👉 Watch the full video on YouTube!

Link: 

Prefer to listen? Click to hear this post!

 Hello. Welcome to Judith Barnett Sells Homes, and today the topic is going to be 1031 Exchange. I had a one hour interview with Rick Wittstock, who was the video you saw earlier at the class that I took? And now he is personally chatting with myself, answering my questions and questions that I think my clients might want to know in regards to 1031 exchanges.

So we get a more in depth opportunity to talk with, Rick and find out what he knows, kind of take, pick his brain a little bit today.

So we are on, and thank you so much for taking time outta your schedule to do this today. truly appreciate you for that. Absolutely. Anytime. It's good for both of us.

There are just certain things that I would like to know as an agent and then obviously as a person who has rental properties and you know, funny thing Rick. I don't think I even knew anything about 1031 exchange until just a few years ago. It wasn't something that real estate agents really even talk about.

No. Well, there's a joke. It's like it's the most unutilized tool in the real estate agent's pocket. It's something that is there. Some people are aware of it and some people are not. But using it is the intimidation part. If you're not familiar with some of the facts or some of the timelines. But overall, it's amazing if once you do get familiar with it, and if you're working with investors, it's a no brainer to have that knowledge.

For sure. Yeah. Funny, I started looking into real estate many years ago. Read the Rich Dad Poor Dad book. And he's, you know, all about real estate as your, you know, foundation investing and growing wealth. And I do not remember anywhere in there him talking about 1031 exchanges. I just never saw it.

It was always take what capital you can from the properties and reinvested into another property. But he didn't talk about how to do that without paying capital gains. And now that I know what I know, it's like that really was a huge component that he forgot. Because otherwise you're going to be paying capital gains, even if you're investing all that money again, you know?

So I was like, huh. So it's been enlightening. And I guess, is there a reason that it's not really talked about a whole lot? Is it just 'cause it's scary? It's scary to a point, and it's a lot of people don't think about what they have to pay in tax when they sell a property. Even primary residents, you don't necessarily think about the two outta the five year rule.

You just, it's like, oh, this is how much money I'm gonna gain from the property. And they figure that out later for the most part. And of course, later there's surprises that could hurt financially. Not knowing that information, but I've been educating people on this for decades, and I mean, even the people that I educate forget the details on it.

'Cause you may only do maybe two or three exchanges as a real estate agent a year. If you're working primarily with investors, you might do a lot more. But It's a, like I say, it's something that people just don't think of. Like even when you watch those fix and flip TV shows, They don't, they don't talk about how much you have to pay in capital gains tax or tax in general.

If they're not paying capital gains long term, they're paying ordinary income tax so that sometimes that 30,000 is not really 30,000 when you go to jail. Yeah, that's That's so true. So true. And you're getting my brain kind of like cooking on some other ideas. So I'm trying to like listen and not jump ahead because I wanna take it.

I'm glad this is recorded because. I want to kind of, I'm sure I won't remember everything, but it is something that is more relevant to me and I will remember for the simple fact that I and my partner both have investment properties. And funny thing is, is that right now NAR is bringing a policy to the table in Washington, asking to change the capital gains, like allowance for singles and married people because the value of properties have gone up so much that a lot of people, especially people, have been in their homes for a long time.

They don't have a mortgage. They may have been there 30, 40, 50 years. They have capped out. They're gonna have to pay capital gains on their home. And so they're looking at changing that to hopefully 500 for single people and a million for couples. And that makes sense to me because even looking at my own property, if I pay it off, I'm gonna be paying capital gates because.

I'm single. I'm not married. And so I am like, that would be really good for me. I'll still have to pay capital gains, but it won't be as much, you know? Right. Yeah. And that's a good point. It's something that they talked about raising those numbers for some time now. And hopefully we have a positive outcome because there is a lot of people that are in their retirement years.

And they don't wanna sell necessarily that property, or they need as much money as they can to go into assisted living or whatever the case is. And still have to pay that tax no matter if you're retired or not. So having that exclusion. Exactly. Yeah. Yeah. And so, and that's, they're saying that actually that's keeping people locked into their homes because of that capital gains tax.

So just again, understanding taxes and real estate is. Something that, again, is not talked about a whole lot. Everybody wants to know, well, how much will I get when I sell my house? 'cause then I'm gonna buy another house, et cetera. And if you are an investor, again, nobody, I've never really heard anybody talk about it.

My partner sold a property, couple properties and I said, did the mortgage lender anybody talk to you about 1031 exchange? And he's like, what's that? So. You know, and I, and I had a gentleman in my neighborhood here that he has a property in Minnesota that his family has been living in and maintaining and improving, but pay him rent to live there.

And he wants to sell it in a couple of years so then they can move down here and he'll buy another property for them to live in down here. And I said, do you know about the 1031 exchange? I said, otherwise you're gonna have to pay capital gains tax. And he's like, what's that? So I did give, this was before I met you, Rick.

Who knows if he still has the information I shared earlier. But I will definitely share your information when he and I chat again because that somebody who would benefit from doing the 1031 exchange 'cause he is selling to buy another rental property. That's exactly what it's created for. So I mean, he's the ideal candidate for it, but.

We all assume that as real estate agents or as loan officers, even as title companies, we just assume that your investor is savvy enough to get that information from your tax advisor, and you know how that is. Sometimes they do it after the fact and then it's too late. I mean, I, like I said, our class I had with you that this comes up a lot and we don't like having that call.

After the fact, it's like, well, it's too late, and they find out that they have to pay 30, 50, a hundred thousand in capital gains tax. Now what? So that's, yeah. Yeah. You find out sometimes the hard way and Yeah, for sure. Well, I know that my partner did, and he's like I said, so in the future, if you have to sell anything, we need to look at like property and try to not have to pay capital gains.

So. Let's kind of, for people that may be watching and then we can break it down and my, we can. Maybe come up with an outline, but because I didn't recorded your whole class, that was three hours. And I don't wanna make torture people for three hours. Great jokes. Oh, you're, I wasn't tortured. But if you don't want to need to know this for a class, try and expedite this.

So if a person. Has an investment property, and I'm gonna keep it simple first and then we're gonna walk through some examples and you can tell wonderful stories. So I love to hear a story that might fit the absolutely scenario as we go. You had stories. I want you to know that you were getting a lot of attention on Facebook and Instagram from our reel

Posted. We got over a million views on one of 'em. I'll have to send it to you. Absolutely. I love to hear that stuff. That's great. So, I mean, do you wanna just kinda run over what a, a real example is or something like that? Well, here is kind of the most basic, which would be my gentleman in the neighborhood here.

He wants to, he's gonna sell his property. That's an investment property in Minnesota. And buy another rental slash investment property here for his family to live in. Again, there's another add off on that, but we're gonna come back to it. 'cause I know there's scenarios. So very straightforward.

One investment property to another. When should they start talking to a 1031 exchange vendor? As soon as possible. Like I say, it's, the information is very important. So if he's even just thinking about doing it now, talk to someone like me, speak to their tax advisor, get that information up front because it has a lot to do with what your decision's going to be if you have to pay extra money to capital gains tax.

That's less property that you can buy in Arizona in that example. So You need to know that information so you know what you're gonna qualify for and buy on the other end. And then, so a lot of those initial questions like what is like kind, what can they buy? All that would be handled upfront whenever they're just thinking about it.

And then there's the other option that maybe your client that has investment property, that he is collecting rent. But maybe there's another property that needs to do some planning on setting it up to be a rental. So when they do go to sell it, they qualify for 1031 exchange because then there's a wait period that they have to have at least one year rental history to qualify for that property to be an investment property.

So, yeah, so with the Minnesota property, like kind, I don't know how much he's selling the property for, but we'll say what, three 50 maybe? No, it's gonna be, we looked and it's probably gonna be closer to 500,000. Perfect. So 500,000 mechanics of it. Straightforward. You sell 500,000 property, you go minus commissions and closing costs that he has to pay there for that closing net sales price, four eighty

So now that's his target number that he has to find and replacing Arizona or wherever he's taken that replacement funds. Yeah. So it can be another replacement property residential for 480. It could be fixer upper maybe for 300,000. And then he does, improvement exchange and then he fixes up the difference there with the remaining money.

Oh, really? Talk about that for a minute. An improvement exchange. Oh yeah. You already like threw in another little caveat. Thank you. Threw a little nugget in there. Yeah. The improvement exchanges are probably super popular right now because of the market, you might find a good deal that needs a little bit of work on it.

And where the market's a little bit slow, there's less buyers in the market. You can buy that property with using exchange. it's a little different with than it is with the normal delayed exchange because it costs a little bit more. But if you're saving thousands of dollars, it's not that big of a deal.

So in that example, 480, he finds one for 380, keep it rounded off numbers. So he's got a hundred thousand dollars left over in the exchange. What's he gonna do with that? A hundred thousand dollars? We would hold it under the reverse improvement structure and we hold it up to 180 days to do all of those improvements on the property.

So he just draws on that money as he needs it to do those improvements. And they have to be done in 180 days, though. The 180 days is a strict rule. Yes, but okay. Improvements if it's like, you know, maybe a kitchen remodel, bath remodel, things like that, or maybe even add in a pool. Some of those things can be accomplished in 180 days.

But 180 days to build a property from ground up. That's a little tight. Yeah, yeah, yeah. That's not gonna happen. No. That used to happen back in the day, but that does not happen anymore. Yeah. We're talking about updating the tax code. That might be one. The new update is on the improvement exchange, that they extend the time a little bit longer than 180 days.

Yeah, that's do a new bill. That's impossible. The other thing in saying that about the improvement exchange is that you are probably most of it, if it's a lot, you're gonna need to hire contractors to do the work. Is that a requirement or can it be a DIY? It can be DIY, it can be any. Yeah, we, the IRS doesn't care.

They just wanna see the money going towards that improvement property or that replacement property. So it could go to your own self to do the materials and build it yourself, or it can go to a general contractor. Whatever, as long as the value and the money's going towards that replacement property.

Yeah, so it's, it's cool. That's an added cool right now. Yeah, well for sure. That's really, I really do like that because again, a lot of properties are selling for a really good price, and if you can get. A decent property like property and use some of that money to do the work, that would be fabulous.

I mean, why come up with more cash, you know, tax free money that's gone through the exchange, so That's right. That's the beauty of it. Yeah. I mean, I have clients. That's how they use their business model. Like they, we won't call 'em fix and flippers because they're usually two, three month timeframe, but the buy and hold sell model where they buy, hold, sell, buy, hold, sell, that's their avenue right now is they're using these reverse improvement exchanges because they get equity quickly is the, what I call the lipstick and rouge that you put on the property.

You know, update the kitchen, update the bathroom, maybe a new roof. There's some maintenance that's been deferred. Then you're buying a good priced property, but you're, and even when you're finished with the money you're putting into it, there's still gonna be maybe 10, 20% or even higher on, on the value of the property when it's leaving.

Right, right. Okay. I like that. So it. Yeah. That's great. That's another piece I didn't know. That's good to know. Yeah. Well, especially for investors that are like, I'm selling a property that's maybe worth, you know, 500. The difference between I bought and I paid, I can buy another property for x. Make payments, but I'd like to save some of the money to do the improvements.

And a lot of the investors I know, even if it looks nice for a buyer, like I'm gonna live in it, it's fine. It's okay, I'll just do it as I go. They come in and they gut it. They're like, we're gonna redo the kitchen, the bathroom. I mean, they just come in and just redo it and it's like, it's nice for them to have that.

Money in the exchange to do the work. They're still ahead of the game. So say 4, 5, 6 months down the road, they're ready for it to go on the market. They haven't used any of their cash out of pocket. Does that make sense? I mean, that's the way to go. I love it. I love that. Yeah. I mean it's, it's just wish I could just broadcast it to the world and just show I know.

I'm trying to help here. Yeah, I know. I'm trying. It's just people don't understand it and then they don't realize what the real benefits of it are. And I mean, like I say, I mean, maybe there should be a TV show called Fix and Flip, 1031 Exchange. I know. Let's do it. Let's do it. I love it. I love it. Let's do it.

A 1031 exchange, fix and flip. Yeah. Got it. Save, kick the can down the road as far as you can. Look at this money. I mean, other countries do not offer this, so it's something that they put in the tax code that is a big influence on the economy. So it gives incentive, like you were talking about earlier now, is trying to raise those limits on primary residents.

Those people are not selling their houses if they have to pay huge capital gains tax. So anything that helps with that, as long as they're keep investing, that's gonna be stimulating the economy. So it's a good thing all the way around. Absolutely. Absolutely. So quick question, going back to family renting.

So you buy a property and you rent it to family. You're helping out your cousin, your kids, whomever, and you're renting it out. Now, I remember in the class you said that it has to be rented out for a certain amount of time. At current market rates. Can you talk about that a little bit? Yeah. So it's current market rates are, you know, whatever you find on the MLS or whatever you think is within reason.

But family members, a lot of, I mean, it might start it off that you bought a property for your college bound daughter or son and they, you bought that property, they got roommates, they rented out the property. You're collecting rent from your daughter or son. That's a true rental property in the IRS's eyes, as long as you're claiming that income and doing a Schedule C or E on the tax returns.

So the benefits of that is that when they go to sell, when the daughter or son graduates, they can take that funds, sell that property under exchange, not pay capital gains tax, and maybe help 'em find their first home and then continue to rent it out to that family member, but right. What's fair market value?

Like you say, look at the MLS, if the going rate is about 1500, you know as long as you're within that ballpark because you can minus some of that rent, that gross rent on return labor. So if they're maintaining a property or they're mowing the lawn or they're doing whatever else, that has to go with the maintenance that is avoiding you taking outside of the family member, that could be discounted on the rent.

Again, all this has to be disclosed in your tax return. But that's great way to invest, help out a family member. I mean, I have one client, I'll tell you, I don't know how much time we have, but I'll tell you this story. Yeah, no, no, we got time. We're good. This one's amazing story. This was a client a few years ago.

I don't think I told this one in a class. He's very wealthy individual. Probably. I would guess he's in over 90. I know that for sure, but maybe around 92 93 years old. He donated a lot of money. He's doing a lot of estate planning. Donated a lot of money to charity. But he has all these billboards on the east coast.

I think he had over 30 billboards. And they were all bringing in six figures a year. Very profitable billboards. And so this is the part that people don't understand, like kind those billboards. He owned the easements that they were sitting on off the freeway. So he owned those easements, which mean they're real property that he could sell those, do an exchange, and then go off and buy a single family rental property.

So what his motivation was, not so much for the money, he was doing more estate planning for all of his heirs, so his kids. Their kids and their kids. So like three or four generations down, he was selling those billboards, doing an exchange and buying homes for family members that he's gonna rent out or the trust was gonna rent out to them.

So when he did pass on. Every one of his members, even if it was a two month old baby, was going to have a home, that they would receive in their inheritance. Oh my God. There's nothing you could, that is so cool. I love that. I love that. And, you know, people don't think about that, and these days it's really actually a great way to get a house to your family without

anybody paying taxes and capital gains and inherit tax or anything. Is that You gift them the house, so to speak, but you pay rent. And when I die, you get the house, right? And what you do with the when I die is on you. You can live in it, you can sell it, you can do whatever. But they're not caught in that tax issue, right?

You kick to that tax issue down the road enough that it's just really, unless they hold it. We'll come back to that. Then if they inherit it and keep it, or they inherit it or sell it, if they sell it right away, they don't have to pay taxes and this in Arizona, but if they inherit and hold it and live in it, and then eventually, like the example, the million multimillion dollar one.

We got so many hits, I gotta tell you, they love that story. Like, what the hell? Yeah, yeah. What's wrong with you? But we won't. But that would be, you know, if you hold it, you have to think about, and again, this is where you would talk to a 1031 exchange person and say, okay. Should I keep paying rent?

Should how, when? What should I do with this property so I don't have to pay capital gains down the road on this? You know, I mean it's, it's just as simple as that. Just getting information. Have a plan that is set forward, not just pass it on. Say, oh, I'll just let my kids deal with it when I pass on.

That's not, I mean, we all know, we all heard their horror stories. We all have friends or something that's gone through probate. That don't talk to their siblings anymore or don't talk to their uncle, whoever family member, because they fought over money. So, I'm an example of that. Yeah, yeah. Me too. I I, my family as well.

And it's probably in a lot more families than you wanna say, but with what you're describing was called the stepped up basis. So basically stepping up the value on your inheritance. Whatever it is when you receive it, you can sell it, like you said, and not have to pay that back taxes. So the tax dies with the state or dies with the person that owned the property.

The parents. Yeah, so that's a good thing because it came out in 2015, so let's keep our fingers crossed That stays, because that's really good for a lot of people. Yeah, for sure. Especially in inheriting. I mean, that's such a gift question. How so going back to owning property as a rental and talking primary residence.

Now. Now I think I asked you this question. I, I know I asked somebody. I have a property that is a rental currently. Right, and if I moved into it and lived in it for two years, I can claim it as my primary residence, but I cannot claim it as a rental and take advantage of the 1031 exchange. Or can I, or is it the reverse if I live in it for a couple years and then make it a rental?

Can I use both? Can I take advantage of both? Not both, but you have a choice. You could either use the primary residence exclusion 'cause you got two out of the five. Or you can do it at 1031 exchange where you buy another property and deferring it. 'cause you got two years history there. So you can't use both tax codes in that example.

There is some that you can use both where you're selling a property that's a mixed use property. I think I talked about this in the class, but, and then to clarify that last question. You'd have to pick which one's best, and the only time that it probably would go 1031 exchange is if they're over the exclusion number.

So primary residence, single 250 currently, and then 500,000 jointly if you're over that, You've been a rental for the last two years, you might wanna use a 1031 exchange. Ah, okay. But if I'm in it, right, but if I'm living in it currently as my primary residence, I can't do a 1031 exchange. You, you can if Oh really?

If, if you got the two out, the five, so, oh, if the last two years you were claiming as your primary residence, but on year one and two, so you're on year four now, so your first two years as a rental. Third year, fourth year as primary residence. You qualify for either one. and that's, you just have to weigh out the pros and cons.

Which one's better for you? I mean, of course, if you're married, filing jointly and your gain is less than 500,000, no brainer, just do the primary residence exclusion because you don't have to deal with any timelines. but if you're making 800,000, you may want to consider doing a 1031 exchange because then now you can defer the whole thing into the next property.

So these are things that come up in conversation Upfront, but not at the end. Because at the end it's a little bit more scrambling, a little bit more stressful, and then people don't end up doing anything then other than paying the tax. which is not too bad, but nobody wants to do that unless you have to.

No, we don't. Sorry Uncle Sam, but we do not wanna where uncle? More of our money. Yeah. We dunno where it's gonna go. It could go in a hole somewhere and never see it again. So Yeah. I wanna have control. Exactly, exactly. So. Oh yes. Yeah. So there, there's those options and a lot of estate planners use this as a vehicle to help people get into that situation.

So where they can help with. Estate planning so that their heirs are not going to probate court and fighting about the property, so yeah. Right, right. Okay. Wasn't that great information. Rick is just so knowledgeable about 1031 exchanges, and as I said in the video, I didn't know anything about 1031 exchanges up until a few years ago, and it is such an important tool in a realtor's toolkit to work with their investors and people, even if you only have one.

Rental property to save paying capital gains. So come back like and subscribe. So you'll get to see part two. Thank you. And again, Judith Barnett sells homes with my home Group Realty.