1031 Exchanges with Dave Foster
The first time you do a 1031 Exchange might be utterly confusing. However, with people like Dave Foster, you can be spared from all the confusion and wasted time and money. Today, Mitch Stephen chats with Dave about 1031 Exchanges and gives you all the details you need to know about this investment “magic.” The Executive Director of The 1031 Investor, he explains how he can help you in this strategy and provides all the great real estate options. He also shares some money-making habits that you can apply when opting for real estate investments.
I’m here with Dave Foster and we’re going to be talking about 1031 Exchanges. This guy is an intermediary for 1031 Exchanges. I’ve done a few in my life, not a lot of them. I’m interested to learn from this guy because he’s a pro. He’s over in St. Petersburg, Florida. He likes to sail. Before we get started, let’s talk about our sponsor, TaxFreeFuture.com. If you don’t have a tax-deferred or tax-free retirement account or some account to grow your funds, you are missing a huge tool in your tool belt. You can do a lot more with it than you might think. Go to their website. Give us a little micro information. I promise that they won’t beat you up with 1,000 emails every day or anything like that. You’ll be opened up to 37 little video vignettes about the amazing things you can do and what it’s all about. You won’t believe what your financial advisors are not telling you. We’re going to tell you what they’re not telling you and we’re going to tell you why they’re not telling you and the law makes sense. You can proceed from there as you wish. It’s a real eye-opener. Go to TaxFreeFuture.com. Dave, how are you doing?
I’m doing awesome, Mitch. It’s great to be here. I love your sponsor because they are to retirement what the 1031 Exchange is to outside your retirement. That strategy is why pay tax when you can shelter it and use it for your own purposes?
I had a strange old man tell me once, and he was wealthy. He says, “Let me tell you the rules about taxes. Here’s the main rule, ‘Postpone, postpone, postpone, die.’”
We turned it into the four Ds, Defer, Defer, Defer and then Die.
I like that better.
Do you know why that is critical? When you die owning a piece of real estate, your heirs get what is called a step-up in basis, which means the day you die, all of that tax that you didn’t pay through the course of your life disappears and your heirs get the property to start over with no tax too. It’s a great gift for your kids, but you better be careful if you’re going to tell them about it.
They might knock you off. You’ve got a lot of information. I love it. Let’s back up. Tell us a little bit about your history. Tell us how you got to this point or where you’re from and then we’ll go on.
I grew up in Kansas, but I’m a sailor at heart. I migrated from Kansas to Colorado looking for sailboat water and that didn’t work. I don’t know why. I’m also not the brightest geographical guy in the world. While I was in Colorado, my wife and I were desiring to get off the corporate train and find a way because we had our first son. We were excited to find a way to start to generate income that was not going to require being a slave to a job. Looking at real estate seemed perfect then. I did what all kinds of your readers did. I went and bought a duplex, fixed it up and slaved away and turned around and sold it. What happened? I was all fatty sassy.
As soon as I went to my accountant and he said, “Here’s the tax bill,” I went, “No way.” I started weeping almost. It’s like how much of that hard work went to paying a tax bill? That was 1996 and the IRS had changed the Tax Code relating to 1031 Exchanges so that they were now going to be user-friendly. I didn’t even know what they were, but some friends of mine called me to mock me about my tax bill. That’s the kind of friend I got. They said, “Dave, we’re starting a business to become qualified intermediaries,” because those are the people that do these 1031 Exchanges. “If you would have been a part of us and done one, you wouldn’t have had to pay that tax bill.” The light went on. I looked at the statute, I said, “I’m in.” For the next few years, when I sell and buy real estate, I used 1031 Exchanges and I don’t pay tax in the game. I’ve been working with thousands of investors over that time. That’s the power of it. I get to use those tax dollars now to buy more investment real estate and never pay the tax until what happens, Mitch? I defer, I defer, I defer and I die.
One of my things is I buy houses and then I seller finance them, but my 1031 Exchange person was telling me.
There’s not a statutory holding period. It’s your intent. The way the statute reads is your intent must have been to hold the property for productive use in trade business or investment.
That’s your intent when you bought it.
Most people will tell you that they’re comfortable with a year. The reason for that is that a year takes property from short-term capital gain to long-term capital gain. That feels long. A year also ensures that the property is on two consecutive tax returns and it goes across two calendar years. There are some court rulings out there that talk about two tax years, two county years. The bottom line is it’s subjective and it’s up to you to be able to demonstrate what your intent was.
What I heard was if I buy something in November, I might have to wait until January to sell it.
If you meant to hold it, you could absolutely 1031. Here’s my favorite story of all time on this subject. I had a client call me up. He goes, “Dave, I wanted to sell a property. Does it qualify?” We were talking through it. “We owned it for two months. It was in Tennessee. I said, “Why did you buy it? You can’t buy properties, turn around and resell them into 1031 Exchange. Your intent has to be to hold it.” He said, “Does it help if, in the purchase and sales agreement, I had to agree to honor the lease of the tenant who was a friend of the seller?” “That would certainly help. It’s documented. You were buying it to hold and honor that lease. Why are you selling the property now?” He said, “I lost the tenant.” “How do you lose a tenant in a month?” He said, “The bear took up residence by her trashcan and now she’s scared, so she left.” I said, “I got to think that’s probably a good demonstration of your intent.”
You can’t use that intent 65 times in a row.
How do you plan on a bear?
How many bears are there? I’m asking personally too. One of the reasons I do this is because I get a lot of good information. If I’m holding a thing for a year and then I sell or finance it on payment, do I get to collect all those payments for free?
You don’t if you simply do owner finance. You’re going to pay the tax over time. There is a way to combine a 1031 Exchange with owner financing that would let you collect those payments for free. One of the keys to remember in a 1031 Exchange is that in order to defer all tax, you’ve got to do two things. The 1031 we’re talking about is of sale of the real estate followed by a purchase of the real estate. That’s the mechanism. You’ve got to purchase at least as much as you sell and you’ve got to use all of the proceeds from the sale in the purchase. In a normal course of events, you sell a piece of property, a mortgage may be paid off and cash goes into your exchange account.
You have to purchase as much as you sell and use all that cash. When your owner carries finance, there are two proceeds to the sale. There’s the cash down payment from the buyer and there’s the note that they agree to pay off you. Let’s say you recite a property for $100,000 and then you do $20,000 down and you carry a note for $80,000. You can’t touch the money. They’ve got to go to your qualified intermediary. The two proceeds that would go into your exchange account would be the cash of $20,000 and a note for $80,000.
Would it have to go to the intermediary too?
Initially, but they ended up washing back to the client. Those two things have to be used to purchase the new property. You could either sell the note on the secondary market to create cash, but you’re going to take a haircut. It may not be the best. You could also find from any source anywhere $80,000 in cash. Liquidate a stock account. For the people at Tax-Free Future, why don’t you go and borrow against a 401(k) or something like that? Wherever you want to get $80,000, take it and swap it for the $80,000 note. How much did you buy that note for? $80,000. Now, your exchange account has $100,000 in it. Buy a $100,000 property. You deferred all your tax and now you also have a note that you paid $80,000 for.
If you had it in your IRA, it’d be perfect.
Tax-free, except for the interest in your IRA.
It’s an arm’s length transaction. Is it between your IRA and your 1031 Exchange? That might be a conflict.
I’m not an IRA expert, but I think what you’re going to find is that it’s two separate transactions. There’s 1031, which is the sale of the purchase, and then there’s the lending of the money from the IRA back and forth.
The IRA is buying from the intermediary. That makes it at arm’s length again.
The principle is either way. Think about that. I could generate tax-free cash from a note and only pay tax on the interest. At the same time, I can tax-defer all of the capital gains.
For the record, I want the readers out there to know, you too, Dave. I sell my notes whenever I want to and I don’t ever give a discount. If you go to the institutions, you will take a haircut, but there are ways to sell notes. There are a lot of people that want to make 8%, 9%, 10%, average Joe’s that would love to have a piece of collateral and get 8% as their rate of return.
For those people looking to do 1031 with owner financing may be, call Mitch.
Private money is a wonderful thing. Once people trust you and you got things down, even if they don’t trust you, if the collateral is worth that much more than your note balance, it’s a no brainer for most people. How long have you been doing this?
I did my first 1031 Exchange back in 1999 and I’ve been doing it for other people since. I’m old enough to know better, too young to care.
You’re offering a free pamphlet or download on how to accomplish a 1031 Exchange, what you need to do. It’s a free consultation and then you’re also offering $50 off your first 1031 Exchange and 1031s run between $700, $800 generally, I’m guessing.
When you compare the cost of 1031 in general versus the cost of paying tax and what that’s going to take off the table. It is a specific process that has tick marks like a lot of regulatory constraints to talk about. The timelines will get you. I like to say it’s like being two miles deep in a two-foot wide creek. The consultation side of it, the strategic side of it are critical because using 1031 Exchanges most effectively is going to be different depending on the stage you’re at in your career and depending on what stage of the market is in. There are different ways to use them as to your benefit.
A lot of people in my city are saying they’re not doing 1031 Exchanges because it’s hard to find a deal on anything that they have to pay the market price for the next thing, some of these commercial guys. Smart commercials were around here, but I will attest that time frame, 120 days or whatever it is, it seems like a week. If you don’t get off your ass the day that you go, but what’s better to do is don’t even have your sale, you’ve got a property in your sight or something. That’s how I like it.
The actual timelines are you have 45 days from the date you close your sale to identify your potential replacements. When you think about that 45 days, first of all, do exactly what you said. Start shopping before your old property closes. Get a property under contract before your old property closes. If you could get a contingency, that’s awesome. All of a sudden those 45 days became three minutes. There are plenty of ways to mitigate that, but the illustration is exactly right. The best time to sell a piece of property to maximize your revenue is the worst time to try and buy a property in that same market. The converse is true also. The hardest time to sell a property to do 1031 is the best time to go shopping. How do you use it to work?
One key would be to not look into the same geography. 1031 works anywhere in the country for any type of real estate. If you’re at downtown San Antonio, things are tight, the market is tough. Maybe Tulsa, Oklahoma is a hidden little gem where there are opportunities. Maybe for a lot of my clients, California has peaked out with appreciation and so they’re all trying to jump ship and move to places like San Antonio where cashflow is better. The 1031 works perfectly for those things. Depending on where you’re at in the market, selling residential, buying commercial or selling industrial and buying vacation rentals, you can change the type of real estate. Take advantage of whatever the market is going to give you.
I’ll pull my pants down to show my heinie. One time I was doing a 1031 Exchange and I ran out of time and I bought a house for barely under market so I could put it up and do another 1031 Exchange. I could start over again.
Sometimes that’s worth it. If you overpaid $10,000 for $20,000 house, you think, “I lost $10,000.” What if your tax bill would have been $50,000?
I bought one. We’re $10,000 under, which wasn’t asking for the moon. I had to pay another $750,000. I sold the house for a little bitty tiny profit, a couple of thousand dollars. All I wanted to do is reset the clock. What I did during that time was I formed the leases. I formed all this stuff, so my intent was and then the bear came and camped out by my trash cans.
There are only so many bears.
I only needed one. You only need to find one bear. You don’t know where he came from, but I did that one time. The nicest time I ever did it, I did it on a $1.7 million building that I had nothing in hard because I bought it during the height of the recession in 2009 or ‘10 or whenever. That felt golden to have escaped because when you look at what the tax bill was going to be on, that was horrendous. It was golden. Honestly, after that closing, I did go out in the parking lot and danced the jig in front of everybody.
You’ve done a beautiful job running through your cycle. For my story, there’s another application that’s almost as much fun and that is that you want to remember there are two parts of the Tax Code that talk about real estate. There’s 1031 which deals with investment real estate. Few people know about that but slowly words are getting out. There’s also the Primary Residence Section 121. Strangely enough, many of your readers don’t know about it yet. What it says is that when you sell a property that you have lived in and owned for at least 2 out of the 5 years prior to sale, you get to take, as a married couple, the first $500,000 of profit tax-free. I know you know that because you’ve got it. What most people don’t realize is you can do that once every two years. All of a sudden, you think about the average person stays in their house for an average of about five years. Over the course of a lifetime, you’ve got 8 or 9 opportunities to sell your house and take the money tax-free. It goes in your pocket.
That’s what I tell the young kids. You don’t have kids yet. You’re not tied to a place or a school district and all that. You should be moving every two years. If you have to live in a neighborhood that isn’t your favorite, the hell with that. Do what you’ve got to do and keep buying a house at a discount and then do some stuff to it over the next couple of years and then grow and keep rolling.
Here’s where Dave and Vicki Foster combined the two. What we did is we would do 1031 Exchanges into another region or area where we were going to move. A year or so later after using them for investment, we would sell the house we were living in and move into the old investment house and convert it into our primary residence. Every time we would do that, the sale of our old house was tax-free. When we converted the rental house, it then became our primary residence and two years later, the proceeds prior to 2008 were tax-free. We would move into another investment property.
You had bigger houses or more expensive houses?
What I did was I kept building up the bank account. Ultimately, we ended up using tax-free money from investment real estate and we bought a 53-foot sailboat and lived on it for ten years with our kids without paying a penny in tax.
Now we know why you ended up in Colorado. You found a deal in Colorado and that’s how you ended up in Colorado. Am I right or wrong?
I turned left and I meant to go right. I don’t know.
Is that how you ended up in Colorado?
That’s exactly right. We moved the portfolio from Colorado to Connecticut to Florida to Kansas, back to Florida. We never paid tax because of the 1031 Exchange.
I want to bring up a point and I want you to chime in on this. You hear on the radio like, “The rich are getting richer and the rich don’t pay taxes.” Here’s the thing. The rules are the same for everybody. The people that study these rules and introduce themselves to people like Dave Foster and learned legally how to defer tax. That’s all I’m going to say. Learn how to defer, defer, defer, then you’ll be one of the people that don’t pay the tax. It’s there for anybody who wants to learn how to do it. Believe me, when I started learning about it and when Dave started learning about it, he wasn’t rich. Making money is only half of the equation.
You’ve got to learn how to keep the money that you make. There are all kinds of tax-free exchanges and like that. Sell your home set every two years and IRAs and 401(k)s. If you’re not wealthy, the only one you can blame is you as you go and look in the mirror. I’ve got people all the time say to me, “You got lucky or you have money or Dave has money and you guys are all going to get in the right place at the right time.” We went and studied money. How many hours did you study money? If you don’t have money, how many hours have you spent studying money? Money is a science like anything else. The Wright Brothers studied how to get wind to move over a wing so it’d get lift. We’d study how to use programs and laws and loopholes. I say loopholes, but they’re completely legal to give our bank account a lift. Chime in there, Dave.
I can jump in by telling you about my favorite client of all time, who was a lady in Cape Coral, Florida. She came across one of those swampland cities where she had bought a lot for nothing and she was selling it for $10,000. Somehow she got connected with me. She said, “I want to do 1031 Exchange” Her tax was going to be $1,500. By the time she got through with the whole process, she would have paid the 1031 Exchange fee. She was only going to save about $750. I said, “Do you realize you’re only going to save $750?” She said, “Dave, that’s my $750.” If it was worth it to her on a $10,000 sale, think about what’s out there for everybody.
It’s even more important than that. She started out doing it the way that you need to do it, even if it was only $750. That’s the mindset that she’s in. I don’t give my money away. I use things that I know are to my advantage and I’m going to get in the habit of doing that.
That’s a great way of phrasing it because that’s exactly what it is. When you have a habit, one of the interesting things that studies tell us is that there are actions and activities that precede you doing your habit, whether it’s brushing teeth. Think about the habit of brushing your teeth. You walk into the bathroom, you automatically reach for the toothbrush. That’s all part of it. What are the habits of making money? First of all, we adhere to the first rule, which is you make money in real estate when you buy it. We start to precede that with all of the things that you would do to find the right properties to buy. Secondly, the world that I live in, you keep most of your money when you sell it. Preceding that, you start to do things like exporting 1031 Exchanges, look at buying a property in an IRA. Doing all these things that will help you keep more of your money when you sell it. Those habits of being focused, generate actions before that. That’s what you’re talking about. It’s planning.
Maybe the first time you do a 1031 Exchange, it’s a pain in the ass. It’s foreign. You don’t know what to do. If you’ve got someone like Dave in your corner, the thing is it’s not normal to most people. You could have to change the way you do it, which is uncomfortable for a minute but if you make it how it is, then you do one. The first one is new and different and not fun. It’s awkward, it’s foreign. The next one is not quite that foreign, not quite that awkward. Deal number three, you’re humming down a track. This is how it works. It’s the same thing every time.
By the 3rd or 4th deal, they don’t even call me anymore. They call my processors and I’m begging for Christmas cards, “Tell me how it’s going.”
I’ve done that many times at my office early on in my career. I said, “We’re putting everything in a land trust. We’re going to buy it. Everything in a land trust.” All my office was up in arms. That change was way too much for them. I said, “Figure it out how to do it or pick up your last check on Friday.” Amazingly enough, everybody figured out how to do it. A month after that 10, 15 deals in a row, it became routine. That’s how we do it. Tell us about what you’ve got going on. I already mentioned the free stuff. I want people to go to REInvestorSummit.com/1031exchanges and tell us what you’ve got going on. Reiterate the free stuff and then talk to us about it.
In the spirit of what we were talking about, you can download from our website not only a free consultation. We spent some time talking through your process. I can tell you one of the greatest referrals I’ve ever received was from a guy who said, “I love Dave. He talked me out of doing 1031 because he didn’t need it.” I’m like, “I do like that because it’s a great tool, but it’s only a great tool if it works for you.” Spending the time with me, getting a consultation, let us talk through your process. You could also download for free a brochure that’s going to walk you through all of the detailed requirements of 1031. You sit there at the dinner table with a cup of coffee and you go through it. It’s all checkmark. What does that mean? Let’s call Dave. Those two tools are going to help you jumpstart the planning process. There’s going to be a link here that’s going to take you to our portal where you can get $50 off your exchange with us by signing up online. Not only am I going to save you tax dollars, but I also give you $50 for doing it. How’s that?
It’s a free consultation. Figure out, make sure you’re coloring inside the lines, that you’re not getting outside the lines on anything and check it out. Always on your first one, no matter what it is, get some counsel, someone who’s already done it. Here you’ve got a pro. Go to REInvestorSummit.com/1031exchanges. That’ll get you over there for the brochure, the free offer for the consultation and the $50 discount on your first 1031 Exchange. Is that 1098 where you can exchange something that you’re building?
We call it the reverse exchange. A reverse exchange does not change the statutory over 1031. You’re still going to sell your old property followed by the purchase of the property. When that property doesn’t exist yet, what can happen is that your qualified intermediary takes title to the raw land and then holds it while it is being built or until your old property sells. Either way works. What’s key is that you control it and it’s being improved, but you don’t have title to it. Once it’s built, close the sale of your old property, buy the new property. For improvement exchange, these are cool. Let’s say you sell a property for $300,000 and you found purchase for $250,000 but it needed $50,000 in improvements. When it got those $50,000 of improvements, it was going to be worth $400,000. We would take the title to the property at $250,000. You would put in the $50,000 in improvements. Now it’s worth $300,000. You sell your $300,000 property and buy that one. You completely deferred all tax. You got the perfect property you want and you got it for $100,000 under market because it’s worth $400,000 but you paid $300,000.
There’s a lot to know, but you only need to know the piece that you need to know, which is how you stay from being overwhelmed. That’s why you talk to Dave. He keeps you from being overwhelmed. That’s what a good consultant or advisor does. If it’s a big task, they give it to you in little bites or make it simple for you. Go to REInvestorSummit.com/1031exchanges. Dave, is there anything you want to say to people?
I lived in the world and I’ve seen the people who succeed and the people who succeed are almost always the ones who pay less tax. Take the opportunities you’ve got and you will live well because it’s your money. You ought to be able to use it for your benefit.
They’re giving you opportunities to keep it. You’ve got to be aware of them. It’s like Monopoly. It’s hard to win if you don’t understand the rules. Understand some rules and memorize the ones that are in your favor. I’d like to thank everybody for stopping by to get you some Dave Foster. One last time, REInvestorSummit.com/1031exchanges. I’d like to thank my sponsor TaxFreeFuture.com. Those can be a perfect combination sometimes or not, but learn the rules of all the different things you can do and win. That’s what you do. People ask me all the time, “What’s better? LLC or corporate?” I say, “I don’t know. Pick one, figure out the rules, and win. It doesn’t matter, as long as you win.” Dave, thanks for being on.
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