The Storage Investor Show
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The Storage Investor Show
1031 Exchanges Demystified with Mike Auerbach
Links
https://www.1031specialists.com/
https://www.linkedin.com/in/mikeauerbach1/
Description
Want to know the secret to self-storage wealth building? Behold the 1031 exchange. Mike Auerbach, VP of Growth at 1031 Specialists, explains how they work and how you benefit. You don’t want to miss this episode.
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Hey everybody, welcome to the Storage Investor Show. My guest today is Mike Auerbach. He's the VP of Growth at 1031 Specialist. He's very active on LinkedIn talking about 1031 exchanges. I thought it'd be great to have him on the show and just share with you guys how a 1031 exchange works and, obviously, educate myself as well. So, mike, thank you for being on the show. Yeah, chris, thanks for having me. Awesome man, can you briefly explain what a 1031 exchange is and how does it benefit real estate investors?
Speaker 2:for a hundred years. If you think about what a 1031 exchange really does, it allows an investor to generate more cashflow, more depreciation, buy bigger and more productive properties, and it's a great strategic tool to generate wealth and get to someone's destination faster.
Speaker 1:Okay. So when you're talking a lot of things to unpack there, so you're talking about exchanging Okay. So when you're talking a lot of things to unpack there, so you're talking about exchanging, swapping or exchanging one property for another, practically speaking, how does that work? And I'm assuming this is for beginners. So some of you guys out there who might be advanced in this or have done this before you may have heard these things in the past or have experience. But just hang tight for a quick second. I want to understand from the very basics. Let's say, does it work for commercial? Obviously it works for commercial. Does it work for residential investment properties as well? Is it just commercial properties?
Speaker 2:Yeah, it works for anything that's investment. So there's more than 16 different types of real estate investment property that qualify for a 1031. Exchange must be held for investment purposes or business. If you've got a manufacturing site where you conduct business out of, it has to own the real estate, and so, whether you're going from a single family home and investment property in Kansas and swapping it out to a multifamily in Florida, that's more than doable. I think. Where a lot of people say, hey, I don't have a lot of options when it comes to replacement property, they're pretty misinformed. There's actually infinite exchange options, and it allows an investor really to look at the market, look at different geographic regions and determine whatever's best for their investment portfolio at the time being, or whatever the market's dictating. They could swap in and out. Of. So I think there's a lot of myths and narratives around it, chris, but I think, for the most part, an investor really has unlimited options as long as they plan ahead.
Speaker 1:Okay, so it works for commercial, works for residential, as you mentioned. There's 16 or so different property types. We won't list them all here. I'm sure you'll have some resources to share at the very end. So guys stick around for that. But okay, so let's say we buy a I know we do storage on this show, whatever. Let's say we buy a storage facility that is a million dollars and we put in $300,000 of equity, just to keep the number simple. The rest of it is debt $700,000 of a loan from somewhere, and we go to sell that property. Obviously, this comes into play when you sell a property, so we go to sell it. So how does that work exactly? And then, what are some misunderstandings, I guess around it, because I'm thinking of one right now, but I don't want to jump ahead too far. So that's the scenario. How does this work and how does this save me on taxes as an investor?
Speaker 2:Yeah, so you have to. When you sell a property in your portfolio, let's say for a million dollars, and you've got $300,000 of equity and $700,000 of debt, you have to replace the proceeds which make up that million dollar. You know, you have to replace the proceeds which are, you know, which make up that million dollar number. So you have to purchase something that's greater than or equal to a million and use all of the proceeds to get the full tax benefit In this case that's $300,000 of equity and put a new mortgage on a property of 700,000.
Speaker 2:If you don't want to put a new mortgage on the property of at least a million dollars, you can bring more cash to the table. But I think a big misconception is purchase sale price minus mortgage equals equity amount and all I have to do is replace the 300,000. You actually have to replace the entire proceed amount which make up that million and that's why when people say light kind, it's really greater than or equal to whatever the sales price of what you sold your property at is what you have to replace.
Speaker 1:Okay, so let me redo this scenario. Let's say we bought the property for a million 300,000 of equity, 700,000 of the loan You're saying number one. We have to purchase a property that is greater than a million dollars and take all that $300,000 of equity that we got and put that into the new property at least yeah, greater than or equal to at least a million.
Speaker 2:So you can buy a property worth 1.2 and put 300 down and take out a loan that's greater than 700,000 if you want to. But the whole point of a 1031 is either trading into a property that's equal or greater value, and so what a lot of folks do, chris, is they'll buy one self-storage property, maybe for a million bucks, and then they'll purchase a replacement property that's maybe a million, five right, depending on and scaling up a little bit. So it's a great tool to go from one property that's producing a certain amount of cash flow and then take that and lever it up into another property that generates more cash flow. And that's really what the tool of a 1031 is really all about. And when you go in purchase a new property, you can start the depreciation schedule over on that new property and be able to get more benefits, as you were as a real estate investor. So it's a really great tool and I think in general, people just need to understand how to utilize it better.
Speaker 1:Okay, so we'll talk about depreciation and all that. Let me go back to the scenario. Let's say that the new property I want to purchase is $750,000, but I'm willing to put my whole $300,000 into it. Sounds like you're saying you can't do that. Has to be a million or more.
Speaker 2:Yeah, you can do something called a partial 1031 exchange, and a partial 1031 exchange is when you take some equity out or some proceeds out, whether it's putting a loan that's smaller on the property than you had before but you're going to get taxed dollar for dollar on whatever that amount is. So in this scenario $750,000, you're going to be taxed dollar for dollar on $350,000, which in some cases, depending on your tax bracket, can be anywhere from 30% to 40% taxes. So I think what we recommend a lot of people doing and obviously every situation is different. Some people need money for life, college, medical, all that stuff. The most effective thing someone could do is to continue to compound their money tax-free to generate more, more cash flow and more wealth for that person. So each time you opt out and pay the tax, chris, whether it's 30 or 40%, you have less equity left to reinvest and naturally you know you'll be able to not buy bigger and more productive properties, you know, as opposed to doing a 1031.
Speaker 1:Property. That is not a million, that's less than a million, but I put the whole $300,000 in.
Speaker 2:I'm still going to be taxed on that difference between the 1 million and the 750,000 in this case. Is that the idea? Yeah, unless you bring the difference in cash to the table. But I think a lot of folks don't want to do that, so they take out a loan, right, okay, got it.
Speaker 1:So you got to exchange at the purchase or sale price, I guess you'd say or higher. Now let's say we bought a property, you know, three years ago, whatever. It's a million dollars at that time. Same scenario, $300,000 down, $700,000 loan, million dollar purchase price three years ago, five years ago, whatever in the past. Fast forward to today. It's now worth 1.5 million. Let's say, when we sell the property at 1.5, we obviously put $300,000 of equity. So we have some upside in the deal. We've almost at least doubled our money. Do we have to take that entire? Is it based upon that sale price that we have to then move into another $1.5 million property or greater at that time? Okay, you couldn't take any proceeds off the table.
Speaker 2:Exactly, yeah, and look, I think that the whole point is to be able to use more proceeds and take out a loan that's probably a little bit more than you had to lever up from a one point back to a $2 million property, right? It's really all about how you strategically look at leverage. Some people are leverage averse, but we know that most people in real estate that use leverage are able to buy bigger and more productive properties and essentially in the self-storage space where you really only need, in some cases, probably 20 to 30% down, it's a great tool to go from you know, smaller to bigger properties and scale quickly, assuming that, um, you're going to sell the property at you know a profit, right, which a lot of people during the last couple of years assuming they didn't put floating rate debt on it, um, you know, have done.
Speaker 1:Yes, okay, got it. So that's that's how that works. You gotta at the sale price, you gotta be able to. You gotta exchange or move into or purchase a move up, I guess you'd say into another property. That's either uh, same side or same per, say, I'm sorry, I can't talk same price or more uh, in order to move up and you don't pay any taxes. Okay, got it. So what is the? I know that there's a timeline involved in this whole process. Again, from the eyes of a beginner, and those are the timeline involved what does that look like? And when does cause? You can't just like sell the property and then wait three years and then decide to 1031 into something else. There's a timeline there. What does that look like?
Speaker 2:Yeah, so I think the timeline is there's. There's a couple of misconceptions I just want to throw out there and address, and there are some challenges to doing 1031s. Number one kind of feels like I've got a gun to my head in far as timelines are concerned. Like a lot of folks frantically think like, oh, I'm not going to have enough time to find a replacement property. It really doesn't have to be like that. The timelines are as follows On the date that you sell, at the date that you close the property that you're selling it's known as the relinquished property you have 45 days to identify up to three replacement properties, or more in some cases, and you have to close on those properties within 180 days.
Speaker 2:Now, the smartest family offices, the smartest investors out there, they're actually going to start to plan ahead and part of the process right now is putting their property on the market, and we know how long that marketing process can take, especially today, right? So 45 days really can turn into however much time you want. If you're really strategic about it, chris, you're going to line up a property before you even list your property and put an extension in an option contract out there for the property that you're buying right. So these are things that you can do. I think, like a lot of us, including myself, we want the easiest path possible to find deals and a lot of people don't want to do the hard work right. Like, you have to do the hard work, you have to treat it like a job to find a replacement property. But the alternative is paying 30 to 40 percent in capital gains taxes. So we always say, like, why not do the hard work up front and compound tax free? And you know it really comes from a strategic place of planning and a lot of the most sophisticated people out there essentially will line up their properties really close to closing, even on the same day, because they understand the opportunity cost of the money just sitting there.
Speaker 2:So my advice is plan ahead, do it smartly. If you're working with a broker, have them shortlist 10 properties for you. They have to be real properties, they can't just be any properties. Um, you have to close on the properties which you which you list on a 45 ID identification form and, um, you know we're making a promise to our clients, chris, that you know we give a 100% money back guarantee. So we're actually trying to encourage people to do a 1031 exchange and if, for whatever reason, they can't find a property that they don't like, we're going to refund them the fee and it'll just be like doing any other real estate transaction. And so I think planning is the main thing and number two.
Speaker 2:The other challenge with 1031s, and not really a timing thing, is the notion out there that 1031 buyers overpay. Right, we hear it all the time like got this listing, you know, I hope this 1031 buyer comes in and hits my number. 1031s really aren't inherently set up to make anyone overpay, but it just comes down to the planning aspect which, you know, as a clock starts ticking down, you've got 14 days, 10 days, five days left. That's when people tend to, you know, make decisions that may not align with their investment criteria. We like to say don't let the tax tail wag the dog, and so if, whatever reason, you're going to purchase something just to save on taxes, it's probably just to opt best, opt out and just pay the tax right, because you don't want to buy a bad deal, because that'll severely hamper what you're trying to do in the future.
Speaker 1:Yeah, you don't want good money chasing after bad.
Speaker 2:Exactly should. You should talk, and you should talk to your strategic advisors as you're thinking about us listing your property. No one says, hey, chris, you got to market your property right now or you're not going to get your price right, like these are things that people should do, um, ahead of time. And you know, planning prevents poor performance. That's that's what we always say. And, uh, we've learned from some of the most sophisticated, you know, institutions and family offices out there and they're closing same day or they even buy their property first and do a reverse exchange and sell one of their portfolios and their property to satisfy it. But you got to be well-capitalized to do that and that's a whole nother story. But I think for the average investor out there investor out there like, have a plan, execute it and um, you know, don't, uh, don't, don't have a fire drill occur?
Speaker 1:Uh, cause it's not one involved. Yeah, you don't want to wait to the very end. Okay, so can you? I think we kind of touched on it earlier on, Can you? I have the idea of it, the concept of it. I hope that the listener or the viewer does as well. So can you then go from? Let's say you have a rental property, a single family home rental, and you want to exchange into a storage property? Obviously, the purchase price has to make sense. Right, it has to be greater than or equal to that or above what you're exchanging out of. But is that doable? Can you exchange into different types of properties? Because I've heard that you can't.
Speaker 2:Yeah, I mean, that's another big myth. You can definitely do that, as long as it's investment property. So what does investment property mean, chris? Well, typically you have to look at something called intention, right? So when someone buys an investment property, the intention is for them to collect rental income from a tenant. So whether that's single family, whether that's self-storage office retail, you can even buy land and have it just sit. You know that's investment property as well. That is something totally doable, any city, any state. You know we see people from California sell their single family home investment properties and buy something in the Midwest where there's yield, and they go from one asset to another. So they can definitely do that.
Speaker 2:The only thing that you can't do is a primary residence, and a primary residence you can't do. There's something called a 121 exclusion where for the individual or joint married, you can exclude 250,000 or 500,000 of capital gains. A lot of people call in about second homes or Airbnb properties. The way the IRS reads that, chris, is if you spend more than 14 days in that property, it's clarified and classified as personal use. You can't do that. So, purely investment property, any city, any state, any asset class, as long as you're collecting income from a tenant. You know it doesn't matter, you know what asset type it is. And so, um yeah, from my perspective, like again, infinite options out there. Just talk to a specialist that, uh, they can let you know that and then all of a sudden you've got a lot of options, versus thinking that I've got to. You know, go from a single family rental and in Kansas City and buy the same thing in Kansas City. That would be pretty stressful in my opinion.
Speaker 1:Okay, yeah, that would be pretty difficult to do. So you can. You can go and buy a single family. You can have a single family as long as it's an investment property, like you said, and it qualifies like with Airbnbs that you don't live in it more than, or utilize it more than 14 days in a month, I assume. But the point is that there are restrictions around that. But you can have a single family home as an investment property in exchange to storage, exchange into whatever retail, whatever, that multifamily, whatever that looks like for you. You obviously have to meet that minimum purchase price. That's what I'm calling it minimum purchase price criteria, but otherwise you can exchange. So that's the opposite of what I've heard in the past.
Speaker 1:I remember being in a. I had my real estate license in North Carolina and I was in a continued education class one time. It was a commercial, specific continued education class because the residential ones put me to sleep but they were arguing for, like you know, this is before I really got into storage. But they were arguing for a little while. One guy said I've done this before, you got to do this and this, and the other guy's like no, you can do this, and the instructor was at a loss as to you know kind of how to, I guess, teach the class, because obviously he wasn't very much involved in 1031 exchanges, but I remember taking that away is that you have to actually exchange into the same type of property. But you're telling us that's a total myth, right?
Speaker 2:That is one of the largest myths out there because, think about it, like 40 to 50% of the 1031 exchange market comes from some type of residential single family home, multifamily. A lot of those folks, after they are tired of being active investors doing the property management, they want to go into something more passive. So you're seeing them buy single tenant net lease deals, a Chick-fil-A, a Starbucks, one of those things, so they can still have exposure to real estate, and so that happens all the time, all throughout the country. And I think, chris, really systemically, there needs to be better 1031 education taught at the licensing level, and we're trying to figure out some ways to do that. But the fact of the matter is, whether you're a broker or an investor, I mean, 1031s are a win-win situation for the broker you get another opportunity to find your client or replacement property. It's a win for the investor they get to continue generating more cash flow and not having to pay the tax man. It's just for whatever reason.
Speaker 2:All the information previous to when we started this company two years ago has been so hard to digest. It hasn't been really well packaged and part of what we're trying to do is simplify it, make it more mainstream and make it easier because, know, because they're not exposed to it or haven't learned from it. You know in the beginning, unless they're in it Right. And um, I can tell you that some of the most well-known real estate families and individuals utilize the 1031 all the time and you don't even hear about it because, uh, you know they're, they're private. You know off-market transactions, but you know they utilize this and you know, when their time on earth is up, their heirs inherit their portfolio and property. Their kids get to step up in basis in the lifetime of appreciation that they made happen. Um, you know they don't pay a dime. You know their kids don't pay a dime in tax for so um, really interesting.
Speaker 1:I think that's great. I think I don't like it being. Have you ever heard it called a loophole, like a tax loophole?
Speaker 2:Yeah, it's that really like it's interesting, like how narratives and stuff gets portrayed Like if I was doing it, I wouldn't call it a loophole, I would call it like one of the best. You know one of the best. You know one of the best. Uh, you know wealth generating tools out there.
Speaker 2:But I think, like a lot of things Chris is, you know there are a lot of different great tools in real estate, um, that I'm sure you know about and you've had guests on that that speak about that a lot of you know people don't even know about. They just are taught. Oh, let me buy this, uh asset, let me learn to raise rents and operate it, but there's a whole bunch of other ways to mitigate taxes and all these other things that can help someone really pour gasoline on their investment career and get them to a level that will generate a lot of cashflow where they can have a great portfolio. It's really interesting. You know that it's portrayed as like a wouldn't call it a negative but, like you know, kind of like you mentioned loophole doesn't have like a great connotation and you know we're trying to make you know 1031s.
Speaker 1:you know mainstream, it's hard for sure You're trying to make them great again, just saying.
Speaker 2:I know I was going there, but um you know, I knew you, I knew it, ma'am, that's so it.
Speaker 1:But it does bother me, in the sense it doesn't keep me up at night, but it does bother me when I hear somebody say a 1031 or just like the tax code has loopholes and we got to close the loopholes like 1031 comes from the tax code, right? That's why it's called a 1031 exchange, correct.
Speaker 2:Yeah, I mean 1031s have been around for a hundred years, okay, and I think what a lot of folks don't really like, realize, chris, is, like you know, for us and for people in general, like it's really meant to be a great thing for investors in the United States. I think a lot of folks want more opportunity out there. I think the path to wealth creation you can't get there in just your job anymore. I think a lot of folks. That's why self-storage, multifamily, all these different types of avenues for people, people are starting to wake up a little bit and say, oh, you know what this can be, a great operating business to give me the life that I want. And the other side of it is based on the election. People are asking us all the time do you think 1031s are going away? And I will emphatically say no, I don't think they're going to go away in our lifetime. I think you look at the incentive for people in real estate transactions to transact. The 1031 gives a lot of transaction volume out there, even though we think it's 15 to 20%. Imagine if there is no incentive for you to sell your property, chris, and not be able to defer taxes. Would you ever sell? Who knows right, and so it's a much bigger part of the real estate landscape than I think a lot of people know about, and we just got to get the word out there more about why it should be more mainstream. And it's really not that complex at all, and so I just want to reiterate this for everyone listening.
Speaker 2:A 1031 is really just like a normal real estate transaction, except for a couple of key differences. Okay, number one you have to use an independent third party called a qualified intermediary. It's mandated by the IRS, like my company 1031 specialists. There's title companies that have ancillary services like that too, or CPAs or attorneys. And the second thing, the most important thing, is you cannot take constructive receipt of the funds, meaning the funds cannot hit your bank account. So what happens is we facilitate. We're not the bank, we don't hold the funds. We partner with a publicly traded banking institution. We set up a segregated trust account in your name or your entity's name At closing. The funds will go there and they'll sit there. They're protected, they're secure, you've got access to them 24-7.
Speaker 2:And then when you say, hey, I'm looking to close on this property that I identified, we instruct the partner bank to wire the funds to the seller of the replacement property, thus completing the 1031 exchange. So you know, that's really how it works. The timelines obviously play a role in there too 45 days to identify, 180 days to close from the time you've sold your property. But really, guys, it's almost like buying and selling your primary home, right? Think about it. Anytime that you've been under the gun, trying to sell your home, put it on the market and then go buy another home, it's almost the same thing, right? So you're kind of used to that behavior already, you know. But for a 1031, you actually get to dictate when you get to strategically look for investment property, because it's a little bit of a different scenario and you can plan ahead. So you know, I think, if you think about it that way, like we've been doing this, it's almost in our real estate buying DNA for our primary homes, like it should be like that for our investment property.
Speaker 1:That's a really good point, that it's exactly the same thing. If you're going to switch from one home, buy another home, you have to qualify, you have to find something pretty quickly and make that move, that transition. So that makes a ton of sense. What is the reason, you think, is the qualified intermediary? Is it more of like an accountability situation? Because, like you said, you guys don't touch the funds, you don't do anything there? Is it just to make sure that the seller or the previous owner of the property doesn't do anything nefarious with the cash that's in the bank account? Is it for that reason? How does that? What's the reason here?
Speaker 2:Yeah, I think first and foremost, the IRS deems it a taxable event if the funds are in possession. They don't want someone possessing the funds or else they'll say you have to pay the taxes. I think qualified intermediaries are, on the West Coast, also known as accommodators. I don't think a lot of people know anything about them at all and, as a guy that has done a lot of 1031s and has been a part of having clients when I was in brokerage a long time ago doing 1031s, we had no clue. We had no idea that these folks even existed, nor did we really even care, because it just wasn't taught to us that way. I think maybe in licensing courses there's maybe one sentence about 1031 exchanges, that's it. Doesn't tell you the mechanics, doesn't tell you who's involved, doesn't tell you anything. And we live in this great area. My partners are CPAs by trade and we work with some of the best tax structuring attorneys in the country. But we're not the ones giving the advice, just like I'm not the one giving the advice to the investor hey, I've got a great deal for you to go out and 1031 into. We play a small but very important part and I can kind of break it down into three things, chris. Number one we do a lot of consultation calls, we educate, we make sure people are aware of the options that they have. Number two we make sure from a compliance standpoint they get the tax benefit. So when it comes to working with their CPA at the end of the year and they notify the IRS that they did a 1031, they'll get a form called 8824 that they informed the IRS. And number three we protect and direct the funds.
Speaker 2:We're not the bank, we don't hold the funds. We partner with the fortune a 500, uh, a publicly traded banking institutional partner. You know we have something called a qualified escrow agreement. Not every qualified intermediary has this. It means the funds cannot move unless there's three levels of authorization between us, the client and the banking partner. Otherwise, that's where the real risk is, is in the transfer, and so we make sure that it's notified and has three layers of authorization.
Speaker 2:So I think from our perspective there's probably 75% of the industry, chris, is owned by the big three title companies. I'm sure a lot of folks have had exposure to those. The other 25% there's probably around 150 to 200 qualified intermediaries out there. My partner, john, has the exact number. We've got the exact database.
Speaker 2:Most of these folks have been doing this for 30 to 40 years in their local markets. They don't have any, just by nature of the evolution of everything. You know they've been doing lunch and learns and missionary marketing for the last 40 years. There's been no tech, no innovation and no digital brand, and so, you know, we're trying to evolve the space a little bit and get this out to the masses. And you know, I think, think about it this way, like for self-storage investors, that they knew that they can eventually go from one self-storage to multiple different cities, different states, is is more opportunities. You know, come up, completely change their entire strategic plan on how they deploy capital and and go go about. You know their, their process and, um, you know, we're we're trying to, we're trying to make them aware of it for sure yeah, I was going to ask you, bring up an interesting point there, let's get in a second.
Speaker 1:Let's get to like depreciation, because you mentioned that earlier on and how that actually works in this scenario. But you can't. Does it have to be? You mentioned multiple properties. Can it be by split up the purchase price amount into different properties, or does it all have to go from one to one?
Speaker 2:No, you can do one to two, one to three, three to one. You know we're starting to. You know, I think that the cool thing about 1031s is, you know, it gives you the ability to diversify, whether it's diversify like specific asset, like self-storage, diversify the geographic location, diversify different asset types. Someone could go from a multifamily property to one self-storage, one single tenant, net lease and a piece of land, for instance, in three different parts of the country, as long as they're being able to replace the proceed amount. However, that's broken down. So we have people all the time do that, right, and I think, I think that you know, you think about it, you know you're an investor. So investors, a lot of great investors diversify and whether it's by geographic region, different real estate asset types, um, it's, it's a great tool, um, to help someone do that. But first and foremost, chris, like they have to be aware that it's even an option and they have to get the good advice. And I'm here to tell you it's definitely possible.
Speaker 1:Okay, perfect, so you can move up in proceed amount, not go down, obviously, otherwise you trigger a taxable event. You can go from one property type to another or to multiple no-transcript deferral of depreciation recapture taxes.
Speaker 2:So when a property is exchanged for another replacement property, the depreciation recaptures deferred along with the capital gains tax. So the deferral is it acts just like an interest-free loan, allowing the taxpayer to reinvest the proceeds into the replacement property. Now, basically, a lot of people are going to want to know about, like, the basis. And so in a 1031 exchange, the basis of the replacement property is generally the same as the basis, as the relinquished property, and it's adjusted for any additional cash or gain recognized. So you know, I think, for you know, just for simplicity reasons, you know, if you decide to do a 1031, you know you've done five 1031s in a row. You've, you know, deferred the capital gains and the depreciation on all of your properties. You've bought a new property, you've depreciated to a lower basis properties. You've bought a new property, you've depreciated to a lower basis. If you decide to sell and not do a 1031, you're going to get all those depreciation recapture taxes that you'll have to pay.
Speaker 2:So, yeah, the smartest people, chris and I'm sure you've got buddies and know people that do this they will start a new depreciation schedule on a new replacement property that they've 1031, depreciate it as much as they can and then do a 1031 into a new replacement property that they've 1031, depreciate, depreciation as much as they can and then, you know, do a 1031 into a brand new property. So, um, as long as you keep swapping, you can defer that depreciation. And again, I think the 1031 and cost, said used together, are tremendous tools. Um, and a lot of people need to know more about it and there's um, yeah, there's some great, great companies doing some great things in that space, but we don't, we don't partake in in, in in the cost seg. We just do the 1031 facilitation. But I definitely recommend listeners to you know, talk to someone in that space, because that's a great tool as well.
Speaker 1:Absolutely. Yeah, I interviewed, uh, sean Graham from. I interviewed Sean Graham from Maven. He was on the show several episodes ago so you guys can listen to that if you'd like to. Also talked about VA's virtual assistance in storage and sourcing deals. So a great episode. But, yes, okay, let's talk about the 1031. Okay, so you can. Essentially is the idea then, if we're going to do, let's say, the scenario where they're guy or gal, they 1031 four, five, six times. They've deferred a ton of taxes. Obviously, if they don't 1031 before they pass away and they sell their properties, they have to pay all that stuff, all that back. However, you mentioned briefly earlier on about the step-up basis. What does it look like if they own this property and then God forbid suddenly pass away, or they have it set up to pass on to their kids or their heirs or whatever? How does that work at that point in time? Is there a new tax bill? Or what happens to the heirs? Do they have to pay taxes now? How does that work?
Speaker 2:Yeah, it's the time of, it's the time of, uh, when they pass, like typically there's like an appraisal or something done for how much the property is worth. But again, I think you know, we, we like to say something like swap till you drop. I actually posted about it something today Like it's, this is, this is really the, the greatest benefit of doing this. Like, eventually I'm going to have to pay Uncle Sam. And the reality is you don't, you don't ever have to pay Uncle Sam, and that is the most I think, when people realize that they're like, oh my God, like I can keep doing this. And then, you know, when my time on earth is up, my heirs will inherit this. Look at a step up in basis and I won't, they won't have to pay any taxes at all. It's, it's incredible.
Speaker 2:Sometimes we even tell people like, hey, just hold on to your property, you know you're, you're 86, 90 years old, you know your kids will, you know, get, get the, get the step up in basis, and they won't have to pay anything. Because a lot of times, chris, a lot of people, as they progress throughout their careers and obviously age and, and you know, they just don't want to deal with the properties anymore, right, like they're just they're tired, they want to retire. You know, do other things and there's other, like I mentioned, passive vehicles. But you know, if you're just going to eventually just cash out, we should probably have a conversation, because that's probably not, you know, the most cost effective thing to do and think about all those taxes from all those properties that come up that you or you know your estate will be liable for. So you know our recommendation keeps swapping until you drop.
Speaker 1:Interesting. I mean it's a good point, so are there any? Should investors be aware of any tax laws or changes policy changes that can impact 1031s? Do you foresee any of that happening in the future?
Speaker 2:Yeah, you know, I think the tax code is always changing. You know, what I think a lot of people don't realize, chris, is that you know, in a 1031 exchange, there's multiple layers of tax that someone defers and they're subject to really four taxes, right? First is the federal capital gains tax. It could be anywhere from 15% to 20% for high-income earners. The second is state taxes. These obviously are variable, from California having as high as 13.3 to Florida having zero percent state income tax. There's something called net investment income tax, which is an additional 3.8% tax that may apply as investment income for high income earners, not general for a lot of folks. And then, obviously, we just went into depreciation recapture tax and, yeah, that can be 25% for the depreciated amount. So there's a lot of different taxes that someone could essentially defer when they're doing a 1031, besides just the capital gains taxes. Right, and you know that's something that I think people need to understand as well.
Speaker 2:And you know, like a lot of people I think I mentioned before, like Mike, do you think the 1031 is going away? And you know there's, first and foremost, there's a lot of people in our U S government that had utilized the 1031, including our upcoming president, right Like he, he's used it for sure, a lot of people in Congress, on both sides and, um, you know, it wouldn't be beneficial to anyone or give incentive for anyone to not do a 1031. And if you don't, if you get rid of the 1031, there's brokers, there's lenders, there's appraisers, there's investors Everyone makes money off of fees. Chris, right Like you're going to be destroying an entire ecosystem. For what? For what? Right, and um, yeah, when, when you think about it that way, like, I think it's in everyone's best interest to, to, to keep it, uh, to keep it around for a while.
Speaker 1:Yeah, yeah, if you think about the implications. So, like you said earlier on it, if you get rid of the 1031, owners, investors in properties are disincentivized to sell properties at that point in time because they're going to have to pay a big tax bill. So then you affect title companies, insurance companies, obviously, the brokerage market, the investment market, et cetera. So it makes it very that will that could probably have a larger impact on the economy and on the moving parts within the economy than keeping the 1031 exchange in place. It is interesting, you know, scenario. Do you think in like a, in a?
Speaker 1:We've gone through a situation where there's higher interest rates for the last couple of years, prior to that, very low interest rates. Does a strategy behind a 1031, does it change when the market changes or is it just hey, you just got to identify the next property within the right timeline and it depends on where the market is. You may or may not want to sell your property at this point in time. So really that's the decision you have to make, or is there more at stake than that?
Speaker 2:Yeah, it's a really, really great question and, as an investor myself and talking to a lot of folks that have been doing this for 30 years, I actually just talked to someone who's been through this will be his fifth cycle. He thinks this is kind of similar where we're at in like late 2007 and how the rest of that turned out. But essentially the problem right now is we've got a gap in the bid-ask spread. Right, chris wants $5 million for a self-storage property, mike wants $4 million because the cost of capital and debt is super expensive. Maybe I get super aggressive and I say, hey, chris, I'm going to give you a 5 million bucks. Chris is like well, great, well, how am I going to replace my cash on cash return or you know, my cashflow going to, you know, find new properties that can generate that? And I think that's the problem right now.
Speaker 2:We're in this weird gridlock, I'd call it, and for a lot of people in general, even if you play a game, hit my number, their number gets hit Like you know, where are the opportunities for them to, you know, make an investment? So I don't have a crystal ball. I think a lot of people are just trying to understand, like, what yields better opportunities in general, different sectors, you know, and I think you know think there is opportunity. It's all about finding that basis, which is really tough, and I think in the future you're going to have a lot more people doing more transactions that maybe need to sell. Maybe they have floating rate debt on their property that wiped out all their yield and maybe they want to sell and get out of it.
Speaker 2:But for most people I'd say real estate's all about capital and deal flow, and when either are tough, it makes the situation today a little bit tougher, but we're seeing a lot of transactions. We're seeing a lot of folks in the one to $3 million space that don't necessarily have a lot of debt requirements, that they can do a 1031. But if you're telling me that the cost of debt is X and my return is Y and there's not a good spread, well it's just natural. Will people transact? I don't know, and so I think we're trying to get to a normal market and I think that's what everyone wants. No one wants a mania anymore. People just want a normal market.
Speaker 1:In my opinion, yeah, yeah, some level of stability. That's a good point, though I didn't really think about it from that perspective. If I want to sell my property and get a high number, that's a great situation, obviously. But now I have another problem where I need to buy another property and the yields might be lower than what I was actually getting at my high number. It just may not make sense for me to do a 1031. I might have to hold on to a little bit longer, but that's interesting. That's really good. I never thought about it that way. I don't know why, but that's a really good point. Can you remember, like any story time? So, can you remember any challenging 1031 situation that you were involved in or worked on, and maybe a lesser two that was learned from that?
Speaker 2:Yeah, I think you know a lot of people buy deals in partnerships. Partnerships, as we know, don't always go according to plan and we had a scenario where, you know, three people owned a large you know large piece of land and you know one guy wanted to cash out. Another guy wanted to go there. You know they wanted to hold the property and buy out their interest and you know, moral of the story is they didn't. You know they didn't seek the proper counsel. They didn't seek you know the appropriate path to do a 1031.
Speaker 2:This guy ended up paying, I think, like you know, 10 or $15 million in taxes by selling his interest. Instead of doing something called the drop and swap, which essentially is you go from a partnership to a tenant in common interest and, instead of the LLC owning the property, everyone's interest has a percentage on the deed and it just goes back to another example of someone not taking the time to literally save 10 to $15 million because they just didn't understand it or they're lazy or for whatever reason, and I just hate stories like that just because of how much money that they're paying, uncle Sam, and for almost no reason. Right, this could have been prevented. It's preventable and I think a lot of folks, for whatever reason, they just it's hard. The human psychology is really tough to make. You know, we're not the decision makers, we just lay options out on the table. But when I hear stuff like this, chris, it's like it's kind of nauseating. Like that 10 to $15 million could essentially, you know, 5% of that.
Speaker 1:I mean, you're, you're looking at, you know good cashflow for uh, for someone's life, right, it was an amazing amount of money. So explain to us what a drop and swap is.
Speaker 2:Yeah. So a lot of folks will um, they'll, they'll be in partnerships. You know, let's say, chris and I are in a partnership. You know we're in LLC. The LLC owns the property. You know we've done well on this property, but you know Chris wants to cash out and I want to keep it rolling.
Speaker 2:So you have to set up something called a tenant in common, which you can do before you close on the property that you're selling. It has to be done ahead of time, but essentially we will both have a percentage of ownership of in this case it's probably 50-50 for two partners. I'll own 50%, chris will own 50%. It'll be on the deed. Instead of having a partnership, it'll just kind of be something called a tenant in common and this way we can go our own way.
Speaker 2:Whether you know, chris wants to do a 1031 himself, I want to do a 1031 myself. It's a great strategy that a lot of folks utilize before when factors change and we know in real estate factors change all the time, for whatever reason, and a lot of people will utilize it to go on and, um, you know, have more control if they want to do a 1031 on you know themselves or not. So it's a great, great strategy. We see it all the time with partnerships and, um, you know, some guys just want to cash out, some guys want to keep it rolling and, um, you know, it's a great way for folks to get to their investment goals individually.
Speaker 1:That's excellent man. I didn't know that that's what it was called, but it makes a ton of sense For anybody who wants to learn more, and we'll give folks a chance to reach out to you. But is there a good resource that they should check out to learn more about 1031 exchanges?
Speaker 2:Yeah. So you know it's kind of funny. We live in this weird chat GPT world you know about. Nine months ago we decided like this is where the industry is going. And you know, I can only name, recall so much information, chris, you're you know, you can only recall so much self-storage information, investment information, no-transcript, best tools. We've got a 1031 exchange calculator that you can download there. It'll calculate your basis and net proceeds and if you were to do a 1031 versus not doing a 1031, we've got different other tools, like our Bible and some other things. But the point being, chris, is we've consolidated, we've repackaged all this data and this comes from spending a year of us downloading our competitors data and making it better and more concise. So, um, it's a big lift, but we're just trying to get people information quicker and instantaneously, because I know that's what, what, what people want these days and um, you know, it's all about information at our fingertips.
Speaker 1:A hundred percent, man. Does the chat bot have a name?
Speaker 2:It's Mr 1031. You should name him Fred or something like that.
Speaker 1:You should name him like Fred and have like Fred. Stand for something, go talk to.
Speaker 2:Fred, you'll see it. I mean it's, uh, it's, it's, it's pretty amazing, but uh you know, a lot of like, think about a deal.
Speaker 2:A lot of like when you're in a deal, it's like, oh, you know, time kills all deals and if you have more information, if you have more time, that I can't reach my, my 1031 guy, I can't reach my CPA, I can't reach my broker, the probabilities of the deal falling apart, you know, increase and there's a lot of money in a line for everyone. So we want to uh, you know, we think that people that use AI in the future you're never going to replace the human. It's human. We're not trying to do that, but we believe this is the biggest, you know, the biggest uh thing in a generation.
Speaker 1:Oh, absolutely For sure.
Speaker 2:Yes.
Speaker 1:A hundred percent, 100%. I still think you should name him something like Fred Free free resource exchange database. I don't know whatever the heck, but it says your acronym that you guys have, and then you say, hey, go talk to Fred. And then it pops up.
Speaker 2:It's a good thought, for sure. Maybe we will.
Speaker 1:Bro, I'm so good at this stuff. You can't. You know, you had no idea, so maybe let's let's wrap everything up.
Speaker 2:Man. Uh, what? The final four questions? What is one memorable mistake that you made in your career and how did you overcome it or learn from it? Yeah, I think, uh, not having a mentor early on? Uh, you know, I would, I would be super aggressive if I was someone younger and, um, you know, call them up, ask for someone to take, you know, take them under your wing. I didn't do that at first, um, and as I, as I'm progressing throughout my career, it really is all about your network to help expedite whatever you want to do, and I think that's super important. And you got to put yourself out there, like you have to. Like, I'm doing that with LinkedIn now, I'm not a social media guy, but the amount of opportunities that led me to you, chris, and then some other things, and, and, um, I w, I would recommend people to just put themselves out there and get a mentor as soon as possible.
Speaker 1:That's great man. What's one thing you did right, that you feel like you did right in your career? Uh, that you would, that you learned from.
Speaker 2:Yeah, I think you know, as a real estate guy like I always say this like getting into commercial real estate brokerage, it is less, in my opinion, about you know selling the deals. It's more about learning about business and human psychology. I think you know you learn how to database, which is the same thing you'll need to go after deals. You learn about human psychology. You'll learn about you know when to push, when to pull. It was a tremendous learning experience. Talk about putting yourself out there and calling and doing all these other things.
Speaker 2:Like you know, you're really learning how business is conducted. You know people will ghost you. Then they'll resurface and I think it's a great you know foundation for anyone who wants to learn and get in there. Otherwise, it's super, super competitive to go to. You know to start on the principal side, you have to be an analyst, you know there's certain prerequisites and you know brokerage. You get to interact with a lot of these real estate investment firms and it's a great way to get exposure to a lot of different you know people and a lot of different deals for sure, 100%, man.
Speaker 1:What's one good investing resource that you'd recommend people check out? Well?
Speaker 2:it's not really real estate related. I know a lot of people like podcasts and stuff. I like the All In podcast. It's a great, great podcast just on investing on a macro level. They go into some real estate on a micro level at the time, but it's really about trends and so I think, as an investor, you have to understand trends right. If you're telling me that there's no one from a self-storage perspective in a certain market and then you buy a bunch there and there's population growth and all this stuff, like you know, you have to learn that, that that type of stuff. So it's a great pod, really great hosts, really great people. I'd totally recommend that.
Speaker 1:I'll have to check that one out. That's really good man. Mike, how can people reach out if they have questions or they want to use you guys to help with their 1031 exchange?
Speaker 2:Yeah, you can Well my. Our number is 631-438-1031. You can go to our website, 1031specialistscom. My email is mike at 1031specialists, with an S dot com. You can message me on LinkedIn. Whatever, we need to help you guys do deals, whether you're a broker, an investor, or give the necessary resources. We're just trying to help people do more deals, whether you use us or not. I just want to help people do more deals, whether you use us or not. Um, you know, I just want to help people do more 1031s and, um, you know, I think we've created a pretty good platform for it and we're looking to, uh, looking to grow for sure.
Speaker 1:Perfect, Awesome guys and this episode was not sponsored by 1031 specialists, just so you guys know wanted to bring Mike on and bring the information to the audience. So thank you, Mike, for being on the show.