Air Date: 07.28.2020
In part two of our discussion on 1031 exchanges, we pick up where we left off with Michael Brady and Alex Shandrovsky. As more and more syndicators are advertising them, it’s crucial to get educated and understand the intricate rules. One of the strict constraints is the two different timelines, namely the 45-day replacement property identification period and the 180-day closing period. We learn more about these parameters, along with the consequences if they are not adhered to. Michael also sheds some light on the COVID-related changes in the space. From there, we move onto the Delaware Statutory Trust, which can be used in conjunction with a 1031 or instead of one to defer capital gains. We get an overview of how this structure works and when it makes sense to utilize it. Finally, we round the show off with our keys to success, where Michael shares why he’s most proud of his kids, and Alex shares the role Michael has played in his success. Kent even talks about how meditation has helped him stay more present and focused in daily life. This was a great conversation, and Michael and Alex do a great job of unpacking this complex but effective wealth-building tool. Don’t miss out on today’s show!
Key Points From This Episode:
- Learn more about the two strict time constraints that come with 1031s.
- Why it’s recommended to only identify three replacement properties.
- The constraints that come with identifying more than three replacement properties.
- Some 1031 timeline changes that have happened in light of COVID-19.
- Why it’s preferable to have a contract and even do due diligence in the 45-day period.
- How the identification period works if you’re looking at a syndication.
- A look at a Delaware Statutory Trust, an alternative to defer capital gains tax.
- The main takeaways from all this dense 1031 information.
- The final keys to success with Michael and Alex: One sponsor question, what they’re most proud of, and more!
“You don’t want the tax tail to wag the dog. You’re better off paying taxes than making a bad investment because you know how much you’re going to pay in taxes. You don’t know how much you can lose in making a bad investment.” — Michael Brady [0:13:08]
“If you’re doing a syndicated deal, make sure you know who you’re doing business with because no matter what’s on paper, it’s really important to find good people. If you find good people, then the paper doesn’t matter. People are going to do the right thing.” — Michael Brady [0:13:30]
“I think a really crucial thing is having people in your life that you can really honestly talk to in different areas who are more specialists who have a track record.” — Alex Shandrovsky [0:18:30]
Links Mentioned in Today’s Episode:
Federation of Exchange Accommodators
National Association of Realtors
The 7 Habits of Highly Effective People
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—Full Transcript Below—
[00:00:00] MB: I think Alex said it earlier, don’t want the tax tail to wag the dog. You’re better off paying taxes than making a bad investment, because you know how much you’re going to pay in taxes. You don’t know how much you can lose in making a bad investment.
[00:00:12] KR: Welcome to Ritter on Real Estate, the show about how to passively invest like a pro. On each episode, I interview real estate experts who give their top investing advice, strategies and tools and I break down their insights into practical steps to avoid the pitfalls and make better investments. I want to help you passively invest like a pro. This is Ritter on Real Estate I’m your host, Kent Ritter.
[00:00:35] KR: Yeah, I’ve definitely seen it advertised more and more from syndicators. I’m really happy to have you guys on, because I wanted to clear some of that up, because I don’t want people thinking that they can just get in, take their money, put it in and then end up in a situation where they end up owing these capital gains and they never realized that just because they didn’t follow the rules, because the rules are pretty complex from what you guys just walked through. I mean, you just have to follow the right steps and have the right guidance, right?
I want to make sure that we get into some of the nuts and bolts of the 1031, some of the rules and guidelines, so folks really understand, because I know that there are pretty strict time constraints. If you guys could elaborate on some of those for the group, I’d appreciate that.
[00:01:15] AS: Essentially, part of the challenge of the 1031 exchange is the guidelines and the time frame. You would need to know two specific timelines. 45 and 180. If you’re into geometry, maybe that would make it a little bit easier. 45-degree angle and a 180. What essentially, you’re looking at is 45 days to identify replacement properties from the time of closing, so essentially, you’ve sold – the property has been sold. The QI has received funds. That clock is not running. You have 45 days to identify your replacement properties. Typically, those are three properties of any value.
Essentially, if you have sold a million dollars’ worth of beautiful Indianapolis properties and you are going to reinvest the proceeds of that, you can choose one property in Indianapolis, one property that’s a million dollars in Kansas City, one property that’s in Florida. It’s a million dollars, not a problem.
Then 180 days from again, from the sale to close on a property. Now it’s really important to know this is that you want to invest all of the proceeds, because any proceeds that are not reinvested, they’re considered boot. Why is it called boot? Is there an analogy to some football reference? We don’t know, but it’s called boot, and that is going to be taxed at capital gains tax. Those are the two important timelines.
Mike, maybe you can share about more than three properties and also corona guidelines.
[00:02:44] MB: Yeah. Most investors, we recommend they only identify three, because it’s very simple. As Alex said, you don’t have to worry about values or anything like that. If you identify more than three. You would typically only do that if you’re going to buy a bunch of smaller properties. As Alex said, you sold for a million dollars and you were going to build up a portfolio, or several $250,000 properties, then you might want to identify more than three. If you do that, you’re limited to identifying properties a total less than 200% of the value of what you sold.
If you sold for a million and you identified four properties, you’re limited to 2 million dollars total value of what you identify. You can’t exceed that if you wanted to buy a big portfolio of properties that was going to be an all-or-nothing transaction, so you’re going to buy 10 properties and you knew you were getting all 10 or you’re getting zero. You could do that as well as long as you buy 95% of the value of what you identified. Again, you can sell for a million, you identify a portfolio worth 10 million. That’s fine as long as you buy 9.5 million dollars of property in that portfolio. 95% of the 10 million.
[00:03:49] KR: Even if you, you’re sitting on a million dollars of gains that you want to put forward, then if you identify you said, like the 10 million, you still have to purchase the nine and a half. You can’t just out of that take the million and put that forward?
[00:04:03] MB: Well, you could if you only identified three properties. Yeah, so if you knew there was one 10 million dollar property, we’re going to buy that, and you identified three of them, three 10 million dollar properties, you bought one, which would be hard to do without an additional cash, you can do that. Only if you exceed those three properties.
That’s only if you knew you were going to buy a portfolio, like one seller is going to sell you 10 properties worth 10 million dollars or something like that. That’s the only time you would use what we call the 95% rule. Typically, we recommend you stick to the three property rule.
Just quickly onto COVID-19 update, they’ve extended the time for people to pay and file their tax returns for 2019 to July 15th. They did the same thing with 1031 exchanges. If you have a deadline, a 1031 exchange deadline that falls between the April 1st and July 15th, it has automatically been extended to July 15th. We think there might be a basis to say that you get an additional extension of a 120 days if you don’t fall on that guideline, or even if you do, but that hasn’t been proven yet and we’re waiting for guidance from the IRS on that question.
We’ve also as an industry, that Federation of Exchange Accommodators I mentioned, has teamed up with other groups like the National Association of Realtors and some other ICSE, I believe was part of the groups that are involved to lobby the IRS for further relief. The American Bar Association also has lobbied the IRS for further relief, recognizing that this pandemic is ongoing. Even if you close today on a 1031 exchange, July 15th doesn’t do much for you. You might need extensive time to go beyond that. Maybe a 120-day extension is a more fair timeline.
[00:05:33] KR: Got you. Do you have any sense of when, or if further guidance comes out on that 120 day extension?
[00:05:39] MB: I was hoping it was going to be every day up until today and it hasn’t been. The IRS has had their hands full with the PPP loans and they have a whole bunch of other stuff. Yeah, to their credit, they’re doing yeoman’s labor these days and hopefully, they’ll get around to us very, very shortly, so we have some guidance for our clients.
[00:05:57] KR: Got you. We understand the timelines. We understand that you’ve got to stick within those. I mean, are there other things that people need to be keeping in mind that could cause their 1031 to be unsuccessful?
[00:06:08] MB: Yeah. Well, one thing about that identification period is – so once the 45 days expires, you are stuck with whatever you identified. You do not have to have a contract in the 45 days, but it’s a really good idea. You want to have those bound up, as in negotiated as much as you possibly can. If possible, you’d love to get due diligence done in that 45 days too, because you don’t want to be on day 90 and all of a sudden, run a phase 1 on your property, phase 1 environmental inspection and you find out that it’s on a superfund site, because then you’re stuck. Maybe you could go to one of your backups if you have backups, but maybe not. You want to start shopping as soon as you list your property for sale.
[00:06:46] KR: How does the identification period work, going back to trying to invest in a syndication? If you were going to sell your property, you want to go into a syndication, how does the identification period work? You have to identify three different syndications to invest in?
[00:07:02] MB: Yeah, you would. They’d have to be specific properties. You’re not buying actually a syndication in that case, you’re buying a Tenant in Common interest. Not only are you – do you have to identify one, two, three Main Street in Indianapolis, such a property exists, but you have to identify what percentage interest you’re going to buy in that property as well. You would have to say, not that I’m buying one, two, three Main Street in Indianapolis, you have to say, ‘I’m buying a 5% interest in one, two, three Main Street, Indianapolis.’ You have a little bit of wiggle room, but you want to be as close as you possibly can.
[00:07:34] KR: Understood. Again, it does add an extra layer of complication. You do have to be working very closely with the syndicator upfront. It sounds like not just one syndicator, but you would have to unless the single syndicator could have three properties, it’s just that the number of properties is really what you’re going after in the identification period.
[00:07:51] MB: You don’t have to identify three. If you know that you’re going to buy that one syndication, then just identify that one. You may want to have some backups in case it falls through, if for whatever reason. There’s some other things out there that are good backups, which we can get into, but other products out there, but you want to get it done as fast as possible.
[00:08:11] KR: You don’t have to identify three?
[00:08:12] MB: No.
[00:08:13] KR: But if you only identify one, you have to move forward with that one. If you get past the 45 days, then you say, “Oh, actually I don’t want to invest in that one.” Are you just dead in the water at that point?
[00:08:26] MB: Yes.
[00:08:27] AS: No, sorry. I think just to clarify. I think I understood Kent’s question a little differently and just make sure. You mean, once you identify a property, are you forced to buy it. Is that what you’re asking?
[00:08:38] KR: No. But if you don’t buy it, then you can’t go get another property, right? Essentially, you’ve lost your ability to do a 1031 exchange.
[00:08:45] AS: Yes. Then you are going to be liable in the capital gains tax. Exactly.
[00:08:48] KR: Right. Okay. Yeah. No, that makes sense. It’s important to identify multiple. They can be all different kinds as you said, but three seems to be that magic number. I think it would be interesting. You alluded to Mike that there’s the fallbacks maybe, some other options and what would those be for investors?
[00:09:04] MB: Yeah. There’s something out there called the Delaware Statutory Trust. This is a take on that tech structure we talked about. Now, it’s similar to a syndicated deal in some ways, but essentially, usually you’ll have institutional property, it’s bought by – it’s not a real estate management type companies. We’ll go out and buy a property. Two of the biggest ones in this industry are Inland Capital and Pasco. There’s a handful others, Cantor Fitzgerald is in this space. There’s a couple of those types of institutions.
They will buy a property. It could be anything. Could be a shopping center. It could be a retirement community. It could be multifamily. It could be self-storage. It’s really any sector. They buy a property and they put it into a trust, a land trust, usually formed under Delaware law, thus the Delaware Statutory Trust. They then under a red ruling that came out in 2004, can sell off beneficial interest in the trust to 1031 exchange investors. In this case, we said before, you have to buy a deed of the property interest. This is the exception. You could buy an interest in the trust and that will qualify. It’s as if you bought the underlying property, almost like a TIC. These worst structures takes up until a financial collapse of 2008 and then they move more into this structure. That will qualify for 1031 purposes, like a syndicated deal, you’re away from the three T’s, the tenants, trash and the toilets.
They’re like a syndicated deal. They’re not that liquid, so you’re not just going to sell it a year from now. You’re going to have to wait till the entire property sells and then you’re eligible and you go to another exchange, but they allow you to diversify because you could buy several DSTs and different property sectors, or areas of the country. You can tailor your investment. If you sold for a million dollars and you found a property you really like for $700,000, but you had $300,000 of cash left over, well you could roll that in excess into a DST to complete your exchange.
Or just choose it as a standalone. This is the property you want and you want to get out of the management. You do have to be an accredited investor, which is not unusual in these types of deals, meaning that you have to have income of $200,000. I always get them messed up. It’s 200 or 250 as a single person and $300,000 a married couple filing jointly prior two years, or have a million dollars net worth, excluding the value of your primary residence. For accredited investors, that’s an option that’s either a backup, or even as a standalone.
[00:11:30] KR: This Delaware Statutory Trust is a benefit, because it’s something that exists that can always be invested in? It’s not something where you have to align property necessarily, is that right? The property can exist, other people are invested in it and you can essentially add to that. It’s like a mutual fund, if you will?
[00:11:49] MB: In a way. Yeah. In a way. The property exists and that was the advantage over a TIC structure, where you had to buy in, could have up to 30 people investing in a TIC, but they all had to close on the same day. Right here, the property exists. You can close whenever it makes sense for you. I mean, they do sell out. If they sell out, then you would maybe have to buy somebody’s interest who’s in the project, which is sold more difficult. Typically, if not this DST, then maybe others. There’s a steady supply of DSTs on the marketplace.
[00:12:17] KR: Got you. Well, I think that’s a great fact for investors and in a good alternative for folks that are coming up on a 45-day deadline.
[00:12:25] MB: Yeah. We do have a lot of people do them last-minute.
[00:12:28] KR: Yeah. Is it something that if you’ve maybe identified two properties and then can you identify a DST as that third option?
[00:12:37] MB: Absolutely. Yeah, absolutely.
[00:12:37] KR: Okay. Then it can really play as a fallback if the others don’t work out. Okay. No, thanks. That’s very helpful. Awesome. You guys have provided some fantastic info.
For somebody that’s – we covered a lot of dense information. Let’s take it back up to the top for a second. Say, for somebody that’s just getting into investing in real estate, they’re looking at deals, they’re trying to understand how the process works, they’ve heard about 1031s and there’s a lot to unpack. I mean, what’s the one thing that they should really take away today?
[00:13:06] MB: I think Alex said it earlier. You don’t want the tax tail to wag the dog. You’re better off paying taxes than making a bad investment, because you know how much you’re going to pay in taxes. You don’t know how much you can lose in making a bad investment. I’d rather take the one-third haircut on my profit than lose everything.
Due diligence is key. You can’t stress that enough. Alex and I say it over and over again. Also, if you’re doing a syndicated deal, make sure you know who you’re doing business with, because no matter what’s on paper, it’s really important to find good people. If you find good people, then the paper doesn’t matter. People are going to do the right thing.
[00:13:40] KR: Yeah, I think that’s fantastic advice. To round the show out, we like to do a segment called keys to success. I have a few questions I’d love to ask you guys, starting with as a passive investor, if you can only ask your sponsor one question, what should that one question be?
[00:13:58] MB: I like to know track record, what have you done before? It’s no guarantee, but somebody’s successfully has managed properties for years, you can work off that track record and then hope that that continues. Particularly, if you’re dealing with people who have been around long enough that they’ve survived a downturn, how they treated their investors during the downturn.
[00:14:15] KR: Alex, what do you think?
[00:14:16] AS: Yeah. I think what Mike just exactly. Having someone with experience is really, really crucial. Or I think that at least initially, the syndicator is usually having conversations with people that are close to them, and so usually friends, family, neighbors. I think you just want to make sure that you trust the person. That’s really, really crucial. Whatever questions you think are best in determining trust of an individual, that’s the ones you should be asking, because you’re investing into the person as much as you are in the property.
[00:14:44] KR: That’s exactly right. What are you most proud of?
[00:14:48] MB: For me, it’s my kids. We were talking earlier, I have three boys who are all adults now, various stages in their life; finding jobs, in college. At the end of the day, that’s all important. You want your kids to succeed and achieve. The one thing I could point to with my kids that I am most proud is that I raised three good people. They all have hearts of gold. They all go out of their way to – I see them with they’re my younger nephews. They’re just good people with the younger kids. They’re people who are out in the world looking to help other people.
I have an English teacher. My oldest, I have a son who’s in business, he helps hospitals save money on their service contracts and things like in supplies. My youngest is in college now and is a college soccer player, but has always been – and all my kids have been involved in coaching and sports and helping kids who were younger than them learn the ropes. I can’t say enough about having good people and having produced good people, despite maybe some of my best efforts to screw them up.
[00:15:49] KR: That’s the most important thing.
[00:15:51] AS: I’ll say that we can’t be proud of the same thing. I’ll say that of course, my children. They’re still very young, so we’ll see how that – I don’t have the track record yet that Mike has. I’m still in the process. I will say, I think that there are several individuals that my previous company has employed that I think really turned their life around. They’re individuals who are – the statistics would point that they would not be able to turn their life around, they’d have to go back in jail. I think having the environment that was up to people specifically come to mind that were there. It was really their last chance, so they were going to make another mistake, that would be the third strike. I think we gave an environment, a job for people other people would not provide jobs for. It was a very special company. I’m very proud of some of the results that we have at changing people’s lives.
[00:16:41] KR: That’s an excellent service and a great story. What’s the book that everyone should be reading?
[00:16:47] AS: I’ll start I think that one of the partners that we ignore in a lot of deals is our spouse, assuming that presents a spouse. I’m going to make the assumption. I think it’s really one of books that helped us a lot, my wife and I is Getting the Love You Want, excellent book and gives you a little bit of insight about why you choose the person you’re going to marry. It’s really, really crucial. It’s really, really crucial as you’re building a generational wealth philosophy. You and your spouse align. Working in marriage as much as on your business is really crucial.
[00:17:21] MB: Yeah, I want to put a plug in very briefly for Moby Dick.
[00:17:24] AS: Oh, interesting.
[00:17:25] MB: I’m going to move on from that. Moby Dick is such a great piece of American fiction that I think to get an understanding in this country and then I’m very into the sea and the ocean and all that. I’m a paddle boarder, so I love that stuff. On the business sense, there’s a couple books out there, Eckhart Tolle’s book is fantastic. I think 7 Habits of Highly Effective People is just one I falling back on for business purposes.
If you look and you read that book and it talks about the importance of education and time management. It’s all in there. It’s an old one, but it’s something that I read periodically and I’ve read several times.
[00:17:59] AS: It’s a great choice, Mike.
[00:18:01] KR: Right. The last question, what’s your number one key to success?
[00:18:05] AS: I’ll go with my number one key success is Michael. I will say that –
[00:18:10] MB: You’re going to make me cry.
[00:18:13] AS: What I will say is that mentorship is really crucial. Working with someone that has as much experience as he does in this area and Mike is an example of a mentor. I have mentors in my marriage, in my raising my children, in my spiritual life. I think that that’s a really crucial thing is, having people in your life that you can really honestly talk to in different areas who are more specialists who have a track record. I would highly encourage it. People are so disconnected and advice is so generalized that unless someone can know you and your give situation, you’re missing out. That’s my one key that I have.
[00:18:51] MB: Yeah. I appreciate that, Alex. I talked about 7 Habits of Highly Effective People, if you spend a lot of time on LinkedIn like Alex and I do, there’s a lot of people that talk about time management. I see all these people and the one thing I often see that scares me is that a lot of people are too dedicated to their businesses. I think you have to have something outside of making money and work that drives you.
We talked about, I think the three of us, our kids, our family are so, so important. You also have that outside interest. You have to have some things that recharge your battery. For me, when exercise regime has been very important throughout my career. I’ve been a runner since I was in high school. I still run four to six days a week. It clears my head. it makes me more productive through the day. More importantly, I just enjoy it. I enjoy that time outside being in nature. Likewise, as I mentioned, I paddleboard too when the weather permits. Both those two things together and the other activities that I do drive me, let me recharge my battery, reset and just add purpose and value to living.
[00:19:53] KR: That’s great. Now, I think that those are awesome keys to success. I think both are extremely important.
[00:19:58] AS: What’s yours?
[00:20:01] KR: You’re the first one to ask me that. Look at this. My key to success is well, I mean, honestly to play off of you guys, a mentorship. I’ve had mentors in various aspects of my life that have propelled me faster and further than I ever thought I would be. Mentorship, I can’t go beyond that. Also, one of mine is meditation. Like exercise, just spinning that time each day to get focused, quiet your mind, helps me stay engaged, stay present, and be able to really hone in on what’s important.
[00:20:32] AS: Do you use an app or some guidance.
[00:20:35] KR: I use Headspace.
[00:20:36] AS: Headspace. Yeah.
[00:20:37] KR: I’ve used a few. I’ve done it on my own as well. The reason I like Headspace is because it tracks it for you. It makes it very easy. It’s not something you have to think about. You just go in every day and you’re able to update and it keeps track of how many minutes you’ve done it and all that good stuff, so there’s some gaming to it. Yeah, that has been extremely valuable for me over the past few years. As my life continues to get crazier, that’s the thing that helps me stay centered and maintain.
[00:21:03] MB: That’s great, because I’m terrible at meditation. I get into a meditative state through running, but sitting and meditating I’m really bad at. I’ll have to check that out.
[00:21:11] KR: Yeah. It’s something that you could start for just five minutes, or even one minute. You just sit there and you concentrate on your breath and that’s really all it is. There’s no right or wrong way to it, but it’s something that I find if I don’t do it for a while, I actually get almost a little anxious about being, “Oh, I have to sit down for 15 minutes.” Your brain, you have to unwind things and then you start to actually look forward to it and you can use it as part of your process. Yeah, I would highly recommend it.
[00:21:39] MB: Yeah, that’s great.
[00:21:39] KR: Well, thank you guys so much for being here today. I think to summarize things quickly. Some of my big takeaways were just because you’re a qualified intermediary doesn’t mean you’re necessarily qualified as an investor. You need to be doing your due diligence on the organization and making sure that the organization truly has the expertise and the technology and the know-how that you guys obviously displayed here today, so I appreciate that.
Don’t let the tail wag the dog. Like we said a couple of times, to pay the taxes, then put yourself into a poor investment just to save on that. As we think about being limited partners and investing in syndications, it’s important to understand what a drop and swap is. It is possible to get into a syndication using a 1031, but it takes a lot of upfront planning and you have to have a syndicator who’s willing to work with you in a Tenant in Common relationship. While it is possible, it’s definitely more difficult and it takes some additional conversations.
Then we learned about Delaware Statutory Trusts, which I didn’t know about, so I appreciated that extra information is the fallback to using a 1031, to make sure that you are able to save on those taxes if you haven’t identified a good property.
A lot of great information today, guys. I really appreciate you being on the show. Last but not least, how can folks reach out to you if they want to learn more about what you guys do and about 1031s?
[00:23:02] MB: Yeah. For me, e-mail is typically best. I’m really good at getting back on my e-mail. Unfortunately, I look at too often and I haven’t figured out that four-hour workweek yet that Tim Ferriss talks about. I look at my e-mail all the time. You can reach me at firstname.lastname@example.org. I’m also on LinkedIn, so you can always look me up there. And Alex?
[00:23:21] AS: Yeah. The best way to reach me is through LinkedIn. That’s a great platform to reach out to me.
[00:23:26] KR: Great. I’ll make sure we include out in the show notes for you guys. Thanks again. Alex, Mike. Thanks for being on the show, a ton of great info. With that, we’ll sign off and now I hope that you all can take this info and go out and passively invest like a pro.
[END OF EPISODE]
[00:23:41] KR: Thanks for listening to another great episode of Ritter on Real Estate. Hit the subscribe button to make sure you don’t miss out on the content that will make you a better investor. Also, visit kentritter.com for articles, videos, and tools curated just for passive investors.
Until next time, this is Kent Ritter with Ritter on Real Estate. Now go out and invest like a pro.