Owning real estate has some major benefits. For instance have you ever heard of a 1031 exchange? Property owners can use this transaction as a great way to build wealth and avoid paying capital gains taxes on real estate with the help of a real estate expert in Contra Costa County and a reputable title company. View the video to find out, how does a 1031 exchange work in California? Enjoy!
Hi there, I'm Elizabeth Russo and today we're going to talk about the 1031 exchange and find out if this is something you need to do. I've brought Toni on with Old Republic Exchange to chat with us about what is an exchange. Toni.
Well, I'm Toni Esposti. I'm with Old Republic Exchange and an exchange is a tool for people who own investment real estate or real estate that they use in their trade or business. If they want to be able to sell this property and not pay capital gains tax to the government they can use and exchange.
What they would need to be doing though, is their plan would need to be to sell a property and then buy a property as well. If it structured like an exchange, then you can defer. This is a great way to build wealth and people with loans and people with cash can do this and avoid capital gains. That's correct. The wealth building tool can be really powerful. I've got a slide presentation here that is interesting and it shows an example of two people who buy properties at the same time at the same valuation. It shows them putting down 25%, assumes maybe 4% appreciation. You can see when you go through these that the difference if you sell and pay your taxes as you go in real estate versus doing exchanges. It can just be incredibly powerful and you can end up with a good deal of real estate wealth this way. Obviously, as we can see.
Who qualifies for a 1031 exchange? Well, people or entities. It could be a corporation or a partnership who own property for an investment or use in their trade or business. It's really more about the property and whether the property qualifies as to whether or not it will work. The property needs to be something that they have owned and held for investment for a period of time. It can not be something that you are just buying for the purpose of reselling, so flipped properties are not a real good fit.
Now, I had a client ask me, hey I have residential and I really want to go to commercial and I'm tired of, what do you call those the three T's. Oh, tenants, toilets and trash. I've got to tell you I'm tired of the tattle-tales too. For people like me that want to trade out into commercial property is that possible with a 1031 exchange? Absolutely! That's ones of the more misunderstood aspects of exchanges. There is a requirement that you buy something that is like-kind. Like-kind when you are dealing with real estate, is just what was the intention of ownership. Did you hold it for investment and did you hold it for use in your trade or business and is the property you are going to buy something that you are going to hold for investment or use in your trade or business and it's interchangeable. People can go from residential rentals to commercial, from commercial to retail, retail to industrial, industrial to apartments.
What about anther one that brings into my mind. What about a guy who owns like 150-acres and he lived in the little house on the side over there and he was holding that acreage for investment. Can he do a 1031 exchange? Yes, he can. What he would need to do is separate out the portion of the property that he actually lives in. Files taxes that way? By percentage that would be best if it were filed that way, absolutely. Then the portion of the property that is held for investment could be exchanged into other real estate. If it's just land, you can exchange into income producing properties as an option. That's really wonderful. I know that, can you explain what the timelines are? How quickly you have to put up your house for sale, find someone and then find another like-kind real estate property and marry then. This is quite a stressful event. I've heard about someone closing 1-day early and losing their tax benefit or closing 5-days late and losing their tax benefit. Can you tell me a little bit about the timeline here?
One thing that's really important. If somebody wants to do an exchange it needs to be setup in advance of them closing on the property that they are selling. If it's not, then it's too late. One of the requirements in an exchange is that you need to, you can not have constructive receipt or control over the exchange fund, so that's why the exchange needs to bet setup in advance and you need a company like ours to handle it as a qualified intermediary. And so you don't have to pay massive capital gains. Extremely important to use someone like Toni if not Toni herself. Right.
Now the timelines with an exchange they start from the date you close on the property you are selling. You've got 45-days to identify in writing the property or properties that you would like to acquire. You can see on the chart over here, that spells out the timeline. Now you're not required to be in contract on a property in order to identify it, but honestly, you want to be in contract with all of the inspections done if at all possible, because once you go past that 45th day, you can not switch properties for any reason.
The other timeline is a little easier. It's the closing timeline. From the date you close the property you are selling, you've got 180-days to close on one or more of the properties you identify in that first 45-days. That timeline can be shortened the end of the year, so it's really important to talk to the qualifying intermediary. Based on when you file your taxes. Exactly. Again, speak to Toni, it's so important. You don't want to screw it up, really.
What if you're not a timeline person, you just see a big picture and just need this to happen. Do you do, I know you do. Tell me about a reverse exchange. This is my kind of deal right here. I'm a big picture kind of girl. Absolutely!
Well, reverse exchanges, particularly in the marketplace that we're in, in the San Francisco Bay Area. There's limited inventory for people to be able to locate properties to buy. Very limited. And to be able to get into contract in 45-days from the day you close can be a little daunting, so what some people will do is a reverse exchange. This allows people to buy a property before they sell a property. They just can't own both properties at the same time, so what happens is we step in and we either take title to the property being sold or the property being acquired. It really depends on how someone is going to pay for the property as to which property we actually take title to. Generally, if somebody is going to pay all cash we can take title to either property. We just look at which is going to be the most cost effective for the client.
If they are going to get a loan on the property that they're buying, normally we will try to take title to the property they are selling. The reason we do this is that the lenders don't want to lend to us. There are some lenders who will. You have no cash, you have nothing. We create a shell entity that has no assets. Nobody. Little vampires sitting there for all the bank knows. Exactly. Even though the exchanger can guarantee the loan, most banks just don't want to go through that. They want to be able to sell the loan off very easily, so what happens is we will take title to the property being sold so that the client can get a loan if they're getting a loan on the property, but the challenge that creates is that the equity position they have and the property their selling. Another words, however, much cash they expect to get out of the property their selling, they need to be able to come up with that money, even though they haven't sold the property that they're intending to sell. If they have the capability of coming up with that money and all they're looking for is cheap short-term money, they don't want to pay big points or prepayment penalties, don't care so much about the interest because you're going to be paying it off within 180-day period.
Bottom line if they can come up with that cash they can put that down and get a loan for the balance on the property that they are buying and the reverse exchange can work. It's going to be more expensive than a regular exchange, but a lot less expensive than paying taxes. That's really great.
Hey if you want to get instant home valuation, I do offer this on my website and here is a link here. You can go to it. I also offer 3D tours and hopefully get your home sold for top dollar. Now if you want to search for property, we are area experts. We have gone in and mapped out our favorite areas of Contra Costa County, so you can search all the homes for sale in our favorite areas.
Thank you so much, Toni for coming out and really just explaining the 1031 exchange and saving us our money so that the government won't steal it. My pleasure. Thank you so much for having me. You have a good day now and I'll see you guys soon.
When buying or selling a home, contact Elizabeth Russo, an experienced Contra Costa County Realtor.