Next year will mark the 100th anniversary of the 1031 Exchange!

Designed to encourage investors to remain fully invested in real estate, the strategy allows a taxpayer to a swap one investment property for another in a way that allows capital gains taxes to be deferred. Throughout the years, even in times of crisis, this trusty instrument has helped keep liquidity in the market and allowed people to reposition or repurpose. Now that we are all trying our best to navigate this unprecedented crisis, losing the 1031 Exchange would be a big blow to investors and the whole real estate market in general. In this episode, Exeter Trust CEO, Bill Exeter joins Chris Larsen to discuss what exactly a 1031 Exchange is, who can use it, and how the next administration may affect future options.

Listen To The Podcast Here:

Explaining The 1031 Exchange With Bill Exeter

On this show, we have Bill Exeter. Bill is the Founder, President and Chief Executive Officer of Exeter 1031 Exchange Services, LLC. He’s headquartered in San Diego, California. He’s also a CEO of Exeter Trust Company headquartered in Cheyenne, Wyoming and their affiliate companies. Mr. Exeter is based in the company’s national corporate headquarters office in sunny San Diego, California. Bill, welcome to the show.

Thank you. It’s great to be here.

I’ve enjoyed some of our previous conversations, and as I was planning our upcoming shows, I thought I got to have Bill on. I want the audience to hear a little bit about your background. We’ve had guests on that are in their early twenties all the way up the spectrum. It’s a real honor to have somebody with your history in the industry on the show. If you don’t mind share with the audience some of your history and how you ended up in this business here.

That’s always a funny story. You don’t go to college and say, “I got to be a 1031 exchange guy.” I was a controller of a commercial bank up in Los Angeles and the chairman of the board who was the developer said, “We’re going to start a qualified intermediary.” Back then they called them accommodators or what have you. An outside counsel said, “Do not have the escrow subsidiary run it. We think it’s a problem.” He threw it at me and I had no clue what it was. That was back in the early ‘80s. Many years later here we are, my career did a left turn and stayed in banking for the most part but differently. We’ve done 1031 exchanges now for many years. It has always been a trust company operation as well. It’s a non-depository banking.

Why is your trust company headquartered in Wyoming?

A number of reasons, one is California getting crazier and crazier from a political perspective. The regulatory oversight is ridiculous. That was one issue to look at. Number two, we trust laws that were updated a lot more frequently that were better for the consumer. We started looking around and narrowed it down further and further until we picked Wyoming. We flew out and met with the regulators and loved what I saw. It felt like a real partnership, which was the first time I’ve ever experienced that. I decided that is where we put it. It got us out of California from that perspective and got us into a state that wanted us there and had some great trust laws that help our clients. We’ve done it well.

I hear a lot of things and that can be a topic of an entire other show. I want to talk about 1031. Our group has exited a property, going through a 1031 exchange. We did a 1031 exchange selling a property. This was about a few years ago. It was a little single-family property. I put $2,000, $3,000 down when I bought this property. I sold it and rolled it into a seven-unit property here in Asheville. I now get cashflow in excess monthly that I put down. I haven’t paid tax on any of the gains in that property. A lot of people are surprised. They’re like, “How can you do that?” Bill, you’ve done over 125,000 1031 exchanges. Could you walk us through how 1031 came to be and who is a benefit for?

When you said that it triggered a thought that 2021 is the 100-year anniversary of 1031 exchange. It goes back a long time. It’s not in a way a tax planning strategy. It’s a building strategy, but it’s also an economic stimulus program. It’s truly designed to encourage investors remain fully invested in real estate. It keeps the liquidity in the market. It helps people reposition or repurpose, especially coming up at COVID-19 or I’m not sure we can say we’re coming out of it. There’s going to be a lot of these. Retail space is going to have to be repurposed. It’s difficult if you sell and have to pay taxes. The 1031 exchange allows you to sell your property. Let’s use your example.

You sell a single-family. If you had to pay 20% to 30% of your profit in taxes, that makes it difficult to trade up into the seven-unit you were talking about. With the 1031 exchange in your case, you could sell your single family and you pay no federal and no state taxes. It keeps all of your money, your profits, your equity in your pockets. You can reinvest that, which allows you to trade up into a seven-unit. It allows you to trade up into more units or more multiple properties or larger assets to increase your cashflow without getting killed on taxes.

It was eye-opening to me. I knew about the 1031 exchange when I was selling the property. When I was selling it, I didn’t fully expect to do it, but I had this opportunity pop up. I moved quickly. I can’t even remember who I used at the time to do that. As I talk about in my book with the multifamily side, which is about 80% of what we do at Next Level Income, it’s a big part of the strategy. If you aren’t paying taxes on that income and you have a 50% gain coming out the other side of a project five years in, keeping that money working for you. I do an illustration in my book. Over a twenty-year period at reasonable rates, you’re talking about doubling the amount of money that you end up keeping at the end of a twenty-year period. If you could give an example of a market that sticks out in your head with the amount of tax people saved on a 1031 exchange?

Our transactions have ranged from $10,000 to the large we’ve done so far is $340 million. The amount of tax saved is amazing, but you hit the nail right on the head. A lot of people look at this as a transaction tool, “I’m selling real estate. I don’t want to pay tax.” It’s a wealth building strategy. Every time you sell an investment property, if you 1031 exchange, you keep exchanging over and over, it keeps all the money in your pocket, which means you can leverage that and you build your wealth that much faster.

If you compare one family who always sells and pays the tax over a family who always 1031 exchanges and defers the tax over 40 years. The family that 1031 is going to have a net worth that is vastly larger than the one who always paid the tax. If you’re a buyer and a strategy person, that allows you to keep exchanging over and over. When you pass on, wherever you leave the property to will get that step-up cost basis, which means your capital gain tax goes away, your depreciation recapture tax goes away. We have a morbid sense of humor that we call it swap until you drop.

I’ve said it myself. It’s hard but it’s predictable. I talk about that in my book. I say how you can delay paying taxes. We’re not doing anything untoward the IRS. It’s a stimulus and that’s how I see it. When I took a course by a former IRS agent back in college, the reason I took it was because I read something somewhere. It was probably Rich Dad Poor Dad. He said, “The IRS has these rules to tell you where to invest your money and what to do with it.” I thought, “Why would I not go talk to an IRS agent and figure out what the rules are?” It’s a lot easier when you play by the rules to keep more of your money. You can buy bigger properties. You can keep more money in the economy. You can do that. Some people may be reading and saying, “How do I ever get my money out of the real estate if I’m always doing a 1031 exchange?”

A lot of the information you’ll see on the websites or brochures make it sound like you have to trade equal or up in value. You have to stall your equity and you have to replace your debt. They say that because most people want to defer all their taxes, but you don’t have to do any of it. Maybe you sell for $500,000 and you reinvest $400,000. You trade down a little bit. You would only pay tax on the amount you don’t reinvest. That gives you the ability to do a couple of things. One, you can pull cash off the table when you need it. Most of us are real estate rich and cash poor. You create a little cash position. You pay tax only on that you pull out. It allows you to plan how much to trade down by. You can control the rate of taxes you’re going to pay. That is one way to pull cash out. A lot of people will just refinance and pull equity out to create a cash position. There’s no way to pull cash without either getting additional debt or getting hit with taxes, but to do a little bit every now and then it’s not quite painful.

I didn’t know about that when I did my 1031 exchange. I didn’t know you could pull a portion out. What we ended up doing was we rolled the entire amount of the proceeds over. I even added a small amount to get to closing. After two years, it was a commercial property. We refinanced and we were able to pull more than our original equity out during that refinance. There are multiple strategies and I tell people, “If you’re paying taxes on your real estate investments, you’re either doing it consciously or you’re doing something wrong.”

A lot of people too when you’re younger, they tend to look for growth strategies. They’re exchanging even the properties that are going to grow in value and probably produce cashflow. The closer you get to retirement or in retirement, then the strategy normally is I just want cashflow. I’m not necessarily worried about growth. There are all sorts of strategies out there, but that’s one way to take a look at it.

That’s one reason why I call multifamily the Holy Grail because you can get a little bit of both. You can push more towards the cash. You can push more towards the growth. You mentioned you have done transactions ranging from several thousand to $340 million. At what point does it not make sense? Do the costs exceed the benefit?

The costs never exceed the benefit in most cases unless it’s small. The $10,000 transaction was funny because we recommended the client to sell it, pay the tax and not worry about it. Some margin there doesn’t make sense per se. I would rather pay you to pay the IRS. There’s no magic number. 1031 exchange fees range from $750 to about $1,000 and maybe $1,200. That’s the range you’ll look at and then you compare to what taxes you would pay. If you’re going to pay $2,000 or $3,000 in taxes, I’d pay the tax and not worried about the 45-day deadline. Each person got a different threshold. They have to figure out, is there a threshold for $5,000 in taxes? Other than that, there’s no magic numbers. It’s whatever the investor is comfortable with.

You mentioned the 45-day window, if you could walk us through the mechanics. I’m selling a property and I come to you, I say, “Bill, I’d like to execute a 1031 exchange. I want to be tax efficient here. Walk us through what that looks like on a timeline and mechanics.” If anybody’s reading says, “This sounds like it makes sense. I want to take advantage of it.”

The first thing I would say is if you’re going to remain in real estate, you should try to do a 1031 exchange in most cases. If you can’t find property or it doesn’t make sense, then let it fail. There’s no penalty for a failed exchange other than you pay your tax. Some people go in and go, “I don’t want to deal with it,” or they go into it and they junk it to defer the taxes. Sometimes you pay the tax. Part of that, you take all that into consideration while you’re going through the 45 and 180-day period.

Using the example that you outlined in your book where you sell the single-family property, the day that home sells and closes, and is closing is the trigger point, that triggers your 45-calendar date identification periods. You’ve got exactly 45 days to identify what you’re going to acquire. After the 45-day period, you have an additional 135 days to complete your 1031 exchange. That means you’re closing on whatever your acquisition properties are going to be. It’s a total of 180 days. One of the statements out there often is it’s 45 plus 180. It’s not. It’s a total of 180. The first 45 days is your identification period and you have an additional 135 days after that.

If I’m selling that property, I can’t touch that money as it goes through. How does that all work? How do we make sure that we’re complying with all the rules that the IRS has on that?

That brings up an ancillary point, which is you have to have your 1031 exchange set up before closing occurs. When the closing occurs, whoever is listed as the seller in that transaction has the right to receive the proceeds. If the 1031 exchange is not set up prior to closing, then the seller, the taxpayer has the right to the proceeds. Even if they say, “Don’t disperse the funds, I’m going for a 1031 exchange,” that won’t work because they still have the right to receive the proceeds. When you set the 1031 exchange up and put that in place, the transaction, the purchase and sale agreement, if there’s any escrow instructions, they are assigned to us as the qualified intermediary. When the closing occurs, we have the right to the proceeds, not the client. That way, the taxes are deferred. The most important part is making sure that 1031 exchange is in place prior to closing.

You hold those funds for that up to 180-day period until the other property is identified and closed upon. Is that accurate?

Exactly. Until the closing occurs, they’re going to send out the closing statement. It’ll have a net proceeds number that’s wired to us. We’ll deposit that in qualified trust account for the individual that’s doing the 1031 exchange.

When I did it, I’ve had a lot of closings. It was seamless and easy from my perspective. It was no big deal. You said, “The money has to go into that account.” Is there something called a reverse 1031 exchange where you can do it after the fact?

There is, especially in this market where you’ve got fast-paced markets, bidding wars, multiple offers, etc. The reverse exchange allows the investor to buy first, which means you can close your acquisition first. You then have 180 days to close on the sale of your property. It sounds easy, but it’s more complicated. There are more costs involved, etc. If I’m doing an exchange, I would do a reverse exchange every single day of the year because it takes a lot of the risks of the 1031 exchange. You close on your property. You know you’ve got it. You don’t have to worry about what if I can’t find property, but the downside is your equity is still trapped. How do you buy replacement property when your equity is still trapped?

That’s the problems you have to solve up front. If there’s a lender involved, lenders are not terribly thrilled with the reverse 1031 exchange because we have to take title to 1 of the 2 properties, either the one you’re selling or the one you’re buying. That’s where the complexities come in terms of structuring the transaction. Depending on lenders and all of that, it could be a lot more complicated. The fees are anywhere from $5,000 to $10,000 on a reverse exchange. We’re reverse. It takes a lot of the risk out of your 1031 exchange because you closed on the property.

That doesn’t sound bad if you’re buying a few-unit building or a single-family residence or something like that. When you’re buying a $22 million apartment building, it gets a little more challenging I would imagine.

This market is especially tough. You’ve got the phase market, low inventory, multiple offers, bidding wars and COVID-19.

We closed on two transactions here. I didn’t know if we’d do anything in 2020 when COVID hit. We are hearing a lot of things going through the election cycle here. What are you hearing? What are you seeing when it comes to the 1031 exchange? I remember hearing Joe Biden talk about it a little bit here during his campaign.

It’s probably on the agenda for the new administration coming in. The first thing to remember is that almost every single administration back quite a while has submitted some type of suggested or proposed change to 1031 exchanges. There’s only maybe one or two that didn’t. A lot of people focus on whether this is a Republican or a Democratic thing, and it’s not. We’ve managed to explain the issues in the past and talk most of them out of those changes. I’d say it’s an educational problem now. The current administration has done the same thing. They’re describing it as significantly-reduced 1031 exchanges. For most intents and purposes, it’s eliminating most 1031 exchanges.

What they’re proposing is that if you make more than $400,000, you don’t qualify for a 1031 exchange. If you make less than $400,000, you do. Most people are saying, “It’s less than $400,000 so it’s not a problem.” The problem is if you sell real estate in one particular year, your adjusted gross income went over $400,000. You may not normally make over $400,000 but when you sell real estate, it’s easy to go over that $400,000 limit and not be able to do a 1031 exchange transaction. That’s the issue. We still have a lot of unanswered questions now, but the way it looks is that Biden will be the president. It looks most likely that the scenario will be that the Republicans retain the Senate, and the House is still under the Democratic control but the margin has shrunk a little bit.

What we’re going to have is, President Biden will probably introduce a legislation to increase taxes and try to eliminate 1031 exchanges. The House will pass it and the Senate will kill it. We’re going to have a good check and balance that will solve the problem. Regardless of what happens, we need to continue the educational process to the congressmen that have known relationships with Biden. We can educate them on why the 1031 should not go away, what the benefits are, and the devastating impact if it did.

There are lot of property owners in Congress. It’s almost like the founding fathers thought about this when they developed a system of checks and balances that far back. It’s fun teaching my young 8 and 10-year-old boys about this. I know you guys do more than 1031 exchanges. I want to get into that, but I also want to talk about other types of exchanges. There’s not just 1031 exchanges. There’s the life insurance industry and there are also 1035 exchanges. Do you do any of those? Can you maybe speak a little bit towards what the other types of exchanges are? People may be saying, “What else can you exchange?” Can you exchange cars, planes, life insurance? What else can you exchange out there?

The first thing to note is that we’ve been talking about 1031 exchanges and it applies to anything that’s rental investment or business use. What a lot of folks don’t know is the Tax Reform Act of 2017 eliminated the ability to do personal property exchanges, which is anything that’s not real estate. That was at a federal level. Some states like California is in conformity with the January 1st, 2015 status of 1031 exchanges. They did not update anything past that. In California, you could still do a personal property exchange. You defer the state taxes, but not the federal taxes. 1032 exchanges are the exchange of your stock and certain closely-held corporations.

1033 exchanges, there are still a lot of people who’ve never heard of them. 1033 is coming to play where there’s a natural disaster or an eminent domain reinvesting. If natural disaster like fire, flood, hurricane, tornado partially or fully destroys the property, you file an insurance claim and you get the check, that’s considered sale proceeds. Most people turn around and reinvest by repairing or rebuilding the property. That’s a 1033 exchange. They probably, but they should. The other areas where we like to talk about is the eminent domain. If your readers are considering and they’re negotiating with some type of government agency that has eminent domain authority or taking authority, they can ask the government to threaten and say, “If you fail to sell your property, if you fail to close, we’re going to take your property through eminent domain.”

They qualify for the 1033 exchange. That gives them up to anywhere from 2, 3 or 5 years to reinvest depending on what category they fall into. There are some great planning opportunities there. Going back to one of the questions you asked about how do you cash out. With a 1033 exchange, you can pull cash out and not get hit with taxes. There’s no tactical boot for not reinvesting the cash in at 1033. The 1034 exchange was repealed in 1996. It was replaced, the 121 exclusion. If you have the primary residence and you’ve lived in it for 2 out of the last 5 years, you get $250,000 or $500,000 tax free.

Before that, you could do a 1034 exchange. You sold your primary residence. If you reinvested and traded equal or up in value within years, you can roll over your taxable gains. That was a roll over provision. You mentioned 1035, that’s the exchange of annuities. You can exchange annuities for annuities. You don’t need a qualified intermediary to do any of those other exchanges. 1032s, 1033s, 1034s and 1035s do not have any type of third-party intermediary to administer.

You can check out Bill’s website as well. I’m going to give you a chance to go through that. Bill, I know you do more than 1031 exchanges. I teased it a little bit. If you could share a little bit more about what the Exeter group of companies does, what other services you provide, and then where everybody can take a look and find you if they’ve heard something that may benefit them.

A number of years ago, we went through a couple of year process of regulatory review and approval. Once we went through that, we’re approved as a trust company. Exeter Trust Company is headquartered in Cheyenne, Wyoming. That does a couple of things for us. One is we are now one of the only qualified intermediaries that has direct both licensing regulatory oversight and audit by a government agency. Failures and my many years’ experience could have been avoided if there was government oversight. We went down that path to better protect the clients.

It also gives us the ability to roll out other products. We rolled out self-directed IRAs. The focus there is not what typical banks or brokerage firms do. Our focus is alternative assets. We want to use the IRA to buy real estate, buy mortgages, deeds of trust, tax lien, certificates, etc., LLCs, limited partnerships. They could do that through their IRA. It’s the same IRA. They just roll it over to us as a brand-new IRA custodian. We do title holding trust or land trusts. Few people understand those. We act as the trustee for the land trust when someone needs a corporate trustee to do that.

We do specialty holding escrows. If there’s a large real estate transaction and it gets closed, maybe there’s some cash hold back. The escrow title company will say, “We’re not permitted to do that under regulatory authority because there’s no real estate transaction. There’s no title insurance.” We can certainly handle those type of escrows. We offer general custody services as well. If the client wants non-retirement funds or assets to be held and accounted for, and summarizing the statement, we can do that.

What’s the best place to track you guys down if people are interested?

You can get to us in a number of ways. You can call me direct. Our San Diego headquarters number is (619) 239-3091. Email us at Ask@ExeterCo.com or go to ExeterCo.com and ask for Mark Turok and he’ll take care of it. He’s our business development officer down here in Southern California area.

Mark is the man and you guys are terrifically responsive. I enjoy that about you. One question we always ask our guests on the show and I’m excited to hear this from you is, if you can go back to your 25-year-old self and give yourself some advice, what would it be?

I can think of probably a lot. It’s funny if we knew what we know now, we’d be in big trouble.

People are like, “If I can give you money or go back in time to be eighteen again, what would it be?” Take the time every time.

From my perspective, I was in banking back then. I learned a lot, but I didn’t put a lot of the things into action personally that I should have. My advice to me back then would be get off the bench and do something when you’re 25.

Take massive action as Tony Robbins says. Bill, I’ve enjoyed this conversation. We got in a little in depth in a couple of different things. Please if you have something out there that you’re looking to sell or looking to take advantage of some of these tax advantages, reach out to Bill and his team. They’re fantastically responsive. You might have heard about the self-directed IRAs. You can take your IRA and invest in real estate. Reach out to Bill to learn how. Thank you for reading. If you enjoyed the show, please hit like, subscribe and get our free book at NextLevelIncome.com. Bill, thanks.

You’re welcome. It’s my pleasure.

Important Links:

• MFINSummit.com

• Exeter 1031 Exchange Services, LL

• Rich Dad Poor Dad

• Ask@ExeterCo.com

About Bill Exeter