Performing A Real Estate Exchange With Luke Hays
2nd April 2020 • Business Leaders Podcast • Bob Roark
00:00:00
00:45:45
Shownotes
Many financial and real estate professionals out there, including CPAs and attorneys, don't know anything about real estate exchanges, and how these transactions can help their clients. While seemingly byzantine at first, this system of exchanges actually yield a lot of benefits for people who are looking to reinvest their money in different kinds of real estate, sometimes even to diversify their portfolio. Luke Hays is a Vice President and Business Development Officer at IPX1031, where he specializes in real estate exchanges. Luke speaks to Bob Roark about the basics of real estate exchanges, and how one can navigate the processes involved. If you're looking to reinvest your assets, don't miss this conversation. It might just be what you've been looking for!
Real Estate Exchanges: There's a particular knowledge gap about exchanges, and particular attorneys and CPAs just don't have the time.[/caption]
I'm in Colorado and you're in Tennessee. If somebody is from Wyoming, there are qualified intermediaries with your companies scattered throughout the United States, correct?
Correct, we have representatives across the US, even in Hawaii. My region specifically is Tennessee, Alabama, and Mississippi. However, I can handle an exchange anywhere in the US and our Southeast office can handle an exchange anywhere in the US. That's where 1031s must occur, in the US. We're not trying to help other countries’ economies. I always joke, “Unfortunately, you can't sell here in the US and buy a chateau in Paris,” even though we wish we all could. This is an economic stimulus. It's to help stimulate the US economy. It does need to be in the US. Another question I get is, “If I use yourself, myself and IPX, do I have to wait two years to use you again?” No, that's not correct. We are a third party to the real estate transaction. I'm never going to be involved and offer acceptance, contract negotiations, specific tax or legal advice, any of the closing documents. Our sole role is to advise on 1031 issues, to gather the documents for the exchange, to set up the exchange, then to pull the proceeds. We separate ourselves in that way. Thereby, they will never disqualify so we can handle multiple exchanges from the same person.
That's all you do. You're the 1031 wizard in Nashville.
Years ago, an attorney had the entire market and he retired. I think that’s maybe why I was brought in. They saw an opportunity. The Southeast, in particular, is an area where a lot of out-of-state investors are going, particularly from California, New York, and Chicago for a couple of reasons. In Tennessee, there's no state tax, which is quite valuable in Texas and Florida or other states without any state income. If someone's selling in California where they're having a 13.3% state tax, Tennessee looks pretty good in terms of, “Maybe that's where I want to take my investment dollars and reinvest into real estate in Tennessee.” I would say another reason is people are looking for value buys. They're looking for properties that they think will grow in appreciation significantly over the years.
We released a newsletter that went over the top 30 cities where people want to buy. I was lucky enough to have 6 or 7 of those cities in my region. There are a couple of those cities in Alabama. Alabama, Tennessee, and the Southeast in general, is a major area, but 1031s are being done across the country. My biggest obstacle is the lack of knowledge here in the Southeast. In California, they know about 1031s. For commercial real estate, it is done almost 80% to 85% of the time. I would say in Tennessee, Alabama, Mississippi, it's probably less than a quarter of the time. That goes back to the educational role. People don't know when their properties qualify. They don't know when to set it up and that's why I'm here.
I think about the ability for you to reach out to the individual person that's the real estate holder, there's one of you. I think about the people that influence that, whether it's the business broker helping the business owner sell, the real estate crowd, the state planning people. Any of those types of people that have financial advisor types, that maybe have the people that they're trying to advise on how to take instruction in what they're doing. I would say that from my experience, there are not many guys that are in the wealth management space that is much up to speed on 1031s either.
I would agree with that assessment. We can go over the benefits and we can separate it out for the investor, the agent, the broker, in terms of marketing it out and pushing it out more. CPAs and attorneys go down the line. For the investor, the biggest thing for 1031 is you're not giving any money to the government when you sell your investment or business-use property. Let's begin with what qualifies for 1031s. It is any type of real property with an investment or business-use intent. Typically, there are a variety of things the IRS looks at, but the necessary holding period for a piece of real estate would be a year and a day. That gets you in that long-term capital gains tax rate.
[bctt tweet="Not a lot of people know about exchanges. They don't know when rules apply." username=""]
The types of properties that would qualify, it could be raw land, farmland, timberland, water rights, mineral rights, air rights, residential types investment properties like single-family rentals, condos, apartments, multifamily, commercial, triple net lease, industrial and Delaware Statutory Trust. What I'm trying to say is there's a portion of the code that a lot of people misunderstand, perhaps maybe the number one misconception is the like-kind portion of the code. The code says that in order to defer your taxes, you need to buy a replacement property of like-kind. A lot of people think if I sell a commercial building, the only thing I can buy is commercial. If I sell a piece of raw land, the only thing I can buy is raw land. It's the exact opposite. You can sell them by any type of real property, as long as you have the same investment or business-use intent. It's the intent that matters.
That's the first thing for the investor. They're not pigeonholed to a certain property. If you have readers who own a small business, they can sell that business and maybe buy something completely separate. They can go through the list in terms. As long as it's real property, it can qualify from a 1031 perspective. People exchange for a number of reasons. It generates cashflow. You can sell something that's not producing any type of income, buy something that will produce income. Properties that are fully depreciated, you could sell those and maybe buy up in value. A lot of our clients do buy up in value because they're not giving any money to the government. When you buy up in value, you may be able to take depreciation on that new property.
Let's say I'm a business owner. I own the real estate and my business separate from my business. I'm interested and I have a buyer for my business. If you think about the business, the guys find the business might want to buy that building too. You think about the business owner trying to fulfill his income requirements to retire and you go, “Do you want to take in 1031 that piece of real estate into another one that cashflows somewhere else and avoid that gains tax on the real estate alone?”
A classic example would be a doctor that's retiring. He sells his practice and real estate. He's not going to buy another doctor’s office. That's why he's retiring. That person can go out and buy a beach house and rent it out. After a two-year restrictive period, there are ways for people to buy their second home or vacation home via 1031 exchanges. You're exactly right. People that are tired of maybe property management, there are mechanisms for them to buy something to defer taxes and, at the same time, buy something that is not as heavy on the property management side. Triple net lease properties are a classic example of that. That's your CVS, your Walgreens. The Delaware Statutory Trust, I don't know if you're familiar with a REIT, Real Estate Investment Trust. A Delaware Statutory Trust or DST is a way for someone to buy into a trust. This trust can have a number of properties. You have that automatic diversification and it's run by a major DST company, a large property owner. You get a monthly check in the mail based on the returns. That's completely management free.
I think the readers are probably going, “There's a ton of things that can be done.” The thing that strikes me about all this is as for a lot of these people, they're building their team. They've got their CPA, attorney, real estate agent and maybe a business broker. What strikes me is they need to have a 1031 person on their team too. They could say, “This is my goal. I want to do the following things.” It's like going to the doctor and saying, “My head hurts right here, but I'd like an appendectomy.” How do you know that's what your problem is? For the readers, there's a lot to know. There are a lot of permutations. My sense is that for them to reach out and bring you on or bring the 1031 people on the team, you're there to take and offer alternatives.
When I give classes, towards the end, I see in people's eyes the fear of maybe having a client that wants to do an exchange. One way to do a 1031 and to try and alleviate some of those fears, is limiting requirements. If you're an agent, a broker, a CPA or an attorney, the only thing I would need would be your client's contact number. If they decide to do an exchange, we will then need the signed purchase contract, and the title commitment. From an investor perspective, I need time to speak with you in regards to does your property qualify? In every consultation I give, and I'm pretty sure this applies to everyone in my company, they're complementary, meaning we don't charge unless the closing has happened. I don't want to say for people to use-abuse, but if they have questions about, “Does their property qualify?” I love taking those calls. Those are educational opportunities for that investor.
A lot of times, even if they're not able to do an exchange with their current property, at least they're able to prepare for the future and know what to do in order to make that property qualify for a 1031. The end goal with most people who are doing exchanges is to continually defer their taxes so eventually when they pass, they're going to leave these properties to their heirs. When an heir receives a property, they get an appraisal done. They get a step-up in basis. An example is, if I have a $1 million property with a $100,000 basis, $900,000 of tax will gain and that property is inherited and the appraised value is $1 million. My basis is stepped up from $100,000 up to $1 million. If I sold for $1 million, my basis is a million, how much do I pay in taxes?
[caption id="attachment_5027" align="aligncenter" width="600"]
Real Estate Exchanges: A lot of people have different ways to invest their money, but real estate is one of the safer options, barring the 2008 market collapse.[/caption]
I think it's in the round numbers.
It's nothing. We call that swap until you drop. Our clients are trying to continually defer these taxes until they'll go away via that step-up in basis. You can think of that as similar to the American dream or building generational wealth. You're trying to leave your heirs in a better situation than you. A lot of people have different ways to invest their money, but real estate, besides the 2008 collapse, it's one of the safer options. Even if you're not strictly investing in real estate, you want to have diversification in your real estate portfolio or in your investment portfolio. A lot of our clients who have these properties, they're using 1031 to diversify to make sure that if the market turns, they're at least getting steady returns even if not as high as it was. I would say, nowadays, it's top of the market in terms of what people are getting on returns and investment real estate. It's that diversification. It's deferring those taxes and hopefully eventually, having them go away.
Let's walk through this innocent process. Here I am, I'm a potential 1031 candidate. I have a piece of ground A and I want to defer taxes. On top of that, I want to leave a high tax location and go to a low tax location. How far ahead of time do I need to reach out to you?
Believe it or not, people will call me an hour before they close. It's not that dissimilar from the people that will call me after they close. They're still going to get the name wrong, but we can handle those exchanges. We call them rush exchanges because everyone's trying to rush to get the documents in. As long as you haven't closed yet, we can set it up. I would recommend probably when you're under contract for the property or selling would be the best time. The time between contract and close is 30...
---
Watch the episode here:
[embed]https://www.youtube.com/watch?v=J_YCobtceXY[/embed]Performing A Real Estate Exchange With Luke Hays
We're very fortunate because we have Luke Hays out of Nashville, Tennessee. He's with IPX1031. Luke is a specialist in Real Estate Exchanges. With that being said, welcome to the show and tell us a little bit about what you do and how you got here. We're very fortunate because we have Luke Hays out of Nashville, Tennessee. He's with IPX1031. Luke is a specialist in Real Estate Exchanges. With that being said, welcome to the show and tell us a little bit about what you do and how you got here. I was born and raised in Birmingham, and went to Alabama for undergrad. I hope that doesn't scare away some of your readers. I went to law school at Tulane and then after law school, I joined IPX. As an attorney in Tennessee, my sole practice is 1031 exchanges. In the company I work for, IPX1031, we act as a qualified intermediary. I'm sure at this point you have no idea what that is and that's most likely why I'm on here is to go over some of that terminology, as well as the 1031 exchange as a whole. I usually like to begin with a call I normally get because I give a number of continuing education classes to agents, brokers, CPAs, real estate attorneys. This is a small part of the code. I'll address the background of the 1031 exchange, why it was implemented and why I worked with IPX. The call goes something like this, “Luke Hays, IPX.” “I want to do 1055.” If someone's in a rush, if they're in a hurry, they're going to get the name wrong. They're going to call 1055, 1088. They're going to say, “I don't want to pay any taxes.” I'll say, “Where are we at in the real estate transaction?” They'll say, “I closed and I have the funds. What is my next step?” Unfortunately, the bad news is coming at this point because I have to inform them that their next step is to contact their CPA or tax advisor. The number one rule in a 1031 is it has to be set up prior to the close. You would think that would be something that everyone would understand. It goes into a lot of what I do, which is more of a teaching element. Not a lot of people know about exchanges. They don't know when the rules apply. Maybe they have some rules correct, but the other rules are incorrect. My role is the combination of an advisory role as well as a teaching role and setting up these exchanges. Many people, we all specialize and people don't know what they don't know. In the 1031 space, it sounds pretty simple to say, “Consider doing 1031.” Anything past that, even if they know that much, there's a real acknowledged gap. I would agree, particularly attorneys and CPAs. They don't have time. It's a small part of the tax code; they don't have time to comb through the way we do. If I was an attorney in private practice, I wouldn't be able to do 1031s. I wouldn't be able to apply the bonding and insurance necessary to set up these exchanges. I wouldn't have the resources needed that IPX provides as a QI. We’ll address some things to look for in qualified intermediaries, but you do need a national presence in order to offer the clients, the exchangers, the investors some low fees as well as sufficient bonding and insurance. For the people that might be going, “What's a qualified intermediary?” you've got the piece of real estate, the target piece of real estate and the intermediary in between. To begin with the 1031 exchange, you have to go way back to 1921. That's when it was created by the IRS. We're coming up on 100 years of exchanges. The basic idea is you have some real estate investors who might sit on their property because of the tax liability associated with the sale. You have other people that are maybe waiting to sell it in a new calendar year or leave it to their children or their heirs. There's a big group of investors that are maybe sitting on their property. 1031 allows those people to take the plunge, sell their property, and defer their taxes by buying another piece of property. From the IRS’s point of view, this helps create real estate transactions. It's considered an economic stimulus. A common question I get is, “If I do 1031, will I get audited?” I have to go back and say, “It's directly part of the Tax Code. We're coming up on 100 years. It was reaffirmed in 2018 the necessity for it. That's a common myth.” Going back to a qualified intermediary, you have to use a qualified intermediary to do a 1031 exchange. You might find this funny, but the definition from the IRS is in order to be a qualified intermediary, you must not be disqualified. We can only use tall people and if you're not tall, we can't use you. In order to be disqualified, you cannot be an agent of the exchange for within the past 24 months, the past two years. The final question that needs to be asked is, “Who qualifies as an agent?” For an investor, their broker, their agent, their CPA, their attorney, whoever they're going to use for the closing, if they're handling some of the legal docs associated with it, they're disqualified. Besides that, it is the Wild Wild West. Someone mentioned that to me one time and it stuck with me in terms of the lack of rules and regulations. As long as you're not disqualified, you can act as a qualified intermediary, but you have to use a qualified intermediary to handle 1031. That is exactly what IPX is. IPX1031 is a subsidiary of Fidelity National Financial. It is a Fortune 300 company, based in Chicago with offices across the United States. In our company, we specifically handle 1031 exchanges. That's the bit of the background on what a qualified intermediary is. [caption id="attachment_5026" align="aligncenter" width="600"] Real Estate Exchanges: There's a particular knowledge gap about exchanges, and particular attorneys and CPAs just don't have the time.[/caption]
I'm in Colorado and you're in Tennessee. If somebody is from Wyoming, there are qualified intermediaries with your companies scattered throughout the United States, correct?
Correct, we have representatives across the US, even in Hawaii. My region specifically is Tennessee, Alabama, and Mississippi. However, I can handle an exchange anywhere in the US and our Southeast office can handle an exchange anywhere in the US. That's where 1031s must occur, in the US. We're not trying to help other countries’ economies. I always joke, “Unfortunately, you can't sell here in the US and buy a chateau in Paris,” even though we wish we all could. This is an economic stimulus. It's to help stimulate the US economy. It does need to be in the US. Another question I get is, “If I use yourself, myself and IPX, do I have to wait two years to use you again?” No, that's not correct. We are a third party to the real estate transaction. I'm never going to be involved and offer acceptance, contract negotiations, specific tax or legal advice, any of the closing documents. Our sole role is to advise on 1031 issues, to gather the documents for the exchange, to set up the exchange, then to pull the proceeds. We separate ourselves in that way. Thereby, they will never disqualify so we can handle multiple exchanges from the same person.
That's all you do. You're the 1031 wizard in Nashville.
Years ago, an attorney had the entire market and he retired. I think that’s maybe why I was brought in. They saw an opportunity. The Southeast, in particular, is an area where a lot of out-of-state investors are going, particularly from California, New York, and Chicago for a couple of reasons. In Tennessee, there's no state tax, which is quite valuable in Texas and Florida or other states without any state income. If someone's selling in California where they're having a 13.3% state tax, Tennessee looks pretty good in terms of, “Maybe that's where I want to take my investment dollars and reinvest into real estate in Tennessee.” I would say another reason is people are looking for value buys. They're looking for properties that they think will grow in appreciation significantly over the years.
We released a newsletter that went over the top 30 cities where people want to buy. I was lucky enough to have 6 or 7 of those cities in my region. There are a couple of those cities in Alabama. Alabama, Tennessee, and the Southeast in general, is a major area, but 1031s are being done across the country. My biggest obstacle is the lack of knowledge here in the Southeast. In California, they know about 1031s. For commercial real estate, it is done almost 80% to 85% of the time. I would say in Tennessee, Alabama, Mississippi, it's probably less than a quarter of the time. That goes back to the educational role. People don't know when their properties qualify. They don't know when to set it up and that's why I'm here.
I think about the ability for you to reach out to the individual person that's the real estate holder, there's one of you. I think about the people that influence that, whether it's the business broker helping the business owner sell, the real estate crowd, the state planning people. Any of those types of people that have financial advisor types, that maybe have the people that they're trying to advise on how to take instruction in what they're doing. I would say that from my experience, there are not many guys that are in the wealth management space that is much up to speed on 1031s either.
I would agree with that assessment. We can go over the benefits and we can separate it out for the investor, the agent, the broker, in terms of marketing it out and pushing it out more. CPAs and attorneys go down the line. For the investor, the biggest thing for 1031 is you're not giving any money to the government when you sell your investment or business-use property. Let's begin with what qualifies for 1031s. It is any type of real property with an investment or business-use intent. Typically, there are a variety of things the IRS looks at, but the necessary holding period for a piece of real estate would be a year and a day. That gets you in that long-term capital gains tax rate.
[bctt tweet="Not a lot of people know about exchanges. They don't know when rules apply." username=""]
The types of properties that would qualify, it could be raw land, farmland, timberland, water rights, mineral rights, air rights, residential types investment properties like single-family rentals, condos, apartments, multifamily, commercial, triple net lease, industrial and Delaware Statutory Trust. What I'm trying to say is there's a portion of the code that a lot of people misunderstand, perhaps maybe the number one misconception is the like-kind portion of the code. The code says that in order to defer your taxes, you need to buy a replacement property of like-kind. A lot of people think if I sell a commercial building, the only thing I can buy is commercial. If I sell a piece of raw land, the only thing I can buy is raw land. It's the exact opposite. You can sell them by any type of real property, as long as you have the same investment or business-use intent. It's the intent that matters.
That's the first thing for the investor. They're not pigeonholed to a certain property. If you have readers who own a small business, they can sell that business and maybe buy something completely separate. They can go through the list in terms. As long as it's real property, it can qualify from a 1031 perspective. People exchange for a number of reasons. It generates cashflow. You can sell something that's not producing any type of income, buy something that will produce income. Properties that are fully depreciated, you could sell those and maybe buy up in value. A lot of our clients do buy up in value because they're not giving any money to the government. When you buy up in value, you may be able to take depreciation on that new property.
Let's say I'm a business owner. I own the real estate and my business separate from my business. I'm interested and I have a buyer for my business. If you think about the business, the guys find the business might want to buy that building too. You think about the business owner trying to fulfill his income requirements to retire and you go, “Do you want to take in 1031 that piece of real estate into another one that cashflows somewhere else and avoid that gains tax on the real estate alone?”
A classic example would be a doctor that's retiring. He sells his practice and real estate. He's not going to buy another doctor’s office. That's why he's retiring. That person can go out and buy a beach house and rent it out. After a two-year restrictive period, there are ways for people to buy their second home or vacation home via 1031 exchanges. You're exactly right. People that are tired of maybe property management, there are mechanisms for them to buy something to defer taxes and, at the same time, buy something that is not as heavy on the property management side. Triple net lease properties are a classic example of that. That's your CVS, your Walgreens. The Delaware Statutory Trust, I don't know if you're familiar with a REIT, Real Estate Investment Trust. A Delaware Statutory Trust or DST is a way for someone to buy into a trust. This trust can have a number of properties. You have that automatic diversification and it's run by a major DST company, a large property owner. You get a monthly check in the mail based on the returns. That's completely management free.
I think the readers are probably going, “There's a ton of things that can be done.” The thing that strikes me about all this is as for a lot of these people, they're building their team. They've got their CPA, attorney, real estate agent and maybe a business broker. What strikes me is they need to have a 1031 person on their team too. They could say, “This is my goal. I want to do the following things.” It's like going to the doctor and saying, “My head hurts right here, but I'd like an appendectomy.” How do you know that's what your problem is? For the readers, there's a lot to know. There are a lot of permutations. My sense is that for them to reach out and bring you on or bring the 1031 people on the team, you're there to take and offer alternatives.
When I give classes, towards the end, I see in people's eyes the fear of maybe having a client that wants to do an exchange. One way to do a 1031 and to try and alleviate some of those fears, is limiting requirements. If you're an agent, a broker, a CPA or an attorney, the only thing I would need would be your client's contact number. If they decide to do an exchange, we will then need the signed purchase contract, and the title commitment. From an investor perspective, I need time to speak with you in regards to does your property qualify? In every consultation I give, and I'm pretty sure this applies to everyone in my company, they're complementary, meaning we don't charge unless the closing has happened. I don't want to say for people to use-abuse, but if they have questions about, “Does their property qualify?” I love taking those calls. Those are educational opportunities for that investor.
A lot of times, even if they're not able to do an exchange with their current property, at least they're able to prepare for the future and know what to do in order to make that property qualify for a 1031. The end goal with most people who are doing exchanges is to continually defer their taxes so eventually when they pass, they're going to leave these properties to their heirs. When an heir receives a property, they get an appraisal done. They get a step-up in basis. An example is, if I have a $1 million property with a $100,000 basis, $900,000 of tax will gain and that property is inherited and the appraised value is $1 million. My basis is stepped up from $100,000 up to $1 million. If I sold for $1 million, my basis is a million, how much do I pay in taxes?
[caption id="attachment_5027" align="aligncenter" width="600"] Real Estate Exchanges: A lot of people have different ways to invest their money, but real estate is one of the safer options, barring the 2008 market collapse.[/caption]
I think it's in the round numbers.
It's nothing. We call that swap until you drop. Our clients are trying to continually defer these taxes until they'll go away via that step-up in basis. You can think of that as similar to the American dream or building generational wealth. You're trying to leave your heirs in a better situation than you. A lot of people have different ways to invest their money, but real estate, besides the 2008 collapse, it's one of the safer options. Even if you're not strictly investing in real estate, you want to have diversification in your real estate portfolio or in your investment portfolio. A lot of our clients who have these properties, they're using 1031 to diversify to make sure that if the market turns, they're at least getting steady returns even if not as high as it was. I would say, nowadays, it's top of the market in terms of what people are getting on returns and investment real estate. It's that diversification. It's deferring those taxes and hopefully eventually, having them go away.
Let's walk through this innocent process. Here I am, I'm a potential 1031 candidate. I have a piece of ground A and I want to defer taxes. On top of that, I want to leave a high tax location and go to a low tax location. How far ahead of time do I need to reach out to you?
Believe it or not, people will call me an hour before they close. It's not that dissimilar from the people that will call me after they close. They're still going to get the name wrong, but we can handle those exchanges. We call them rush exchanges because everyone's trying to rush to get the documents in. As long as you haven't closed yet, we can set it up. I would recommend probably when you're under contract for the property or selling would be the best time. The time between contract and close is 30...