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  • 1031 exchange. Has anyone actually done one?

    Sounds like a great idea on paper but sheesh the stars must align to pull off the time constraints?

  • #2
    We have had clients who have done them. A 3-way exchange isn’t so difficult if you are working with an accommodator who can help you find qualifying properties and sellers but, you’re right, it can be much more difficult to accomplish than most people realize.
    Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      Interesting that there has not been much response. I have not done a tax deferred exchange because I’ve held my two rentals long term. But I have looked into 1031’s quite a bit because I plan to exchange one of the properties. (Which one depends on timing. I have been building up nominal losses through TLH to cover the other.) The key, it seems to me, is to have the follow on property (or several possibilities) identified in advance. I have also checked with a law firm that routinely does the exchanges just to make sure I have a professional on my side for documentation when I do it.

      Anyway, for me the hard part is not the timing, it is correctly calculating the depreciation that carries over. (The original property is fully depreciated, but we are carrying half as stepped up basis from an inheritance plus some current depreciation on improvements.) I think I have it right, but something tells me I should hire a professional for this too!

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      • #4
        I've done it as a principal and for my clients more times than I can count. In the current market it's definitely more difficult to find your replacement property. In fact, right now I'm doing a lot more reverse 1031s (you actually buy the replacement property first which is held by by an intermediary until you close on the relinquished property). It's more complicated and expensive and probably not worth it if you're talking about a SFH you were renting out, but if you're dealing with a commercial asset with a much higher value it may make sense. As an alternative, I would recommend just looking for your replacement property and have it identified prior to even going to market with the current asset.

        The reality is that many times while completing a 1031, you'll end up reaching a little bit on price, because ultimately paying an extra 10% on a replacement property is better than writing a check for 20-30% to Uncle Sam that you'll never get back. It still makes sense, as long as you don't get carried away and let the tail wag the dog.

        Like most things, it's best to start planning and getting a strategy in place well in advance rather than waiting until the clock has started. At the end of the day, finding the replacement property is really the only difficult part. The rest is just some paperwork that the title company, intermediary, and broker will take care of.

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        • #5
          I guess I'll also add that the time constraints aren't that big of a deal unless you're VERY particular about your replacement property. It's really just the 45 day window that is a big deal, and again as mentioned above in my previous post, if you start in advance you have even more time. You can also identify multiple properties, so you don't even have to commit to a single property out of the gate. The 180 days to close is not even a consideration that comes up in 99% of the transactions. If you can't close in 6-7 1/2 months, you have other problems.

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          • #6
            Haven't done 1031 directly yet. Several friends have and in this environment it has been particularly hard to identify appropriate targets because EVERYONE is looking for good properties that simply aren't there -- hence driving up offers in the first place is exacerbated as we enter year 2 of white hot market and people want to cash out ---- but no 1031 to move into.

            So folk either cash out and pay taxes, or simply don't sell --- yet.

            1031 works when there's planning ahead vs taking the 'make me move' offer.

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            • #7
              I did a 1031 a couple of years ago. It's not easy. The problem is you have 45 days to identify 3 properties, and you must close on one within 180 days. So typically you're sending out letters of inquiries (LOI) left and right, and it's a while before you can identify the 3 properties. Then when you identify the 3 properties, you MUST close on one of the three. Well you never know about financing, the seller, and then you have to investigate the property itself. I ended up narrowing it down to two properties after flying around the country touring the properties on my list. I used a Delaware Statutory Trust (DST) as a back-up. I ended up buying one of the two properties I identified.

              My concern right now, is that cap rates are very compressed, and it's really tough to find good properties. It might be easier to do a reverse 1031, where you buy the property first and then sell yours.

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              • #8
                Yes. I did one in 2020, selling a money losing property with a high interest rate and exchanging for a better property with much better cash flow.

                Selling our property wasn't too difficult. The buying was more difficult. Fortunately, we used some geographic arbitrage (100 miles closer to home) to make everything work. We had to look at multiple properties and change what we were looking for a few different times. We resisted getting into bidding wars to make sure the numbers would still work for a rental property. We made offers on probably 5 properties before getting a new build that worked out.

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                • #9
                  Successfully did one 3 yrs ago and had a couple fail because we couldn't close on the properties we identified in 45 days. Fortunately we were able to find a buy in the same calendar year and then did a bonus depreciation cost segregation study on the acquisition that covered the capital gains so didn't have to pay the tax.

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                  • #10
                    Originally posted by RacerX View Post
                    I did a 1031 a couple of years ago. It's not easy. The problem is you have 45 days to identify 3 properties, and you must close on one within 180 days. So typically you're sending out letters of inquiries (LOI) left and right, and it's a while before you can identify the 3 properties. Then when you identify the 3 properties, you MUST close on one of the three. Well you never know about financing, the seller, and then you have to investigate the property itself. I ended up narrowing it down to two properties after flying around the country touring the properties on my list. I used a Delaware Statutory Trust (DST) as a back-up. I ended up buying one of the two properties I identified.

                    My concern right now, is that cap rates are very compressed, and it's really tough to find good properties. It might be easier to do a reverse 1031, where you buy the property first and then sell yours.
                    Thank you to everyone who took the time to write here and tell us of your experiences. Realestate is without a doubt a wonderful investment.

                    However, it is far from passive and far from easy (IMPO).

                    In 2005 (2006?) I bought a home and ended up changing jobs, moving, and trying to rent it out. 10 years later I sold if for a loss.

                    I lost 100k after 10 years. Just typing that sounds ridiculous. I am not a total moron.

                    I got unlucky (market bubble) and made some foolish choices (never should have purchased a house I did not need when I had a bunch of student loans and was only 8 months into my first job, long distance landlord headaches, old house and blah blah blah.

                    Guess my point is:

                    1. RE is not always easy. You have to know what you are doing and it takes time / effort / energy.

                    2. Docs are often at an informational disadvantage in this inefficient market. To claim otherwise is foolish.

                    3. You can lose money in RE. I did. (I have made money too, on primary residences, but that is not newsworthy) I write of my failures because people tend to brag about success but ignore failures and I think we can learn from both.

                    4. 1031 exchanges (which to me sounded awesome, simple, and easy) are apparently not easy or simple.

                    5. There is a giant industry (like actively managed mutual funds) that wants us to believe it is simple, easy, passive. RE agents, Banks / Brokers, RE syndicates, RE courses. I am not picking on anyone, but they make money selling stuff to people who are trying to invest in RE and they make it sound simple easy and tempting.

                    I am not saying I won't invest in RE again the future, nor am I picking on the industry, but it sure is easy to buy index funds and work a little extra at things I understand rather than tying to compete with RE pros when I look at single family homes or evaluate RE syndicates.

                    All this and now (thanks to this thread) my illusion about 1031 exchanges has been shattered, or at least cracked.

                    Comment


                    • #11
                      Originally posted by RacerX View Post
                      It might be easier to do a reverse 1031, where you buy the property first and then sell yours.
                      I didn't know this was an option and it might be a better option particularly in a seller's market where selling quickly generally isn't an issue. I'm kicking around the idea like Larry Ragman has mentioned doing an exchange on a rental property in a resort area where I'd like to eventually retire.

                      Thanks everyone!

                      Comment


                      • #12
                        Just some follow up thoughts:

                        First, yes in a strong market it's harder to find replacement properties, thus making the exchange more difficult. However, planning well in advance can help alleviate that. Again it will depend on how particular you are. Are you looking in a specific geographic region? How big is that area? Are you looking at a specific asset class? What is your budget? Can you add capital to your 1031 to bump your price range? The wider the net the more likely you are to find something.

                        Second, I think sometimes people have a hard time completing a 1031 because they have unrealistic expectations. For example, you bought a property 5 years ago for $1,000,000 that was an 8 cap. Now you sell the property at a 6 cap (we'll use the same NOI for ease of example) for $1.33M. You've now made $333k plus whatever you cash flowed for the 5 years, and principal pay down. Sometimes what I've seen is that the expectation is that you're going to go out and purchase another 8 cap property like you did the first time. The obvious flaw here is that the reason you were able to sell your property at a 6 cap is because the market has moved and expecting to get the same deal that you got 5 years ago isn't realistic. There are still good reasons to do a 1031 (trading up to a larger property/more leveraged cash flow, repositioning portfolio, moving to something more passive vs. management intensive, mitigating risk, etc.). I've dealt with a lot of people over the years that just think they're going to have their cake and eat it too. You're just not going to be able to take advantage of compressed cap rates and appreciation from a strong market on the sell side but think you're going to go out and get a replacement property that's equivalent to where you bought your relinquished property years ago.

                        A couple of other thoughts - throwing a DST in your 1031 can be a good fallback. It's probably not the ideal option for most, but if you're facing a big tax liability, it at least gives you an option to simply roll it over into a large portfolio that's well diversified, get a steady return, and avoid the taxes. Additionally you can also roll into something that is highly stable and tradeable to park for a year or two and buy yourself more time. For instance, buying a McDonalds with 10 years of term on the lease in a good market. Worst case, you collect some rent for a little while and down the road if you identify something you'd rather own, the McDs will trade rather easily and you can 1031 into whatever you found. Obviously there are costs and small risks associated with this strategy, but can make sense depending on circumstances.

                        In a strong RE market, it's obviously harder to find a suitable replacement property than in a weak RE market, but I guess it's all relative. It's not really any harder to find a property to complete a 1031 than it is to just find a property to acquire period. While there are timelines, it's really longer than 45 days since you should be looking before even putting your property on the market and DEFINITELY looking once you've went under contract which is another 30-60 days typically. Remember the 45 day window only starts once you've actually closed on your relinquished property.
                        Last edited by CREGuy; 03-01-2022, 07:44 AM.

                        Comment


                        • #13
                          Exactly. 1031 takes planning. Reverse 1031 takes planning AND significant additional capital to float the mortgage with the intermediary holding company.

                          Yes extended closing on the initial property is a way to extend the start clock but weakens the sale potential in the hot market. If residential property this is actually the time to initiate 1031. Market it as such with expected closing time to extend to June....most won't mind that as many will be moving at school year calendar anyways.

                          These are little tricks to make it work and having a listing agent experienced in 1031 exchanged really helps.

                          Yes, our exit strategy for our rentals are vacation/family retirement locations to move to and downsize cashflows at end and optimize potential of keeping property or ease of sale at inheritance after stepup

                          Comment


                          • #14
                            Originally posted by StarTrekDoc View Post
                            Exactly. 1031 takes planning. Reverse 1031 takes planning AND significant additional capital to float the mortgage with the intermediary holding company.

                            Yes extended closing on the initial property is a way to extend the start clock but weakens the sale potential in the hot market. If residential property this is actually the time to initiate 1031. Market it as such with expected closing time to extend to June....most won't mind that as many will be moving at school year calendar anyways.

                            These are little tricks to make it work and having a listing agent experienced in 1031 exchanged really helps.

                            Yes, our exit strategy for our rentals are vacation/family retirement locations to move to and downsize cashflows at end and optimize potential of keeping property or ease of sale at inheritance after stepup
                            I guess I am speaking more from the commercial side, so our 30-90 day due diligence period isn’t an extended closing, it’s just normal. Many more moving parts though.

                            For smaller 1031s the vacation/retirement exchange is a great strategy. Allows you to acquire your retirement or vacation home in advance while avoiding taxes.

                            Bottom line is that they’re are many ways to give yourself more time in a 1031 and making the mistake of waiting until the day the clock starts is a mistake. That doesn’t mean that 1031s are hard or difficult.

                            Comment


                            • #15
                              Originally posted by CREGuy View Post
                              Just some follow up thoughts:

                              First, yes in a strong market it's harder to find replacement properties, thus making the exchange more difficult. However, planning well in advance can help alleviate that. Again it will depend on how particular you are. Are you looking in a specific geographic region? How big is that area? Are you looking at a specific asset class? What is your budget? Can you add capital to your 1031 to bump your price range? The wider the net the more likely you are to find something.

                              Second, I think sometimes people have a hard time completing a 1031 because they have unrealistic expectations. For example, you bought a property 5 years ago for $1,000,000 that was an 8 cap. Now you sell the property at a 6 cap (we'll use the same NOI for ease of example) for $1.33M. You've now made $333k plus whatever you cash flowed for the 5 years, and principal pay down. Sometimes what I've seen is that the expectation is that you're going to go out and purchase another 8 cap property like you did the first time. The obvious flaw here is that the reason you were able to sell your property at a 6 cap is because the market has moved and expecting to get the same deal that you got 5 years ago isn't realistic. There are still good reasons to do a 1031 (trading up to a larger property/more leveraged cash flow, repositioning portfolio, moving to something more passive vs. management intensive, mitigating risk, etc.). I've dealt with a lot of people over the years that just think they're going to have their cake and eat it too. You're just not going to be able to take advantage of compressed cap rates and appreciation from a strong market on the sell side but think you're going to go out and get a replacement property that's equivalent to where you bought your relinquished property years ago.

                              A couple of other thoughts - throwing a DST in your 1031 can be a good fallback. It's probably not the ideal option for most, but if you're facing a big tax liability, it at least gives you an option to simply roll it over into a large portfolio that's well diversified, get a steady return, and avoid the taxes. Additionally you can also roll into something that is highly stable and tradeable to park for a year or two and buy yourself more time. For instance, buying a McDonalds with 10 years of term on the lease in a good market. Worst case, you collect some rent for a little while and down the road if you identify something you'd rather own, the McDs will trade rather easily and you can 1031 into whatever you found. Obviously there are costs and small risks associated with this strategy, but can make sense depending on circumstances.

                              In a strong RE market, it's obviously harder to find a suitable replacement property than in a weak RE market, but I guess it's all relative. It's not really any harder to find a property to complete a 1031 than it is to just find a property to acquire period. While there are timelines, it's really longer than 45 days since you should be looking before even putting your property on the market and DEFINITELY looking once you've went under contract which is another 30-60 days typically. Remember the 45 day window only starts once you've actually closed on your relinquished property.
                              Excellent points. You're not going to find an 8 cap property if you're selling at 6, unless there are serious mitigating circumstances (like expiring leases). DST's are a good fallback but the downside is they tend to be fee-laden. Still it beats having to pay a big tax bill to Uncle Sam. The due diligence part of a 1031 needs to start well before you sell your property. IMO the due diligence part of it is the most difficult. Fortunately we have things like CoStar and Google Maps to help us. Still, I like to actually see the property in person. And that takes work. There are a lot of moving parts and it can be a nerve racking process. Make sure you're working with a good team - sellers broker, buyer's broker, mortgage broker, exchange intermediary, etc.

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