1031 Exchange - Tips and Strategies to Save You Thousands

Foreign. Welcome, everyone to the Main Street Business Podcast with Mark Kohler and Matt Sorenson. Just another great day here on the Main Street Business podcast. We're excited you're with us here today to talk about saving taxes on real estate.

Yep. Excited to be here. I had a really interesting weekend. It was power packed with just a little of everything.

Power packed.

Yeah. Let me, let me just give you a little teaser here. I'll just go through the list and then give you the highlight. Was first, as many of you know, my hsa, if you've been following the show, has opened an LLC called the Kohler Dutton Livestock Company, which you Yellowstone fans know what that means. And my five cows and my HSA formed an LLC called the Coleridge Dutton Livestock Company and bought five cows who were with child or with calf and gave birth to five bulls. That was a month ago, and Saturday was the fateful day for these bulls to become what we know as steers. Now, I'm not going to go into, you know, the birds and the bees here, but that I know I can't because it's a prohibited transaction. I was able to go to the ranch and assist in some of the other castrations and branding of other bulls, but my bulls were handled by the ranch and my 10 cows now are often a little pasture eating grass. My wife was very upset about the process of branding and castration, thinking it was cruel and unusual punishment. But that's the birds and the bees, that's what cattle.

Yeah, that's the cowboy way. I mean, how you do how you do it, that's how you get it done.

Then that night, this is another announcement. We need to have some pictures for the show here. Yours in the house here. Our producer, Corey White. Some of you have seen him before on cameras. He's adjusting mics right now. Always making things run well. Was a driver in a demolition derby. He has a car. Yeah.

So I'm just happy he's still alive. Yeah, we're.

He's walking and alive. He got a concussion, so the camera's off a little kilter today. But Corey, we sponsored him. I still owe you some more money, don't I? Okay, so we sponsored Corey in the Demolition Derby at the, at the fairgrounds Saturday night. So I was with cows in the morning, causing pain and anguish for some bulls. And then we went to the fairgrounds for a demolition derby. It was like a awesome summer, small town Hickville, white trash weekend for me. And at the Demolition Derby, I'll leave it there. Saw a woman that there's no kidding. I was in the line for some nachos. Right? You gotta have nachos. So in the line, and there was a woman wearing camouflage cowboy boots, Daisy Dukes, a tank top, and a full holstered.44 gun on her side. I was like, wow, I'm in America.

Yeah.

I just want to throw that out. I'm glad to be here.

That's the heartbeat of America right there.

It's something. It's maybe some people, but I was like, do you. You don't see that every day, folks. I'm like, can you pass me the ketchup? And if there's an active shooter in the fairgrounds, she's throwing down. And I. But I was impressed, you know, so. But that was my Saturday. Did you do anything as exciting?

I mean, I was on vacation, actually. I vacationed with my daughters this weekend. Got some surfing in.

Oh, nice.

Mark. Now, before Mark became a cowboy, he was a surfer.

I've been play both teams.

You can still. Okay. All right. Had a great time, though.

What. How long was your board?

It was a 10. Oh.

He went, oh, see, see, Matt said he was surfing. He was. Really. For you surfers out there, he was longboarding.

Yeah.

Which, hey, I'm an old man.

I mean. Yeah.

I gotta be.

Yeah. Anyways, it was a great time. I. I got. There was a ripped. A rip current. Yeah. There's a rip that you would take out. It was like, you have to paddle out and then you just cut back over and take the wave in. It was like a ski lift. It's amazing. Seriously. Surf instructor showed me where to go. I was like. He's like, just, let's just take the rip out. And I'm like. I'd have been like an idiot going right into the waves, you know? So, anyways, good time, though.

Okay, well, thanks everybody, for being here. Tell us. Tell everybody our topic today. They're a little light. Light conversations. You get to know Matt and I, we're legit. We're real accountants, tax lawyers. Got a good time today.

Can't believe it. Yeah. 1031 exchanges. Now, what the heck's 1031? It's a section in the tax code. So it's a favorite. It's a favorite. There's a few favorites that we have here, but 1031, section of the tax code, the favorite. And this is the strategy you can use to sell property, not pay taxes, so long as you roll that gain into another deal. That's the basics of it. This is a tax deferral. Strategy. It doesn't eliminate the tax. I mean, there's ways you can do that at the end here by passing it on to family, perhaps, and we'll go through that. But you're deferring it into the next property rather than paying the gains. Now it requires you to reinvest. We're going through all the rules on that, but that's the basics of it. The tax deferral strategy. We hate paying taxes, of course. We want to keep as much of our assets growing as possible. And if you're wanting to stay in the real estate game, buy more Real Estate. 1031 Exchange is an awesome tool to do it.

Yep. And let's set a few parameters for those that just are coming in for this portion of the podcast. The 1031 is all about staying in your lane. You know, for a little analogy here, because you can't use a 1031 for capital gain in the sale of stock or crypto or equipment. That used to be an option now, now no longer under the Tax Cuts and Jobs act, it is strictly a real estate strategy for buy and hold, which we'll get into here in a moment. You can't, you can't do a 1031 on a fix and flip, but they're very, very popular. The super wealthy use these to kick the can down the road when it comes to taxes. And if you're a real estate investor, you got to know the ABCs. You really do.

So, yeah, this could be a single family rental. You've got. This could be farmland. This could be a commercial building. You know, all real estate qualifies here, but it must be investment. Okay, you're not going to do a 1031 exchange on your home. Do the sell of home exemption on your home and get out of the gain entirely. But this is for investment properties you're selling.

Yep. Now, I would highly, at this point, I would highly encourage any of you that have the opportunity to watch this podcast on YouTube. I've got about 10 slides I want to show. It's the best 1031s are complicated enough. So I've got some slides, some charts. We're going to do our best to explain them verbally here. I think you're going to. If you pay attention while you're on your treadmill or your bike, you'll be okay or driving down the road. But it might behoove you to go check this out on YouTube and you can just type in Main street business podcast 1031. It'll pop right up on YouTube. I'm sure. And we're going to have this probably cut up into multiple YouTube videos. So if you're watching on YouTube right now, we are covering the basics in this section, and then we're going to go into some more unique strategies that you might encounter. And you could do a whole day of 1031 exchange. This is so complicated. We've taken one for the team, people. We went to the most boring seminars and distilled this down into an hour or less of what you need to know. But I'm telling you, if you can't, if you're trying to make some headway with your lover, I'm just saying pull out the 1031 tax code. You start reading this at night.

Oh, yeah.

Sparks are flying. I mean, this is.

Yeah, that'll really set the mood. It will. Yeah.

It's good stuff.

Yeah. All right.

All right. Okay. So we just do the basic transaction.

Okay. All right, well, you start. You got your slides ready?

So, yeah, I got some slides here. All right, so, Corey, we're going to go to the slides now. Everybody driving down the road, I'm going to do my best to explain this. All right, you're on the left, and we're going to kind of flow down into the right and back. So it's kind of a loop. Now let me explain why it's a loop. The general rule is if you want to sell a property and trade it, it's called a like kind exchange. That's the concept. You're going to trade your property worth 100 grand for another property for 100 grand of equal or greater value, and that person that has that property you're going to get is going to trade. That's the theory. I'm going to trade you my property for 100 grand. You're going to give me your property for 100 grand. We don't pay tax, and we just take our basis, whatever we bought our property for, and it moves to the next property. Now, in the history of the universe, there's probably never been a perfect 1031 exchange where someone trades their property to someone that wants their property and you want their property, and they're the equal price. Never going to happen. So that's why the term delayed 1031 exchange evolved. So the code said, all right, if you want to sell that property worth 100 grand and buy another one of 100 grand or equal value or greater. Equal value or greater. Well, cool. That's cool. Because you're never going to find someone that wants your property and it's going to be a perfect trade. So what you could do is sell your property. So this is taxpayer on the left. They're going to sell the property to a buyer that really does want your property and they're going to pay for it. The money's not going to go to you. It's going to go into a holding tank called a QI qualified intermediary. It's like an escrow where the money's held. Now if you had a mortgage on the first property, whatever you get less. The mortgage goes into this qualified intermediary and is holding and there's a holding tank for it. Then we're going to go through some timing rules. You're going to shop for the property you really want. So on our diagram, you're going to sell the property down to the buyer. At the bottom of the diagram, the buyer is going to put the money in and it goes up to this holding tank in the middle. And then when you find your property you want, the money's going to go out to the right to the seller and the property you really want is going to come back to you all the way to the beginning at the left. So it's kind of a little circle. It goes down to the right, then over to the right and then back all the way to the left. And that's where you end up with a property of equal or greater value with the one you really wanted. But you can't touch the money. That's why you have to use the qi. And if you have to get the same mortgage amount or greater, you'll have to. And we can talk about that. But Matt, does that do it justice? That's kind of just the basic diagram.

Yeah. So at the end of the day, I can sell a property. Let's take the hundred thousand dollar example. Roll that. All the gains I get from it, maybe I'm, you know, I'm selling it for 100. Who cares what I bought it for? I bought it for 50. I'm making 50 on it. So I'm getting 100 back. I'm gonna invest that reinvest and buy another property for 100. Now maybe they're always only I paid off a loan for the other 50 when I sold the 100. And the profit of 50 go to the QI, right?

That's right.

I just got to re buy another property for a hundred thousand or more and I might get a new loan.

Yeah, right.

Or put in money or put in more cash if I got it. Yep. Or maybe seller finance the Seller, seller finances it and get that effect will be some debt there. So it's not like the just want to throw in. A lot of people are gonna have a loan in the mix here. So the gain and the money coming out is the key. You don't touch it in the 1031. It's got to go into that holding tank, as Mark may call that. Yes. I feel like that's like the, you know, on Law and Order. That's where they, they go before they get booked. Go to the holding tank.

Yeah, I've been in the holding tank.

Yeah. Is that why that popped into mind after the demolition derby? Did you end up in the holding tank, Mark? Yeah, that was.

That's a story for another day.

Okay. All right. But you know,

but let me say this. I like where Matt's going. A lot of people get hung up on what's the gain. I've got to reinvest the gain. Nope. I don't care if you make 20 grand, 50 grand, 70 grand or 10 grand. It's sales price. Buying something of equal or greater value doesn't matter what the gain is. Also, people get stung up, hung up on the mortgage. I got a mortgage of 20 grand or 50 grand or it doesn't matter. If you have to get more mortgage or put more money in, who cares? What matters is the sales price and then the purchase price must be equal or greater of the replacement property. That's your basic 1031.

Yeah. And we do care about the gain because that's where the tax savings is. So you generally want to be aware of it. But in terms of the qualifying of the 1031 and pulling it off, it doesn't really matter. That's not in the equation. But we do care about it because that's what the tax savings is. So in that example of $100,000 property you bought for 50, the other 50,000 you're making is. Is capital gain. You know you're going to pay tax on that. Let's say you're at the 20% bracket for capital gains. You know, what is that? That's 10 grand. And so you could roll that. And obviously think of a million dollar property. We're talking about $100,000 that you could rebuy a property. In that game, you're not paying tax, you're not sending money to the irs.

I like it. Now what we're going to do now is stay with basics for a minute because we could dive deep on each one of these rules. But I'm just going to list them off, if that's okay. Yeah, everybody, you get the basic rules down, then I know Matt's prepared something on what the Biden administration wants to do for 1031s. We'll talk about what if you're a partner on a property. I want to do a 1031. What happens if you take boot? Like, you take some cash out? So we're going to talk about several little factors or common questions people have that'll be separate videos, probably on YouTube, but it's all here in one big podcast. But we're going to kind of carve out those more unique questions separately. Now, staying with the basics, let me go through. I've got three different slides here, and I'm just going to go through these. And for those that are on YouTube, you'll be able to pause and zoom in or whatever.

Okay.

For rule number one, you must hold both the property you traded and the property you receive for business or investment purposes. So it could be the building that you run your restaurant in or your dental practice. It could be a storage unit. It could actually be water rights, mineral rights, anything that has a real property deed. It could be raw land. And I could shade Mississippi swampland for a downtown LA high rise. They're both real estate. When they say like kind, they don't mean the same kind of real estate. It's just real estate in general. And like Matt said, number two. No, no, no, no. I don't have it on a bullet point. Let me ask you how it can't be.

Yeah, yeah. But could it be Baltic Avenue for Waterworks? Could it be Baltic Avenue for Railroad?

No, because I think Waterworks and Railroad constitute a company. And even though the company owns real estate, you got to trade real estate for actual deeded title. Real estate. You can't trade into a reit. You can't trade into some of these unique funds that might own real estate. Now, we're going to talk about ticks in a separate A little later here. Tenant in common ownership, where you might have multiple partners. We'll talk about some options there, but let's stick with this. Okay? Number two, the property traded must not be held primarily for sale, such as inventory, AKA fix and Flip. You can't do it. Fix and flip. And if you're a developer, building spec homes can't 1031, because to you, those are inventory. Third, the properties must be tangible real estate. It cannot be stocks, notes, securities, or evidence of debt. So can't trade a property for a note that's on real Estate, Come on, it's a note on. Doesn't matter. You need the real estate itself. You must use a qualified intermediary. If it's a delayed exchange and we recommend tax and legal advice, you just talk to your accountant, talk to one of our tax lawyers or accountants. Just get someone to walk you through before you. Because once you take the money, it's over. Can't do it. Advice early on.

Yeah, you've got to use a qualified intermediary. And this is going on your return. It's not like one of those things you skip on your return because you're like, well, I did a 1031 exchange. No, this is going to be on your 1040. Yeah, okay, that you. Because it's going to show the sale, but it will show that you did a 1031. So your account needs to be involved. And no. And the best advice is just don't touch the money. Have a qualified intermediate in place that knows when you're selling the property. You don't get the qualified intermediary ready when you're buying something. Okay, this is going to happen before you sell. You need to be planning this before you sell and close.

I like it. Now I'm going to hit the timing rules, which are part of the basic rules and a couple other points and then will get more unique here. Okay. Another point that's very basic and I should have said by now is you can trade one property and buy three. You could sell three and buy one. It's the cumulative purchase price that matters. So let's say, for example, yours, the selling price cumulative either way. So let's say you sell a property for a million dollars and you go out and buy four $250,000 homes. Well, what you bought was of equal or greater value. Sold something for a million, you bought a bundle of four properties that equal a million or more. You could sell four properties for 250 grand, pool the money and go buy a million dollar property. So you sold a cumulative of a million and you bought one property worth a million. So the quantity of properties doesn't matter. And again, it's the cumulative sale price compared to the cumulative purchase price. Once back we did a project, it was about four years ago. It was a Newport Beach, California beach house sold for like, oh my word, it was like 5 million. And we ended up buying 30 properties in a 1031 exchange. They were just. And they deployed the entire 5 million and 30 properties and it worked out great. Okay, now here's the timing rules. The day you sell let's say for, ironically, you sold on January 1st of any given year. Let's just, just keep it simple. 45. You have 45 days from the day you sell to identify what you're going to do. The IRS says, hey, you can do a delayed exchange, that's cool, but you can't take three years to do it. So the minute you sell, that money better go into the QI and the holding tank. And then you got 45 days to submit in writing with a verified fax or email that state date stamped that says, here's the property or properties I'm going to buy. I'll come to that rule in a minute. But you got 45 days to identify. Now, after that, you have 180 days from the date you sold to close. So they said you got to wrap this up in six months. So if you sell January 1st, you have until July 1st to wrap up all the deals, and you have until February 15th to let the IRS know what's going on. So it's kind of like 45 days to identify and then another 135 days to close. That's your timing rule. Matt, you want to add to that?

Yeah. When Mark says 45 days to identify, or let's say 50, February 15th, this is internally, you're not actually sending something to the irs. This is something your intermediary who's involved is going to want to have documentation of because they're going to be holding your funds in this interim period here and waiting for you to identify in order to be able to meet these rules. So they'll feel good signing off on the 10:30. Yeah.

Now, here's a few practical points on a basic exchange. If you identify and close, if you do your purchase, let's say you do your sale on January 1st, and you were already shopping, which we highly recommend to all clients. Yeah. So you were already shopping and you close on something February 1st.

Done.

You don't have to do the identification period. You already closed. So within 45 days, you can replace the exchange property with as many replacement properties that you choose and at any value. So as long as you close within 45 days. Done. There's none of this replacement period or identification period crap you have to worry about. But let's say it's getting close to February 15th, and you really haven't found the property you're going to buy yet. All right, ready? This is the last of the base. You may say this is the basics. This is the basics at the 45th day. This is in the Bullet point here at the 45th day, you may identify three properties. You got to have them by address. Here's three properties I'm looking at of any value and close on any one or three of those, so long as you close within 180 days. So on the 45th day, you've got to say, here's three properties I'm looking at buying. I might buy one, I might buy two. I might buy all three. But the IRS says, fine, you can't buy anything else. You're stuck with one of those three or your 1031 fails. So by on the 45th day, you got to have it down to three. A lot of clients will make offers on three properties and pending inspections and pending due diligence and blah blah, blah, and then they're okay. Did you like my blah, blah, blah?

Yeah, that's, that's a technical term. Yeah. So, okay, here's. That's the downside of a 1031. Let's be clear about that. The 1031's awesome. But here's a, A cautionary note. There's been people, many investors over the years that get rushed in a 1031 exchange. They're. They're hell bent on not paying taxes and they end up buying a dumb property.

Yeah.

Okay. This is, I've seen it over the years helping clients and they're like, I was just in a rush. I had to get something. Generally I wouldn't have otherwise bought this, but I just went in on it and I just bought what I needed to to keep the 1031 alive.

Yeah.

Okay. Just be careful on that. Don't chase a property and close on something in a day. If you're identifying three on day 45, great. You know, but then take the time in that next 135 days to be like, is this really a good deal?

Yeah, I'm.

If you're not finding the right deal.

Yeah. And Matt, I love what you said because what's worst case scenario, you just pay the tax on the original capital gain. There's no penalty, there's no fine. QIS will hold your money for sometimes as low as 500 bucks to 250. Depends on how many properties are involved. So you can price shop that. It's really a commodity type service. They're not a tax lawyer. They're not a law firm or accounting firm. They're just holding money. So you're not going to have a huge cost there and you just shop. Worst case scenario, why buy a property that sucks to save taxes? Just Pay the tax and be smart. Okay?

Right.

And you thought we were done. Let me give you the next rule. Let's say you found more than three properties you might want to buy and you're kind of feeling under the gun here, okay? At the 45th day, you can identify as many properties as you may want, so long as the aggregate value of the properties you've listed does not exceed 200% of the property you sold. So if you sold a property worth 400 grand and you got to go out and buy something of 400 grand or more, you can identify six properties, but in total they don't exceed 800 grand, they cannot exceed double the value of the property you sold. And last bullet point, you can violate that rule, the 200% rule, so long as you close on 95% of the properties you identified. So if I identified five of them and I only close on four, that's 80%. I didn't hit 95, so I'm screwed. So you've got to. So I tell clients if you identify 11 properties, you better close on 10 of them. Nine out of 10 won't even cut it. So it's really. But that if you say I'm going to identify 12 properties and I'm going to close on at least 11 of them, then you can violate the 200% rule, you can violate the three property rule, but you better darn well close on 95% of them. So that's kind of. So I know that sounds crazy. Off the slides for now. That's the basics. You got lot, you're going to get a lot of support from your accountant, your lawyer, you've got this exchange thing going on the qi. And I tell clients all the time, if you're going to sell something, throw it in the intermediary. What do you got to lose?

Yeah, yeah, you got 45 days. Now go shopping. And I think that's a worst case scenario. You pay tax like you would have anyways when you sold the property. But here, let me just simplify it so it's pretty clear because I think some people are like, oh my gosh, all these rules, here's all you need to worry about. And for, for most people out there doing a 1031, you're going to sell a property, defer the gain. You just have to buy a property of equal or greater value of what you just sold your property for. You get 45 days to identify what you want to buy. Mike Mark said you can do up to three, easy peasy. Pick one of the three you just got to close within a total of 180. So another 135 days after the 45 and now your gains all deferred and it's into the next property. Now when you sell that property you could pay tax on and your gains built into that one in addition to the gain you have on that property or do another 1031 on that one and keep the kicking the can down the road, baby. Yeah.

And I want to give one more example on this basic section too because a lot of people get hung up on the debt point. So let me use a specific example and we'll wrap up this basic portion. Let's say you bought a property for 100 grand and now it's worth $400,000. It's not your primary residence. We got another Q and A on that and another vid. We'll come to it later in the podcast here. But let's say you bought it for 100, it's worth 400, you got a $300,000 gain. Now when you bought it for 100, let's say you got a mortgage for 80 grand, interest only. So now you've got a mortgage on there and you go to sell it for 400 grand, got to pay off the mortgage. So you got 320 sitting in the bank because you have this interest only mortgage you had to pay off. Well, if you say, well, Mark, I got to buy a new property of equal or greater value. I sold it for four, I got to buy a new one for four. I just want to pay off the loan and be debt free. That doesn't work in a 1031. You got to go get another mortgage of 80 grand because you got to end up with a purchase price of 400. And this drives a lot of people batty. But you can still now on the second purchase, you might get a 15 year AM on that mortgage and pay it down quickly. Nothing wrong with that. You got more cash flow. You bought a bigger property for $400,000. Now you're on a pay down mortgage bed and you're like, I'm going to pay off that mortgage. That's cool. Just cat 1031 and pay it off. So yeah. All right, so let's go to our next question. All right.

Okay.

I'm going to pose this for Matt. So let's say you want to do a 1031 exchange and we're hearing a lot in the news that President Biden's administration and he even campaigned on this. Joe Biden said, I don't like the 1031 for the wealthy. And he said he had to kind of make sure he was careful because the real estate association, NAR now National association of Realtors, and a lot of real estate groups said, whoa, this is like sacred cow. You can't get rid of this 1031. And so he kind of changed his position. And in the recent proposals this year, he said, okay, okay, we'll keep the 1031. But if you're going to have a big profit, I don't want the super wealthy to get the full benefits of the 1031. So I'm going to kind of carve out rich people not getting as much benefit. So, Matt, what do we have is officially currently. And we. It's like watching sausage made. We don't know what it's going to ultimately be. What are we looking at right now?

Well, there's some good news and bad news. What we're looking at here, okay, Depends on how you look at this. I guess the bad news is it's at 500 grand. You can do a 1031 exchange up to a total of $500,000 of gain. Okay. This is not sales price. This is a gain, or what they've called profit in the proposals. Now, the real estate industry has basically came out and said that basically takes that off the table for commercial apartments, all bigger properties. The only people that will use 1031s anymore are going to be individual investors doing maybe single families or smaller properties where there's smaller gain. And I think that's kind of Biden's point, what the of his proposal is. This is, I want this for the little people, the smaller operators, the bigger operators that are buying the bigger buildings and stuff like that. You should pay taxes just like everyone else when you sell an asset and have a gain.

Yeah.

And whether you like it or not, I'm just saying that's. That's the pitch.

Yeah. And the pitch behind. And we're not trying to pick on President Biden here. There's a lot of us and you that like some of his proposals, you may have voted for President Biden. This is one where if you have a financial interest in real estate, you're like, I'll take some bad with the good. You may have not liked some of Trump's proposals, and so you voted. So we're very nonpartisan here. Every president's going to have some good and bad to him. And so you may look at the 1031 as damn right. Let's get some more money. In the system for those that need it. And the super wealthy shouldn't do a 1031. So that's fine. Now, with that politics set aside, some of you may be joining us on YouTube. We have another video on the basics of the 1031. And what we do in there is give some more examples. So I want to give an example of this Joe Biden proposal. Let's say you bought a property for $400,000 and now you're going to sell it for $1 million. Okay, cool. So in the basics, we go through what you have to do. You have to go buy an equal property of same value or greater, or two or three properties that equal $1 million or greater. So you're going to take this $400,000 property, sell it for 1 million and go reinvest that million. Get more mortgages if you need to put in some cash, but you're going to do a delayed exchange. And under the current 1031 laws, that $600,000 of gain would be kicked down the road into the multiple properties of the new property. Joe Biden and his administration say, Whoa, whoa, whoa, hold on. You had a $600,000 gain, okay, 500 of that. Kick it down the road. That's cool. That other $100,000, we're going to treat it like boot, meaning you took cash out or whatever. You're going to have to pay tax on that 100 grand so you could do the 1031 up to a $500,000 worth of gain and pay. Just so we don't, we're not going to kill the entire 1031 for you, but you're kind of limited to a can that you're going to kick down the road, which used to be a 55 gallon drum. In such situations now, now it's just going to be kind of a pop can full of 500 grand. Hey, how'd you like that analogy, Mr. Sorensen?

I like that. I like that.

Used to be a coffee can.

Yeah.

55 gallon drum can of oil. Now it's just like a hungry man soup can. Chili, caramel, chili. Kind of a 16 ounce can. You.

Okay, all right. So recyclable too.

So, okay, so everybody, that's. We'll see what President Biden comes up with. Matt, any final words? Yeah, President Biden proposed.

Well, I was, I was going to say the good news is his tax policy has kind of not gone very far in the Senate, which has got, you know, a 50, 50 Republican Democrat and the Democrats out control because the vice President, but there's a lot of Democrats that aren't fans of a lot of his tax proposals, including the 1031. So this is one that the sausage making, for lack of a better word, may come out in your favor. And either we're going to see a larger limit on this and a cap, or you're going to see this go away altogether. I mean, get negotiated away because it appears that it's, and who knows what other horse trading is going to be involved in this. But the good news is there's a lot of congressional pushback on it and they're trying to negotiate it. Actually, just like literally, like last few days, there's been a lot of headway on talks of finally negotiating some of these items Biden came out with.

All right, now, Matt, why don't you choose the next most common question and I'll pose it here.

Okay. All right. This is a common question that comes up for people looking at 1031 that are flipping their property. Maybe I bought a property, I rehabbed it. I've owned it for six months. And I want to, I was, I'm just gonna flip it. Can I do the 1031 on my flips?

No, but maybe. And here's the trick. And I've had clients do this.

That's an answer you give your kids.

No. Yeah, maybe go ask your mom, dad.

No, but maybe.

Maybe. How much do you want to pay me or want to go clean the garage? Here's the maybe. Because we're tax lawyers, we want to always, whenever a client calls us, we want to say, here's the technical answer. No, but here's a couple options. So there may only be one. But here's the option. Let's say you finish that fix and flip. Now, a lot of people that are in the fix and flip industry, and Matt and I have done a fair amount of real estate, but we really are not experts in the actual nuts and bolts of real estate. But helping clients save taxes in real estate, thousands of clients we've worked with over the years. Years. And anybody that's done a fix and flip, I'll ask Matt. What's the fallback if your fix and flip doesn't go well, if you're smart, what have you got a plan to do?

It's a long term rental.

It's a long term rental. Right.

Maybe it's a short term rental, but like it turns into a rental.

That's right.

I myself have had a flip turn into a rental.

Yep, me too. So, okay, very common. But so that's why when you're out shopping for a fix and flip, you're like, ooh, we could rehab this and sell it. You always want to be thinking, what would the average rents be on this if I had to? And make sure that pencils out at least positive cash flow, even if it's not the total rate you wanted your roi, at least you could rent it and cover the cost of debt service. So that's what you do. If you've got a fix and flip it took you six months to flip it and the market is not what you want. At that moment, you pop in a renter.

Yeah.

Now it's a long.

Let me say that this is the reason for this is because of what the tax code actually says. It excludes the 1031 exchange for people buying real estate with the intent to immediately resell. So you have people to be buying and saying, my intent isn't to immediately resell this. So can I buy a property and just flip it in a month and get 1031? No. What if I held it nine months, Matt? What if I held it a year? Well, there's no guideline of the time period really, but the IRS is looking at what was your intent when you bought it? Did you put a renter in it? If it was a had a building and was like a rental type property, did you just improve it? And you know, what was the, what happened during your ownership period? You want to show some investment intent. Yeah, generally anything under a year is going to be suspect.

Yeah, this is where we get into 50 shades of gray. So if you have children in the car. No, I'm just joking. Okay, so here's the gray part. So let's say you go, okay, guys, I'm going to turn it into a rental. So a month later I can 1031. No, that's kind of more darker gray. That's shade number one. Pretty gray. Barely making NC17. You know, it's pretty dark. But then you go, well, I'm going to what we like to do. And most accounts are going to say Safe harbor is nine to 12 months. Now, if you're a developer, you're going to go hardcore on 12 months. If you're only doing one or two fix and flips a year, you're not a biggest target for this. Maybe you have a day job, you have some other ways and you had that investment intent if you had to. Now we're moving a little more to a lighter gray, to a bright white. Maybe around nine months you could pull off a 1031. So that 50 shades of gray is kind of that one month to 12 months. But most accounts agree after a 12 month holding period, not from the day you bought it, from the day you felt finished the fix and flip, that's when the 12 months starts. Then you could maybe pull off at 10:31.

Yeah. And I think if you do that every year as well, you're like, okay, Matt, Mark, I'm just going to do one of those every year. Well, now you're getting back into the, to the dark gray, right?

Yeah, yeah.

Every time you try and take the rule and the little loophole the iris gives you and you want to kind of, you know, make a few more loops within it, you're kind of going back to dark gray.

Yeah. So hopefully that helps a lot of you out there that might be in the real estate business. Okay, I got a question.

All right.

A lot of people ask, can I do a 1031 with my home? Okay, but this is your personal home. The answer is no. But maybe. Now what's funny now what's funny about this, man? I literally got a text from, from a good friend of mine in California last night and he's selling his home in California. Now this is where California so is in Chicago, New York, out in Westchester, Long island, whatever. There's all these little pockets of very wealthy communities around the country. San Fran, you know, you may have bought that two bedroom, 1,000 square foot house for $1 million.

Yeah.

And now it's worth 2.5.

Yeah.

Okay, so tell us about the sale of home exemption. And then you know the way out of this. I mean there's some options, but yeah,

I mean the nice thing about the sale of home exemption is you can get up to 250,000 of just gain. Totally excluded if you're single, 500,000 if you're married. Well, if I bought it for 100 and it's worth 2.5. Now I'm only going to get out of, if I'm a married couple, 500,000 of gain and I'm going to pay tax on the, on the other a hundred thousand. Now the cool thing about it is the sell of home exemption, if you owned it and lived in it for, for two out of the prior five year window. Just think of two years really owned it and lived in it for two years, I can then sell it and exclude 500,000 of gain. Now anything on top of that, I am going to pay capital gains. But if this is, this exemption exempts the tax. Remember the 1031 is only deferring the tax till later.

Yeah.

To you sell the next property and then when you may not do a 1031. Yeah.

Now here's where we can get creative. Now I'm going to go to the diagram. For those of you that are just catching this video. We shot a whole video on the basics of the 1031. So we highly encourage you to go look at that and get the numbers down. But let's talk about the tax tables. I know this seems like someone's going to swerve off the. Yeah, yeah, there's an attention grabber. I'm just reeling them in, man. Five people just unsubscribe. Okay, now, okay.

For Mark's mom, who's still listening. Everyone else is gone.

Yeah, yeah, yeah.

Thank you.

Okay. All right, now, so we're going to look at this. How trading. Well, hold it. Let's do this. Okay, so check this out. I've got a chart here of the ordinary tax rates for 2020 and the capital gain rates for 2020. Now, if you're on YouTube, you're able to see this. If you're driving down the road listening to the podcast, hang tight. Here's what I want to make a point of. Let's get some real numbers on the table. Matt threw out 100,002.5 million. Let's, let's get a real example here. Let's say you brought, bought a property for a million dollars in this wealthy community, and now it's worth 2 million. And that's a, that's a fair assumption. We've had a run up over the last 13 years. So a million dollar purchase of your primary residence, now it's worth 2 million. Now, the first thing you do is say, well, did I do any improvements? Because that would increase your basis. So let's say you put in 100 grand for landscaping. Maybe you put on something permanent, attached fixture. You put on a new attachment to the room or remodel the garage. Any remodel or improvements of the home adds to your basin. So let's say you did $100,000. So you bought it for $1,000,000. You put in $100,000. That's your basis. $1,100,000. And now you're selling it for $2,000,000. Now, let's assume you're married, Matt. How many can we exclude?

500,000.

500 grand. So I've got $900,000 of gain minus the 500 free and clear have to do anything. Now I got a $400,000 capital gain. Oh, I heard about this 1031 exchange. I'm going to buy a new home of $2 million or greater. So I could just roll that $400,000 into the new home. No, you cannot 1031 exchange your own home. Well, before we look at your option here, let's look at what the rates would be. Now. You'd say, well, capital gain rates start at zero, then they go to 15% and then they go to 20. So this is the mistake people make. They'll go, oh, okay, well, zero to 80 grand is zero percent. Sweet. So on the 400 grand of capital gain, no tax on the first 80. All right, sweet. Then on 80 to 500 grand, it's 15%. So you're thinking, okay, I've got $900,000 minus the $500,000, that leaves me a $400,000 capital gain. The first $80,000 is taxed at zero, so I've got $320,000 at 15%. So I'm going to ask Siri. $320,000 times 15%,

that would be $48,000.

$48,000. Now that's federal tax, not including state, so you got to write a check for $48,000. Now you're selling this home for 2 mil. You may say, ah, fine, I'll pay the tax of 48 grand. I can go take my money and run. Slow down, tiger. In this next slide, you will see that as you assumed I had this animation, I thought I had it turned off. In this animation slide, I kind of throw out. You think the capital gain tables apply to your capital gain separate from your ordinary rates? Nope.

One would hope.

One would only hope.

That's wishful thinking.

Yeah, very wishful. And you're thinking, you mean the tax code screwed me over again. Hey, don't hate the player, just hate the game. I'm just bringing you the playbook. So what happens is it's called capital gain stacking. So what really happens is your long term capital gain of 400 grand stacks onto your ordinary income to determine what bracket you're in for capital gain rates. So you still get the capital gain rates, but the bracket is based on the combination of your capital gain and ordinary. So let's say you have 200 grand of ordinary income. You and your spouse, day jobs, small business, whatever. Oh, 400 plus 200. Now I've got minus your standard deduction. We're going to take a few assumptions here, but let's say I've got 600 grand. Of taxable income. I go back to my table now and I go, oh, now I'm in a whole different bracket. The first 500 is 15%, but everything over 500 is at 20%. Oh, crap. So now I'm getting no, zero. And based on your ordinary income, you might get popped into the 20% bracket and you might think you were finished at that point. But Obamacare kicks in at 3.8%. For those that are married, it kicks in this additional 3.8%. I got to pull over here to my table sometimes.

This is called the investment income tax, I believe.

Yes. This is the ACA Affordable Cares act investment tax. And it kicks in at 3.8% on the first 200 grand if you're single, 250 if you're married. So what was your capital gain? 400. So everything over 250, that would be another 150 grand at 3.8%. And don't forget your state tax. Man, I feel like I'm just, I'm just ruining someone's day kicking them in the car. So when you. So here's the point. I'm going to tee this up for Matt Sorensen. So we got all these taxes on this additional capital gain. I'm thinking twice about selling my home. Now, if I can't exclude any more than the 500, what's my option, Matt?

Well, I mean, you could always turn this into a rental.

Matt Sorenson, have you ever done that?

I have done that, actually.

I thought you'd be a perfect candidate to explain.

Yeah, I, I like this strategy from just sometimes when buying the right time to buy real estate is usually not the right time to sell real estate.

Right.

Doesn't that make sense? So if you're buying real estate, even your home, a lot of times when you're buying your home, you know, you're changing jobs or moving locations, and there's other, there's many other things going on that you can't control. But say in general, if you're buying real estate, it's usually not a good time to sell. So if you don't need to sell your home, don't turn it into a rental. All right? And you've already got the mortgage in place, you probably got it at a lower rate. The smaller payment, you're going to cash flow it immediately from the get go. And now just keep that as a rental. And later on, if you want to sell it and buy a bigger property. Now you can do the 1031.

Yeah.

Now you're going to give up the sale of home exemption though. All right, well, if you're out of it for three years, boom.

Okay, yeah, well, yeah, so remember the rule on the sale of home exemption? You had to live in it two out of the last five years. So let's go back to this example. You bought it for a mill, you put in $100,000. It's now worth 2. You sell it now you have a 500,000 exemption. You pay tax on 400. It's adding up quick. You're freaking out. You turn it into a rental. Airbnb, vrbo. Maybe you leave some furniture in, maybe you don't. Maybe you get a leasing tenant on an option to buy. So now you've got a lease to own tenant that's going to take care of it with a huge down payment as a tenant that you're going to apply to the purchase price down the road. So now you go to sell it a year later. Two years later. Two years and 364 days later, you have three years to meet that two out of five year window. So if you sell it two years later, you still get the $500,000 exemption and the 400. Kick it down the road, baby. But that 400 is bifurcated based on the value of the property. So you take 400 grand divided by 2 million. Or is it a 2 total gain?

Oh, boy.

I'd have to figure out. I think it's. You're going to have. Oh, the math I've kind of screwed up right on at the moment. But you're going to have to buy an equal or greater investment property with the proportional value of the home attributed to the rental. So you'd have to look at the value of the rental or the home when you saw you turned it into a rental versus the value when you sold it. There's some math involved. This is why it's 1031. Could be a full long day class. But the point is you're going to end up with the home you want, not pay any tax and turn out with a little rental property on the side as well, which could be a really good equation. It's not perfect. We're just giving you some ideas.

Yeah. Okay. So that's the no, but maybe.

Long answer. But our viewers want 10 years ago.

10 years ago was the call me maybe. Now it's the no but maybe. Yeah, that's, that's the 2021.

Instead of swiping left, we're gonna go, we're gonna check out. You know, could be some maybe no. Okay. All right, we've got, we got one last example now. So, big question. Matt and I are partners on a property. We're in an LLC, and I want to do a 1031 exchange, but Matt Sorensen doesn't. He wants to take his money, pay off some debt, take a trip around the world, go buy a cool yacht. Who knows what. This isn't a big investment property. Buy a little boat, little bait based. What do you call those?

Dinghy.

Dingy. So Matt's going to take his money and go buy a dinghy. I'm going to take my money and go buy a rental property. So I want to do a 1031 exchange, but Matt does not. Now, I have some slides on this that are really good. Now, if you're just joining us for this portion on YouTube, if you're on our podcast, you've caught in the basic section and two or three other complex examples. But now we're just going to talk about this partnership example with some slides. And please go back and catch the entire the video on the basics of the 1031, because you're going to need to know that because this is going to get really complicated for some of you if not. So, Matt, we've got the diagram up here of this tick example. Why don't you set the stage? What are we going to have to do?

Okay, so here's the problem. The same entity that sells must rebuy so that when you sell the property, and if you want to do a 1031 exchange, the buyer of the replacement property, which is the new property you're buying, must be the same. So if Mark and I have an LLC together, which we do, that owns real estate, we have a couple, and we're selling a property. Again, Mark doesn't want to cash out. He wants to 1031 in another deal. I want to cash out. Well, we can't use that same LLC because it's got both of us in it. All right, so what the general strategy is, what we want to do is we're 50, 50 in the LLC. We would deed the property out of the LLC before sell. All right, it's going to go 50% as a tenants in common interest to Mark or to his entity of choice that he wants to use that could buy his replacement property. 50% tenant, common interest to me. Yeah.

Now, I did in this, this PowerPoint slide for those that are on YouTube, I put three owners in here. So I apologize. I probably should have started that. Corey, you just got in on the deal, so Our producer, our demolition driver producer. Okay.

All right.

He's. He drives derbys, folks. You got it. You got to check out our podcast and show because we love Corey. Okay, so there's three owners in an llc. We're going to deed out the ownership in ticks, tenant and common interest. Usually included with that is a tenant in common agreement. You don't want to just start deed in pieces of property all over the place without coordinating with the lawyers, making sure everybody is positioned properly and protected. You may have tenants in the property and a window of exposure because ticks, there's no asset protection with the tick. So once it leaves the llc, you got some exposure. So you want to do this quite quickly, quickly before closing. And the irs, there's all sorts of rules on this process and the tick and the timing and all that. We're not going to go there today. But you, you deed it out in these tick. And one of them, Matt here is owner number one says take your cash and go. Number two could be Corey and he's going to do an opportunity zone holder show we've done on opportunity zones. Me, I'm going to take my money and, and I'm going to go buy a property of equal or greater value. Now, do I have to buy, say we sold this property for 1 million. Do I have to go buy a property of a million or more? No, because I only owned 34% of this deal.

So I've got to go buy a

property of $340,000 or more. I'll probably have to add a mortgage to it or some additional cash. But on my K1 from the LLC, I won't pay any tax.

Yeah, when that. Yeah, when the title company closes it, there's going to be three sellers of the property. It's not one LLC. There's three separate sellers. They're going to 1099 each seller separately, actually. And so Mark's going to get 1099 for his one third and that's going to then go on to the. You know what he's going to then take to go buy his replacement property and go on and do the next deal use his 1031. So if you're in a partnership or in an LLC that's on title and one of the partners wants to 1031 and another doesn't, deeding it out to a tenant in common interest on the deed. Tenant in common has nothing to do with landlord tenant. It's just a way of having multiple people on a deed. You'll specify the percentage on the actual deed. Then you sell, Everybody gets their money, and then everyone can decide, do I want a 1031 or not?

Yeah, I like it. Now this little beautiful diagram over here to the side for those watching this on YouTube. That's why you want to go watch the basic video. We also talk about 1031 in your home with the Biden administration is talking about with ten 31s. There's three or four videos. Go check those out. Now, a lot of people ask Mark, what should I do? Well, I've got one example to make sense of this. I was down in Vegas with my good friend Matt Swornson, and we were at the roulette table. And I'm kind of, since I'm an accountant, pretty good at roulette. You know, I'm counting. Some of you think you count cards and poker, but there's some roulette strategies. So, so, so, Matt, very common. We were sitting at the table. We both had 100 bucks left. You know, we were kind of up. And I remember Matt Sorensen. He's like, I'm out. I'm going to take my cash and go right here in this option here. He's gonna like, take my cash and go. Me, on the other hand, in this one instance, oh, I took my money and I put it. I took the entire hundred and I of equal or greater value, and I spread it all out over all these little different sections of the roulette table. Because you have it, you have to spend all your money of equal or greater value. And I had to do it before the guy raised his hand and said, no more bets. So I met the timing rule. It's like 1031s is such a good analogy. And I put my. My chips down. Guy puts his hand, he kind of waves it. It's kind of a cool little way.

You identified.

I identified my numbers. One of those little. That ball landed on one of my chips. Paid 64 to one. Right. Was it 32 or 64 to one? If you get it on that one, one number, is it 64? See, this is how good, how well I know roulette.

Yeah, I think it's 64. Yeah. Got the red and black. Yeah. That's total 32 and 32. I don't know.

Yeah, but I. But it paid off. So I did the. The whole. The whole dealio. And. Yeah, okay, 37 to 1. So I. I'm sorry, everybody. That's embarrassing. Some of you that are, you know, you can split. You could do a whole row 18 to 1. But 37 to 1. So I, I made some big money that day and Matt lost out. So it's good.

Yeah, I was happy to, happy to bow out and help you increase your chances.

Thank you. So, okay, everybody, 1031s are alive and well. They're still going to be available under the Joe Biden administration. It's just, is there going to be a cap on how much you can 1031. So we'll wait and see as the Senate fights it out in a 5050 battle. But thanks everybody for listening to our podcast. For those that were able to catch it on mainstreetbusiness.com podcast, please get over there. We've got hundreds of podcasts on all sorts of ways to make money, save taxes, build wealth, protect it. And we got several YouTube videos out of this too that I think let people take this in bite sized pieces. So, Matt, any final words of wisdom?

Now just, here's one last thing I'll do. This is just a little tip and you can't blame me for bringing it up. There's one great deferral strategy better than all of them with no timing rules, and that's the self directed ira. Sometimes it's even tax free. You can use your retirement account to buy real estate and sell it for a profit and pay no tax. So if you, if you're not familiar with that, of course you get a lot of content on that on here on Main street business on our sister podcast directed Iraq, 45 days, 180 days, doesn't matter. Sell it, cash it, go buy stock, go sit in cash. Wait till the next deal comes along. No rush, no hurry.

Yeah, I love it. And perfect timing. Corey brought me a diet Mountain Dew because he worries about me. He would think if I'm going to go to Taco Bell, I'm going to think, you know what, what would Mark want? Was that passive aggressive enough?

Yeah. Okay.

All right. Everybody cool? You here next week?