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1031 Exchange Concepts with Dino Champagne

Joe Torre, RealWealth Investment Counselor

Joe Torre

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Joe Torre: Hello, everyone. My name is Joe Torre. I’m an investment counselor here at RealWealth, and today we’re going to talk about 1031 exchanges. This can get very complicated, so today we’re just going to do a brief overview about the concepts behind it and how you can use 1031 exchanges to avoid paying capital gains taxes and accelerate your wealth growth faster.

Rather than try to do this on my own, today I brought in the heavy guns. We have Dino Champagne from Asset Preservation, and she’s going to walk us through how the 1031 exchange works.

Dino, can you hear me?

Dino Champagne: I can, Joe. Thank you for inviting me. I appreciate the opportunity. A little bit about who I am. My name is Dino Champagne. As you can see, I’m with Asset Preservation. Asset Preservation is a national 1031 qualified intermediary. I’ve been associated with RealWealth for several years now, and I’ve helped their clients do 1031s. Personally, I have helped over 15,000 investors do 1031s through the 21 years that I’ve been doing this. As a company, we’ve done well over 200,000 exchanges nationwide. For seminars, I’ve taught over 1,500 seminars, if not more, over my 21 years, and even had the privilege of speaking to the IRS in Long Beach back in 2004, I believe when that was. That was rather an interesting event, to say the least.

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Now, when we talk about 1031s, what is a 1031 exchange? A 1031 actually is a part of the tax code. In fact, 1031s have been around for well over 100 years now. I shouldn’t say well over, we’re just slightly over 100 years now. What we like to look at a 1031, especially in the qualified intermediary industry, is that we look at it as a reinvestment plan for those investors that want to continue buying investment real estate. It’s a very, very powerful tool, which helps real estate investors to grow their portfolios exponentially. It’s very, very powerful when we talk about doing something like a 1031.

Now, let me give you an example of how powerful this tool could be. Here we have a married couple in California. Now, remember, California does have state income tax, so when we talk about the taxes, we’re talking federal, as well as state. Now, we have a married couple in California filing a joint return. They’re going to sell an investment property that they’ve owned for around five years. They want to take that property and go off and buy additional property in, say, other parts of the country. The sales price for that particular property is $400,000, and then their purchase, what they originally paid after all the adjustments to the basis of the property, was $200,000. They would be looking at gain of around $200,000, and their tax liability is estimated to be somewhere around $60,000. Now, remember, that’s both state and federal.

Now, here’s some guidelines. If we have a sale price of $400,000, the adjusted basis, which is all the adjustments your accountant will do to determine your gain, say, in this example here, it’s $200,000, the capital gain is $200,000. If they were going to pay taxes, if their tax liability is somewhere around $60,000, at the escrow level, after paying the closing cost and paying off the loan that they had on the property, they would have approximately $120,000 to reinvest. If they’re not doing a 1031, that means they have $120,000 to put down, and they could possibly buy maybe two $250,000 properties.

Now, if the investor wanted to do a 1031, they would have a roughly $180,000 to put down, because they’re not paying that $60,000 in taxes. In this example here, the investor theoretically could buy three investment properties. You can see how when you’re doing a 1031, the investor can grow their portfolio. It is a tax-deferred transaction, so you have to keep that in mind, but it’s really a very, very powerful tool for those folks that want to continue investing.

Now, the IRS giveth, and they say, okay, well, we’re going to allow you, as an investor, to defer those taxes, but there’s going to be some rules that you have to comply with. There are four basic rules to doing a 1031. The first rule would be the property qualifications. The property that’s being sold must be property that’s been held for investment, or if you operated your business out of. You cannot do a 1031 if you’re selling your primary residence, and that’s the sole use of the property that you’re selling. Primary residence does not qualify for a 1031, nor do properties that you fix and flip. That’s considered deal of property, so they’re not allowed to do 1031s. If you have investment real estate, that’s what you’re able to do with a 1031.

Now, we talk about like-kind properties in a 1031. When you’re selling investment real estate to comply with the 1031 code, you must also buy property that you’re going to hold for investment. That’s one of the major requirements for doing a 1031.

The next requirement is how much money do you have to spend. In order to defer the tax on the gain of the sale of the property, the government wants you spending all of the cash coming out of the sale and replacing any debt. In other words, you need to purchase property that, or properties, that are equal to or greater than your sale price, minus the closing costs, such as title, transfer tax, attorney fees, real estate commissions.

Those are certain expenses that are considered acceptable exchange expenses. When you’re thinking 1031, think you have to buy property or properties that are equal to or higher than your sale price, minus the closing costs. You have to spend all of the cash and replace any loan that you had when you paid off the property.

The next one is the timeline. Regrettably, you don’t have forever to do a 1031. The government’s very specific about how much time you have to complete the 1031. The timeline for the exchange is going to begin the date the sale closes. The closing date is going to start the time frame for the exchange. The taxpayer that’s doing the exchange, so the investor, is going to have 45 calendar days, from the date of closing, to identify any property or properties they would like to purchase as a part of the exchange. From the date of closing, they have 180 calendar days to complete the exchange.

Let me say this another way. You have 180 calendar days to complete your exchange. The first 45 days of that 180-day period is when you have to identify the property or properties that you wish to purchase as a part of the exchange. That’s one of the difficult things with the 1031, is going to be the timeline. When you’re entering into a 1031, you want to make sure that you are prepared to meet these timelines.

Now, the next requirement is the identification. The taxpayer or the investor must identify the property or properties that they are going to purchase as a part of the exchange. When I use the word identify, I’m not referring to being in contract specifically. There is a form that an investor has to fill out saying, I wish to purchase these properties as a part of the exchange. The taxpayer, in order for it to be a valid exchange, the taxpayer needs to fill out the identification form.

Those are your four basic guidelines for a 1031. First, does the property qualify? Is it property that I’ve held for trade or business or for investment? The second is, I have to buy property equal to or greater than my sale price minus the closing costs, spend all the cash, and replace any existing debt. Then, I must identify and complete my exchange within the 45 and 180 calendar day period. Fourth, I must formally identify any property or properties I would like to purchase if I’m the investor as a part of the exchange. Those are your four basic guidelines for doing a 1031.

Now, I get a lot of questions. People say, well, when do I need to set up the exchange? The exchange must be set up prior to the closing of the sale. I’m going to repeat that. The exchange must be set up prior to the closing of the sale. In setting up the exchange, the investor contacts the qualified intermediary, somebody like me. I am going to reach out to whoever’s handling your closing. I’m going to be requesting the documents that we need to prepare the exchange agreement. You have to sign the exchange agreement prior to the closing of the sale.

If you close your sale and you do not set up an exchange, you cannot set up an exchange after the sale has closed. Please keep that in mind, if you’re considering a 1031, it must be set up prior to the closing of the sale.

Now, what can you expect during the 1031 process? When you’re working with the qualified intermediary, we’re going to be another component to your transaction, which has already been– You’re dealing with your real estate professional, your investment advisor, the closing agent, whether it’s an attorney or an escrow officer, and then there’s going to be the 1031 company. We’re going to be coordinating everything with the closing settlement agent. When the sale closes, the money comes to us. When you’re buying your replacement property, we’re going to be preparing the exchange documents on the buy side. We’re going to be wiring the funds out. There’s going to be your real estate professional, your investment advisor, the closing agent, and then there’s going to be the 1031. This is what you can expect through the process. We’re going to be working with, after the sale, holding the funds, and then wiring the funds into the purchase or purchases.

A lot of times, people will ask, “Why do I have to spend all the money? Why can’t I just reinvest the gain?” When you’re thinking of a 1031, view it as a continuation of ownership, albeit with a different property or properties in a different location. You’re rolling everything over. That’s why you have the ability to defer the tax on the gain. The government wants you fully invested, both your basis and your gain into the new property. That’s one of the criteria for the 1031. That’s why you have to spend all of the cash coming out of the sale, and replace the debt.

Now, other times people will say, “Is there ever a time where I can take any funds into a partial exchange?” The good news is, it’s not an all-or-nothing system. If you’re in a situation where you want to keep some cash out of the transaction, you can do that. You just have to be prepared that you are going to pay tax on that portion.

The four basic questions. When do I set up an exchange? Must be set up prior to the closing of the sale. You are working hand in hand with your real estate investment counselor. You’re working with the 1031 through the process of the exchange. Again, remember that you need to spend all of the cash, replace any existing debt in order to achieve full tax deferral. If you wanted to, you could do a partial exchange.

This is the highlight of a 1031. If you have any questions about the 1031 process, here’s my contact information. More than happy to answer any questions. Again, this is just to give you a broad overview of 1031s. Everybody’s situation is going to have some slight nuance to it.

Joe: Great. Thank you very much, Dino. Just for the viewers, I personally have done four or five 1031s with Dino, and they all went very smoothly. I recommend her highly.

I just wanted to reiterate one point that Dino made about the compounding effect of deferring your taxes. In her example, because you could defer taxes, instead of buying two properties, you could buy three. That’s powerful over time because you could sell one property and buy three, ten years later, sell three properties, buy nine. ten years after that, sell nine properties and buy 27. That really grows your portfolio. If you pay taxes, you could sell one and buy two, and two will turn into four, and four will turn into eight. Eight houses is a good portfolio, but it’s not as good as 27. The ability to defer taxes really enables you to compound your wealth and accelerate your wealth building. It’s very powerful.

All right. That’s all we wanted to cover today. A quick overview of the concepts of 1031 exchanges, and why you would want to do them. I hope it’s clear that it’s a great thing to be able to do to compound your wealth. If you want more information, just click the link in the description. There’s a more detailed webinar where Dino spends an entire hour going through all the nuances of how 1031s work, and that’ll give you a much deeper understanding of how to do them.

Thank you very much, Dino.

Dino Champagne: My pleasure. Thank you for having me, Joe.

Joe: Thank you, our viewers, for watching.

Dino: Bye-bye.

Joe Torre, RealWealth Investment Counselor
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