Master the 1031 Exchange Strategy with Julie Bratton

Interview Transcription

ADRIENNE:
Welcome back, and thanks for listening to the Team Lally Real Estate Show, home of the guaranteed sold program, or we’ll buy it. I’m Adrienne and I’m Attilio. If you have any questions, you can reach us at 799, 9596 or check us out online at Team lally.com

ATTILIO:
our guest today earned her degree in our architecture. Almost said, agriculture. What is she a farmer? No, she ain’t no farmer and interior design from San Diego State University. She started her real estate career in 1994 selling homes and managing transactions for top agents recognized

ADRIENNE:
for her talent, she joined Old Republic to lead a statewide transaction service by May 2001 she was running the 1031 exchange department for Hawaii, and has since advanced to Vice President, leaving a strong legacy in the real estate World. Please welcome back today’s guest, Julie Bratton,

ATTILIO:
Hey Julie,

JULIE:
hi guys. How’s it going? Good,

ATTILIO:
good, good. So we want to talk about 1031 exchanges. And yeah, this

ADRIENNE:
seems to be coming up quite a bit. A lot of clients that you have misconceptions and are maybe not even aware of this. So option, Julie,

ATTILIO:
how long you been in the 1031, biz,

JULIE:
almost 25 years.

ADRIENNE:
Okay, almost.

ATTILIO:
Would you I feel like, I feel like you’re an expert witness ringcord and I’m the attorney. And would you consider self an expert in this field?

ADRIENNE:
I would say she’s mastered it. She’s at the mastery level one thing

ATTILIO:
you’ve been doing all this time.

JULIE:
So I know I can’t say I know everything. Every once in a while, someone tries to slide something by me. Yeah, you know, you’ve seen a lot,

ADRIENNE:
seen a lot of different situations.

ATTILIO:
I think it would be safe to say, you don’t know everything, but you do know a lot.

JULIE:
So let’s talk about that’s very safe. Yeah,

ATTILIO:
let’s tap into because it’s not like you’re doing this. And then you’re like an Uber driver on the weekends, and then, you know, you’re a professional surfer, you know, traveling around the world. This is, like, your one thing that you do that, and Bon Jovi concerts. This is it. So anyway, start with the basics. People hear that number. It’s what I call a buzzword. And a buzzword for our listeners is words that you hear and you you’re talking about it at like, one party or something like, Oh yeah, you know, I just deal with 1031 exchange. And your friends over there like, oh yeah, I know what that is. And then you start asking them some detailed questions. They don’t

ADRIENNE:
know what it is, or they’re confused a little bit about what specifically it is 1031

ATTILIO:
exchange, oh yeah, that’s what you know anyway, and they don’t know what it is. So help people you know, break through this buzzword called it, you. The basics of it. What is a 1031 exchange?

JULIE:
Okay, so, great questions. The 1031 exchange is for people who own investment properties. Yes, that’s number one. And if you own investment property and you sell it, a house, a condo, a commercial building, a industrial building, vacant land, and you have gain you would pay taxes on it, but the IRS has the 1031, exchange procedure that allows you to defer paying the capital gains tax if you follow a few steps, follow the rules, yeah, yeah. The rules is, as long as you are selling investment for you and you have gain 1031 allows you to just differ it. So you sell the investment property and you have to buy another piece of investment property within a specific period of time, and you can buy a couple of properties if you wanted to. So let me give you an example. If you sell something for 500,000 and you want to defer paying the capital gains tax, you would have to buy another property, or properties that are equal to or greater than 500,000 if you want to have 100%

ATTILIO:
deferral, gotcha So,

ADRIENNE:
Julie, if there’s a mortgage on this $500,000 property of let’s say 250,000 How does that work? Like you only have 250,000 left? Like do you have to buy, right?

JULIE:
So, yeah, that’s a big question for people as well. So good question. So when you sell the property for 500,000 of course, right before it closes, escrow is going to pay off all the fees, admissions and that mortgage. They have to pay off everything Yes, to make sure the new buyer gets clear title. So now, yes, there’s 200 let’s call it $250,000 left over that I’m holding. The exchange company is holding till you’re ready to buy the replacing property, and you’re thinking, Well, how am I going to get to 500 100% deferral. You have to replace that mortgage that you originally had on that relinquished property. When you sell it and it trans when I say you have to replace it, it translates as, if you have to get another mortgage, you don’t have to get another mortgage if you want to replace it with cash, you can. But that does hold up a lot of people, because they think, Well, I don’t want to get another mortgage, or I can’t get another mortgage right now because of my job situation or whatever. You can bring in cash if you want. It doesn’t have to be a mortgage, or you can bring in a little more cash and have a smaller mortgage. But as long as you get, I don’t care how you get to the 500,000 almost as long as you use all of the proceeds that you received from the sale of the relinquished property and use it for your down payment to the new property, you’re good.

ATTILIO:
Well, it’s, you know, it’s kind of like Monopoly, because, you know, when you say the gain, it’s the profit, you know, the profit that proceeds to the seller after it’s all said and done, you know, what’s hits your checking account? Well, would it hit your checking account? If it did, you can take like, 20, 30% of that, and Uncle Sam’s gonna get it, and Uncle Kimo stayed Hawaii,

JULIE:
yeah. Along those lines, that you’re just talking about. You know, when I tell you guys, you need to buy something equal to or greater than 500,000 Yeah, people don’t like that. They only want to buy something for 250 Yeah,

ADRIENNE:
yeah. So then what happens if they don’t get advice

JULIE:
you only Well, first of all, you only pay taxes on your gain if you are going to just outright sell. The taxes are on your gain, but in order for you to take advantage of this deferral, you actually need to reinvest both your basis, what you bought it for, and your gain. That’s why I’m concentrating on the sales price of 500,000 and not just the proceeds. Now, somebody just wanted to do 250 I’m going to send them back to their CPA and have them ask two questions. Number one, if I don’t do an exchange, how much am I going to pay depreciation? Number two, if I do do an exchange and only buy for 250 How much am I going to pay? Yeah, if it still makes sense and they’re going to diverse them, then okay, fine. But if it’s a wash, why be stressed out about going through the process of finding a replacement property in 45 days if you don’t have to, so it’s okay to buy less if you want to just the difference would be taxable. Yes,

ADRIENNE:
and just do it with making an informed decision, right with advice from a CPA, so you know what you’re into. And I would guess so

JULIE:
people do. People do partial exchanges all the time, but when we talk about it on the air like this, of course, we’re talking about the best case scenario, 100% deferral, but you can buy less and have a partial. Change if you want, as long as you’re okay with some taxable event, you’re going to have a check

ATTILIO:
to Uncle Sam. Uncle Kimo. You know, I would guess, another thing that

JULIE:
comes up a lot, thing that comes up a lot, is the timing. People are very stressed out about the timing, because you do have to do within the specific period of time. So when you sell this property, and let’s say, you know, the clock starts ticking the day they close on their sale. Okay, from that date, they have 45 days to identify what they’re gonna buy and 180 days to close on it. So that 45 days is really stressful for people, but

ATTILIO:
not 45 plus 180 it’s

ADRIENNE:
45 days to identify and 180 days,

ATTILIO:
yeah, the start time on the 45 and what I’m saying is the start time on the 45 and the 180 is the same day,

JULIE:
yes, yes. 45 days is included in the 180 so you don’t get 45 and then a fresh 180 Yes. So the 45 days is stressful for people. And you know, when you identify property, it’s not a requirement to have an accepted offer, yeah, but you have to purchase something that’s on your list. So you can make changes to your list

ADRIENNE:
all the way up until day 4044 change them.

JULIE:
45 Yeah, you can make any changes to you, as you like, up until the 45th day. So the 45th day, I would need the final list,

ADRIENNE:
and then how many? How many properties can be on this list? Julie,

JULIE:
so two ways to identify. The first way is three, three property rule, where you can identify up to three, which is fine, of any value. The second rule is the 200% rule, and you only use this if you want to identify four properties or more, okay, and if you do that, you have to add up the fair market of all the properties that you list, and that fair market value cannot be double or 200% or over double or 200% of what you sell your relinquished property for. So if you sell something for 500,000 and you want to identify four properties, or five properties or more, that list can exceed one penny over 1 million, like you can’t go crazy and identify an entire neighborhood and later, which is probably what somebody did, and that’s why we have that’s why we Yes.

ATTILIO:
But can you? Can you sell a $500,000 property and buy a $2 million property?

JULIE:
Absolutely. So then you’re gonna be identifying under the three property rule, yeah, three properties,

ADRIENNE:
yeah, yeah. So one of the things that atilio And I always advise our clients, especially the ones that are wanting to do this. 1031 exchange is to add the DST as one of the properties on the list, just to, you know, make sure, in case something happens, right with properties financial

ATTILIO:
advisor in Waianae said, make them one of the tree, yeah,

ADRIENNE:
just in case, because anything can happen, right? When you’re doing this, like you’re in the j1 you’re doing some negotiations, and, you know, maybe the house is not in as great condition, and you don’t want to buy that house. Yeah,

JULIE:
you know, I know on your show, you have talked about DST, so that’s great. It is a more. It is an option. It is a replacement property option. And I think people in general have really been warming up to this concept because of the market that we’re in, the inventory that we have, the interest rates that we have, and it’s a hands off approach. You know, you can’t go drive by it, touch it, smell it, feel it, but it accomplishes everything you need to do. You defer paying your capital gains tax, and you get income. And, you know, it’s been around for a long time. I think 2004

ATTILIO:
Yeah, and, and I’ve been doing

JULIE:
this for a really long time, but I really think now it’s in this environment, people are starting to pay attention to it a lot more. Yeah,

ATTILIO:
and DSTs are invested into things. I’m not sure if anybody’s heard of these businesses, Amazon, distribution centers, Walmart, storage

ADRIENNE:
facilities, storage facilities. Yeah, you know how I how, how

JULIE:
I describe it is, you would be putting your money instead of a house or condo. You’d be putting your money in and with shares of other people, you would buy a percentage interest in a certain asset class, maybe student housing. Maybe it’s an Amazon storage building. Maybe it’s a medical facility, and it and the probably the biggest thing people have to get over is that they have to look at it, at a set as a long term hold, yeah. It’s not something you can just call up and say, Okay, I want to sell it. Yeah. So that’s probably the only little you know,

ATTILIO:
too. If you buy an investment property and you got a tenant in there and you just signed a lease.

ADRIENNE:
Yes, yeah. Well, I mean, then, you know, the other thing that I want to bring up about the DST is, we had a client who thought, oh, once I 1031 exchange into it, I have to, like, stay in that or

ATTILIO:
I can’t get back into real estate, yeah? So,

ADRIENNE:
like, once the the life of the DST has, you know, like, let’s say it’s time to sell on the DST. Whether it’s a five year cycle, or seven year cycle. You can 1031, out of that and back into a single family home or condo or commercial property, like whatever you can do both, or a combination

JULIE:
you can, you can get out of it. And you like the DST, but you want to be a little bit more liquid. So, you know, put $100,000 in the DST and then buy your 800,000 house. Dollar house Exactly. Do both? You buy two replacement properties. So it’s really a good conversation to have with investors, especially if they’re stuck, and it’s a very good way to diversify your portfolio. You know one thing, all the same results. You get all the same results. Real

ATTILIO:
Estate, yeah, without the terrible tease the tenant or or, in Adrienne’s case, teenagers. But

ADRIENNE:
hey, Julie has some teenagers. She had a teenager too. We’re

ATTILIO:
all we’re all once teenagers also. So we’re putting the finger at ourselves. But the main thing is, yeah, that’s you get two of the three, equity growth income without direct property management and with the other with the real properties. You have to, you know, you have property management either by yourself or by a third party. Talk about what they call, you know, the real quick to disclaimer for everybody. We are making this conversation very simple, but I would tell you, no matter even how much Adrienne and I, as 20 year veterans in real estate, understand the 1031, exchange, we wouldn’t do it without an intermediary,

ADRIENNE:
which is what and what is an intermediary? What are the qualifications to be an intermediary? What is that?

JULIE:
Okay? Well, that’s what I do. The IRS. Does you have to have a Qualified Intermediary when you do an exchange? So we’re not escrow. We are the facilitator that handles the exchange. So we, you know, obviously set up the exchange, tell you all about it, but we draft the exchange documents. We review contracts, title reports, settlement statements. We of course, draft the exchange agreement, the assignment agreement, and we hold the money in an exchange. The exchanger, slash seller is not allowed to touch any of the proceeds. So what I think the consumer knows us for, mostly, is to hold the money. We hold the money until they’re ready to buy the replacement property, and then when they go to buy the replacement property, we’re reviewing contract. Reviewing contracts and title reports and settlement statements and just it’s quite the orchestration to do an exchange. But what’s super interesting is it’s an unregulated field, and anybody can have a business card printed up and say they’re a Qualified Intermediary, which is pretty crazy. Could be handing over hundreds of 1000s, maybe millions of dollars, to a QI that doesn’t have, you know, any oversight. They can take your money and invest it in whatever they want. They can go to Tahiti. I mean, when the market crashes, that’s when you see, you know, the intermediaries go out of business and take your money. Yeah, wow. So it’s a very, very interesting. I mean, us, we at Old Republic exchange, we have, like, a $50 million fidelity bond, you know, we have all of those bonds and insurances in place for all all things. But one thing is really kind of cool, just if I can give myself a little plug, is older public exchange, just last year, had their 30 year anniversary as a company. Nice, and we are very proud to say that we have never had an exchange fail on an audit for something that we have done, and we’re super proud of that. That’s awesome.

ATTILIO:
That’s when the IRS comes back and say, Oh, you owe capital gains. No,

JULIE:
I know. Well, you’re, you know, your companies get audited too, and we are one of them. So you know where it’s been. It’s nice to know. Yes. So one thing I wanted to mention on the exchange, though, if we have some listeners here who are really, you know, worried about finding a replacement property in 45 days, I’ve been starting to have this conversation with people, and I feel like it kind of relieves some angst. So when people are looking for replacement properties, I don’t think they realize that you’re just looking for an investment property. It’s, I think they start looking for perfect, and they don’t even realize they’re looking for perfect. They’re not going to live there. They’re not going to marry it. They’re not stuck with it. Of course, don’t buy a piece of junk, but if you have to make a lateral move just to defer the taxes, do it? Hold on to that property for a year or so. If you still don’t like it, you could always sell it again and get into something you want. When things calm down or it becomes available, it’s

ADRIENNE:
like you gotta look at the numbers, right? Getting in the wrong way, yeah? What? So you gotta be looking at the numbers. Not so much of like, oh, do I like this, you know, neighborhood or the style of the house? Like, do the numbers? Yeah.

JULIE:
So I was support. I was talking to this couple, and she was trying to show it on the house, and the husband was like, Well, I don’t like the street or I. Like this. And she’s like, What do you care? I’m not gonna live there. What do you care? I’m not gonna that was her answer for like, five of his objections. And then he’s like, oh, yeah, you’re right. It’s gonna be good for investment properties. I might not be good for me, but it’s gonna be a great investment property. So

ADRIENNE:
get out of your own way. Yeah. Now Julie is

JULIE:
so innocent. It’s so innocent. They don’t do it on purpose. They don’t realize, they start getting into their that trap. So

ADRIENNE:
there’s like, there’s another, I think it’s like, not as well known, or it’s maybe a little bit more expensive, but there’s another strategy. It’s called a reverse exchange. Why don’t you share with our listeners what that is? Because that kind of like, I guess, helps you to have a little bit more time on that, identifying the property well,

JULIE:
it doesn’t really give you more time. It’s more expensive. It what it does is, so a regular exchange, what we just described is where you sell first and then buy, yes, so you’re selling, and you have your 45 days to find something, and you close on it, 180 a reverse exchange is, if you get into a situation is where you have to buy first. You find something you love it. It’s to die for. You have to have it and you go, but I have to sell this other investment property that I have in the Lonnie first. That is a reverse exchange where you buy first and then sell. Yeah, it’s the timeframes are the same, but in reverse. So you still have 180 days to sell your relinquished property. Gotcha. So it’s more expensive. It’s, you know, a regular exchange is $950 when you sell, $575 when you buy. But a reverse exchange, just to give you perspective, starts at 8500

ATTILIO:
Yeah, remember that? Because we had one client start one, but they’re like, oh, never mind. Yeah?

JULIE:
Well, you know, 8500 compared to a regular exchange, yeah, it sounds really high, but if you find a property, or your client finds a property, that’s great, and they really want it, $8,500 is probably a drop in the bucket compared to what they’re going to pay in taxes. Yeah, so you know, if they have a $200,000 tax bill, but they can get the property that they want and still defer paying capital gains tax on $8,500 doesn’t look so bad. So again, that’s not for everybody, if you have to put it in perspective, but it does allow somebody, if they can meet all of the requirements, to buy first and then sell maybe the a lot more of these reverse exchanges. Adrienne, so it’s a good thing you brought it up, and I’m doing a lot more of them, because people are so stressed out about finding a replacement property, they’re like, You know what? I just want to find it for. Yeah, we

ADRIENNE:
actually know we had an offer by relinquished property. We had an offer come in on one of our listings, and it’s a buy, the buyer is doing a reverse exchange. So it’s like, we’re starting to see them more often as well. So yeah, I thought it was important to just, you know, to bring that up, because it’s not like, maybe not commonly, maybe they

ATTILIO:
identify the property, and it’s such a good deal that if they wait to sell a subject property, that it’ll be gone. So it’s worth it to make a move now. That’s a

JULIE:
perfect, yeah, that’s a perfect example, yeah, yeah, perfect.

ATTILIO:
And, you know, it’s

JULIE:
available.

ATTILIO:
That’s a key people don’t know. They’re like, Oh, I guess I’m gonna just take it in the shorts on the capital gains. Oh, wait, there’s a reverse. There’s a

ADRIENNE:
strategy for that one.

ATTILIO:
I did not know that.

ADRIENNE:
Yes, not great. That’s

JULIE:
why they have to have experienced Realtors identify these objections as soon as possible, yeah, so they can move their

ATTILIO:
client in the right direction, yeah. And always bring in the experts, because

JULIE:
there’s a lot of objections out there that are, that are very easily can be moved to the side if they have the right people, yeah, and

ATTILIO:
the knowledge and all of that. So you, I think one of the other things too, that you mentioned is people wait to the last minute to call you. Call you now.

JULIE:
Get that all the time. Yeah, I get that all the time. I mean, I can do documents really quick. I don’t mind doing that. But a reverse exchange, though, we need at least two weeks notice for a reverse. There’s no such thing as a rush reverse, but a regular exchange. I mean, I usually tell people, when I talk to them on the phone, that as soon as you get an accepted offer on the property, let me know that’s when I can get started. Yes, I mean, if you decide not to do it, you decide not to do it, but at least you’re ready, and that’s one thing off the table that you don’t have to make scrambling for. Yeah, your your inspections and your deposits and all of that kind of stuff. Yeah? So I Yes, but I can do it at the last minute.

ATTILIO:
And I think for you it’s important to I think it’s important to bring somebody in like you, and you’re the only one we recommend. So people are like, Well, who else you recommend? Julie. Who else? Julie? What a third one. Julie.

ADRIENNE:
Julie, thank you. I appreciate. I have a question that I know I’ve probably asked you this before, but like, let’s say that a homeowner, like, they live in part of the house and then they, like, rent out two other units, but it’s like, owner occupant slash rental. So can they be excluded for the capital gains, for like the homeowner part, like the 250,000 and then exchange the rest, or defer the rest of the game when it’s kind of like a

JULIE:
half and half? It’s possible. So my question to you, or whoever I’m talking to in that scenario, I would say, I would ask them, what percentage of this address do you allocate for investment on your tax returns?

ADRIENNE:
So it all has to do with how it’s reported on the Yes. And

JULIE:
then we will apply that percentage to the sales price and move on. And then they can do their personal residence exclusion on the other portion. Gotcha. IRS likes to see consistent consistency, so that’s why I say, Well, what? How do you do it on your tax returns?

ADRIENNE:
Yeah, so it just needs to match that. Yeah, it was always curious about that, because there’s, you know, we come across clients that have, you know, they rent part and they live in part. So yeah, I’m glad they’re just a little pocketing the

JULIE:
money, and they’re not reporting their income. Then it’s really going to be hard for the IRS to believe.

ADRIENNE:
Yes, yeah, there’s

ATTILIO:
not a tax code for the under the table stuff anyway. Yeah,

JULIE:
I don’t check, you know, but you know, that’s on them. Yeah?

ATTILIO:
Okay, all right, Julie,

ADRIENNE:
all right. Well, we we’ve got a couple minutes left. Is there anything that we didn’t cover that you want our listeners to hear before we wrap things up with you. Julie, yeah,

JULIE:
no, I think we did pretty good. I really just wanted to stress the the people when they’re looking shopping for a replacement property like I really wanted to I’ve been really having this conversation with so many people lately, and I can, like, see the light bulb going off over the phone in their heads. In fact, I talked to a girl the other day, and I was like, remember, you’re not looking for perfect I mean, if, of course, you want a great property and be a great rental, but you’re not going to live there. And she’s like, I’m so she started laughing her and her husband were on the phone. She’s like, I’m so glad you said that, because that will totally be me when we start searching for properties. Yeah. So I mean, like, yeah,

ATTILIO: 
if the numbers work,

JULIE: 
shopping for property, that’s it. Some people list their properties when they start listing, if you know you’re going to get an offer fairly quickly, I would really start being more serious about shopping. You know, go through the areas, the projects you like and you don’t like. So when you’re in your 45 days, you either already are in contract with something, or, you know, pretty close what you’re going to buy and that you can buy it. Yeah, so otherwise, that 45 days is stressful, and yes, the DST is a great plan B or A plan one. People don’t want to get into real estate anymore, exactly.

ATTILIO: 
Well, thank

ADRIENNE: 
you. Thank you, Julie, yeah, thanks for all the info on the 1031 All righty, thanks so much for having me see each other soon. Yes, bye, Julie. Take care. Bye, bye.

Follow Us On Social Media