digital currencies and cryptocurrencies. So that trend is going to happen. There's going to be a trend toward universal basic income. There's going to be a push for a nationwide section 8 style housing assistance program. There may be a baby boom. Hey, everybody's cooped up in the house, they don't have much to do. They're getting a little bored. So, hey, why not visit the master bedroom? Okay, so there you go. And nine months later, what do you get? You get a little mini baby boom out of this. But you also might get a higher divorce rate where people just, you know, they're together a little too much and they get on each other's nerves and they decide to split up after this. So sadly, there might be an increase in divorce rates. And by the way, they're already seeing that in China, where in some places they're coming out of quarantine and the divorce rate has increased. Told you. So I've been predicting that one for a while. I've also predicted that roommates are going to realize they need to split up because they're working at home. There's not enough space. And families are, are going to realize that they need a bigger house with an extra bedroom or two because they got the kids studying at home and the parents working at home. So a lot of changes. And all of these changes, other than the precarious nature of we don't know what's going to happen next. Okay, that is an issue. But the macro trend, the megatrend, if you will, is toward the things I'm predicting. And I feel extremely confident in my predictions. We'll see if I'm right. Look, if we go into the next Great Depression and the death rate is into the millions and millions of people, let's just pray to God that that does not happen. But, you know, in that kind of circumstance, all bets are off, at least for a while. But coming out of anything, whenever we come out of it, these trends will happen. I am pretty darn sure of myself. So it's on. It's, it's recorded, as are my other predictions. I've been very good about predicting a lot of things, except, of course, interest rates. I've been terrible on that one. Let's see if this happens. You know, come back in 90 days and tell me if I'm right or wrong. Six months, a year, three years, whatever, whatever it takes, this stuff will happen. I really believe that. So there you go. Okay, Reach out to us. Jason hartman.com, 1-800-hartman on the phone. Our investment counselors are available to you. And let's get to our guest segment today where we discuss 1031 tax deferred exchange alternatives. And until tomorrow, be safe, be well. Let's go to our guest.

Many of you who follow the show regularly have been Listening to me talk about alternatives to the wonderful and traditional 103031 tax deferred exchange. I always say that income property is the most tax favored asset class in America. And that is definitely true. One of the wonderful benefits beyond depreciation and the beautiful tax benefit that offers is the 1031 tax deferred exchange. When you trade properties throughout your lifetime, you can reinvest pre tax gain from the sale of the prior Property using the 1031 tax deferred exchange vehicle. It's excellent. I love it. Done many of them and have recommended many of them. And I know we've helped many of you listening do 10:31 tax deferred exchanges too. However, it's not perfect and there is an alternative. Basically, if you were to sell a property that you have gain in, maybe it's highly appreciated. Maybe you exchanged into that property from a prior deal or a couple of prior deals and you've got a bunch of gain stored up in that property that could become taxable. There is another way to shelter it. Now, before I bring our guest on, I do want to of course say that we are not tax advisors and we are not attorneys and talking so much about what's going on in the news today. We're definitely not medical professionals either. That's a new one, I have to say. But we do have firsthand experience and that's what we want to share with you today is that 1031 tax deferred exchange alternative. Tom, welcome. How are you doing?

I'm doing great. Thanks for having me.

It's good to have you on. And you are a neighbor here with me in Florida along the kind of the Treasure Coast. I don't want to say south Florida because we're not that far down. And you helped me through this process and helped me understand it. I appreciate that. And one thing that I alluded to in that little introduction was that you can pay tax slowly when you relinquish a property. When you sell a property that has gain in it. If you do an installment sale, then you're basically in the position where you pay taxes on an annual basis as those proceeds are paid back to you. And the IRS has installment sale rules. Do you want to speak to that first and then we'll take it to the next step?

Well, you're absolutely right and I would take it to the next step. One of the issues with doing an installment sale that people forget about is the fact that any depreciation that you've taken must be recognized in the year of the Sale. So if you've got a highly appreciated property, doing an installment sale is. I mean, it's a great way to spread the taxes out over a while, but you are going to have the hit of all that depreciation or the tax on the depreciation that you've taken in the first year.

Okay, so let's talk about that for a moment. Sometimes people don't realize that when they sell a property, they kind of think of it in this very linear fashion. Okay, I purchased the property for $100,000 and now I'm selling it for $110,000. I've had some good cash flow along the way. I've had some good tax benefits along the way. But the way they think is by the time they pay closing costs, they have very little or no gain to pay taxes on. That's not true because you have probably taken depreciation on that property and you have to pay back what's called depreciation recapture. And this comes as a surprise to people sometimes. So be careful, Tom, if you want to speak to that and then talk about the solution that's available.

Well, I think you've covered the depreciation recapture. The solution for it is to do what's called a qualified intermediary installment sale. To do that, you would use an intermediary similar to what you use when you do a 1031 exchange.

Right. Right. Now, whenever you do.

Not to get too complicated, but the rules surrounding a 1031 exchange allow for the intermediary to not have to pay that depreciation recapture because it's an installment sale for them. Again, we're not tax advisors, so not tax advice.

Right, right, right. Okay, good. Good to know. So that's an important thing to know. And whenever you do a 1031 tax deferred exchange, we've referred companies that can act as your intermediary. Sometimes it's called an accommodator, but mostly a QI, a qualified intermediary that can perform that 1031 exchange with you. And let's talk about for that for a moment. Why is that needed? And I think that helps set up this whole discussion a little bit better because basically the qualified intermediary is actually buying the property from you or your entity that's entering into the exchange. Right. You're not really selling it to the buyer directly, Is that.

That is correct. If we can make an analogy to the 1031 exchange, maybe it'll help make it a little bit more clear for your listeners in a 1031 exchange, most people think that you're simply rolling the gains forward into another property. And if the installment, or I'm sorry, if the exchange fails, you have to pay the taxes. Well, there's actually a little bit more to it than that. The reason why you don't have to pay the taxes in a 1031 exchange is that you or the seller never gets their hands on the sales proceeds under the hood. What's really happening is the seller is selling to the qualified intermediary on basically 180 day sales contract. It's an installment sale. Then the intermediary is turning around and selling the property to the buyer that you've already identified during that 180 day time period. The qualified intermediary is hanging on to that money. And if the seller finds a new property, the funds are distributed to escrow to close on that new property. And if the exchange fails, now the intermediary has to complete the 180 day sales contract. So they have to basically make that payment to the seller and that's what triggers the tax on any gains. Does that make sense?

It does, and I hope it makes sense to the listeners. So the way the tax is deferred is by selling the property to the intermediary, then the intermediary essentially sells it to who many people think of as their buyer. Would that be a fair way to say that? Exactly. Okay, now that intermediary could, if you arrange it with them, instead of paying you all those proceeds at once, could pay you in installments. Would that be right?

That is exactly true. Instead of being a 180 day contract, there's no reason why it could not be a 30 year interest only installment sale.

Right. So there, if you have $100,000 in gain, for example, and I'm just using that, it could be a million, could be 10 million, whatever the number is.

Maybe you make the deal where it's 7% interest. So that would be $7,000 a year, or on a million $70,000 a year in interest that you would actually have a tax liability on each year. Right. On those installments.

Correct.

Okay, now to take it to the next step and then we'll kind of wrap this up. One strategy that can be used is to, instead of taking those installments to essentially finance them. But you got to do this very specifically in a very specific fashion. Right, right. Talk about that a little bit.

Well, if you couple a non secured loan with the qualified intermediary installment sale, it's a way to structure your sale so that you can defer the taxes for 30 years and yet still receive funds at closing. Now, those funds would be coming from the loan that you're receiving. But those loan proceeds can be used to finance any future investments. If you want to stay in real estate, you can stay in real estate. If you want to hold onto the cash for a little while and wait the market out, that would be prudent right now in today's climate. But you can do whatever you want with the money.

Okay, what happens on a 1031 exchange? And it's a pretty great vehicle for sure, but what happens, one of the pitfalls is, and I've had this happen to me, is that I'll have started this sort of series of 1031 exchange, and maybe you look at it like generations in a family tree almost. I'll do this 1031 exchange that I started 15 years ago, and then I'll sell a property, I'll have gain rolled into the 1031 exchange and depreciation rolled into it, and then I'll do another one. I'll sell the property again and maybe buy multiple properties with those proceeds and all inside of this 1031 tax deferred exchange. One of the pitfalls there is that as real estate investors, we love depreciation because it's a phantom write off, It's a non cash write off. So you sort of get this wonderful tax benefit and in a way you don't really directly pay for it. Whereas in the rest of the world, in the real world, if you want a tax benefit, you need to, if you have a business, spend more money on your business, hire more people, buy some equipment, spend some money on marketing, and you can take a deduction or donate money to charity, and you can take a deduction for that charitable donation. Assuming all of this qualifies, of course. But in all of those instances, you're actually paying to get the write off and the government is sort of your partner, where they will partner with you and share some of that expense based on your tax bracket and such. But with a 1031 exchange, this depreciation, this non cash write off, this phantom write off, it kind of runs out after a while, after you've built exchanges into it over time, you don't get as much depreciation benefit.

Well, exactly. You point out one of the biggest problems with doing a 1031 exchange, and that's once the property is fully depreciated, there's no more gain. When you roll forward into the next property, you're rolling forward your current basis so if you've fully depreciated, you don't have any basis. So there's nothing left to depreciate.

Right.

I guess the great thing about coupling a non secured loan with a qualified intermediary installment sale is that when you get back into real estate, you start with a brand new property and a new fresh depreciation schedule.

And that is a beautiful thing.

That is a really beautiful thing. So basically, if you have that 27 and a half year depreciation schedule, you get to start over. Which is exactly what you want, Right?

Exactly. As a finance guy, I would argue that the present value of the depreciation that you can take is greater than the present value of deferring your taxes in perpetuity with a 1031 exchange. Clearly it's deal dependent. I think if you ran the numbers you would find that to be true.

Okay, dive into that one a little bit more. Of course, present value analysis takes into account the time value of money. Okay, so just take us through. Do you have an example you can share of that? Or maybe it's too complicated, but let's elaborate on that one a bit.

There's going to be multiple savings from doing this type of transaction. One is you get to use the government's money for 30 years. Because if you're deferring the tax on a qualified intermediary installment sale, you've got 30 years before you have to pay the government the money that they were due. And that amount doesn't change whatever the tax is on that gain, they're going to calculate the same gain 30 years from now. There's no inflation. You're paying the same dollar amount of taxes, but 30 years out in the future. If you think about the inflation, if you owed me a million dollars, would you rather pay me today or pay me in 30 years?

Like I've said to my listeners for years as I teach them about inflation induced debt destruction, my trademark technique for getting this incredibly cheap 30 year fixed rate debt and then paying it back in cheaper dollars over the time. I jokingly say that I learned about the benefit of net present value analysis and inflation through a cartoon character on Popeye's cartoon. It was Wimpy. And Wimpy's famous line was, I'll gladly pay you Tuesday for a hamburger today.

And so he always wanted to pay later, which was brilliant, because if he pays later, the value of those dollars will be lower through inflation. So just remember folks, the greatest economist is Wimpy. I'll gladly pay you Tuesday for a Hamburger today. Or maybe it was a cheeseburger. It might have been a cheeseburger. I'm not sure, but he was great.

Let me use a good example that I with people. I'm sure your listeners are familiar with the rule of 72. If you can take the interest rate that you're making on your money and divide it into 72, that's how long it takes to double your money.

If the tax bill were $200,000, for example, in today's dollars, and you took that $200,000 and invested it at 7.2%, 7.2 into 72 is 10 times. Theoretically, you would double your money three times during that 30 year period. Your $200,000 10 years from now, if it was growing at 7.2% would be worth 400,000 and in eight years it would be worth 800,000 and in 30 years it would be 1.6 million. Yet in 30 years your tax bill is still going to be $200,000.

Well, you're assuming tax rates stay the same, which you can't assume that, right?

Well, tax rates could change, but you're still multiplying the funds by a factor of eight. Even if they change the tax rate to 100% of the gain, you've already grown that money to be well beyond that. Does that make sense?

Yeah.

Okay, so the benefit of restarting the depreciation clock. Huge. That's a big one. I really like that feature. The other opportunity is that if you wanted to go, to use the sports analogy, sit on the bench for this inning, for example, and you wanted to wait to buy back in later. Now listen, any financial advisor will tell you, including Warren Buffett, that timing the market doesn't work very well. But yet as humans, we all think we can do it.

So fine, okay, indulge yourself. But maybe at the time you sell a property, you think that it's a really good time to sell a property. But you can't quite meet that 45 day deadline on the 1031 tax deferred exchange to identify a replacement property for the relinquished property. And then of course, you've got to close within 180 days. There could be marketplace issues, there could be financing issues, property inventory issues. Maybe you find a property, you identify it and you've done everything right. And for some reason you can't make the deal close. The seller backs out of the deal. In a really hot market you have that as a problem where sellers back out of deals and sometimes you got to just sue them because they Cause you damage by backing out of the deal. Right. Things are tricky in real life. Okay? It's never that simple in real life in the adult world. So this can be a form of a rescue opportunity as well. And I guess you can do it one of two ways. You can either plan to do it or you can use it as a rescue operation if an exchange fails. Right. Would that be a fair statement?

That is true. Just keeping in mind that you have to identify a property before the 45 day mark and this has to be done before the 180 days is up. Once the 180 days up, that original 180 day contract is done, it needs to be satisfied and there's no rescuing it at that point.

Okay, so just to recap those rules on the general 1031 tax deferred exchange, you sell a property and you put special language into the contract identifying that you're planning to do a 1031 tax deferred exchange. And then within 45 days you must identify a replacement property or properties. And there are three different rules by which you can do that. And I don't remember them all offhand, but there's like the 200% rule. And basically what that does is it keeps people from identifying every property in the country. You can't do that, but you do have some leeway so that if you can't do one deal, you can do another deal potentially. But say that that all falls through and you just can't make another deal work. This can be an option to rescue you from a 1031 exchange that just isn't working out. And again, we want to say be sure you check with your qualified tax professional. You may also want to consult an attorney on this. Or really a tax attorney would probably be the ideal sour. These things are complicated. 10:31 Exchanges can be complicated. There are attorneys who literally just specialize in 1031 exchanges. They don't all do other areas of law. That's like their specialty. Everything in life is there's a lot of depth to it. There's a lot of law in the United States. And that's one of the great things about it is nation of laws. And these laws have nuances, including tax law, of course. So be sure you check with a good qualified tax professional. You know, many. It's pretty frustrating. Well, I guess it's just because the tax code is so long and over complicated. Many tax professionals, they don't necessarily even know about a lot of real estate. You know, they'll sort of, they know what a 1031 tax deferred exchange is right. But they don't really understand how to necessarily optimize things. So you really got to get a person who understands real estate investing.

If I can interject here, there's no need to reinvent the wheel. I've assisted probably close to a dozen clients with these types of transactions, and I've got the contact information of the lawyers who worked with those clients.

Right, good.

There's no need to pay an attorney to learn something brand new on your dimension.

And you referred me to one of those. I had a long talk with him and he was very insightful. Good stuff. All right, well, listeners, reach out to us and we'll be happy to help you with this. It's a good alternative and many of you have been asking me about it. So we finally did a show on it and we will be glad to connect you with Tom. He can connect you with other advisors that you may need, and we can connect you with a qualified intermediary and help you get all this going. Okay? So thank you so much for joining me and bringing this to our listeners. We appreciate it.

Thanks.

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