Cold open

SPEAKER_00 0:00

Welcome to Live Let Thrive, a podcast about the Airbnb life, the share economy, and everything in between. Here are your hosts, Micah and Steve.

SPEAKER_01 0:11

Hello, hello, hello, and welcome back to another exciting episode of Live Let Thrive. This is episode 297 of your favorite short-term, mid-term, long-term rental podcast in the world. Coming at you from Fort Worth, Texas, I'm Stevie Stacks, your host, and we have a special guest today. Special guest I speak of is David Foster. Who is David Foster, you ask? Well, David Foster is a qualified intermediary QI investment professional who understands that real estate is really an investment in your future. As a multi-industry visionary, he has over 25 years of experience working in all phases of real estate investing. From commercial to residential, he brings his clients to a fresh perspective and clear vision for strategic development. As an investor himself, he views each investment as a unique opportunity to maximize returns. David used the 1031 exchange to move across the US and realize his family's dream to live on a sailboat in Florida, raise four boys on a boat. That sounds uh like a lot

What a qualified intermediary does

SPEAKER_01 1:25

of fun. Welcome to the show, David.

SPEAKER_04 1:27

Thank you. Hey, if reading that bio didn't wear you out, raising four kids on a boat will definitely do it.

SPEAKER_01 1:36

Yeah, you put some big words in there for me, but I appreciate it, man. I was uh cleaning out my garage earlier and it was really hot. So I don't know why I decided to do that before a podcast, but that's what coffee's for. It gets me back, gets me back to the baseline, you know what I'm saying? There you go. I'm right with you. So you are a qualified intermediary. What the hell does that mean, David?

SPEAKER_04 2:00

Yeah, exactly, right? Hey, in the old days of this, I've been doing this now for 25 years. In the old days, when we first started the company, we would take our staff out to a dinner theater or something like that. And the MC wanting to find out what everybody's doing would say, the exact same question. You're a qualified intermediary. What's that? And my partners would always say, if we told you, we'd have to kill you. And I said, Stop. This is not good marketing. We got to get the word out. So we've we found a kinder, gentler, less threatening way to describe this. What a qualified intermediary is, is someone who the IRS requires to work with when you want to do a 1031 exchange with your real estate. Now, the next question, of course, is what's the 1031 exchange? 1031 exchange is where you sell a piece of investment real estate. And by following the steps and using the QI, call over an intermediary, you purchase new replacement investment real estate, and you get to indefinitely defer paying the tax on the profit that you normally would have had to pay. You get to use that money for yourself as long as it stays deferred. So, you want a really sad example of how that works? It's true. My very first real estate sale 30 years ago, before I

The $30,000 tax bill that could have been half a million dollars

SPEAKER_04 3:31

knew about 1031s, I made a such a profit that I was all fat and sad. As a matter of fact, we were ready to set a 10-year goal to get the boat, sail away. I sold that property. My accountant informed me that I was gonna have a $30,000 tax bill. One transaction. Now, he goes, okay, well, $30,000, you had to pay tax, that sucks, but what of it? But what if I would have gotten to keep that $30,000 and use that to make money for the next 30 years until today? You run those compounding interest scenarios, and if I would have kept it in real estate, made 10%, fairly normal, I would have had like between $500 and a million dollars more from one transaction. That's what the power of the 1031 exchange is, is it lets you keep that's those tax dollars working for yourself, and all you're doing is selling and buying just like your normal business practice is.

SPEAKER_01 4:36

Right, right, yeah. Yeah, I I've heard about this and I'm fascinated by the 1031 exchange. I haven't used it yet. I I own a few rental properties, I haven't sold any to move up to get another one yet, but I do intend to use it now. Now, the big question to me the government loves our tax dollars, right? They love to tax us as much as they can, you know, into uh you know, into infinity. Why the hell would they allow such a big loophole like this? And they're losing out on billions in taxes.

SPEAKER_04 5:05

I mean, first of all, the purest in me says, please don't call it a loophole. It's actually been part of the statute, part of the code

Why the IRS lets you defer capital gains since 1920

SPEAKER_04 5:14

since 1920. Isn't that crazy?

SPEAKER_01 5:16

That's crazy.

SPEAKER_04 5:17

Here's why they had us do it, they let you do it in the first place. It was originally designed for farmers. Now, if you remember, we were just coming out of the homestead age. So there were a ton of farmers out there that are all homestead at 160 acres, and our nation was hungry. Post-World War I, pre-World War II, we were trying to grow our agribusiness industry. But all these farmers sitting on 180, 160 acres, if they sold their property to go buy a bigger farm to grow, many times they would not have the money left after they paid the taxes to be able to do it. So not only could they not grow, but what about all those young kids wanting to break in and buy their first small farm? Small farms weren't selling, so they couldn't break in. So, in order to break that log jam, the IRS put into place Section 1031, which allowed these farmers and aggro agro and uh industrial business owners as well to sell their properties and not have to pay the tax so they could afford to buy bigger properties. That was the logic in the very first place. Now, fast forward 100 years and what do we got going on? Here's a challenge for you, Stephen. Think of the tax code not as a way the government gets a hold of our dollars. I know that they do, and I'm totally with you on that. But think of the Internal Revenue Service Code as more of an incentivizer of behavior. Just like in 1920, what were they trying to incentivize? Farmers to buy up, new farmers to get in. What are they trying to incentivize now by letting us as real estate investors keep those capital gains tax dollars working for ourselves? Well, they desperately need and want a very vibrant US economy that is founded on real estate investment. So what they've done is they've created, they've tailored this statute so that yes, they're giving up capital gains dollars to you and me when we sell real estate. But you know what they're getting? The tax on two real estate commissions, the tax on two title closings, the taxes on the profits from title insurance underwriters, the taxes from two appraisers, two inspectors. Um, and the list just goes on. Everybody, all of these people that are involved in the real estate industry would be doing less work if there wasn't the 1031 exchange incentivizing you and me to sell our real estate and move it into other into other real estate. So it's a key to keeping the economy going and the velocity of real estate, which by extension means the velocity of money going. And the best way to beat inflation is to have the same amount of money working twice as hard rather than printing twice as much money, which the government seems to have done a really good job of for a while. So that's that's the whole rationale of why they let us do it. Because they make a lot more money. But guess what? If we use it right, we make a lot more money.

SPEAKER_01 8:59

No, no, I I love the concept, I love I love the bone that the government uh seems to have thrown us with the 1031 thing, because you know, there's some houses in my portfolio. I would love to sell 1031 into something else, you know, and just you know, advance that way. And then plus it gives someone else uh, you know, another

Selling in Silicon Valley 2015 to buy dirt cheap near Austin

SPEAKER_01 9:20

starter home that they could that they could purchase, you know, that's pretty cool, right?

SPEAKER_04 9:24

That's exactly right. There is a uh well, like let's let's talk about a few of your homes. Why would someone want to pick out some of their portfolio to do a 1031 to sell? Because the the foregone conclusion is that if you're gonna sell real estate and buy new real estate, do a 1031 exchange. Why just give up the tax dollars? So we really have to back it up and say, okay, what's the why of why you're selling? To see then if the 1031 is gonna work for you. So the 1031 exchange can be used to sell any type of real estate, as long as it's investment, anywhere in the United States. So a lot of people would start out living in one part of the country and that's where they like to invest, but then they want to move. So they will 1031 exchange their portfolio where they want to move, so they can keep their portfolio close to them. Or maybe they want to transition from an area where appreciation has been great to an area where appreciation still has some legs on it. I can't tell you how many 1031s we did for people who were selling in Silicon Valley in 2015 and they ended up buying dirt cheap, I mean, literally buttons did dirt cheap property near Austin. How have they done?

SPEAKER_01 10:52

That's pretty good.

SPEAKER_04 10:53

Yeah, I think so. I think so. So you go from areas of low appreciation to high appreciation. Maybe you're the kind of person that's looking for cash flow. So you go from a California property where you get great appreciation and cash flow stinks to Kansas City where the appreciation isn't so good, but you get great cash flow. Or maybe in your case, Steven, one of the things I'd consider is take a look at those properties and say which ones are at risk for a heavy capital expense. One roof can eat up how many years of cash flow. That's true. So the idea is to sell those where they're maybe getting a little long in the tooth and go buy newer construction where the risk of surprise repairs is much less.

SPEAKER_01 11:46

That's that's yeah, all that sounds great.

Bonus depreciation and cost segregation carry over in a 1031

SPEAKER_01 11:49

Um what what I was gonna ask also, so with my houses, I recently did um some cross segregation studies, right? So I was able to get the bonus depreciation, all that hundred percent bonus depreciation, beautiful thing. It countered all the rental stuff I'm doing with my you know, Airbnbs and all my rental properties. So it's it's a cool little uh IRS bonus. I wouldn't say loophole again, like you said. Don't say that. Um, so my my question is, and I haven't researched it yet, but what happens when I 1030 out 1031 out of one of those houses where I sucked all the meat off the bone as far as depreciation? Do I gotta pay that back when I 1031 into the next house?

SPEAKER_04 12:31

Well, the bad news is if you don't do the 1031, that's exactly what happens, is you got to pay all that. And so then, yeah, you can start over with a new property and do it again. But if you do the 1031 exchange, not only all of the profit, but all of the depreciation, including cost segregated depreciation and bonus depreciation is also deferred. Now, here's where we can throw some gasoline on that fire. Let's say you're selling a property for 500,000, you bonus depreciate it out, it's at zero. If you sell it, you got to pay depreciation recapture on 500,000 bucks. But if you 1031 that and go buy two $500,000 properties, the the depreciation is carried over into the first $500,000, and the second five hundred thousand dollars that you bought more than you sold, is additional depreciable basis. So then you go right ahead, depreciate that sucker out year one as well, or whatever you're able to get at whatever stage the tax code is. So you can actually not only avoid paying the recapture, but you can buy more depreciation to use using the 1031 exchange.

SPEAKER_01 14:00

And and so that's what I was gonna ask too. So if I if I just went and bought one house, if I just 1031 from that house to the next house, whatever, about the same price, um, then I can't do depreciation on that one house. I have to do it on if I have to do it on two houses.

SPEAKER_04 14:19

Yeah, whatever depreciation you've taken goes into the new property and affects its cost basis. Oh, okay. So if you sold for 500 and your basis was zero and you bought for 500, your basis is still zero. It doesn't disappear. But that's why a lot of people use that tactic of either buying something much bigger or buying multiple replacement properties so they can get more depreciation to use, and you just keep banking that and banking it and banking it and banking it until there's a couple things yet that can happen. You ready to talk about these?

SPEAKER_01 14:56

Yes.

SPEAKER_04 14:57

I mean, man, these are like taking guns to a knife fight. So let me let me couch this as in the four D's of why you would 1031 exchange. The first one we've talked about, it's the compounding interest of simply deferring having to pay the tax, whether it's two years or whether it's 30 years. There's a huge benefit for you. The second D we also addressed, because that was talking about changing real estate types and numbers and locations. So basically, you're able to listen to whatever the market is telling you. And if the market's telling you to get out of single family and get into short-term rentals, you can do that without having to pay tax. If the market's telling you to get out of larger properties and go into smaller single-family homes, like I'm actually kind of a fan of these days, because what are we seeing coming out of Washington? Federal incentives for first home ownership. Well, guess what? That's just going to pass right along to the seller, isn't it? So, what an opportunity to maybe position yourself there. Here's what we're talking about with this third D. Yeah, the fourth one. And that is that the 1031 Exchange allows you to adjust

The four Ds: deferral, diversification, life cycle, and death

SPEAKER_04 16:17

wherever you are in your personal life cycle. So the way that we used it personally, we wanted to be able to sail away and raise our kids on a sailboat. So for us, that meant short-term rentals that we could have managed. It meant we had to buy a boat, it meant we had to get to a place where there was water, because I was a Kansas farm boy. My wife was from Minneapolis and we met in Denver. There's not a lot of ocean anywhere there. So we used the 1031 Exchange to transition our portfolio from Denver to Connecticut, where there was water, but it was cold water, to Florida, where we finally got what we wanted. And along so we are accommodating our life cycle where we wanted to be into vacation when it was there. But also, and this is so powerful, along the way, we would periodically sell our primary residence. And when you do that, if you lived in that primary residence for two out of the five years prior to selling it, as a married couple, we would get the first $500,000 of profit tax-free. And you do that once every two years. So, in my mind, forget 1031, forget everything. That's the single biggest gift that the IRS will give you in for investing in real estate. Invest in buying your own house every two years, that money's tax-free. And so we would do that as we went from Colorado to Connecticut to Florida. But it gets even better, Stephen. I feel like the Romco salesman now, right? But wait, there's more. There's nothing wrong with converting an investment property into your primary residence. As long as you don't sell it, you won't pay the tax. Once you've lived in it long enough, then you start to eliminate that tax. And if you ever sell it after living in it the appropriate amount of time, then you will get to prorate the gain between the amount of time you rented it and the amount of time you lived in it. Now, for us, what we would do is we would convert a property into our primary residence, sell it, and then the money that we didn't have to pay tax on went into the buy the boat kitty. And we did that several times. And so by the time we got to Florida, we had 1031

How David bought a sailboat tax-free by converting rentals into primary residences

SPEAKER_04 18:50

exchanged into a vacation rental portfolio. We'd taken the tax-free money and bought the sailboat. So all we did was move aboard without paying a penny in capital gains tax over the last 15 years. That's how powerful that can be for shaping your life as an end strategy. I have a guy on St. Pete Beach here who did a 1031 exchange into three identical condos beachfront. On the they're literally on the same floor of the same building. Once he had rented one for a couple years, he moved into it and converted it.

The St Pete Beach investor cycling through three identical beachfront condos

SPEAKER_04 19:32

Now, when he owned it for five years, he had lived in it for three, he'd rented it for two. So he got three-fifths 60% of the gain tax-free. Paid a little bit of tax on the rest. Where do you think he moved?

SPEAKER_01 19:51

Florida. Next door to the next one. Oh, wow.

SPEAKER_04 19:55

Because he had three of them backed up. That's good. Did the exact same thing. Whenever it's time to sell that one, he'll take that money tax-free. He'll move into his third one. So you can shape your life totally tax-free. Because the final D is one that we're, it's gonna happen. We're not happy about it, but it's gonna happen. And that is you die. Because when you die, your heirs inherit that property at what's called a stepped-up basis, as if they paid market value for it on the day you die. So when you die, you don't pay the tax, your estate doesn't pay the tax, your heirs don't pay the tax, it truly does disappear. So from your first day as a real estate investor to your last day here on earth, you have a bunch of ways to never ever pay a penny in capital gains tax or depreciation recapture to the government. Because all of that then ends up going away upon death. I get asked the question all the time from financial advisors and people who want you to invest in stocks instead of real estate. Oh, just pay the tax. Come invest in my Google or whatever, because you're gonna have to pay the tax anyways. And my answer to them always is no, you don't. But even if you do end up, the longer you keep it deferred, the more you make for yourself. So that's kind of the 1031 in a nutshell.

SPEAKER_01 21:34

And so, and so when you do 1031 out of a property, you know, sell the property 1030 into the next one. How many days do they give you to do to find or identify? How does that work? The next part.

SPEAKER_04 21:47

Yeah, that's kind of where the devil's in the details, right? So you have to use the qualified intermediary. So hopefully they're your guide, right, through the whole process. They better be. But from the Date of the closing of your sale, you have 45

45-day identification window and bunching your closings to restart cash flow fast

SPEAKER_04 22:04

more days simply to identify your potential replacements. Now they don't have to be under contract or anything, but once day 45 passes, you're stuck with what's on that list and you can't change it. So I tell people, you know what? Don't think of it as an identification period. Think of it as an oh my gosh, I got to get this property under contract period, so that you can avoid any risk of losing it after day 45. As a matter of fact, what a lot of our clients are doing right now is they will wait until their old property gets a contract. Well, that's still 30 or 60 days from closing. But as soon as they get that contract, then they will go into contract for the purchase of their new property. So that in many cases, they will close their new property a week or two or three weeks after they've sold their old property. So that's still within that 45-day period, isn't it? So even if something bad happens, they've got plenty of time to go find something new. But even more important, what a lot of people don't think about is that the closer you can bunch your sale and your purchase, the quicker you're restarting cash flow. So if you're a short-term rental investor, you you know, and you're selling uh, let's say you're selling something in the smokies in the summer, and you want to make sure that you've got your property, your new property in place before fall color season, because you want to get the maximum out of that. So you try to get that sale happening and bunch that closing as quickly as you can so you can get that cash flow restarted.

SPEAKER_01 23:55

I like it. I like it now. Now, now there is a thing I also heard about 1031. It has to be a like property or a similar type property. Uh can you explain that part to us?

SPEAKER_04 24:06

Yeah, that's the most beautiful, generous part of the code, and that is that like kind simply means that it's real estate. Real estate anywhere, US for US, foreign for foreign. And then there's another term that's used called qualified use. And qualified use means real estate that you have held for investment. So it's any type of real estate anywhere in the US as long as you've used it for investment and you plan to use it for investment. So, really, about the only types that don't qualify for the debt 31 are going to be your primary residence. But remember, that's better, that's a better deal. So you don't worry about that. The other type of property that doesn't qualify would be fix and flip properties. Because your motive when you buy a fix and flip property is not to hold it for investment use. Your intent is to fix it and resell it. So that wouldn't qualify. So, what a lot of our clients will do is just slow down that model a little bit. And instead of fixing it and selling it, they'll buy it, they'll fix it, they'll put a renter in it, and then they'll wait. And maybe if they want to keep things going right, if you're an adrenaline junkie like me, you just gotta always have your hands doing something, they'll do a cash out refinance. Pull the cash out, which is tax-free, and go use that to buy your next project while you're waiting for that first one to season, maybe a year. Then once it's seasoned for a year, now it's eligible for a 1031 treatment. But were you slowed down at all? No, because your cash out refinance lets you get the new property. And what are you going to do with that new property? Fix it, rent it, refinance it, and get the next one. So you're really not slowed down at all. And I've had clients doing 20 or 30 exchanges a year when they've

The fix-and-flip workaround: rent it, refinance it, season it for a year

SPEAKER_04 26:17

adjusted their model to this. And in every one of those sales, they've owned the property more than a year. They just simply slowed down at first. And there's another hidden benefit there that I didn't even think about. But one of my clients said, Well, Dave, how do you think I've been able to finance all these? It's because I've got cash flow coming in that shows on my books for all the other rentals. If I didn't have that cash flow, I'd have a tough time owning this many houses.

SPEAKER_01 26:49

That's nice. That's nice. And uh a question that came to my mind because I have a buddy, I had a buddy that uh in the pat in the past few years, you know, he's not an investor, but he he bought some land before everything went crazy, you know, and made about $80,000 profit. And he he kind of moved in, you know, his older guy, he moved in with his um, you know, girlfriend type deal, living in their house, whatever. But and you know, they became serious. What what his what his deal was, he goes, Man, I'm I'm I'm gonna sell this land now. We we don't go to it anymore, blah blah blah. It's gonna be like 80,000 in profit, but they're gonna take a big chunk of it. You know, I've only had it for a few years. And is there any way I could put it? He's asking me because I he kind of they kind of think I'm the real estate guy at work, right? And so I'm he's like, Can I can I 1031 it and I put it into the house that we're living in now, and and um, you know, so I don't have to pay the taxes. And I'm like, I don't I don't think it works that way. You might call a professional, you know, someone like you, to ask how he could avoid paying taxes on that land. But what what is your answer?

SPEAKER_04 27:56

Yeah, that's kind of a nuanced question. There's several different ways it could go. So, first of all, he could simply sell it and use the proceeds to go buy new real estate worth at least $80,000. Now, maybe since he's your buddy, maybe you and he going together on a small rental for $160. You own $50 of it, he owns $50 of it. Well, as long as he purchases at least as much real estate as he sells, he'll defer all tax. So he could do the 1031 himself or with a partner as long as he's buying actual real estate. Now, another thing that he might be able to do is if he's actually living in a house that he doesn't own, he could 1031 those proceeds and buy that house because his girlfriend is not a related party. So he could use his 1031 exchange to buy the house, and he'd have to show that he was using it for rental for investment. So the girlfriend would need to be paying rent so that you know, I mean, there's just all sorts of then, of course, you give it back to her on date night, and there's all sorts of things that you could do. But the 1031 has to be a sale of investment real estate followed by a purchase of investment real estate, and sometimes there's ways to make certain situations work.

SPEAKER_01 29:26

Wow. So I could sell, let's just say, you know, my first house that I bought, I use the the house hacking method, I just hop from house to house every every year or so. And so my first house, real starter home, you know, not the best neighborhood, has good bones, whatever. But let's just say I have a hundred thousand in equity in that that I'll get, right? That I'll want a 1031. Now, from that hundred thousand, I could put that as a down payment. That would that 100,000 could be 20 towards buying something bigger. It don't have to be similar priced, right?

SPEAKER_04 30:01

How much are you selling that property for that you already got a hundred thousand equity?

SPEAKER_01 30:06

Okay, okay, that's a good question. I think it's worth around 250, 250,000.

SPEAKER_04 30:10

So you're selling for 250 and you'll have about 100,000 in cash that comes out after the sale, right? Your responsibility to defer all tax is to purchase at least as much as your net sale, 250, using all the proceeds, 100,000 to do it. So it could be one property for 250 where you put $100,000 down, or it could be two $250,000 properties with $50,000 down each. Now, this is a huge opportunity. Um, let me put it in a here's some math example I use often, so I it'll flow easy. You're gonna sell a property for $500,000 that has a $200,000 mortgage on it. So you got to buy $500,000 in real estate. You got to use all $300,000 to do it. You buy one house for $250,000 free and clear cash. Then you buy a second house for $250,000, using the other $50,000 as a down payment. So at the end of the 1031, did you purchase at least as much as you sell? You sure did. Did you use all your proceeds? Yep, you sure did. But look what you got. You now have two instead of one. So hopefully you're getting better cash flow per door or per square foot, because maybe a $500,000 house gets you $4,000 a month in rent. But a $250,000 house gets you $2,500 a month in rent. So by having two of those, you increase your cash flow immediately. You've also still getting the benefit of a mortgage on one where the tenant is paying the mortgage, but you also have a free and clear property that you don't owe anything on. So the equity is concentrated. It can sit there as long as you want and wait until interest rates come down where you want them to be, or until you find another target that you want, and then all you got to do is cash out refinance and use the money to go buy another property. Meanwhile, though, it's not costing you anything. And that's huge. Because today, especially, it's tough to think about cash out refinancing before I need the money, because that money's pretty expensive now. It's not like it's 2.5 like it used to be, right?

SPEAKER_01 32:45

Yeah, no, that's wow, that's powerful stuff.

SPEAKER_04 32:48

So that's that's a really good one, yeah.

SPEAKER_01 32:51

Or even you know, a HELOC or something like that.

SPEAKER_04 32:54

Exactly, because that's all tax-free. You can do that now. You had mentioned house hacking. That's another crazy 1031 opportunity. Um, because when you're house hacking, you're using part of your residence, your primary residence for investment, and part of it is your primary residence. So when you sell that property, guess what? It's your primary residence, so a certain percentage of that is tax-free. If you sell it while you've still lived in it for two out of the previous five years, so my guess is a bunch of those houses, you're already past that. But you then still have the 1031 opportunity for the rest of it. So, like let's say a lot of times a very common house act is to buy a small multifamily, like a duplex, and you live in one side and you're at the other side. You buy it for $200,000, now you're gonna sell it for $400,000. Well, the profit that's allocated towards your primary residence unit, tax-free. The profit that's allocated the $200,000 to the other side, you do a 1031 exchange on. And you go buy another duplex for $400,000. Now you only have to buy $200,000 in real estate, right? Yeah, the other $200,000, or in other words, the other unit, you can use however you want, including as your next primary residence.

SPEAKER_01 34:32

That's cool. Isn't that awesome?

SPEAKER_04 34:35

And the money then that was tax-free from that first sale of your primary side, you could go to Vegas with it's tax-free money to be used however you want.

SPEAKER_01 34:48

Now, now, okay. Let's say I wanted to sell three of my properties to get a nice chunk of change, you know what I'm saying? So I can go buy a small apartment complex. Can I do multiple like that?

SPEAKER_04 35:02

Absolutely. That's what's called a consolidation exchange, where

Consolidation exchange: three properties into one apartment building

SPEAKER_04 35:07

you sell uh, you know, let's say you had a five and a three and a two, right? 500, 300, 200. So you're selling for a million total, and you would like to turn that into a two million dollar apartment building. As long as you cluster those sales so that that purchase of the apartment building can meet the timelines for all three sales, it's perfectly fine to combine them. So you're selling three properties worth a total of a million, you're buying one property worth a total of two million, and you're deferring every bit of tax. And boy, are you reshaping your portfolio.

SPEAKER_01 35:51

And plus, you get that extra million of depreciation, right? Is that how that works? That's exactly right. That's I'm starting to get it now. So that one million that you jumped into, that's already uh spoken for. It's you know, you can't depreciate it out, depreciate it out. But the other million you just grabbed, you know, you get to you get to write that off. That's beautiful. That's awesome. Um man, I got so many, uh, so many ideas now. So many ideas. Because I mean, I mean, I could okay. So how how does land play into this? Because I hear people talking about buying land right now. Um, can you go from house to land? It's I mean, it's still real estate, right?

SPEAKER_04 36:36

Absolutely. As long as your intent is to hold it for investment purposes. So it could be say farmland that you want to farm, it could be a chunk of land you want to turn into a campground. What do they call that? A clamp ground. Clamp ground? Yeah, like a clamp ground. Yeah, yeah. Um, it could be land that you want to rent to farmers, or it could be land like you guys have a lot of exchange, interchange, interstate exchanges, right? Where there's no development and it just sits there. I guarantee you, all four corners of that interchange where there's nothing are owned by investors waiting for progress to catch up. So you can buy that land with the 1031 exchange and hold it for appreciation. Sooner or later it's gonna come. So you buy it and you hold it. By the way, you're a Texas guy. What is on every parcel on all four corners of those exchanges?

SPEAKER_01 37:39

What's on every parcel in all four corners of those interstate exchanges?

SPEAKER_04 37:44

A bunch of cows.

SPEAKER_01 37:45

Oh notice that? Yeah, you're right. You're right. Do you know why that is? This goes back to old Texas law. Yeah.

SPEAKER_04 37:53

Because those cows keep the agricultural zoning. So the taxes for those investors are dirt cheap because they're they're actually many two or three acre cattle ranches.

SPEAKER_01 38:06

Wow. Now there's a bonus, not a loophole. A bonus, y'all. Um, that is a bonus. So I wanted to ask two, because we have people come on the show and they talk about creative financing.

Subject-to purchases and the risk-of-loss test

SPEAKER_01 38:19

Subject two, for example. And now I was gonna ask, can you like so I have a have you know several acquaintances that that like to purchase houses, subject two, and you and you know what subject two is? Okay, yeah, you're you're you're you're kind of you're taking over someone's mortgage, you're you're getting the deed, you know, and then the mortgage stays in their name, but you you technically own the house now. Now, I have friends that are acquaintances that that put these you know perpetual. They they they don't say like after five years you have to finance out or nothing. They just hold on to these, their names on it forever, whatever, and they own the deeds. So with those, can you do 1031 exchanges, or is there any risk involved because the actual mortgage is not in your name?

SPEAKER_04 39:05

Well, yeah, I was gonna say the risk really lies around the mortgage, right? And any sort of doant sale issue. Most subject to is I'm gonna I'll say most qualified because I think I can't really say most, but they fall into two camps. There are those that actually happen where the deed conveys. Now, that's hard to do. I don't quite know even the mechanisms that they can use to do it, because there's a lien on that property from the lienholder. So changing the deed without paying off the mortgage, maybe there's a way to do it. But if so, it doesn't matter to us as the qualified intermediary. Because what matters is that you sold a piece of property and you are purchasing property that you are getting the deed on. So that's all that matters for the 1031. If you want to assume a lot of risk, mortgage risk, or even if it's legal to let you assume the mortgage that's on it, that's perfectly fine. Because at the end of the day, the RS wants to know in your 1031, did you purchase at least as much as you sold? Yes. Did you use all the proceeds from your sale to do that? Yes. Do they care where the rest of the money comes from? No. Now you have to care, obviously, because you got those risk factors to mitigate. But that's perfectly fine. Now, here's the other type of subject, too, that I think is more common. And that is where papers will be signed and a contract will be signed for, in essence, what becomes what we would call a land contract, where you're buying my house, but you're buying it without the deed conveying. And you're gonna agree to make payments to me for five years, 10 years, 15 years, whatever. As part of that, you're assuming the mortgage, but I still owe the deed because I can't get it out of my name because of the financing. Now that's an interesting animal because how do you do a 1031 exchange and show that you're actually buying a piece of property when you're not getting a deed? And the answer is a legal concept called risk of loss. When it can be determined that the risk of losing that property, if the property burns down, if there's a natural disaster, if it gets foreclosed on, if whatever, if it can be shown that the risk of that, of burying the loss of that, has shifted from me to you, then that's the same thing as you buying the property, even though you don't get the deed. Another way of saying that is benefits and burdens of ownership. If enough of the benefits and burdens of ownership have transferred to you, then the IRS can see that purchase as happening when you sign the contract and not when the deed conveys. So are you responsible for real estate taxes, for insurance, for making the mortgage payment? All of those kinds of things demonstrate that you're the beneficial owner, even though you don't have the deed. Is the property going to be reported on your tax return? That's huge. Then that means you have bought it, even though you don't get the deed. So you can sell one of the properties you own and go buy a subject to property on a land contract, and still deferral tax as long as you purchased at least as much as you sold and you used all the proceeds in the purchase. That's kind of a deep end of the pool.

SPEAKER_01 43:00

It is, it is. Now I do have I do something came to mind, and it is, I guess it would be a simple way to look at it, because I do have friends that that do buy subject too, right? And part of the contract they sign with the seller, you know, the who stays on the mortgage is I have the right to sell this property at any at any point, and then the mortgage will be first to be paid off. So they could, yeah. So them technically they could sell it, mortgage gets paid off, bank's cool, whatever. You did sell it, you made a profit, and then you could 1031. So that's it, that's easier, a little bit easier.

SPEAKER_04 43:35

Well, yeah, because that's another instance where one of the benefits of real estate ownership is getting the appreciation, isn't it? So your buddy can sell that and he gets to make the spread over what he might pay for it, right?

SPEAKER_03 43:51

Right, right.

SPEAKER_04 43:52

That's a benefit of ownership. That's another piece of evidence that says that in the IRS's eyes, he actually owns that real estate. Yeah.

SPEAKER_01 44:01

Okay. Here's a question. And we we talked about, you know, these tax incentives, right? The how how the government wants to um incentivize people to, like you said, it started with the farmers to step up, buy bigger land, you know, progress. And then it's like, okay, this thing's working great with um houses too. People are stepping up, buying bigger houses. Then there's more houses for the for the small people to buy, small people, the starter homes, whatever. Um, and we're and we're incentivize and they they got more money to to put back into you know investing. Now people talk about this housing crisis, right? So so uh a strange thing happened. What the the the Fed thought, okay, we'll just jack up interest rates, and then you know, the then there'll be more

Why $10,000 first-time buyer assistance just inflates prices

SPEAKER_01 44:48

uh houses to buy, and the price the prices of houses are gonna just plummet, and everybody everybody's happy. There's more more supply now. It didn't work. We got high rates and high prices at the same time because nobody wanted to sell and get out of these two percent interest homes to buy a eight percent interest home.

SPEAKER_04 45:06

Dude, I'm not getting out of mine. Are you no, no, no, what that was the craziest concept anybody ever had?

SPEAKER_01 45:13

And so, anyways, it didn't quite work out. Still have this housing crisis, still a lot of people, and then it's disgusting. Like you have to make uh over a hundred thousand dollars a year to afford a regular starter home now. It's ridiculous, whatever. But anyways, all that being said, if you were uh the housing guy in the government, what incentives would you put in place to to help you know help supply uh help you know grow so people can afford houses? What what what incentives would you put in place to make that happen?

SPEAKER_04 45:50

Wow, that is I'm almost having a visceral response against that. That's crazy. I'll tell you why, Steven. I'm on the opposite side of things. I look at what the government's doing every day because I want to take advantage of it. How wrong? It's like, what would I do to help people? Well, you know, I think we have to be very careful of unintended consequences. And yeah, it's nice every time the government gives you a gift, it's gonna backfire on you. When the government raises minimum wage, if you're not careful, what happens? The price of food goes up. So, yeah, those who are dining out pay more, but who else is paying more per food for food? The people that got the minimum wage raise. So does it really benefit them? Right now, there's all sorts of incentives being looked at to provide for first-time home ownership. Um, I think President Biden's phone when I was like $10,000 down payment assistance. Well, if you're like me, I hear the bills going off and I start buying single-family homes. Because sooner or later, people with ten thousand dollars in their pocket from the government are gonna come to me to buy my houses. What happens to the price of my houses when I know someone has ten thousand dollars more to spend? I'm not gonna sell it for the same price, am I? Unintended consequences. Honestly, I think, wow, this is gonna betray who I am, but I think the best thing the government do is get out of the way, stop spending more than you bring in, and balance the budget and let the market take care of what the market's gonna take care of. Yeah. That's Dave's diatribe right there. Sounds simple, but that's the only soapbox I'll get up on.

SPEAKER_01 48:05

And you know, we if we go down that rabbit hole, uh every every part of the government uh they get rewarded the more they spend. If they start, you know, spending less, then they're not gonna get as much money to spend from the you know, it's it's it's backwards. So it's hard to, yeah.

SPEAKER_04 48:21

Here's a scary thought for you. This one's gonna keep you up tonight. You look at how much our government spends, right? We could subscene. Right now, I think it's approximately 40% of the people in America, the entire population, 40% either work directly for the government, their lives are subsidized by the government, or they have a first degree relation who works for the government. 40%. What do you think is gonna happen to our budget and our ability to balance a budget when that number becomes 51?

SPEAKER_01 49:03

Damn.

SPEAKER_04 49:06

I told you it's gonna keep you up at night, isn't it?

SPEAKER_01 49:08

Oh, geez, and it's only growing, man. It only seems to be growing and growing.

SPEAKER_04 49:12

Uh I think the the answer really is, and it's the simple answer, but there's two groups of people in this world that have always ruled the world, and that are banks and landowners. And I am too lazy and stupid to start a bank, but I can own land. And so my encouragement to anybody and everybody, whether you save up and buy a house and rent rooms in it. My wife and I have been married for 34 years. We've had great great living, we never had to, but we've had roommates for 26 of those 34 years. Because we like it and because it helps with bills. Whether you buy a primary residence and rent rooms out, or you become a real estate investor, find a piece of land and own it. And that's going to be your hedge against inflation and government and everything else.

SPEAKER_01 50:12

And you I assume you use debt as a hedge against inflation as well.

SPEAKER_04 50:18

Yeah, absolutely. Debt can certainly that's kind of a two-edged sword, right? Because it it is a hedge against inflation, but it's also a risk. So you just have to be careful. Things like um adjustable mortgages are like little tools of Satan's imps. You know, stay away from those bad boys. But like this, like you and I have this long-term, we got 30-year 2.5% financing on all kinds of properties. So when inflation doubles over the next 10 or 15 years, I'm protected because I'm still paying back in 2020, or I'm paying back in 2040 by 2020 purchases, and that doesn't get much better.

SPEAKER_01 51:10

And I don't see them stop printing money anytime soon. Yeah, unfortunately not. You can't just leave your money in a bank and make two percent interest, and everything's gonna be fine.

SPEAKER_04 51:21

You know, it's kind of telling you everybody says, oh, inflation's tamed. Inflation's tamed. That's what the fedsman cried. No, it's not. Why do you think you can all of a sudden get five percent on a regular savings rate? It ain't because the banks are being generous, it's because that's where inflation is heading.

SPEAKER_01 51:41

Yeah, I mean, proofs in the pudding. That's all uh $15 value meal the other day. It was a value mill. So it's just the new normal. Um, but yeah, yeah, inflation's but real estate ownership and the ability to do it and shape your portfolio without having to pay tax just allows you all the leverage you need to keep growing rather than building to a point, then falling back.

SPEAKER_04 52:08

Then building to a point, falling back because you're always keeping the tax going for you. And that's where I live with the 1031 exchange.

SPEAKER_01 52:15

Yeah, I always look at that. For example, California, they raise the minimum wage to $20 for fast food workers, right? And I look at someone that's working a job 20 years, they're building up. Oh, I got uh $20, $22 an hour. You know, they they're busting their ass to get there, and all of a sudden everybody makes that because the government, you know, signs something on a piece of paper. That's just to me, that's crazy. But uh we can go down that rabbit hole. One more thing on on the um, I've I heard, you know, this might have been a year ago, what um murmurings from from the from the Biden administration about messing with the 1031 exchange. Now, what did what do you know about that?

SPEAKER_04 52:54

Yeah, you know, I'm not gonna throw him under the bus by himself because every president I've been under for the last 25 years, Republican, Democrat alike, have all

The average 1031 sale is under $400,000 - not a rich person's game

SPEAKER_04 53:06

initially talked about getting away with 1031 exchange, doing away with it. Because why? It seems like low-hanging fruit, doesn't it? Yeah, it's only a rich guy's game, and it's gonna take away all these tax we're not getting. But every one of those presidents has actually looked at the evidence and looked at the numbers and said, no, we need to keep this because of the incentives that we talked about, the fact that they're getting they're losing a few billion in capital gains tax, but they're gaining many billions in ordinary income tax. But here's another thing that comes out of the studies, and this this is where I kind of have an issue with this current administration, is like tell the truth. The average 1031 exchange sales price is a little less than $400,000. Now, we're hearing the cries of it's all the rich guys, it's the Hilton's, it's the big businesses and office buildings. No, it's not. It's you and I and 300 million other Americans that own one small piece of investment real estate. Right. And that's who the 1031 exchange is for. So if they take it away, they're taking it away, not from the rich guys, they're taking it away from mainstream America. And so that's, but again, I I right now the Biden administration has kind of been in this mode where they create their each budget each year, they create a proposal to get rid of it or radically alter it. But I don't think they really want to do it. It's just one of those bargaining chips that they throw out there so that the rest of Congress will compromise and say, don't touch 1031, but we'll give you this. And so so far it's been defeated every time. Maybe a lot of people anticipate anything now.

SPEAKER_01 55:12

A lot of people in you know, Congress and Senate uh own real estate themselves. Who knows?

SPEAKER_04 55:17

Sure, they do. Absolutely do. As a matter of fact, the last budget last year, when the Senate got a hold of it, so the House of Representatives creates the budget, it goes to the Senate to be ratified for their side. They didn't even bother with a headcount vote, they did a voice vote that was unanimous. Every senator voted to not touch 1031 exchanges. So that's the uphill battle that anybody's gonna have to hear into that. So I'm not too worried. I probably got a job for a few more years.

SPEAKER_01 55:55

That's crazy. See, when you first got out when you first uh got on the show, I was thinking, did he 1031 into a boat? Can you do that?

SPEAKER_04 56:01

Well remember what I did was I converted the houses into my primary residence and then took the probation of gain tax-free and put that money in my buy the boat kitty. So we 1031 into the vacation rental portfolio that were all houses on the water, by the way.

SPEAKER_03 56:19

Oh, nice.

SPEAKER_04 56:20

And we did three, and we didn't tell the web, but we took the tax-free money and bought the boat, and then we sailed all over the Bahamas, east and west coast of Florida, the Keys. And if we ever got tired and needed a break, we just pulled up the boat behind one of our vacation rentals

Raising four boys on a sailboat in the Bahamas and Florida Keys

SPEAKER_04 56:38

when it was open. We had a good life, it was fun.

SPEAKER_01 56:43

That's what I was gonna ask. How was life on a boat? And you just kind of answered that.

SPEAKER_04 56:47

Yeah, you know, people used to ask me, uh, like the people who doubted us. Like my father-in-law was he was sure I was gonna kill his daughter, but uh you know, people would come up to me and go, Do you still live on a boat? And my answer just finally became, well, yeah, you mean you still live in a house? Get with it. Go live life, go out on an adventure, whether it's a boat or an RV or whatever. You only get one round at this. Take it advantage of it.

SPEAKER_01 57:19

Do you constantly have the sea legs?

SPEAKER_04 57:23

Well, I've lost them now, but uh yeah, for a long time it felt weirder to be on dry land than it did on the boat. That was pretty strange.

SPEAKER_01 57:33

That is cool, man. I need to look at some houseboats. I've seen a few, but and and you could obviously um Airbnb houseboats, that's pretty cool.

SPEAKER_04 57:41

Absolutely. Now, one thing that we did do was we lived in our boat in a 1031 piece of property because one of my clients had bought in Key West a deeded boat slip, and because the boat slip had a deed, it was considered to be real estate, and so he 1031 exchanged into it, and then I rented that boat slip from him for three years.

SPEAKER_01 58:11

I've always you know, because I've always looked at you know, we like going to South Padre Island, you know, we're Texas. I've always gone there since a kid, and I've always wanted to buy something there, and I've seen a few that say it comes with a deeded boat slip, you know, and I'm like I don't know how to that's huge, that's real estate.

SPEAKER_04 58:27

Now, if it's separated, so you can't do something you want with it, you could always put a houseboat on it. Airbnb the houseboat out, or like what we did is we turned our houses into the short-term rentals, you turn the condo, and then on that deed it boat slip, you put a boat and you make that part of the rental package.

SPEAKER_03 58:51

Wow.

SPEAKER_04 58:52

So we rented our houses and we rented our boats. And if you came during the peak season, whether you were a boater or not, you rented the boat, but then they would never drive it, so we just got free boat rent.

SPEAKER_01 59:08

Man, so many ways to do this, man. I I love that and the creativity. You've been doing it for a long time, and uh, I'm definitely gonna talk to you because uh you can be my uh qualified intermediate intermediary if you're still doing that, you which you are, I assume.

SPEAKER_04 59:23

Uh that's where we live. We've actually that was actually part of the book that I think you've you've gotten or is on its way to you. Oh, we wrote a book called uh Lifetime Tax-Free Wealth: The Real Estate Investor's Guide to the 1031 Exchange. And you can catch it on Amazon. Oh, nice. Because that's where we live right now, is we're trying to help educate the next generation to how powerful this is. So we've got the book, we do 1031 exchanges for people. We're we've had a great run with it, we're ready, and we want to help others get there too.

SPEAKER_01 1:00:06

That's awesome, man. Well, I know a lot of our fans are probably going to be calling you, so where can they find you?

SPEAKER_04 1:00:12

Best place is just go right to our website, the 1031investor.com. And you can put that in the show notes. We'll we'll give you links to our YouTube channel, which has about 52 videos on all kinds of stuff like we talked about tonight. Just those little snippets that change a mediocre deal into a really good deal if you know how to do it right.

SPEAKER_01 1:00:37

Man, yes. I'm gonna get my uh Padre Kondo now with the boat slip, and I'm I'm gonna call you and you're gonna guide me to do how to do it properly. Thank you so much. Well, thanks for hopping on, David. Anything else to add before you before you hop off and and hop back on your boat?

SPEAKER_04 1:00:56

Love the bottle. I think I said it best. If you got something you're interested to do, do it now. Go.

SPEAKER_01 1:01:02

Oh man. That's great advice, brother. All right, man. Well, thanks for hopping on. And I can't wait to chat afterwards about about you know you know shaping my life, how I want it to be. I mean, you only get one, right? Say exactly. Sounds awesome. Looking forward to it. Keep away from them storms. No crazy story. Oh, real quick, no crazy storm stories. You weren't stuck out there on the boat in a storm.

SPEAKER_04 1:01:26

Well, yeah, there's everybody's got those. The only people that haven't been through storms, uh, either never boated or they're lying. But uh, I think my favorite 10-second story was the time we were offshore heading to the Tri-Tortugas, and it was the worst passage I've ever had. Our our uh gym sail broke, my business sail broke, I was on deck all night long trying to fix them. The microwave fell off onto the floor, and finally I just looked at my wife and said, I don't care anymore. I'm going to sleep. Don't wake me if we die. And that morning I got up and staggered to the cockpit. She's just looking like death warmed over. My son comes up and goes, Dad, why is your face green?

SPEAKER_01 1:02:20

Why is your face green?

SPEAKER_04 1:02:22

And we got to the dry tour too, because we did not talk to each other for two days. And after two days, I finally just said, You know, I didn't like that trip. And Vicky said, You know, I didn't like that trip either. I said, What if we got an RV instead? She said, I think that would be a great idea. But then two days later, you're in the middle of the Caribbean, the sun is shining, the fish are jumping onto your boat, you're snorkeling and swimming, and it's laughter and peace. And we said, okay, you know what? For the occasional storm, this is worth it.

SPEAKER_01 1:03:02

That's cool, man. That's good life advice, too, for the occasional storm and this place. All right, man. Well, thanks for hopping on, and we will see you soon. Hopefully, yeah, very soon. Thanks, David. Thanks for having me. Live Let Thrive. Out.

SPEAKER_00 1:03:17

Thank you for tuning in to this week's episode of Live Let Thrive. Be sure to tune in next week for all the latest in the world of Airbnb and all that and kills. Bye bye.