How a 1031 Exchange Works (Rules, Timelines & Tax Savings Explained)

0:00 Is if I were a fifth grader. Can you explain what a 10/31 is? Yes. So a 1031 exchange is a tax vehicle that is completely allowed through the IRS and it allows you to defer your capital gains tax. So in doing so, when you sell one property and you take those proceeds and you use them to put back into another property, you are able to defer 35, even upwards of 40% in taxes that you would normally pay if you just sold your property outright. Amazing, thank you. So for everybody listening who doesn't know what a 10/31 is, it's a highly advantageous tax saving mechanism when buying and selling real estate.

0:48 Yes, you stuffed it up a little quicker tonight. Oh well, you know you, you're a professional. I just passed paper back and forth. No, I'm just kidding. So I was maybe 7 years into the business and I was exposed to a reverse 1031 exchange, which led me to realize that there are there is more than just the classic 1031 exchange. Can you tell us about the different exchange types and what they are and how we can use them? Yes. So typically you, you're coming across 1031 exchanges and they're in a forward manner. So people refer to them as a forward exchange or even a simultaneous exchange where that's almost like a property swap and that is where the property is sold first and then the new one is purchased.

1:38 In a reverse exchange, the purchase is done 1st and it's actually held by a a holding entity in what we call AE or EAT and the property parties held and then that owner has 180 days to then sell their relinquished property. So reverses come into play when a lot of times they don't want to be under the gun for that first 45 days to lock down a new property. So other than reverses, so we have forwards, we have a reverse, there's improvement exchanges and that is where you can actually utilize the proceeds to make a significant improvements on the property.

2:18 And outside side of that there's even non safe harbor exchanges that fall out of the 180 days. They're more risky, of course, but there's actually a lot of creative solutions within the 1031 space that most people normally don't come. Across Tell me about this construction thing. What? Yes, so. How does this work? It can work, really. However, that owner is needing it. So if they're buying a property that's almost dilapidated and they just want to scrape it and build new, they could use it on a property that needs significant improvements. And what happens is it's set up in the same structure as a reverse, where an entity has to essentially park or hold that property, and then the construction expenses are ran through the Exchange account. And then at the 180 days, the property is given back to the owner at that point.

3:15 A lot of planning comes into play with those because you really need to make sure that you have plans in place so that the funds in the exchange account are eaten up and used by the 180 day period. OK. Because then you would be taxed on the remaining funds, correct? You know, they didn't teach us this in real estate school. They don't. They don't. I mean, I, I have a license too and they don't teach you anything about practicing real estate. So. Yeah, so. You were using a few buzzwords. You said 45 days, 180 days. For maybe somebody who isn't familiar with the 1031 exchange, what are those days and why are they important?

3:59 Yes. So total exchange period is 180 days. The 1st 45 days of the 188 period is really the most critical and the most one that people make mistakes with because they're either under the gun and they're not prepared. So the first 45 days is where you have to identify what you want to purchase. And that is a very big kicker because as of day 46, you cannot change what you've identified. If a property that you were under contract with falls through, you're pretty much screwed unless you have some backup options. And it's not something that we can change as AQI.

4:41 Unfortunately, that's a set IRS role so that the 45 days is really the most important. So you have 45 days to identify three properties, correct? There's actually three different ways to identify properties, the first being most common, which is up to three properties. So whether it's 1-2 or three, most widely used, most recommended, because you're not restricted to values on the properties that you identify. There's another role, which is a 200% role. So if you go over three properties, the combined value of those properties cannot exceed 200% of the value of the property you're selling. And then the last and final rule, which is more of like a fail safe, the way we see it is that if you bust the 200% roll, the IRS says, well, you fall under the 95% roll, which means you have to close on 95%, basically everything that you identified.

5:40 And if not, your exchange is busted. So those are there. So there is 3 different ways, but most commonly used is up to three properties. There's no restrictions with that. Every time I talk about 10:30 ones I learn more and more and I get like more irate that I didn't know about it in the first place. But I suppose that's real estate is just getting in the trenches and learning something everyday. Yes. OK. I have AI have a practical application question to some a deal that I'm working on right now. Well, yeah, I figured I might as well ask. Let's do a. Say I'm working with a buyer just sold a property, we're in the 45 days to identify.

6:23 We have identified a portfolio A2 property portfolio that would work for yes, it would work. But my question is, does that qualify as one property or two properties? So. Identifying. When you say portfolio, what is the structure of the deal? Because it because that's what it all comes back to. Normally when I think of portfolios it's in like a manner of ADST, but so explain to me a little more of how these properties are actually set up in the portfolio? That's a good question. It's essentially 2 properties side by side owned by the same ownership group. I think they're strategically being sold together because one is an office building. So it's the idea is like coupling an office building with a warehouse.

7:09 So they could probably move the office building faster for more money is my assumption. If it's under one contract to me that would in it's one property in a sense I would consider that as one property on your ID form, but be just be mindful of the values and you know that she's what we always recommend is that they replace into equal or greater value. So as long as that's there then then they'll have full deferral. Fascinating. Thanks for answering my tactical on the street question. No, those are like, those are the best. It we just, I did a class the other day and it ended up turning to a roundtable discussion of like, I have this still going on, that deal, that deal. And I'm like, I loved, I love it. So yeah, real world application is really the best way for everybody to retain all these rules and regulations. Yeah, because we have to.

8:05 If you're not figuring it out in real time, a book isn't going to teach you it anyway. Does the IRS change the rules annually? Biannually. How does that happen? So the IRS rules last they were changed were like 2018 when they took off personal property and only made it, you know, real estate property. I'm sure there's different pieces of it that change, but not in the way that affects the basis, the foundation of the 45180 days. What qualifies as like kind alternative solutions which are becoming more popular with owners, you know, nowadays who are just like, I just went out of the game. I don't want to manage like I just need something passive, you know, so finding solutions for that. But other than that, it's they'll post disaster areas and that's really the only time that they'll extend a rule of like a 45 or 180 day if there wasn't a nationally declared emergency disaster area.

9:07 It's so funny because I feel like with IRS code, like it can be so black and white, but people can get so creative in terms of how they can color inside and outside of the lines that I'm sure you see and hear it all. Literally so, so many Gray areas, So many Gray areas and we're cut. That's what we're constantly on the phone with CPA S and attorneys because at the end of the day, that's, you know, where the liability is on their return. And so very often there's a collaboration of who agrees to do what and what can and can't be done. You know, people are getting so creative because of the market conditions and I think that's allowed things to keep progressing and it's also allowed all of us in the industry to enhance our skills because we're having to work harder to get bills done, especially on the broker end. But even on my end, I see and I hear things and not just on a 10/30 what side, but I try to provide value or connect people or, you know, because obviously we're, I'm in strict guidelines with the IRS, but I'm always like, what if we could do this? And what if we could do that or structure it this way to allow them to do a 1031 still.

10:15 So I think, you know, you're hearing a lot of like as far as you know, the market and where it's going, But I'm already starting to see more, more action, more calls, calls are flying. Can we do this? Can we do that? And so it's, it's moving for sure. And I think everybody's hopeful, but I think it it's really catered to certain areas, those pockets that still have great deals and then even asset, you know, types right now and what they can do with him. Super interesting. It's a humbling business to say the least. Humbling, but it's rewarding and fun and challenging. And you know, here's to the next 50 years. So Chastity, where can they find you, follow you, contact you for their next 1031, etcetera?

10:58 Yes, thank you so much for having me. This was awesome and yeah so for everybody, y'all can follow me on Instagram, TikTok at the 1031 gal. I'm also on LinkedIn, Chastity, Goolsbee, or just search the 1031 gal. Yes, the 1031 gal Chastity, thank you so much for your time today and for everybody listening. We'll see you next week.