Performing A Real Estate Exchange With Luke Hays

 

Many financial and real estate professionals out there, including CPAs and attorneys, don’t know anything about real estate exchanges, and how these transactions can help their clients. While seemingly byzantine at first, this system of exchanges actually yield a lot of benefits for people who are looking to reinvest their money in different kinds of real estate, sometimes even to diversify their portfolio. Luke Hays is a Vice President and Business Development Officer at IPX1031, where he specializes in real estate exchanges. Luke speaks to Bob Roark about the basics of real estate exchanges, and how one can navigate the processes involved. If you’re looking to reinvest your assets, don’t miss this conversation. It might just be what you’ve been looking for!

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Watch the episode here:

https://www.youtube.com/watch?v=J_YCobtceXY

 

Performing A Real Estate Exchange With Luke Hays

We’re very fortunate because we have Luke Hays out of Nashville, Tennessee. He’s with IPX1031. Luke is a specialist in Real Estate Exchanges. With that being said, welcome to the show and tell us a little bit about what you do and how you got here.

We’re very fortunate because we have Luke Hays out of Nashville, Tennessee. He’s with IPX1031. Luke is a specialist in Real Estate Exchanges. With that being said, welcome to the show and tell us a little bit about what you do and how you got here.

I was born and raised in Birmingham, and went to Alabama for undergrad. I hope that doesn’t scare away some of your readers. I went to law school at Tulane and then after law school, I joined IPX. As an attorney in Tennessee, my sole practice is 1031 exchanges. In the company I work for, IPX1031, we act as a qualified intermediary. I’m sure at this point you have no idea what that is and that’s most likely why I’m on here is to go over some of that terminology, as well as the 1031 exchange as a whole. I usually like to begin with a call I normally get because I give a number of continuing education classes to agents, brokers, CPAs, real estate attorneys. This is a small part of the code. I’ll address the background of the 1031 exchange, why it was implemented and why I worked with IPX.

The call goes something like this, “Luke Hays, IPX.” “I want to do 1055.” If someone’s in a rush, if they’re in a hurry, they’re going to get the name wrong. They’re going to call 1055, 1088. They’re going to say, “I don’t want to pay any taxes.” I’ll say, “Where are we at in the real estate transaction?” They’ll say, “I closed and I have the funds. What is my next step?” Unfortunately, the bad news is coming at this point because I have to inform them that their next step is to contact their CPA or tax advisor. The number one rule in a 1031 is it has to be set up prior to the close. You would think that would be something that everyone would understand. It goes into a lot of what I do, which is more of a teaching element. Not a lot of people know about exchanges. They don’t know when the rules apply. Maybe they have some rules correct, but the other rules are incorrect. My role is the combination of an advisory role as well as a teaching role and setting up these exchanges.

Many people, we all specialize and people don’t know what they don’t know. In the 1031 space, it sounds pretty simple to say, “Consider doing 1031.” Anything past that, even if they know that much, there’s a real acknowledged gap.

I would agree, particularly attorneys and CPAs. They don’t have time. It’s a small part of the tax code; they don’t have time to comb through the way we do. If I was an attorney in private practice, I wouldn’t be able to do 1031s. I wouldn’t be able to apply the bonding and insurance necessary to set up these exchanges. I wouldn’t have the resources needed that IPX provides as a QI. We’ll address some things to look for in qualified intermediaries, but you do need a national presence in order to offer the clients, the exchangers, the investors some low fees as well as sufficient bonding and insurance.

For the people that might be going, “What’s a qualified intermediary?” you’ve got the piece of real estate, the target piece of real estate and the intermediary in between.

To begin with the 1031 exchange, you have to go way back to 1921. That’s when it was created by the IRS. We’re coming up on 100 years of exchanges. The basic idea is you have some real estate investors who might sit on their property because of the tax liability associated with the sale. You have other people that are maybe waiting to sell it in a new calendar year or leave it to their children or their heirs. There’s a big group of investors that are maybe sitting on their property. 1031 allows those people to take the plunge, sell their property, and defer their taxes by buying another piece of property. From the IRS’s point of view, this helps create real estate transactions. It’s considered an economic stimulus. A common question I get is, “If I do 1031, will I get audited?” I have to go back and say, “It’s directly part of the Tax Code. We’re coming up on 100 years. It was reaffirmed in 2018 the necessity for it. That’s a common myth.” Going back to a qualified intermediary, you have to use a qualified intermediary to do a 1031 exchange. You might find this funny, but the definition from the IRS is in order to be a qualified intermediary, you must not be disqualified.

We can only use tall people and if you’re not tall, we can’t use you.

In order to be disqualified, you cannot be an agent of the exchange for within the past 24 months, the past two years. The final question that needs to be asked is, “Who qualifies as an agent?” For an investor, their broker, their agent, their CPA, their attorney, whoever they’re going to use for the closing, if they’re handling some of the legal docs associated with it, they’re disqualified. Besides that, it is the Wild Wild West. Someone mentioned that to me one time and it stuck with me in terms of the lack of rules and regulations. As long as you’re not disqualified, you can act as a qualified intermediary, but you have to use a qualified intermediary to handle 1031. That is exactly what IPX is. IPX1031 is a subsidiary of Fidelity National Financial. It is a Fortune 300 company, based in Chicago with offices across the United States. In our company, we specifically handle 1031 exchanges. That’s the bit of the background on what a qualified intermediary is.

 

I’m in Colorado and you’re in Tennessee. If somebody is from Wyoming, there are qualified intermediaries with your companies scattered throughout the United States, correct?

Correct, we have representatives across the US, even in Hawaii. My region specifically is Tennessee, Alabama, and Mississippi. However, I can handle an exchange anywhere in the US and our Southeast office can handle an exchange anywhere in the US. That’s where 1031s must occur, in the US. We’re not trying to help other countries’ economies. I always joke, “Unfortunately, you can’t sell here in the US and buy a chateau in Paris,” even though we wish we all could. This is an economic stimulus. It’s to help stimulate the US economy. It does need to be in the US. Another question I get is, “If I use yourself, myself and IPX, do I have to wait two years to use you again?” No, that’s not correct. We are a third party to the real estate transaction. I’m never going to be involved and offer acceptance, contract negotiations, specific tax or legal advice, any of the closing documents. Our sole role is to advise on 1031 issues, to gather the documents for the exchange, to set up the exchange, then to pull the proceeds. We separate ourselves in that way. Thereby, they will never disqualify so we can handle multiple exchanges from the same person.

That’s all you do. You’re the 1031 wizard in Nashville.

Years ago, an attorney had the entire market and he retired. I think that’s maybe why I was brought in. They saw an opportunity. The Southeast, in particular, is an area where a lot of out-of-state investors are going, particularly from California, New York, and Chicago for a couple of reasons. In Tennessee, there’s no state tax, which is quite valuable in Texas and Florida or other states without any state income. If someone’s selling in California where they’re having a 13.3% state tax, Tennessee looks pretty good in terms of, “Maybe that’s where I want to take my investment dollars and reinvest into real estate in Tennessee.” I would say another reason is people are looking for value buys. They’re looking for properties that they think will grow in appreciation significantly over the years.

We released a newsletter that went over the top 30 cities where people want to buy. I was lucky enough to have 6 or 7 of those cities in my region. There are a couple of those cities in Alabama. Alabama, Tennessee, and the Southeast in general, is a major area, but 1031s are being done across the country. My biggest obstacle is the lack of knowledge here in the Southeast. In California, they know about 1031s. For commercial real estate, it is done almost 80% to 85% of the time. I would say in Tennessee, Alabama, Mississippi, it’s probably less than a quarter of the time. That goes back to the educational role. People don’t know when their properties qualify. They don’t know when to set it up and that’s why I’m here.

I think about the ability for you to reach out to the individual person that’s the real estate holder, there’s one of you. I think about the people that influence that, whether it’s the business broker helping the business owner sell, the real estate crowd, the state planning people. Any of those types of people that have financial advisor types, that maybe have the people that they’re trying to advise on how to take instruction in what they’re doing. I would say that from my experience, there are not many guys that are in the wealth management space that is much up to speed on 1031s either.

I would agree with that assessment. We can go over the benefits and we can separate it out for the investor, the agent, the broker, in terms of marketing it out and pushing it out more. CPAs and attorneys go down the line. For the investor, the biggest thing for 1031 is you’re not giving any money to the government when you sell your investment or business-use property. Let’s begin with what qualifies for 1031s. It is any type of real property with an investment or business-use intent. Typically, there are a variety of things the IRS looks at, but the necessary holding period for a piece of real estate would be a year and a day. That gets you in that long-term capital gains tax rate.

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The types of properties that would qualify, it could be raw land, farmland, timberland, water rights, mineral rights, air rights, residential types investment properties like single-family rentals, condos, apartments, multifamily, commercial, triple net lease, industrial and Delaware Statutory Trust. What I’m trying to say is there’s a portion of the code that a lot of people misunderstand, perhaps maybe the number one misconception is the like-kind portion of the code. The code says that in order to defer your taxes, you need to buy a replacement property of like-kind. A lot of people think if I sell a commercial building, the only thing I can buy is commercial. If I sell a piece of raw land, the only thing I can buy is raw land. It’s the exact opposite. You can sell them by any type of real property, as long as you have the same investment or business-use intent. It’s the intent that matters.

That’s the first thing for the investor. They’re not pigeonholed to a certain property. If you have readers who own a small business, they can sell that business and maybe buy something completely separate. They can go through the list in terms. As long as it’s real property, it can qualify from a 1031 perspective. People exchange for a number of reasons. It generates cashflow. You can sell something that’s not producing any type of income, buy something that will produce income. Properties that are fully depreciated, you could sell those and maybe buy up in value. A lot of our clients do buy up in value because they’re not giving any money to the government. When you buy up in value, you may be able to take depreciation on that new property.

Let’s say I’m a business owner. I own the real estate and my business separate from my business. I’m interested and I have a buyer for my business. If you think about the business, the guys find the business might want to buy that building too. You think about the business owner trying to fulfill his income requirements to retire and you go, “Do you want to take in 1031 that piece of real estate into another one that cashflows somewhere else and avoid that gains tax on the real estate alone?”

A classic example would be a doctor that’s retiring. He sells his practice and real estate. He’s not going to buy another doctor’s office. That’s why he’s retiring. That person can go out and buy a beach house and rent it out. After a two-year restrictive period, there are ways for people to buy their second home or vacation home via 1031 exchanges. You’re exactly right. People that are tired of maybe property management, there are mechanisms for them to buy something to defer taxes and, at the same time, buy something that is not as heavy on the property management side. Triple net lease properties are a classic example of that. That’s your CVS, your Walgreens. The Delaware Statutory Trust, I don’t know if you’re familiar with a REIT, Real Estate Investment Trust. A Delaware Statutory Trust or DST is a way for someone to buy into a trust. This trust can have a number of properties. You have that automatic diversification and it’s run by a major DST company, a large property owner. You get a monthly check in the mail based on the returns. That’s completely management free.

I think the readers are probably going, “There’s a ton of things that can be done.” The thing that strikes me about all this is as for a lot of these people, they’re building their team. They’ve got their CPA, attorney, real estate agent and maybe a business broker. What strikes me is they need to have a 1031 person on their team too. They could say, “This is my goal. I want to do the following things.” It’s like going to the doctor and saying, “My head hurts right here, but I’d like an appendectomy.” How do you know that’s what your problem is? For the readers, there’s a lot to know. There are a lot of permutations. My sense is that for them to reach out and bring you on or bring the 1031 people on the team, you’re there to take and offer alternatives.

When I give classes, towards the end, I see in people’s eyes the fear of maybe having a client that wants to do an exchange. One way to do a 1031 and to try and alleviate some of those fears, is limiting requirements. If you’re an agent, a broker, a CPA or an attorney, the only thing I would need would be your client’s contact number. If they decide to do an exchange, we will then need the signed purchase contract, and the title commitment. From an investor perspective, I need time to speak with you in regards to does your property qualify? In every consultation I give, and I’m pretty sure this applies to everyone in my company, they’re complementary, meaning we don’t charge unless the closing has happened. I don’t want to say for people to use-abuse, but if they have questions about, “Does their property qualify?” I love taking those calls. Those are educational opportunities for that investor.

A lot of times, even if they’re not able to do an exchange with their current property, at least they’re able to prepare for the future and know what to do in order to make that property qualify for a 1031. The end goal with most people who are doing exchanges is to continually defer their taxes so eventually when they pass, they’re going to leave these properties to their heirs. When an heir receives a property, they get an appraisal done. They get a step-up in basis. An example is, if I have a $1 million property with a $100,000 basis, $900,000 of tax will gain and that property is inherited and the appraised value is $1 million. My basis is stepped up from $100,000 up to $1 million. If I sold for $1 million, my basis is a million, how much do I pay in taxes?

 

I think it’s in the round numbers.

It’s nothing. We call that swap until you drop. Our clients are trying to continually defer these taxes until they’ll go away via that step-up in basis. You can think of that as similar to the American dream or building generational wealth. You’re trying to leave your heirs in a better situation than you. A lot of people have different ways to invest their money, but real estate, besides the 2008 collapse, it’s one of the safer options. Even if you’re not strictly investing in real estate, you want to have diversification in your real estate portfolio or in your investment portfolio. A lot of our clients who have these properties, they’re using 1031 to diversify to make sure that if the market turns, they’re at least getting steady returns even if not as high as it was. I would say, nowadays, it’s top of the market in terms of what people are getting on returns and investment real estate. It’s that diversification. It’s deferring those taxes and hopefully eventually, having them go away.

Let’s walk through this innocent process. Here I am, I’m a potential 1031 candidate. I have a piece of ground A and I want to defer taxes. On top of that, I want to leave a high tax location and go to a low tax location. How far ahead of time do I need to reach out to you?

Believe it or not, people will call me an hour before they close. It’s not that dissimilar from the people that will call me after they close. They’re still going to get the name wrong, but we can handle those exchanges. We call them rush exchanges because everyone’s trying to rush to get the documents in. As long as you haven’t closed yet, we can set it up. I would recommend probably when you’re under contract for the property or selling would be the best time. The time between contract and close is 30 to 45 days. That’s plenty of time for us to make sure that the property qualifies, answer any outstanding issues that there may be inline via the 1031 and to get the exchange set up properly.

They’ve got to identify the destination property, correct?

That’s correct. What happens in 1031 and the way I like to explain it, whenever I go in over any of these rules and restrictions and you or the readers think they’re unfair, I’m just the messenger. I only want to get that out. The only way I can explain it is one, it’s part of the code, so we have to deal with it. Two, I think the IRS, they understand the importance of 1031, but they also enjoy their tax dollars. They’re not going to necessarily make it easy on the exchanger. You’re correct, the 1031 clock starts the day you close. You have a property under contract. It’s going to close 30 days from now. The first thing we need to do is establish does the property qualify? That goes back to that year and a day rule. If it’s raw land with the lack of personal use if it’s a property that is producing some type of income, are you taking depreciation? Are you reporting that rental income? The first thing I like to do is establish does this property qualify? The second thing is to make sure that their potential tax liability is significantly higher than what our fee is.

Our fee does vary across the country, but it’s around $1,000. That includes most of the time one sale of one purchase. That’s a flat fee. That’s something we take out from the exchange account. Again, all consultations are complimentary. A lot of times, I have clients that are selling $100,000 property, but because they’ve owned it for so long, perhaps that entire $100,000 is taxable. They may have a tax liability of somewhere around 20% to 25%, so they’re looking at a hit of maybe $25,000 if they were to strictly sell that property. We have other clients, maybe they’re selling for $5 million, but if they bought that property three years prior for $5.5 million, they don’t have any capital gains. They have capital losses. It’s important to establish what the taxable gain is. I do throw in the caveat. I want to make sure it’s kept in here. We never act as someone’s CPA or tax advisor. They need to talk with their CPA in terms of establishing what their tax liability is.

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This is not to be construed as investment advice, legal advice, CPA tax advice. Get your own advisor.

We get estimates. We don’t give specific legal or tax advice. Once it’s established that a 1031 makes sense, it goes down to the timing aspect. That’s the number one reason an exchange will fail if someone’s unable to find a quality investment property within the time restrictions. You’re under contract 30 days from now, the clock starts the day you close. What happens is the closing’s going to be like any other closing you’ve been a part of. Instead of you, the investor, receiving the funds, they go to us, be held in your exchange account. With IPX, the way we protect those accounts is with a $100 million fidelity bond, a $50 million corporate guarantee, $30 million errors, and omissions. That goes back to why I can’t do this on my own. I’m not able to offer that bonding and insurance. Every account that’s set up is segregated from any other exchanges we have going. The investor knows exactly how much they’re holding. They’ll have their own assigned exchange and exchange coordinator. We apply that bonding and insurance to protect those accounts.

Once you’re under the clock, it is stressful. You have 180 calendar days, which starts the day you close, the first 45 being your identification period. Those two times run together. A property that is not identified in the first 45 days cannot be closed on via a 1031 exchange. You have 45 days, which begins the day you close to at least find an adequate replacement property that you may want to close on. It’s important to note if a property is not identified by day 45, it cannot be closed upon via 1031. Another real-life call I had was a gentleman called. He had a substantially high tax liability and he listed a certain number of properties. He called on day 48 of his exchange. None of the properties he listed were available. He asked if what his options were. Frankly, he didn’t have many options. He had to hope one of those properties came back on the market or maybe he could buy at a premium from the new owner. He has to wait until closing, go directly to the new owner and say, “I’ll pay you what you bought it for, plus $100,000 or X amount.” That’s important to note.

The number one reason an exchange will fail is the lack of identification during that 45 calendar days. In terms of how you ID, we send an ID notice. It can be through DocuSign. We do an e-signature process, which streamlines the process, or you can identify by simple paper and pen. The property does need to be site-specific. If you’re listing raw land, we need a legal description or a parcel number. If you’re listing apartments, we need those specific apartment numbers or condo, the unit numbers. Besides that, all you have to do is list the property, sign it and send it back. During those 45 days, you can change up your identification however many times you want. Day ten, you identify three properties. Day eleven, two of those properties, go off the market. Day twelve, you could add two more properties. You can switch it up however many times you want by following the same steps. On day 45, whatever we last have as the identification is the only property you can close on.

Let’s get to the identification rules. The most commonly used rule, the one that I think your readers will use probably 90% of the time is the three-property rule. It states that if you sell for $1 million, you can identify three properties of any value. This can occur anywhere in the US. They can identify one property at $1.5 million, another at $1 million, and another at $900,000. They can close on all three. They could close on 2 or 1. Another myth is people think if I sell one, the only thing I can buy is one property on the back end. That’s not the case. You can sell one and buy multiple properties. You can sell multiple, consolidate and buy one, maybe a bigger property. You can sell multiple and buy multiple. It doesn’t matter how many properties you buy. All you have to do is keep it at three, but it doesn’t matter what valuations you have on properties. You can identify more than three, but when you do so, you have to be careful of the value of the properties you’re looking at. Any amount of identification above three, the total value of those properties cannot exceed 200% of what you sold for. That’s the 200% rule.

The $1 million property couldn’t be more than $2 million if you had a bunch of them.

You would have to keep the combined value of those properties within 200% of that $1 million or $2 million. You can break those two rules, but you’ll be under the final ID rule, which is a catchall rule. It’s called the 95% exception. In your scenario where you sell for $1 million, if you identified five properties for $500,000 each, we’re breaking the three-property rule and we’re breaking the 200% because the five properties at $500,000 are $2.5 million. That exceeds 200% of that million-dollar sales price. That person can still do an exchange, but they’re going to have to close at 95% of the value of the properties they identify. In the real world, that’s all of the problems. I will say some of our clients do that exact thing.

Maybe if they’re buying from an individual owner in a package deal, they’re buying a package of properties, they might break the three-property rule and the 200%. Most of the time, the DST or the Delaware Statutory Trusts will break those first two, but because you’re closing on that DST, you’re closing on 100% of the properties identified. That’s the basics in terms of the ID process, in terms of the rules requiring someone to fully defer their taxes. When I talk about the taxes associated with the sale, there are four types of taxes we’re dealing with. The first is your federal. That’s the federal tax capital gains. That fluctuates between 15% to 20%, depending on other types of taxable income. The second tax is the Affordable Care Act Tax. This is a surtax on net investment income.

That was the surprise tax of 2019.

That’s a 3.8% surtax on any amount in excess of $200,000 for single filers and $250,000 for married couples filing joint returns. For your larger deals, that surtax is going to come into play. The third tax is the state tax and that depends on where that person files their tax returns. It can go as high as California at 13.3%. It can go as low as Tennessee at 0%. The fourth tax and the final tax is what we call the hidden tax. That’s the depreciation recapture tax. The depreciation is great while you own an investment or business-used property. You’re able to offset that rental or passive income, but when you go to sell, it does hit you a couple of ways. The first thing it does is it lowers your adjusted basis. To calculate our taxable gain, you take your sales price minus any closing costs, minus your basis. Your basis is what you bought the property for. However, it can go up and down. It goes up when you make capital improvements. It goes down when you take depreciation.

When someone takes depreciation while they own it, they’re able to take that offsetting deduction on their income that they have coming in. When they go to sell, it does lower that adjusted basis. There is this recapture tax at a 25% rate. An example is if someone took $100,000 depreciation over the years, this recapture tax would apply solely to that depreciation. At 25% in $100,000, that would be an additional $25,000 tax. I specifically had a client mentioned that the reason he called me, the reason he wanted to do 1031 was his last sale was a loss in terms of the income that he was getting from it because he didn’t factor in the depreciation recapture. Those are the four taxes. The good news is 1031 defers all four of those taxes. The reason is it’s powerful to the investor, they’re not giving any money to the government. They’re able to fully use their sale proceeds to buy bigger properties, newer properties with fewer maintenance costs. Properties that will get them higher returns on investment.

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Real estate investors that use 1031 exchanges grow the real estate portfolio faster and they get higher returns. It’s quite simple because they’re not giving any money to the IRS along the way. The rules governing how to fully defer, you have to look at the sales price, the contract price. Unfortunately, a lot of my clients have the misconception that they think they can only reinvest their profits or they only need to reinvest their net proceeds, the cash portion. I’ll give you an example. Let’s say we have someone that sells for $1 million. They have $500,000 in debt on the property. We’ll eliminate closing costs for simplicity. On the day of closing, the first thing that gets paid off is debt. The remaining amount will go to us as a qualified intermediary. That $500,000 will be held in the exchange account.

The rules state that to fully defer, they need to purchase equal or greater to that sales amount. They have to find a property or properties that’s combined value is $1 million. You can’t just reinvest the profits or the cash. You’ve got to buy equal or greater to the sales price. The second requirement is you reinvest all the sale proceeds. The $500,000 that we’re holding, it needs to be reinvested into the replacement property. Finally, the third requirement is to replace the debt. For a lot of people, this might be confusing, but it is quite simple. If you buy a property at $1 million and you only have $500,000 in cash to facilitate that closing, how are you going to come up with the other $500,000? You’re going to replace the debt.

Debt can be replaced with either new debt, with outside cash or equity. If someone has money they want to bring to the close, they don’t have to buy a property with that even though they sold property with that on it. Finally, you could do a combination of the two. You could bring some money to close and then replace the remainder with debt. Those are the three main requirements, purchase equal or greater to the sales price, reinvest all the sale proceeds, then replace the debt. For your readers that maybe don’t want to fully defer or don’t want to buy a property of equal or greater, they want to take some of the sale proceeds out, does that mean their 1031 fails? No, it does not. We have clients all the time that will take a portion of their sales for themselves. That is what is called boot. In Nashville, I make the joke that boot is mentioned because Nashville is turned into the bachelorette capital of the world with all the brides to be walking down Broadway in their boots.

Sometimes it gets a laugh. Most times, it does not. In the 1031 world, boot means any amount after an exchange is completed, which is still taxable. As an investor, you can do what is called a partial exchange where you defer some of your taxes, but you also have tax liability leftover. For example, the $1 million sales price, the basis in the property is $400,000. Initially, they have a taxable gain of $600,000. They want to take $100,000 out at closing. Is it allowed? Yes, it is. They can take $100,000 and the remainder goes to us. They follow the rest of the rules. They buy a property for $900,000. They use all of the sale proceeds. They replaced the debt. Of their initial $600,000 taxable gain, they’ve deferred $500,000 of that $600,000.

The $100,000 that’s leftover is the boot. That amount would be taxable after the exchange is complete. I think doing a partial exchange for many people is something they didn’t know that they can do. A lot of my clients think, “If I don’t fully defer, that means my 1031 fails.” That’s not the case. As long as you cover your initial basis, meaning you buy a property, you have to cover your initial basis from the property you sold. Every dollar after that, you begin to defer taxes. In terms of a partial exchange viable, it comes down to a determination of what they’re going to buy at and what their basis is. The lower the basis, the more wiggle room they have in terms of not fully differing, but it certainly is an option.

 

It sounds to me within the rules, there’s flexibility. If the client has a goal they want to take in and do something with a part of the proceeds, they can. If they’re trying to pass all of the proceeds, they can too. The solution for the readers is to come in with your goals in mind. Once you have the goals in mind, you can take and start trying to design the 1031 effort to meet your goals.

Our most savvy 1031 investors have already picked out their replacement properties prior to the close on their sale. This goes to another myth out there that when you’re under contract, even when you’re deciding to list investment or business-use property, that’s the time to start looking for replacement properties because you know that the clock is not a lot of time. Forty-five calendar days comes up in quite a hurry. It starts the day you close. The time between contract and close or when you list and close, that’s additional time to start looking forward to replacement properties. There’s no rule against being under contract for a replacement property prior to the close on the property you’re selling. A lot of people will sell in the morning, buy the afternoon, and complete their 1031 in one day. We call that a simultaneous exchange. I would say a decent amount, maybe close to 40% or 50% will complete their exchange within a few weeks’ time. They’re doing that because they’re starting to look for the replacement property prior to that close.

Unfortunately, some people like to do things step-by-step. They like to sell their property first and then begin looking for replacements. Because of the time restrictions, that is not the best option. Coming in with a game plan is certainly important. My grandfather used to say that the most important part in terms of painting a house is the preparation. You got to make sure you have your blue tape in line so that there’s no smudges or anything or you don’t make any mistakes. Preparation is certainly key. My role again is to advise on 1031 issues. That’s where the financial advisor, agent or broker would come into play. It is a team effort in terms of satisfying what their financial goals are from a real estate perspective.

As we talk about this, I think about various tools in your toolbox. For the people that don’t know, this is an extraordinarily valuable tool. I tell most people, “It’s not okay not to know. It’s okay not to do,” but you should know about it, rule it in or rule it out. Does it fit what you’re trying to do?

I think for agents and brokers, it should almost be a requirement that they notify the client at least that they have the possibility of a 1031. I can’t tell you how many clients have never heard of it. They have to do their own research. That’s why I give a lot of educational classes. If you’re the only agent in town, particularly if you’re in the Southeast that has a basic understanding of 1031 and has an attorney that specializes in this type of transaction, and does this day in, day out, that would be a plug for me. You can set yourself apart from your competition.

As you go in and try to take and work on some of these larger dollar figures, it’s unlikely one person’s going to have all the skillsets in hand to do everything necessary. I think in the specialization space for people to understand, there are specialists like you that do this all the time. It’s like when you go to have brain surgery, do you want to go for the first time they ever did it or you want a guy that does it all the time? The answer is all the time. The cost of doing it is extremely competitive. I don’t think the costs of doing 1031 are egregious in any way, shape or form.

The cost, sometimes, a lot of people will say, “This local attorney, he’s charging X amount and you all charge this set fee.” I’d never described it like this, but in some ways, you get what you are paying for it. There are attorneys that abused the 1031 system. There are many cases where a local attorney has stolen millions of dollars’ worth of client’s exchange funds. How are they able to accomplish this? They’re putting all the money into one account. It might be separate from their personal account, but no one knows where the funds are coming and going. Fidelity National Financial is a publicly-traded company. If anyone wanted to do their due diligence, they could look through all of our financial records. The bonding and insurance secure that amount and wire fraud. Did you do an episode on wire fraud or any type of cyber security?

We’ve done cybersecurity more than once.

It’s quite prevalent. There was a qualified intermediary, not IPX in 2019 that was the victim of wire fraud and sent out a large amount of money to an individual that was not supposed to be sent to. It’s quite easy. If someone has access to a password, they can copy and paste an email and say, “There’s been a change in the wire instructions. Please send it out accordingly.” If you send out those funds, you have about two hours to catch it or else it’s gone. Ways we prevent that is any disbursement of funds, we require authorization from the exchanger. We only used numbers that we have on file that had been used in the past. We only use secure lines. If there are any changes in the wiring instructions at any point, that raises some serious red flags. There are a number of instances where our exchange coordinators have caught attempts at wire fraud.

I do want to point out that you’re not dealing with myself. You’re dealing with the entire company at IPX1031. If there’s anything I’ve never seen before and at this point, I’ve come across pretty much almost everything you can see. My manager, she’s an attorney based in Florida, licensed in Florida and in New York. She’s been doing this for several years. We have exchange coordinators. They’re the ones that are on the front lines in terms of setting up the documents, catching any mistakes. They know the 1031 rule book as well as myself, but they don’t like speaking in public. That’s probably why they’re not doing what I’m doing. You have our entire company. If I’m not available, we operate from Hawaii time all the way to Eastern time. Throughout the entire business day, you’re going to be able to contact someone within our organization and they’re going to be able to assist in any 1031 related matters. That goes to another point. We don’t handle forward exchanges, which separates us. There are other types of 1031s that I want to address. One would be a reverse exchange and another is a build to suit, construction or improvement. It has a number of different names.

The reverse exchange, if you have clients or investors that want to buy the replacement property first. They find a property that they like and they want to acquire that. Unfortunately, in 1031 you have to sell and buy to third parties. If you were to go on title to that replacement property, when you back sell the property that you are looking to defer your taxes on, you can’t acquire something you already own. It has to be from a third party. To get around that, what is necessary is reverse exchange. In that scenario, IPX would go on title. We’d become the exchange accommodation titleholder. We will park that property, thereby keeping it eligible so that when someone does back, we then convey 100% interest in the LLC that we created into the new taxpayer. A reverse exchange is something not a lot of qualified intermediaries will be able to do or accomplish. We have a division specifically out in Chicago that is able to assist in that. If anyone has any questions on, “Can you buy your replacement property first?” the answer is, yes.

Another thing is that build to suit if someone wants to sell their property and buy a piece of property, whether they want to have improvements count towards 1031. Unfortunately, if you were to go on the title, at that point, the exchange is complete. Any amount of leftover is considered boot. They have the improvements count towards 1031, we have to go on title. In that scenario again, we act as the exchange accommodation titleholder. We wire out directly to the general contractor because the exchanger is not officially on the title, the improvements will count towards their 1031. That’s the flyby of the reverse and the build to suit. It is possible for your investor, readers, to buy a replacement property first, and then back sell the property looking to defer their tax, as well as buy a property and make improvements to that property and have it count towards 1031. It is possible to buy your second home, vacation home or your dream home. My best advice would be to contact myself or a representative of IPX will be able to talk through those requirements, the rules and restrictions governing that

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The easiest way would be to call my direct line. It’s (629) 203-2725. There’s also a website, IPX1031.com/hays. They’ll be able to start an exchange online. If someone doesn’t want to talk to me in person, they can set up an exchange online. However, if it’s in my area, it will come to me directly.

You’re generous enough to share your time and expertise. For the readers, it looks like complex, much like many things if you’ve not done them a bunch of times. If you take it and get the right team on board, you can take and get the complexity managed. The cost of doing it properly is not egregious as to having somebody that maybe doesn’t do it frequently. The security of your funds is incredibly important, trying to take and recover funds. How many thousand-dollar bills can you take and do before you get your money back? The answer is a lot. For the readers out there, part of the process of doing this is when I had a personal interest in the topic, I think for a lot of the business owners that we talk to in the show, it’s another arrow in the quiver. I want to make sure that they’re aware of or they know that there’s a resource that they can explore. Luke, I can’t tell you how much I appreciate taking your time.

The first item, 1031 has to be set up prior to the close. That’s by far the most important thing. The second item, as a general rule, you need to have held the property as investment or business-use for at least a year and a day. Thirdly, contact me and we’ll go over everything else. We’ll make sure you’re properly advised and make sure that 1031 is worthwhile. I do appreciate you having me on. This can be another quiver for your average investor or if you have a business-use property, this is a way to get out of that property and defer the taxes by buying something that will help produce income.

Luke, it’s been a pleasure. I appreciate you taking the time.

Thank you very much.

Important Links:

·        IPX1031

·        Fidelity National Financial

·        IPX1031.com/hays

·        https://www.IPX1031.com/

About Luke Hays

Luke, a Vice President, and Business Development Officer is located in IPX1031’s Nashville office where he specializes in Real Estate Exchanges. His territory coverage includes Alabama, Tennessee, and Mississippi. Prior to joining IPX1031, Luke worked as Director of Legal Recruitment for a Nationwide Legal Recruiting/Staffing Company.

Luke frequently lecturers on 1031 Exchanges and provides continuing education seminars for attorneys, accountants, financial planners, real estate professionals, and investors. He received his Bachelor’s Degree in Marketing and Sales from the University of Alabama, his JD from Tulane University Law School, and is a member of the Tennessee Bar.

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