What is a 1031 Exchange and Why is it Useful to Me?

Goosmann Law Firm : 0:01

Do complex legal issues. Hold you back? Let's get energized and bring clarity to your top legal questions. This is Law Talk With The Flock By Goosmann Law Firm.

Jeana Goosmann : 0:30

Hello, I'm your host Jeana Goosmann CEO, lawyer, author, and business leader here to help walk you through the law, your life as a leader and business. Welcome Alex. I have Alex Berenstein with me here today. He's an attorney at the Goosmann Law Firm and focuses on Real Estate. We're going to talk about 1031 exchanges. Happy to have you on the podcast.

Alex Berenstein: 0:50

Yes, Jeana. Thanks for having me.

Jeana Goosmann : 0:52

Yeah. Have you been on a podcast before Alex?

Alex Berenstein: 0:54

I have not been on a podcast before I listened to a couple daily, so I have a little experience on the other end, but not on this side of the microphone no.

Jeana Goosmann : 1:02

Exciting. So we're really happy to have you on and we're going to be talking about 1031 exchanges.

Alex Berenstein: 1:08

Yes we are.

Jeana Goosmann : 1:08

What is a 1031 exchange?

Alex Berenstein: 1:11

So the 1031 exchange gets its name from the relevant section of the US Tax Code that for which it's named, another way.

Jeana Goosmann : 1:19

Original Name.

Alex Berenstein: 1:19

Right Yes. Yes. That's the term of art, but what I think most people would consider it would be a Like Kind exchange and that's a good way to think of it because it kind of tells you, what it does.

Jeana Goosmann : 1:30

Like Kind Exchange,

Alex Berenstein: 1:32

Right.

Jeana Goosmann : 1:33

Or 1031 exchange. They mean the same thing.

Alex Berenstein: 1:35

Yep. Interchangeable.

Jeana Goosmann : 1:36

Awesome. And we do these things part of our real estate group and it's part of our practice. And so we're going to dive into them a little bit more and let people know what they're all about.

Alex Berenstein: 1:45

Absolutely.

Jeana Goosmann : 1:45

Okay. Sounds good. Keep on going, tell us more about this.

Alex Berenstein: 1:49

Yeah. So like kind, basically means that you're going to exchange one property for another of similar nature or character. And I think, a common misconception is that somebody who has an apartment needs to exchange it for another apartment, to qualify for this like kind exchange. And that's actually not true. So somebody could own a restaurant or a bowling alley and exchange it for really any other kind of real property. In the United States.

Jeana Goosmann : 2:15

We're talking about real estate deals. There's some dirt somewhere that we're talking about, right. There's going to be a deed and a legal description. And it's how we transfer the property from one to another, through this special tax savings vehicle.

Alex Berenstein: 2:27

That's right. That's really our main advantage is that tax benefit.

Jeana Goosmann : 2:31

Yeah, let's talk. What is the benefit? Why are these popular?

Alex Berenstein: 2:35

Right. Okay. So there's a few tax beneficial treatments here that are important. But the main one is that you're going to have tax deferral on your capital gains from the original property that you're transferring for the new property. And that opens up a couple of different benefits for you. And the first one is wealth preservation, and then the next one is the tax advantage of your cash flow. So you're able to defer the gains that you've already built up from the first property and keep that going moving forward.

Jeana Goosmann : 3:02

Okay. So I'm going to break this down for everybody.

Alex Berenstein: 3:04

Sure.

Jeana Goosmann : 3:04

I bought a piece of property for a dollar, and n ow I'm going to sell it for a hundred dollars. I have a$99 gain.

Alex Berenstein: 3:10

Right.

Jeana Goosmann : 3:10

And instead of having to pay tax on that$99 today, I can roll it into a new property and defer that tax until later.

Alex Berenstein: 3:18

That's right. And the beauty of that is you can take property number two and exchange it for property. Number three and property three for property number four. So you start out,

Jeana Goosmann : 3:27

And now I am a land barren.

Alex Berenstein: 3:29

And now you're a land barren with this huge amount of capital gain. And you're not paying tax on it every time you're changing your investment, you're basically changing the nature and character of your investment by just continually carrying it over. And then in the end, you've just got one tax bill rather than five tax bills.

Jeana Goosmann : 3:45

And hopefully I made money on every one of those transactions.

Alex Berenstein: 3:48

That's right. That's right.

Jeana Goosmann : 3:50

So that's when you talk about wealth preservation it's cause you can keep growing your investment over the years and not have to take that tax hit.

Alex Berenstein: 3:57

Exactly. Yep.

Jeana Goosmann : 3:58

Excellent. And what was the other benefit You've mentioned?

Alex Berenstein: 4:01

Wealth preservation and, and so is that the one we talked about already?

Jeana Goosmann : 4:07

We just did, but there was one l think just deferring the tax.

Alex Berenstein: 4:10

Oh, tax advantage cash flow.

Jeana Goosmann : 4:12

So what do you mean by that?

Alex Berenstein: 4:14

So your cash flow is improving. So you've already got this money invested into this property here and you want to continue acquiring new and better properties and rather than dipping into cash that you might have for another endeavor or that you've got already earmarked away for other things you can use this money that you've got here and flow it into your next project.

Jeana Goosmann : 4:34

You bet. So in my example, after I sold for a hundred dollars, now I could take all a hundred dollars and put that down on my new property. Versus if I paid the tax, I probably would only end up with 80. Correct. So I'm going to have more cash to roll into my next property. Yep. Awesome. Cool. Well, let's talk a little bit about how can this be useful for investors?

Alex Berenstein: 4:55

Okay. Yeah. So, really it's going to be investors who are looking to continually acquire new and better properties, but they're not going to want to take that tax hit every year.

Jeana Goosmann : 5:07

Okay. And how can an attorney help with this 1031 like kind exchange process?

Alex Berenstein: 5:12

So, an attorney can do a lot for you in this process. And the first and foremost is just going to be your drafting and your document review. So you kind of touched on that a little bit at the beginning, and it's important to have an attorney doing the paperwork because there are so many different legal formalities that you're going to bump into. And so many nuances in real estate that even an experienced real estate investor, isn't going to remember. So the document drafting and review are going to be huge. And in addition to that, you're going to need somebody to help you navigate the rules and the regulations that come with 1031 and a seasoned tax and real estate attorney is going to be somebody who can, who can really do that for you.

Jeana Goosmann : 5:50

There's like minimums on time periods or maximum

Alex Berenstein: 5:53

That's right. That's right there. Yeah. There are some specific steps that you're to have to go through and some deadlines that you're going to have to meet. And I think in terms of being deadline oriented, we attorneys are probably about as good as it comes.

Jeana Goosmann : 6:05

Yeah. We like helping our clients with these transactions because we're actually helping them save money. That's right. And they're usually happy in this process too. Aren't they?

Alex Berenstein: 6:13

People are usually happier when they're saving money.

Jeana Goosmann : 6:15

Yeah. And if they're avoiding tax in a legal manner, cause this is the best way to go. That's right. Awesome. But what are some of the other ways that we're able to help as the attorney in this process?

Alex Berenstein: 6:25

So I think another big advantage that we provide is our ability to do due diligence through the process. So we're going to help you identify the right properties for you to be transitioning into, you know, you've got a good property here, but there's obviously there's usually something better out there. And so when you identified the property that you want to move into, it's important that you do due diligence on that property. And I think that's a big benefit that attorneys can add as well.

Jeana Goosmann : 6:50

For example, we're going to review the title report, right? And we can see things that might be an issue on that property. And then if there are issues, we can help them clean it up.

Alex Berenstein: 6:59

That's right. We can identify the issue. And then also hopefully clear it up on the backend too, without too much trouble.

Jeana Goosmann : 7:05

So what are the next steps for people to take if they own real estate? And they're thinking about selling and they know they're going to have a game, what should they be doing?

Alex Berenstein: 7:12

So the steps for a 1031 exchange are pretty clearly defined. And obviously that, that first step is to sell the property. And then the next step after that is you need to identify, like I was just talking about those replacement properties and you've got 45 days to do so, from the time that you sell that first property. And so what I would always advise people is that you should have those replacement properties in mind before you go to sell that first property. So you don't want to be coming up on day 40, 41 42. And you're still trying to narrow down this list of properties that you want to transition into.

Jeana Goosmann : 7:47

And sometimes in fact, I was just talking with somebody the other day and Okoboji is coming up Okoboji season. We have a place up there that we go to in the summer and they were just telling me, well, we ended up getting a place in Okoboji. Because we had to name a property in a 1031. And I'm like, well, that's a good way to inherit a lake home.

Alex Berenstein: 8:02

Yeah, that's right. Another thing I would, I would do on the front end rather than wait until you're in the process is to identify your qualified intermediary. So that's going to be the person who holds the capital gains for you in that transition period between property A and property B. And I suppose that's another big benefit for your attorney involvement as well as they can help you find a seasoned, qualified intermediary, that knows what they're doing. So the transaction gets done by the book.

Jeana Goosmann : 8:29

Yeah. We have those qualified intermediaries on our Rolodex or electronic phone Rolodex. Yeah. And that's probably something that not everybody just has at their hip pocket right. And again, what is a qualified intermediary? Let's break that down for everybody.

Alex Berenstein: 8:44

Sure. So that's going to be either an individual or a company or some sort of group that is going to hold those capital gains for you in that interim period in between when you've sold that first property and then you're purchasing your replacement property. So there's that 45 day period where you have to identify the property. And then you've got 180 days total to close on that new property. So when you reach that 180 day mark, or whenever you get your closing day, your qualified intermediary will step in and they'll take those capital gains. They'll facilitate that to the other seller. They'll make sure that you technically never take control of that money. So that capital gains aren't attributed to you. So they're kind of staying out there in the, in the free space to move around.

Jeana Goosmann : 9:28

There are people that we're working with in the background to help us get these deals done.

Alex Berenstein: 9:32

Yes, they facilitate the transaction.

Jeana Goosmann : 9:35

If they come and they call you or they call the firm, we're able to help them make this seamless and they can close the transaction and be confident that they don't have to pay their capital gains today. And they can defer it until the future.

Alex Berenstein: 9:45

That's right. It's a team effort and we're always willing. We're always glad when those questions come in and call because we want to handle those things with people on the front end.

Jeana Goosmann : 9:53

Thanks so much for explaining all of this for us today. I appreciate you coming on the podcast and thanks everyone. Go make it worth it.

Alex Berenstein: 10:00

Thanks.

Goosmann Law Firm : 10:02

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Alex Berenstein: 10:30

[inaudible].