Agents Building Cashflow

EP 153: How to Build Tax-Free Wealth Today with Dave Foster

• Dave Foster

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Multi-industry visionary and Founder/CEO of The 1031 Investor, Dave Foster, shares his expertise on leveraging the 1031 exchange to strategically build and grow a real estate portfolio while deferring taxes indefinitely. He discusses the nuances of syndications, the benefits of using 1031 exchanges for real estate professionals, and offers practical advice on how to maximize investment returns through tax-deferred strategies. Tune in to learn how to build lasting cash flow and a tax-efficient investment strategy.

Key takeaways to listen to:

  • Understanding the power of 1031 exchanges in deferring taxes and compounding investment gains.
  • Identifying key strategies for real estate agents to leverage 1031 exchanges in growing their business.
  • Exploring methods to structure syndications for maximum tax efficiency and investor benefits.
  • Implementing the daisy chain approach to continuously defer taxes and grow wealth.
  • Learning the importance of aligning investment strategies with personal life cycles and market conditions.

About Dave Foster

Dave Foster, Founder and CEO of The 1031 Investor, is a Qualified Intermediary (QI) investment professional with over 20 years of experience in real estate investing. He is a multi-industry visionary who has worked across all phases of real estate, from commercial to residential, bringing a fresh perspective and strategic vision to each project. As an investor himself, Dave views each investment as a unique opportunity to maximize returns.

Dave holds a degree in accounting and a Master's in Management, building his reputation as a driven, results-oriented QI who relentlessly optimizes value for real estate investors. His genuine desire to help investors excel drives him to create win-win situations continuously. He is a recognized expert in tax-saving strategies such as the 1031 exchange and the Section 121 homestead exemption.

Starting his career in the 90s with fix-and-flip projects, Dave quickly realized that nearly 40% of his profits were being lost to taxes. This realization fueled his passion for mastering and teaching the updated rules and regulations around the 1031 exchange. Dave is known for breaking down complex tax strategies into layman’s terms, helping investors legally compound their tax savings and retain more of their profits.

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[00:00:00] Intro: If you're a real estate agent earning 200, 000 a year and you want to grow your passive income, this show is for you. Learn secrets other agents use and hear from experts in our field who will guide you on your journey to investing in assets like apartment communities. So you can take your commissions and turn them into cashflow. Here's your host, Randall. Let's dive in. 

[00:00:22] Randal McLeaird: Hey, welcome back. It's awesome to have you all here today. I have a 1031 expert, a 1031 exchange expert on today with me. His name's Dave Foster. He literally wrote the book. It is Lifetime Tax Free Wealth, The Real Estate Investor's Guide to 1031 Exchange. We have an awesome conversation.

[00:00:40] Randal McLeaird: I had a bunch of things that I wanted to ask him personally about some of the ways to structure syndications with 1031s, how you can do a TIC structure to set those up. And then he goes through and talks about a bunch of examples that he has used or his clients have used in order to use a 1031 to really [00:01:00] grow their portfolio and to defer the taxes over a long period of time.

[00:01:04] Randal McLeaird: So I hope you get a lot out of the show. If you're getting some value, please go on rate and review. It helps us a ton to bring on guests just like Dave here. So let's jump in, have a conversation. I hope you enjoy it. Take care. Hey, Dave, welcome to the show. It's awesome to have you on today. I am glad we're getting this going and, uh, you're joining me for a discussion about 1031s today.

[00:01:22] Randal McLeaird: So glad to be here today. Thank you. Let's jump in. And I've talked about 1031s in the past on the show. And so I don't want to spend a ton of time explaining the details of 1031. We're going to kind of talk about some strategies and how we use them today. But why don't you just go ahead and give us the 30, 000 foot view, the high level, chunk it up for us real fast of what a 1031 is.

[00:01:43] Randal McLeaird: So, yeah, I think you really spoke to my heart right there when you talk about strategies, because in essence, yeah, you can talk about nuts and bolts, the devil's in the details and all that kind of thing, but ultimately you have to just understand what the power of a 1031 exchange is to strategically build your [00:02:00] portfolio.

[00:02:00] Randal McLeaird: In essence, what they do is they allow you to sell investment real estate. That either has a large gain or has been highly depreciated out, and you can exchange that by selling it and then buying new real estate using a process. And you get to indefinitely, that's a key word, indefinitely defer paying tax on the profit or depreciation recapture you normally would have.

[00:02:25] Randal McLeaird: So what happens is this tax that you would have paid to the government instead. Stays with you to invest. And that's the best example of compounding interest ever. You get to make money on the tax, and then you get to make money on the money you made on the tax. And, you know, before the show, we talked about chaining, daisy chaining, that's exactly what it is.

[00:02:50] Randal McLeaird: You start that compounding train by doing a 1031 exchange. And you can continue that throughout your life and you'll get the benefit. Yeah, I've heard it [00:03:00] referred to as a tax free loan from the government or a free loan from the government, not tax free, but it's a free loan from the government in that sense, where you can take that money you were supposed to give, but you're investing it yourself and now you're getting money from that money that would otherwise have been paid out already.

[00:03:14] Randal McLeaird: So. All right, great start. So let's dive in. Obviously, we have a lot of agents and real estate professionals that listen to the show investors, that sort of thing. So I want to talk about realtor specifically, just to start off, just so we can kind of set the stage. If a real estate broker agent is looking to grow their business or looking to implement 1031 as a strategy for either doing more business or maybe for themselves.

[00:03:38] Randal McLeaird: Let's talk a little bit about some of the things that you've seen people do with a 1031 in order to help them either land more clients or do this on their own as an agent. Right. So there is, um, I don't know if you've ever heard of the far side cartoons. The what is it? The far side. Oh yeah. Yeah. The far side.

[00:03:54] Randal McLeaird: Yeah. Yeah. Yeah. So one of my favorite far side cartoons is a picture of two cheetahs. [00:04:00] With dinner napkins on sitting on a hill above a lake and all the animals, the zebras and the hippos and everything are all coming to that little lake to drink and the caption of that is watering holes of the Serengeti and I looked at that one day I said, Oh my gosh, this is the picture of the real estate industry and how you find 1031 investors.

[00:04:23] Randal McLeaird: Because if you're looking to find clients, right, it's so hard, you've got to hunt here, hunt there. But if you can find a demographic and find the watering holes where they congregate, then that's when you'll start to generate much more leads. And those leads will build on each other. So for 1031 exchanges, What are we looking at?

[00:04:48] Randal McLeaird: It's an investor product. So we teach our realtors. The first thing you want to do, look for investors. Where are you going to find investors? Probably not through direct mail, probably not through [00:05:00] walking streets. You're going to find them at places where investors congregate. So podcasts such as yourself, where investors are looking for information, groups that are like real estate investing clubs.

[00:05:14] Randal McLeaird: Take the time to get involved. Go to one meeting and meet 30 investors. Sorry to interrupt. I'm always shocked at how few realtors are at their REIA meetings that I get. I mean, there's usually one or two, but I mean, it is exactly what you're talking about. You could go in and it's kind of like shooting fish in a barrel.

[00:05:31] Randal McLeaird: Yeah, that's exactly right. And the key is that you're not just walking in empty handed. You're walking in with information that honest to gosh, they don't have. Section 1031 has been around since 1920. But it almost died in 2008 and we all know why, because of the dark time. Every investor that was doing 1031s at that time lost their shorts.

[00:05:53] Randal McLeaird: Two thirds of the realtors in America went out of business. Everybody who is now the biggest real estate [00:06:00] buying demographic At the time of that crash, when we lost all that knowledge, they were in middle school. So there is nobody out there hasn't been for several years to spread the word of the 1031 exchange.

[00:06:13] Randal McLeaird: So in essence, you're walking in with information that's going to let these investors make more money, do it more frequently. One of the things that investors, that realtors forget about is that every 1031 exchange is both a sale and a buy. That's double commissions right there. And because they're reinvesting all of their money, it's bigger commissions.

[00:06:35] Randal McLeaird: And because you're now seen as offering value added, your esteem goes up and you're getting referrals from people that you've helped save money. Cause we all love to brag about how much tax we either do or don't pay. Right. Yeah. So as a realtor search out those things, I called it before the show, a demographic farm.

[00:06:52] Randal McLeaird: Instead of walking a neighborhood, you're finding those demographic. Places, the meetups, the Facebook places, groups, the [00:07:00] real clubs where investors gather the last data we have from the IRS showed that of about all of the transactions That potentially could have been 1031 exchanges, only 85 to 90, well, 10 to 15 percent were being treated as 1031 exchanges.

[00:07:20] Randal McLeaird: In other words, that's a 90 percent untapped market. Yeah. Just waiting for you to provide the education. Did it give the value? Because obviously not every person that sells a single family or an investment broker, I guess. That must be tapping into investment data only, correct? It's like investing, that's exactly right.

[00:07:40] Randal McLeaird: Yeah. Yeah. There was a, I think 5 million transactions, about 50 percent were non owner occupied. Yeah. And that's what you're looking for for 1031s. Those non occupied opportunities. Okay, so let's break down the tactics. You go into a REIA and, you know, I guess you could put on a [00:08:00] presentation and, or you could just hand your card out and say, Hey, I specialize in 1031 exchanges.

[00:08:04] Randal McLeaird: So what are the tactics, I guess, that you would use? An agent who is new, just learning about 1031s that they could use, or even an agent who's done this for years and years and years, top producer, and they just don't have this. Yeah. Great way to start, by the way, exactly what you said. Hi, I specialize in 1031 exchanges.

[00:08:21] Randal McLeaird: They'll automatically say, well, what's that? And this is where you don't do what we did in the beginning. We used to reply by saying, if we told you, we'd have to kill you. Not good marketing, but that's when you get the opportunity to tell them you don't know about this. It's an opportunity for you to sell your investment property by new without paying tax.

[00:08:42] Randal McLeaird: Yeah. And that'll start a buzz. We get asked, and I'm sure other QIs will do this as well. We get asked all the time to go with realtors virtually, and they'll set up a little webinar seminar for either a group of investors or one of these clubs. Title companies are also a [00:09:00] great source of this. Now title companies are one of those watering holes, right?

[00:09:03] Randal McLeaird: Every transaction is going through a title company and they're always trying to find ways to add value to their clients. Well, you have a title company you like as a Realtor? You invite them to work with you on a webinar for investors, they'll dig into their database and they'll invite 50 or a hundred or 200 to a little webinar put on by them, and you joint branded and someone like us comes in and talks 'em through how to use these things.

[00:09:32] Randal McLeaird: For their benefit, all sorts of ways to make yourself look like the hero of the story. And that's what we want. Yeah, that's brilliant. You said QI's just a minute ago, just for the audience. If you're not familiar, that's qualified intermediary. If you do a 1031 exchange, You need to use a qualified intermediary to escrow the funds.

[00:09:49] Randal McLeaird: Yeah, you can't do it yourself. Yeah, you can't just take the capital at closing from the sale of your property and then Hold on to it. Uh, that won't work. So anyway, I just want to clarify that. Okay. So I love [00:10:00] that. That is tactics. That's a way somebody can immediately start to implement this as a strategy that can't build their business.

[00:10:06] Randal McLeaird: So again, if you're looking for a way to grow your book of business, looking for new clients. I mean, that is immediate access. You can call the title companies today. I know. Talk to like a business development person there at the title company, find out exactly when they can book it. They will probably sponsor it and actually pay for any of the foods, stuff like that.

[00:10:24] Randal McLeaird: And then again, you look like the expert because you're putting together the pieces of the puzzle and bringing everybody together. So love that awesome strategy. So let's move on because if, again, if you're a realtor and you're going out and you're just adding this as, you know, another arrow in your quiver, right?

[00:10:39] Randal McLeaird: Some way to get business. That's fantastic. If you're not using it yourself, or if you're an investor and you're not using it, you absolutely should be looking at 10 30 ones. But what I really want to talk about and push into is. Syndications, larger deals, some strategies that some people that I know are using, but I want to break it down here on the show so that others can understand what's going on.

[00:10:58] Randal McLeaird: So typically [00:11:00] with a 1031, it's not typically, but you have to do it on an investment property, right? You cannot use it on a single family that you own and live in and that sort of thing. So when we talk about investment properties on a larger scale, like multifamily, large assets, Where some syndicator may go out and raise capital from a bunch of different sources, individuals, high net worth, maybe a fund of funds, whatever it is, like, how does a 1031 come into play?

[00:11:25] Randal McLeaird: When you are acquiring that on the front end and what should limited partners know when they're going into those types of deals about if they're trying to 1031 into it. Absolutely. So let's start with the premise of what it means, what type of real estate qualifies. As you sort of hit on it, the 1031 has to be a sale of actual real estate, followed by a purchase of actual investment real estate.

[00:11:50] Randal McLeaird: So it's got to be actual real estate. And this is how we're going to move into syndications and start talking about that. But the laws of what are like kind, you'll hear that phrase [00:12:00] quite often are very broad. And in essence, what like kind means is that you can sell any type of real estate. Of investment, real estate, and what that means is real estate you intended to hold.

[00:12:09] Randal McLeaird: So what doesn't qualify your primary residence or fix and flip real estate, real estate that you're buying primarily to sell. But any other type of holding investment real estate, whether it be commercial, multifamily, single family, vacation rental, raw land, all qualifies. But you have to sell real estate and buy real estate.

[00:12:29] Randal McLeaird: The problem with syndications is that most of the time, like 90, 95. 90 percent of the time, you're not buying actual real estate. What you're buying is a membership interest in a limited partnership or an LLC that owns real estate. So even though it owns the real estate, you're not going on the deed to the real estate.

[00:12:51] Randal McLeaird: So it doesn't qualify. So that knocks out 90 percent of the syndications right off the bat. But there are some syndications that will allow you to [00:13:00] come in as a tenant in common. So you and all the other people, or maybe just it's you that the syndicator is going to carve out some interest for, and you buy part of the real estate and the syndication owns the rest of the real estate.

[00:13:16] Randal McLeaird: As you can imagine, that's kind of a management nightmare. So typically they will have pretty high minimums for you to 1031 into a project like that, but it can't be done that way. Now, there is a couple other ways to do that. For the person that is wanting to really get into syndications, obviously the first way is sell your property, pay the tax, go invest in the syndication.

[00:13:39] Randal McLeaird: Well, that's kind of a meh kind of opportunity, right? 'cause you're gonna have to pay the tax. Now many syndicators will sweeten the pot by saying, we're going to do a cost segregation in the same year that you invest and we're gonna take bonus depreciation. So the profits you have to pay by not doing the 1031 exchange, you'll get back from our [00:14:00] bonus depreciation that we're going to take.

[00:14:01] Randal McLeaird: That's great. That helps you in that year, but it's going to come back and bite you later. Because when that project is sold, All of that depreciation has to be recaptured anyways. So what you could have deferred indefinitely, you're not going to. And the answer to that is another opportunity, which we just started to talk about with one of your acquaintances, where they've set up the syndication To be designed to 1031.

[00:14:29] Randal McLeaird: So it's set up as a, as an LP or a limited liability company that everybody's a member of. They did not 1031 into it, but they're all members of this entity when that project is sold the limited liability company or the limited partnership will do the 1031 exchange. So all of the members go along with that into the next property.

[00:14:52] Randal McLeaird: All of the tax. All the depreciation is deferred and goes into the next project. And theoretically they can do that forever. [00:15:00] Yeah, as long as they want. Alright, so let's touch on that. So again, the way they structured it, it's through a fund. So everybody, all the LPs are investing into a fund, buying the securities of the fund.

[00:15:08] Randal McLeaird: The fund then goes and buys that asset with the sole purpose of the fund. Not being a three year exit, like typical syndications, a three to five year, like, Hey, we're buying one asset. We're gonna go into this, uh, the fund is gonna buy maybe three or four assets. Right. And then they 1031, every time they do a transaction, they're taking their 1030 wanting.

[00:15:28] Randal McLeaird: So they may exit that one, two, three main street in year three, immediately 1031 that into a new property, but no one's getting their capital back. So everybody's benefiting. Correct. Yeah. Okay. Just want to clarify. One of the things that syndicators will do though, is they will, if someone doesn't want to go along, they simply buy them out of their interest.

[00:15:47] Randal McLeaird: Okay. Internally and that that can work as well. Yeah. Pay it back through the fund. Yeah. I think that they offer that. Okay, so then you're going through, and then you get to year 10, you've say you've done, you've executed [00:16:00] 3, 10 30 ones in this one fund, and so obviously you have a lot more capital that you were working with because you didn't pay tax.

[00:16:07] Randal McLeaird: No one in the fund pay taxes and year 10, say year 15, I don't know, five year cycles, what happens to everybody's capital? When the fund dissolves and return of capital happens, and the 1031 is closed, if the fund dissolves prior to selling, then they can distribute the property to each of the members that may or may not be possible, or I'm sorry, is tenants in common.

[00:16:34] Randal McLeaird: Okay. And if they do that, then each former member. Now owns their own real estate, not them. So they get 10 31, their percentage into something else. Sometimes the lending that they've got a situation won't allow that. When that happens, you sell it, you pay the tax and you go to the bank. With a tear in your eye, but remembering that [00:17:00] nobody ever went broke paying tax on profit, it just feels like it.

[00:17:06] Randal McLeaird: And, you know, it's just one of those things where what I like to preach to people is a compounding interest of the 1031 exchange. Is going to benefit you, whether you keep it going for 2 years or 25 years, but the longer you can keep it going, the more compounding you'll get. Yeah, for sure. Okay. So let's stay on that.

[00:17:26] Randal McLeaird: I want to get to the exits in just a second, but. So you exit this thing, the way you just described it sounds like a drop and swap is that the like exactly what it'd be called. Okay. So explain the mechanics of that to me, then if I have 50 LPs in a fund and each one, you know, 200, 000 minimum investment, whatever it is, and we've gone out and we've, we've bought all of these properties, how would you manage a drop and swap?

[00:17:51] Randal McLeaird: And that's like, you have to have 50 ticks, right? With a lot of sleepless nights. Yeah, yeah. That's going to be tough to do in a large fund. Okay, so it [00:18:00] doesn't typically happen that way. Well, far and away, the more common model is 1LP1 property. So the larger syndicators with multiple funds typically are not going to be able to do that, but there's not as many of those compared to the one LP one property or at a real micro level, one property for partners and those four partners in their LLC.

[00:18:26] Randal McLeaird: Dissolve the LLC, each partner gets 25 percent of the property, they 1031 after that. So it's not a perfect scenario. Just has to depend on the structure. I would think so. I'm going to take, I've been on tech, right. For several properties. And I think setting it up on the front side is a little bit easier if it's just for, but the strategy that you mentioned where you have the syndication on one side and maybe it's a 10 million raise and the syndication owns 7 million of that raise.

[00:18:54] Randal McLeaird: Yeah. So therefore they have 70 percent ownership of that property. That's kind of how this works. Right. And then [00:19:00] one tenant comes in, tenant in common comes in instead of doing like a side letter, they want to be able to 1031 in and 1031 out. So you have to set up as two tenants in common and the syndication is one tenant and the other person with the 3 million comes in and they're the other tenant in common.

[00:19:16] Randal McLeaird: And so they get all the cash flows. They get everything as if they own 30 percent of that property. Correct. And then, so if you're trying to structure these, obviously get an attorney, talk to CPA, do all the things you got to do, but those are just a few of the ways that you can set them up on the front end so that when you exit on the back end, it's easier than trying to do a drop and swap.

[00:19:36] Randal McLeaird: What I've seen drop and swap, maybe, I mean, obviously you can tell me more on this. What I've seen. Or when I've seen a drop and swap, it's typically from somebody who either hit a home run or, you know, something happened and they're like, Oh, I don't want to pay the tax on this, get out of this thing without, so is that typically when a drop and swap is used or what is the other strategy or bad partnerships?

[00:19:59] Randal McLeaird: [00:20:00] Okay. We loved each other when we started it and now we don't. Yeah. That's very, very common. Differing needs. People are at different points in their life cycle. And so they've got different needs in one of the different ways. There is one other strategy I'd love to mention. That's more designed for the regular investor.

[00:20:18] Randal McLeaird: Wanting to break into syndication investing because as real syndications, they're more like an equity than they are a real estate product and the Indian terms of tax benefits and everything, unless you're actually on the ownership side. So, I like to counsel people to keep your real estate investments separate from your equities investments.

[00:20:42] Randal McLeaird: And treat syndications as if they're an equity investment, because by keeping them separate, you keep your ability to defer the tax using the 1031. And the way that they can do that is by if it's time to sell a property, sell the property, but don't buy into the syndication to complete your [00:21:00] 1031. Use all the proceeds to buy your next property and then refinance it.

[00:21:06] Randal McLeaird: And take the refinance money to invest in the syndication. That's kind of the best of both worlds. That's awesome. For all the tax, you've got tax free, uh, uh, refinance dollars that are going into the syndication and you just started two different avenues of cashflow. That's brilliant. So my big hangup with that would be on a, if I 10 31 hour, I sell and 10 31, my real estate investment.

[00:21:31] Randal McLeaird: And I had a loan on it and I'm not taking all that cash and buying a property cash and then having a big delta between the value and the loan amount. So if I'm 100 percent equity purchasing, just take a deal. You have a million dollar property with a, you know, 500, 000 loan. You sell it, you get in your bank account 500, 000.

[00:21:52] Randal McLeaird: Give or take, right? Or in the QI takes that money in escrow. When I go to buy another property, I have to have at least that 500, [00:22:00] 000 loan amount, correct? Well, you don't have to purchase that much. That's correct. It doesn't necessarily have to be a loan. Here's exactly how you could do it. You take that 500, 000, you can allocate that any way you want.

[00:22:11] Randal McLeaird: So go buy one property for 350, 000 cash. Take the other 150 and use that as a down payment. That's it. On say a 600, 000 property. I got it. Did you purchase as much as you sold? Yep. And you've got a free and clear property that's ready for you to refinance whenever you want. Yeah. Because then you can pull out, you know, 150, 000 out of that tax free.

[00:22:35] Randal McLeaird: Put that straight into a syndication and now you have a different type of investment. So then you've got a loan on that alone on the other one, you hold those for a few years. I'm just thinking it through, like how you then start stacking those things, because then your real estate is still off to the side.

[00:22:51] Randal McLeaird: Yeah, I'll think about it in terms of the internal rate of return, which is what we all that's the holy grail, right? Cash flow plus amortization of the [00:23:00] loan. So even though we've got debt, it's being paid by the tenants, and it's given us our principal back the depreciation benefit of not one, but two properties.

[00:23:09] Randal McLeaird: And then, of course, the interest write offs. The tax benefits that go along with that and the appreciation. Yeah. It can make it pretty healthy. You just start to stack those up. Yeah. And if you took that one 50 and put it into another apartment type deal that had bonus depreciation tacked onto that, you'd have even more of a write off.

[00:23:28] Randal McLeaird: Yeah. Yeah. I love that. Pretty good. . Okay, so let's talk then a bit about the strategy of stacking these and building a chain over time, right? We were talking about it a minute ago and let's say you're investing for the next 30 years. I want to set this up so that I've got something going over time and then I die and then it presumably goes to my kids.

[00:23:53] Randal McLeaird: They can inherit the cash flows, the properties step up in basis. So kind of walk me through some of the [00:24:00] strategies and. State planning issues, I guess, of how you would structure this. Going forward. If you just really want to build this over time, right? So 10 31, the womb to tomb view. Yeah. Nice. When we start out investing, generally we have much more time and much more energy than we do money.

[00:24:21] Randal McLeaird: So we start to buy what we can, where we can to begin our investing career. Right. So single family value adds on the lower demographic in but the 1031 exchange can then allow you to position yourself wherever and in whatever the market is speaking to you. So, as you're starting to build, you're doing diversification exchanges, selling one, buying two, starting with single families, moving into multi, moving into commercial, whatever product you want, wherever in the country.

[00:24:57] Randal McLeaird: Going from appreciation markets to [00:25:00] cash flow markets. So it's absolutely flexible to let you do whatever you want that way. So as we start to get older, then we're at a different place in our life cycle. So we're not just going to listen to what the market is telling us where to go. We're going to listen to what my personal position in my life cycle is going to, what's free to go.

[00:25:22] Randal McLeaird: Maybe I'm now at that point where I've got 30 properties in all kinds of different states. of depreciation, but I'm tired. So I start to consolidate. I sell five small properties, use them to buy one larger multifamily where I can maybe get more dollars per door, but I can definitely decrease my management intensive work.

[00:25:47] Randal McLeaird: So I'm accommodating where I'm at. And that's how the 1031 can be used to go from active to passive, to start to transition into these even more passive investments. Like [00:26:00] triple net commercial properties or the types of syndications where we can 1031 into. There's also a really interesting point in our lives when we start to have children and we realize that Time is our greatest commodity, and I'm sitting here with all these properties that I'm not enjoying.

[00:26:19] Randal McLeaird: So 1031 into vacation rentals can be huge to position your portfolio where you're still making cash flow, but you're also getting some personal enjoyment out of it. And that leads you then further down your life cycle, where it's time to start thinking about retirement. Let's say I'm in Cincinnati and I want to retire in Sarasota, Florida.

[00:26:42] Randal McLeaird: So a few years ahead of time, I would start to sell my Cincinnati portfolio and purchase investment properties in Sarasota, vacation rentals, whatever, doesn't matter, but I'm still keeping that tax deferred over the years, right? Well, when I move [00:27:00] and retire, I'm going to sell my Cincinnati house. That's got different rules because when it's your primary residence, if you're married, you get to take the first 500, 000 of profit tax free.

[00:27:14] Randal McLeaird: And what a lot of realtors don't know is that you can do that once every two years. So instead of selling Cincinnati and using those tax free dollars to go buy your retirement house in Sarasota, why not convert one of your really nice vacation rentals? in Sarasota into your retirement house. The money you got tax free for your sale goes in your pocket.

[00:27:42] Randal McLeaird: The conversion of a 1031 property does not create a taxable event. As long as you own that property, the tax stays deferred. And once you've owned it and lived in it long enough, the deferred tax actually starts to convert into [00:28:00] tax free. How's that? Two year rule still. Yes, you have to have owned it for five years.

[00:28:06] Randal McLeaird: You have to have lived in it for at least two outta the previous five mm-Hmm, . So here's a real world example. Client of mine in St. Pete Beach bought three identical condos at a beachfront condo, actually on the same floor using the 10 31 exchange. Rented them for two years. Which is the safe Harbor from the IRS.

[00:28:26] Randal McLeaird: Yeah. And then he moved into the first one. He lived in it for three years. So had he owned it for five? Yes. Had he lived in it for at least two? Yeah. He'd lived in it for three. So he then, when he sold it, got to take 60 percent of the profit tax rate. That's wild. He paid tax on the other 40%, but Hey, that's wild.

[00:28:47] Randal McLeaird: It's still better than bagging groceries or delivering pizzas, right? Okay, so explain that to me then, because that's, yes, it's better than bagging groceries, yes, for sure. But explain to me, so he paid taxes on 40%. [00:29:00] Is that the basis he had in that deal? So when he converted it to, I, cause I wrote a question here.

[00:29:06] Randal McLeaird: I'm like, what happened to the tax basis that he would have owed for that property before it got converted? It just gets wiped out. The depreciation he had to recapture. Okay. So depreciation. Okay. But the actual profit, the gain, you prorate that between the number of years you've lived in it and the number of years it was investment.

[00:29:25] Randal McLeaird: So if you bought that and used it for investment for two years. And then lived in it for eight, you would get eight tenths of the profit tax rate percent. It'll never go to zero. Right. Cause it's always a proration, but you get to knock away a lot. Now, in that guy's case, where do you think he moved next door and started the whole process over again?

[00:29:51] Randal McLeaird: That was his way of shipping away at that deferred gain and turning it into partial tax rate. Right. Right. It's an awesome strategy. [00:30:00] Yeah, it's a, so he moves into this property and he would have had in that 1031 buying the 1st unit again, say he bought it 500, 000 dollars, whatever it was. And so he has a 500, 000 dollar 1031 property that he would otherwise.

[00:30:17] Randal McLeaird: Have to sell at some point and roll it to something else. Or whenever he ends the exchange, he would have to pay taxes on that 500, 000. Correct. Okay. Or whatever the original basis was. So when he moves into it, it literally wipes that out. Is that what I am understanding? It wipes part of it out, yes, as long as you have owned it for five years, and as long as you meet the primary residence requirements, then you get to wipe out the percentage of the entire gain, not the depreciation recapture, but the entire profit over the years as a ratio between the number of years you lived in that property and the number of years you used it as a [00:31:00] rental.

[00:31:00] Randal McLeaird: Yeah. Okay. Yeah. I didn't know that. That's an interesting way to add onto it. Follow up on that to what we were talking about is the example of say a family that sells a farm and they've still got to make the cash flow off the air real estate, but they're ready to retire as well. So we had a family that sold the farm.

[00:31:19] Randal McLeaird: They sold their primary residence. They took the farm and they 1031 did, but they went to their three children and they said, look, we got to make some money to retire. But if we pick out a property you like, would you be willing to manage it and split the money with us until we die? Well, the kids thought that was awesome.

[00:31:38] Randal McLeaird: So that's exactly what they did. So look at all the good things that happened in that. First of all, they sold their primary residence, they got the money tax free. Secondly, they did a 1031 exchange, which kept all that deferral going. Thirdly, they were still generating cash flow from the 1031 properties that they bought.

[00:31:57] Randal McLeaird: And they all had very motivated [00:32:00] management because the kids were trying to take care of mom and dad. The one that I never even thought, but grandma figured out, was that every trip to go see their grandkids was now a tax deductible business expense. To go see their investment properties. Were the kids living in the properties?

[00:32:17] Randal McLeaird: No, but they were the same town. Got it. We bought a building that the son used for his insurance agency. Okay. We bought some duplexes in Fort Collins, Colorado for one of the girls. And we bought a couple single family rentals for the other girl in Pueblo, Colorado. Got it. So they were the same town, but they were investment properties.

[00:32:36] Randal McLeaird: Now, but what you say though does speak to something. It is perfectly fine to 1031 properties into something where related parties live as long as You are treating them as arm's length investments. In other words, you want to buy a house for your daughter, go for it, but charge her rent, collect the rent, [00:33:00] declare the rent, gift her back the rent if you want, because there's the annual gift exception, but you're treating it like investment.

[00:33:08] Randal McLeaird: That's perfectly fine. Now, the last really cool thing that came out of that scenario is what you and I have sort of been hinting at. And that is my least favorite way to benefit from 1031, but it's going to happen. You have to die because when you die, your heirs will get your property and what is called a stepped up basis.

[00:33:31] Randal McLeaird: So all of the gain, all of the depreciation that you have deferred for decades. goes away. You don't pay it. Your estate doesn't pay it. Your heirs don't pay it. They get the property with no tax due at all. And I can't think of a better way. To start my kids off with a legacy of wealth, then simply hang it on till I die.

[00:33:54] Randal McLeaird: And is there any sort of structuring on that they have to do as [00:34:00] far as, I mean, assuming you've done this over time, maybe you're buying it in LLC, that LLC is the 1031 that that vehicle just keeps going over and over. And so the LLC is. Through the will given to the kids, what's the strategy that like, how does that?

[00:34:13] Randal McLeaird: Yeah, you stay blocked. You get a little murky. There's a lot of different situations like that. The one thing in that that you would not want to do is make your kids members of the LLC because the LLC is who has the deferred tax. Yeah. And if you die, there's still the members, the taxes still just deferred.

[00:34:30] Randal McLeaird: You would want to have the property in your LLCs. Go to your errors. Yeah. Got it. And that's how they get the step up. What about a spouse? If the spouse is not in the LLC and the LLC is the one that's been doing in the, is it a step up in basis on that front? Well, uh, probably how much is gonna be dependent on things like, are they in a community property state?

[00:34:53] Randal McLeaird: Mm-Hmm. Okay. What's the transition there? But in general, if they're filing a joint tax return, they're a [00:35:00] community property state, even if he's the old. Only one on the LLC. It's like they both own it. Yeah, got it. But it is 50%. Would still be stepped up to her. Got it. Okay. No. Awesome. Look, you touched on, we're getting to the top here, but I can geek out on this stuff because I love the strategy.

[00:35:17] Randal McLeaird: You and me both. All right. So you mentioned the four D's and do you want to touch on those real fast? I know death is one, but what were the other ones? Yeah. It'd be real simple. It's kind of a kitschy catch question. The first D is defer because you want to start that compounding. Keep it going as long as you can.

[00:35:33] Randal McLeaird: Okay. The second D is defer. Okay. Because the 1031 exchange allows you to respond to whatever the market is telling you to do. You don't have to change good investing behavior in order to do the 1031 exchange. The third D is defer because wherever you're at in your life, you can use the 1031 to position you to vacation rentals.

[00:35:57] Randal McLeaird: To retirement rentals, to converting property, to [00:36:00] eliminate tax into die. And then lastly, the fourth D is to die. I got it. And give this to public for die . Exactly. Yeah. All right. Yeah. One more thing I wanted to touch on, because we've mentioned it a second ago, but what are some tips that you might have for managing the transition and the timing process?

[00:36:20] Randal McLeaird: For identifying and because I mentioned to you that on the one that I was working on that failed, I had three properties and I didn't have any of them under contract and I didn't have confidence that they were going to go under contract in the time frame. And so if I identified them and yet none of them actually went under contract, then my money would still be tied up for another 180 days or whatever it was.

[00:36:43] Randal McLeaird: Leftover on the 140 days, essentially. Right. Yeah. Because what you're referring to is the fact that once your proceeds are in the 1031, they have to stay there until there's no longer the opportunity to complete a 1031 exchange. So the first time is that that happens [00:37:00] is at day 45. If you don't turn in a 45 day list, like you did, like you didn't do, then you get your proceeds back on day 46.

[00:37:08] Randal McLeaird: Okay. If you name properties on your list and you're past day 45, you're stuck with what's on that list. You can't change it. But even more importantly, the IRS doesn't care that you're not going to be able to buy them. They simply say, those are properties you can buy. And then we have to hold the money for 180 days.

[00:37:26] Randal McLeaird: I actually had this sad opportunity this spring already to work with a client who named a bunch of, it was raw land, a bunch of raw land sections on his 10, 000 45 day list. He did not have any of them under contract, just like you. He got outbid because he was using too sharp of a pencil. He got outbid for every one of them.

[00:37:48] Randal McLeaird: He was stuck with a huge tax gain. You know what he had to do? He went back and negotiated with every one of the people that had out bid him and paid [00:38:00] them money simply for the right that they would assign their contract to him. They loved it. They made a great payday, but he sheltered his tax still. So that's a problematic time period.

[00:38:13] Randal McLeaird: Okay. My tips to navigate that, you can actually go into contract for your new property anytime you want. So when you're in a seller's market, Take care of the hard thing first, which is to find your new property, get it under contract before you close the sale of your old property. Maybe use contingencies, maybe you wait until you're sure your old property is going to sell, but that can buy you another month or two right there.

[00:38:41] Randal McLeaird: Second thing is, don't think of the 45 day period as an identification period. Think of it as an, Oh my gosh, I got to get my new properties under contract, period. And that will help you as well. Yeah, for sure. And then the third thing would be for really unique pieces and larger [00:39:00] investments, a reverse exchange can help in a reverse exchange.

[00:39:04] Randal McLeaird: We form a holding entity that takes title to your new property. And while we are entitled, you have 180 days to complete the sale of your old property. That can really usually be all the time that you need. The problem is there's the financing is peculiar. And they're quite a bit more expensive than a regular exchange, but for larger assets, they're real constant.

[00:39:29] Randal McLeaird: Yeah. I've seen those. We were talking about those as well. Awesome. Well, Dave, I love the information. It has definitely made me think and reaffirm the need to start the chain, the daisy chain that I want to do as well for my kids and family. So yeah, again, I appreciate you jumping on, sharing your knowledge and information with everybody.

[00:39:46] Randal McLeaird: I'm going to put all your contact info in the show notes. If you are looking for a qualified intermediary, if you're looking for 10 31, or you want to get more information on Dave, please reach out to him. I know you just had a book come out as well. So. [00:40:00] Lifetime tax free wealth, the real estate investors guide to the 1031 exchange.

[00:40:04] Randal McLeaird: What I like about this book is we packed it with not just rules. We packed it with case studies, actual investors who used it and benefited. So for someone like you is looking to start the daisy chain. Look where you're at in your, in your life cycle, grab one of those case studies and say, Oh, that's how they did it.

[00:40:23] Randal McLeaird: Yeah, I think that's awesome because just talking to you and hearing what some of your clients have done and knowing how they have used it, it like clicks light bulb and you're like, Oh, okay. I hadn't thought of that. Okay. That's a great strategy. All right, let's start doing that. So. Yeah, definitely grab that book and, uh, and reach out to Dave.

[00:40:40] Randal McLeaird: If you have any questions again, man, I appreciate you jumping on. It was great catching up with you and we will see you guys on the next episode. Take care. Did you know that 80 percent of the agents we speak with got into real estate in order to gain passive income so they could obtain financial freedom and become work optional.

[00:40:54] Randal McLeaird: If you want to stay up to date, the best way is to make sure you're subscribed. So if you haven't done that, go ahead and do [00:41:00] it now. We'll catch you on the next episode. 



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