JLM Blog |Episode 08: Build Massive Wealth by Leveraging 1031 Exchange and Other IRS Tax CodesReal Estate News, Updates, and Tips
Real Estate Agency San Diego
Podcast Episode by Jason Lee – Premiered August 26, 2021
What You’ll Learn in the Podcast:
● What exactly Tommy does and how he became CEO of Investors 1031 Exchange ● Why he also works in Utah with a home building division (hint: it keeps growing!)
● A detailed examination of 1031 exchanges and why you need to know what it is and why you should use them.
● The 3 types of exchanges available to real estate investors and what exactly they offer you.
● Why you need to be aware of reverse exchanges and when it may be useful for you.
● A breakdown of depreciation and how it can actually be quite beneficial.
● How long do you need to hold a value-added property to satisfy the tax codes when looking to invest in another larger property.
● Will 1031 exchanges ever go away?
Summary and Highlights:
A Summary for Building Wealth
This week’s podcast features Tommy Hinson, the CEO of Investors 1031 Exchanges, a real estate consulting firm. At Investors 1031, Hinson and his team advise investors on how to best structure real estate transactions. They also help investors discover new investment properties that fit what they’re looking for. In addition to these ventures, Tommy Hinson has begun investing in Utah. Thanks to rapid population job growth in Utah, he saw it as a lucrative opportunity for investment. Along with his partners, he is developing commercial real estate in Utah with plans to expand.
1031 exchange is an IRS tax code that enables investors with appreciated assets the ability to sell their appreciated assets without having to pay the capital gains tax if the funds are reinvested. These funds can be put into properties of equal or greater value. 1031 exchange is a critical wealth-building tool. This tax code allows investors to build generational wealth and keep money in their family.
Investors 1031 Exchanges work with many investors who don’t have a desire to sell their property since cash flow is steady. However, with his unique skill set, Tommy Hinson has been able to advise those clients to sell if it’s in their best interest. He helps clients differ the taxes associated with the property and take the equity into a new building. Depreciation, deferred maintenance and market drivers are three of the most important factors to consider in real estate investing.
It is always wise to spread out your investments in the event one doesn’t perform as anticipated. It is a good idea to sit down with a consulting firm and find ways to mitigate your risk. This includes how long you’ve owned the property, if you want to enter the development world, your current situation and whether you are ready to do a 1031 exchange.
Consulting is an important part of real estate investing, especially when doing a 1031 exchange. This type of consulting truly focuses on building family wealth and keeping your earnings the right way. Hinson’s consulting firm helps show investors which asset-rich, cash-poor properties in their portfolio they should be trading out of. Talking to CPAs, real estate attorneys and brokers can also give investors the background knowledge they need to make strategic moves towards wealth.
Key Points to Remember
- There are different types of 1031 exchanges. They are reverse exchanges, delayed exchanges, simultaneous exchanges and improvement exchanges.
- Some exchanges are more complicated, such as reverse exchanges. However, a reverse exchange is popular amongst investors in a tight market.
- Depreciation is when the value of the land is subtracted from the depreciating value since the land does not depreciate. The actual structure (commercial or residential) is divided into a depreciation schedule. In other words, with each passing year, the structure will be worth less and less. You can deduct depreciation on your taxes and many investors neglect this option available to them, causing them to earn less than what they could have.
Episode 8: Build Massive Wealth by Leveraging 1031 Exchange and Other IRS Tax Codes
Watch the Podcast | Read the Transcript
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Jason Lee: Part, everyone’s swept me. I have my good friend, Tommy Hinson at investor’s 1031 exchanges. How’s it going, Tommy?
Tommy Hinson: Going Good.
Jason Lee: Thanks for coming on here. I appreciate your time.
Tommy Hinson: Yup. You got it.
Jason Lee: Can you just tell the listeners a little bit about yourself and your background and what you do.
Tommy Hinson: Yeah, for sure. We run a real estate consulting company is what I’ve finally dialed it into meaning. It started out with 1031 exchanges, which is a way for investors to sell appreciated real estate and defer paying the capital gains taxes on it. And from that point, it’s kind of has morphed into more of a consulting firm where we’ll help investor’s structure, certain transactions when it comes to real estate. We’ll help them locate and identify certain investment properties that fit their criteria of what they’re looking for, where they’re at in life.
And from there it’s gone into, you know, sponsoring our own real estate investments. And then, you know, to allow us to help investors put together syndicated real estate deals on their own. So, we’ll put it all together for them, but it’s all based on investment real estate.
Jason Lee: Gotcha. And you have some other ventures going on in Utah and Arizona?
Tommy Hinson: Yes, you know, through raising money for other real estate developments, we started locating certain projects that, you know, we wanted to be more involved in and in the process figured out that Utah’s led the nation and population and job growth for a decade straight. And so, with that found a couple of partners out there. We started buying real estate and titling it, selling it for, to other developers. And then from there it turned into a full home building division.
So now we have next level homes in Utah, which also has an excavation company, general contracting company. You know, now we’re actually in the process of building Mixed use 371-unit apartment building as well. So again, all real estate related type stuff, but you know, because of the job growth in Utah, we really started focusing a lot of our efforts out there.
Jason Lee: I have a lot of clients who are actually looking at Utah looking to get out of California and buy in Utah. So, I feel like a lot of money is going there for sure.
Tommy Hinson: Yeah, it really is, you know, Southern California money is really going their A lot. Entitlements are quicker there. You know, obviously the cost of entry is a little bit more affordable there, but Southern California is still a great market to invest in.
But you know, like I tell all of our clients, it’s not a horrible idea to, to mitigate your risk and spread out geographically, you know, and we also stress by asset class too. But Utah is one of those markets, That’s very strong. You know, the west is very strong in general. It started out in Denver and now it’s in Salt Lake City has been for a while, but now we’re seeing a lot of growth even in Boise and Idaho and some of those places as well.
Jason Lee: And back to your 1031 exchange company for the listeners who don’t know what a 1031 exchange is, can you just in like the simplest terms, explain what a 1031 exchange is.
Tommy Hinson: Yes, definitely. So, 10 31 is IRC 10 31. So, it’s actually a tax code. That’s 1031 is the tax code. And what it does is it allows investors who have appreciated assets sell those assets, not pay the capital gains tax by reinvesting the money that you make in those real estate deals and put it into other real estate that’s equal or greater value.
It used to be several assets. You could do arts business, which was all personal property. After 2017, it was cut down to just real estate. It’s been around since the seventies. So, it’s been around for a while, but it’s really a wealth building tool for investors to use, because if you’re never giving that money to the IRS or the franchise tax board, and you’re taking it and reinvesting it in more real estate, you’re able to multiply, you know, what real estate that you have, and ultimately never give away any of the money for taxes.
Jason Lee: Yeah, that’s a good explanation. I mean, I feel like the number one reason why people don’t want to sell is because they don’t want a huge tax it after they collect their capital gains, right?
Tommy Hinson: Yeah. And so that’s why I call the wealth building tool, a lot of people call me and say, well, you know, is this a way to not have to pay taxes? And obviously it’s a way to not have to pay taxes. One of the biggest misconceptions is that people say, well, it’s tax deferred. It’s not tax exempt. So ultimately, we’ll have to pay those taxes.
And you know, the rule is, is that you should never have to pay the taxes. We call it swamp until you drop actually in our business, but you continue to trade throughout your life. You’re taking those gains. You’re reinvesting it into real estate. When you pass away, there’s a step up in liabilities so that your heirs will inherit all of your real estate. Your taxes will pass away with you. And then they get to start over.
So, it’s a good way to keep your money in your family, to never give away any money, continue to multiply what we call doors. So, get more and more doors. And then, you know, that’d be able to keep all that money in your family.
Jason Lee: And if I were an investor who let’s say I sold my fourplex and a trade all the way up to 25 units in my life, would that basis from that original sale, all the way up to my 25 units carry it with me if I were to cash out, if I was like eighty years old and I needed the money.
Tommy Hinson: Yes. So that’s, that’s how it works. You know, you buy your first piece of real estate. You know, a lot of people will buy just a rental home. They’ll make some money off of that. They’ll trade out of that. Buy into, two-plex or fourplex. But it’ll always go back to the original basis if you do decide to liquidate.
And so, some people will, they’ll liquidate a little over time and that’s another big misconception that, you know, on 1031 exchanges that you have to use all the cash and reinvest it in your new property. You know, you’re allowed to take some of those gains, put it in the bank. I tell people, you know, invest in the stock market, do mutual funds, annuities, and it’s okay to pay a little bit of tax.
You know, if you do a full 1031 exchange, you’ll pay zero tax. But if you do take some of that cash and reinvest it, then you can just pay tax on that portion.
Jason Lee: Yeah, that’s huge. I mean, I get that question all the time from my clients. Like, can I just take some money out, like some boots as you call it and just invest a portion of it and people do that all the time and you only get taxed on the money you take out, correct?
Tommy Hinson: That’s correct. Yes.
Jason Lee: And for people who also don’t know, can you just briefly explain like the different types of 1031 exchanges as well?
Tommy Hinson: Yeah. So, we’re actually seeing a big jump right now in reverse exchanges. You know, you just did a reverse exchange yourself even. And so, there’s three real types of exchanges.
There is the forward exchange, which is you’re going to sell a property, take the funds, buy a new property or multiple properties. It’s a reverse exchange, which is where you’re going to go lock up, buy the property that you want to own first. And then you have a certain time period to pay off to sell your relinquished property
And pay yourself back or pay off the loan that you use to buy the replacement property.
And then the third one is a build to suit or an improvement exchange, which allows you to sell a property, buy a new property, and also use some of the funds that you made on selling the relinquish property to improve the new property, which is what we call the replacement property. So, you know, there are different structures, you know, as you know, the reverse exchange and build a suit change are a little more complicated, a little more expensive, but a lot of investors like the reverse exchange, especially in a market like this, because the markets so tight.
And so, you know, going back to your example, you know, if I bought my first rental property when I was 22 years old and now, I’m 60, I’ve been deferring those taxes over time. Now I have tax liability that’s based on $2 million gain. You know, I don’t want to sell a property and hope that I can find a replacement property and if I don’t then I’m going to get a hit with all the taxes.
So, what more of the savvy investors are doing is saying, let’s go buy what we want to buy. And then we’ll have a certain amount of time, which I can go into the timeframes too on a 1031 exchange, but I’ll have a certain amount of time to pay off or to pay myself back by selling the relinquish property.
The great thing about that is if you never sell the relinquished property, there was no taxable event. So, the worst-case scenario is you’re going to have two properties now instead of the one property. So, it’s a big play for investors. The other thing about a reverse exchange when I was describing the Forward exchange, you’re going to sell a property. The money’s going to come to your accommodator, which is what we are. It’s going to sit there until you find your new property. Then you’re going to go into escrow, which might take 30, 60 days.
So, when you look up your, you haven’t been earning income off your rental property for three months during that process, whereas on a reverse exchange, you’re going to tie up the new properties, start earning your income during that period, you’re still earning income on the relinquished property, the one that you’re ultimately going to sell. When you do sell it, it’s going to go over. It’s going to pay down the debt or pay yourself back for what you put into the new property. So, there’s no gaps in income there. So that’s again, why a lot of the savvy investors like to use the reverse exchange when possible.
Jason Lee: Yeah, that’s a great explanation, but the main difference between a Forward and a reverse exchange is that you’ve got to have the cash upfront to buy the uplink property, correct?
Tommy Hinson: Correct. And there are some lenders that are starting to be more and more open to learning on a reverse exchange. A reverse exchange can be complicated. We have to use special entities to acquire the new property which banks sometimes have an issue loaning to that entity. But we do have several banks now that we’ve put through the process. We’ve actually sat down and helped some of them work through how that loan would look. And so now we’re starting to see the ability to get debt on those replacement property.
Jason Lee: Wow. That’s huge. I actually didn’t know that. Cause I remember a lot of banks would turn away those kinds of deals, because like you said, if you’re buying a property in a reverse exchange, you can’t be the owner of the LLC, correct. If you can only be a managing member, right?
Tommy Hinson: Correct. So, what it says, they are S as you cannot be on title for both properties during the change period. So, if you have your relinquished property, the one you’re going to be selling, obviously that’s in your name or your company’s name. So, you can’t go buy the new property and have that one in your name as well.
So, what we do, it’s called an EAT and exchange accommodation title holder. We create the special entity, which is just a pure LLC. We take title to the property. So, we are the managing, or we are the member of that LLC, as the accommodator, you are a manager of the LLC. And there’s a triple net lease back to you.
So, we don’t see the properties deal with it. We literally are just taking title as the only member. And so that’s where the banks kind of struggle with wait, you’re not a member of this LLC, but you want us to loan to that in order to buy the property. So, you know, we’ve worked through a lot of that with the banks. It’s an easy loan to do its short term generally because you’re going to be, you know, selling the other property and paying off that loan fairly quickly. But it’s definitely doable today.
Jason Lee: Yeah, the reverse exchange is a huge tool that most people don’t know about. But if you’re someone who doesn’t want to like go through all the complications of a reverse exchange, the main thing is that what I realized is if your broker or your agent gives you some extensions, when you sell your down leg like you’re, let’s say you’re selling a four unit you want to buy a 10 unit. I’ve got clients had really good success where if you have sold your property, it’s an escrow, but all the contingencies that have been removed. And then after that, your broker bills in some to like 30-day extensions, then you have an extra 60 days to go shopping after your escrow’s basically a done deal after contingencies have been removed.
And then from there you have 45 days and then 108, no, 45 days to identify and then 180 days to close, am I correct or not?
Tommy Hinson: Yes. Yeah. And you nailed it. You know, the way you want to try to do Forward exchanges, they’re less expensive, less complicated if you can, but that’s the way you do it. You know, you have 45 days from the day you sell your relinquished property.
You’ll have 45 days to identify what you want to use the funds for and the identification process. It is literally a sheet of paper. That’s going to have up to three addresses on it, and there’s other ways to identify, but that’s the primary one that people use is still by midnight on that 45th day, they’re going to get me a list of, you know, these are my three options or I’m going to buy all three of these or I already know exactly what I’m going to buy. Here’s my one option that I’m going to put out.
After midnight on that 45th day, you have an additional 135 days to close on one or more of the properties that you identified. So, total it’s 180 days from the day you sell your property to the day. You need to reinvest those funds, but it’s 45 and 135.
Jason Lee: Got it. And are there any other like processes I have to go through besides sending you a letter and just making sure they close on one? Or is there like any other like complications that an investor might have besides the 45-day window and the 180-day close period?
Tommy Hinson: Nope, there’s really not. You know, it sounds complicated, but when you look at it at the end of the day, we as the accommodator doing is we’re trying to make sure there’s no constructive receipt of the funds.
And so really all we’re doing is we’re opening a trust account on your behalf so that when you sell that property, the money’s going to go into that trust account. It’s going to be sitting there until you’re ready to, you know, acquire the new property. Then we’re going to wire that money to the new escrow company.
So never touching your hands. It’s not considered constructive receipt. And so, it’s not a taxable event, but when you’re out hunting for new properties, you know, we get these questions all the time. It’s like, well, what do I need to tell people about, you know, the fact that I’m in an exchange, you really don’t want to say too much about being in an exchange, because if I’m the seller and you tell me you’re in an exchange and I don’t know what that means, I’m just going to assume it’s something complicated.
Whereas I have somebody else coming in and going, I’m going to pay cash and close in 30 days. Even though you could close cash in 30 days, he’s going to, or she’s going to go draw more towards that other offer because they understand it. So really you don’t have to get too much into, you know, a 1031 exchange when it comes to putting together the new deal. There is some verbiage that we recommend putting in the contract when you’re ready to go to contract.
But it basically specifies that you’re going to work with the buyer on their 1031 exchange. And it’s just one certain paragraph, but you can go in, do it just like you would do any normal real estate transaction. The only difference is your down payment or the cash you’re going to use to buy the property is going to come from your exchange account, not your personal account.
Jason Lee: That’s a great explanation. And to follow up on that, when would be a good time for someone to do a 1031 exchange?
Tommy Hinson: It’s a great question. You know, we have a lot of investors who tell us, we’re never going to sell this property.
They’ve had it in the family its cash flowing Well, you know, we kind of laugh because real estate always has a shelf life. You’re going to have deferred maintenance at some point, you’re going to run out a depreciation and appreciation is a huge factor. You know, so if you’re collecting $25,000 a month in rent from your 10-unit apartment building, but you have no depreciation to offset all that income. It turns out it’s not normally the best investment that you could have.
So, when you sell that and you defer all the taxes and you take that equity and put it into a new building, that’s equal or greater value, you get more depreciation can offset the income that you earn on that. So, it’s real important to look at, you know, when do I want to sell these assets? Obviously, the market has to be a factor there. The loans, most commercial real estate has a 10-year loan. So, investors are faced in year 10 with either refinancing the property or selling it. So, there’s a lot of factors, but it’s primarily it’s appreciations the key one, deferred maintenance is the other one. And then market drivers to determine.
So, it’s also good to look at when you get these assets. They’re highly appreciated, which we see a lot of, obviously in California, that you want to really mitigate your risk. And the great thing about a 10301 exchange is, I could sell, you know, this 10-unit apartment building in San Diego, and I could go buy three different buildings that could be apartments or multi-tenant industrial or hospitality, but you can split up asset classes, which is a smart way to mitigate risk. And then geographically it’s, sometimes it makes sense to spread that money else, so that if one of your investments isn’t going well, you’re still having that income come in.
So, to answer the question, when’s the best time to 1031. A lot of those factors come into it. But really if you sit down with someone like me or you, and kind of go through what you have, how long you owned it, where you’re at in life, are you risk adverse or do you want to play in the development world, which can be a little more risky, but a little bit more rewarding and really break it all out and determine where you’re at and when it’s a good time to do an exchange.
Jason Lee: Yeah, that was a great answer, but I just want to revert back to the whole depreciation concept. I feel like a lot of investors don’t fully understand what depreciation is and what the benefits are. And I feel like you out of anyone knows it better than anyone else in the industry. Can you just elaborate on what like depreciation is and how it benefits you as an investor?
Tommy Hinson: Yeah, for sure. So, the way they look at appreciation is when you buy a piece of real estate. They’re going to subtract the value of the land, land doesn’t depreciate. So, there’s a structure on the land generally that you’re buying, you know, with it. So, when you buy investment property, they’ll separate out the value of the land versus the structure.
Then they divide up that structure and just certain amount of time. So, if it’s commercial, there’ll be a certain schedule. If it’s residential, it’ll be a certain schedule. Those schedules, you know, there are certain numbers tied to. But a lot of investors will accelerate depreciation, meaning they’re going to take more depreciation out to offset their income.
But what you’re doing is each year you’re able to deduct. So, the roof for your property is going to go out at some point. And so, what they do is they know that every year you’re struggling. Is going to be worth less and less and less. Now the value of the land keeps going up, thankfully. So, you know, you don’t see the value of your investment going down, but the structure itself they know is going to have depreciation.
So, each year you’re able to deduct that on your taxes, which allows you to offset the income. And keep more of the money that you’re earning, which is huge. So, one thing that I will mention that a lot of people don’t know is, you know, we’ll have investors calls and say, well, I never took any depreciation, so we’re good there. So, I’m not going to have to worry about taxes on that depreciation or any of that. The IRS doesn’t care if you take depreciation or not. So, if you kept that property for 10 years, never wrote off any depreciation, paid full taxes. They’re still going to look at it like you should have taking that depreciation, which plays into depreciation recapture.
I think that’s something a lot of people understand depreciation somewhat, but they don’t understand what depreciation recapture is. And that means that when I sell my property and I don’t do a 1031 exchange, the IRS wants 25% back of everything I’d depreciated on the property. That’s a huge number when you have, you know, investors who have owned properties for 10, 15 years, they’ve been depreciating it each year. And then they go to sell it and say, oh, the IRS Or my CPA told me that the taxes were only 15%. So, I’m just going to just pay the taxes and they don’t realize that. Oh, yeah, I’d depreciated a million dollars’ worth of this property. So, I also owe $250,000 in taxes on top of the 15%.
So, the taxes can get way up there, but depreciation is a beautiful tool that’s given to us just like the 1031 exchange it should be used. But it’s important to understand that if you don’t use depreciation and you sell that property and you don’t perform a 1031 exchange, the IRS still wants 25% of what you should have taken holding onto that property.
Jason Lee: Wow. That’s bad.
Tommy Hinson: It is a shocker. It’s generally, I tell people in California on average, you’re looking at 30% to 40% of what you made will be given away. If you don’t perform a 1031 exchange. So, it’s almost half of your gain will be given out in taxes If you don’t.
Jason Lee: Yeah. That’s an accurate number. And the normal depreciation schedule for every property in California is 27 and a half years, right?
Tommy Hinson: It’s 27 and a half years for commercial and it’s 29, I believe 29 and a half years now for residential.
Jason Lee: So, at the end of those 27 and a half to 29 and a half years, you would say it’s a great time to potentially do an exchange, right? Whether you own the property, or your family member did, right?
Tommy Hinson: Right. Yes, for sure. But like I mentioned, that’s what we call straight line depreciation. No one really uses that schedule anymore. They’ll accelerate depreciation. So, they do it through what we call cost segregation studies. I’m sure you’ve heard of cost SEG, but that’s where a firm will come in and segregate every single item in your building and say, well, you know, this doorknob is going to be out before the roof’s going to go out. So, they’ll itemize every little object in the property and then be able to deduct at a faster pace each year so that you can you know, write off more and more depreciation, keep more and more of your cash.
So generally speaking, people or out appreciation, you know, in under 15 years, most of the time.
Jason Lee: how fast can you accelerate it though? Let’s say I want to do it as fast as possible and keep as much of my cash flow from the property.
Tommy Hinson: Well, you know, that’s really up to you and your CPA. Some CPAs are a little more aggressive. Some don’t want to do that. You know, there’s new tax laws that are changing all the time, even with the 2017 tax cut, anything that is depreciated in less than 15 years, you can write off all in your one. So that’s where you see a lot of people buying, you know, Marine Stuff that private jet stuff like that, that they can write off everything in year one.
So those laws change all the time, but you know, really depending on your CPA is how fast he or she will allow you to appreciate.
Jason Lee: Got it. And one more question I hear all the time is if someone buys a value-add property where they fix it up and you know, they get a bunch of equity in the property. And they want to buy a bigger property, right? How long does the investor, or do I have to hold the property for, in order to satisfy the tax code for the temporary one exchange?
Tommy Hinson: Yeah, that’s a great question. And a question that comes up all the time with us. You know, if you look online, it’ll tell you two years, two years, one day, one year, one day. If you read the code, there’s no timeframe period. It’s all about intent. And so, what we tell our investors is your intent needs to be to buy your property and hold it for investment. And so, when you talk about value add, fixer uppers, those don’t really qualify. The IRS will disqualify most of those value-add deals.
If you go into the deal with, I am going to renovate the property, I’m going to hold it and rent it out for a period of time. And then something changes. Then you can still qualify for the 1031 exchange. You know, as an example, we had a client who bought a condo in a community, which he later found out would not accept rentals in. They didn’t read the CCNRs, so he had to list it and sold it 30 days later. He got audited, but that qualified, his intent was to buy and hold this property for investment. His intent change, obviously when he found out what the CCNR said.
So, we’ve had clients who bought real property in their own neighborhood. Got a knock on the door, six months later with 200,000 more than they had paid for. Well, I don’t know about you, but my intent would change if I can make $200,000 in six months, you know, that quickly.
So again, it’s all based on intent. The idea is that you want to hold it for at least two years, what we see. So, what we like, and what we’ve seen in audits is that if you hold a property for more than two tax periods, The odds of being disqualified are very, very limited. So, when I say that, I say, if you were to buy a property this year, 2021, fix it up, rent it out. Don’t do anything with it this year. Don’t do anything with it in 2022. And in 2023, you decided you wanted to sell it. The odds of you being disqualified or audited go down significantly.
And so that’s why the value add stuff on residential doesn’t work as well, because normally those turndowns are a lot quicker, but you know, if you’re buying a large shopping center or a big apartment building, and it’s going to take you, you know, a couple of years to really get through the renovation, It’s a pretty safe bet, but we tell our clients go into it with on holding it for investment. Don’t put a bunch of emails out and do a lot of talking about how you’re going to fix this thing up, flip it and sell it because you know, they will disqualify you for anything, but more than likely if you are a flipper and that’s what you do, then they’ll see that and say, you know, well, this particular deal just because you held it a little bit longer, doesn’t mean that, you know, it’s going to qualify.
Jason Lee: Yeah, no, that’s great advice. And I feel like a lot of people don’t understand like the nitty-gritty of like value-add or fixer uppers, right. Because it’s, it’s kind of a gray area in the code. And I feel like people would just try to hold it for one to two years. And like you said, if your intent changes, then if you do get audited, you can say, well, you know, I got this crazy offer for 300K above ask that I thought the property is worth. So, my intent changed. So, I think that’s a great explanation. To follow up on that, is there any other like common questions and concerns that clients will ask you before they work with you?
Tommy Hinson: Yeah, a lot of it has to do with, I would say some of the biggest questions is one to keep in mind this is only for investment property. So, we get a lot of calls with people, especially in California, they’ve bought their property. They lived in it for years. It’s gained a lot of equity and now they want a 1031 exchange It. It’s important to know that this is only for real estate that is held for an investment or used in a business. You know, it can’t be your primary, but the question comes up with, can I ultimately move into this property, even if it is an investment property.
And the answer is yes. I mean you can, but again, your intent is what this whole thing is based on. So, your intent has to be to buy and hold for investment. If you decide to move into it, it has to be, and you were to be audited they’d have to show why your intent change. It’s a pretty simple explanation. Most of the time, it’s, you know, I rented it out for a few years. I decided I didn’t want to be a landlord anymore. I liked the location better than my primary. I ended up moving into it.
So, you know, it’s where you run into problems is when you’re performing a 1031 exchange, and then you send me an email and say the moving vans out front, we’re about to move in.
And now you kind of get stuck into, you were always planning on it being your primary residents. So, we’ll get questions about that. You really need to wait If you’re going to move into it and be prepared for renting it for a good period of time, then we’d get people that want to try to do their primary. Can’t do that, but really, it’s more about the timeframes and the stress of If I sell this, am I going to be able to find something in the timeframes?
That’s the hardest part about a 1031 exchange, but that’s where, you know, our firm, for instance, we really do help them locate we’ll put, you know, for instance, you, if somebody wants to own an apartment building in San Diego, I know who to put them in touch with to help them locate those assets.
So, we do more than just us accommodate the transaction. We really make sure that our clients don’t ever pay taxes, you know, and that’s our ultimate goal.
Jason Lee: That’s huge. I mean, I feel like you offer so much more than just moving money from the property to your account and other property. I mean, I feel like in our transactions personally, I mean, we’ve done what? Like 10 or 15 transactions together in the last year. I feel like every single time my clients say, hey, Tommy was great. He told me exactly how to maneuver the exchange, how to do this and that in order to never pay taxes. And also, after you’re completed, I feel like you also give more advice on how to never pay taxes in the future.
I feel like having an advisor like you on your side is extremely important if you’re actually trying to build wealth and your goal is to grow from a small number of units to a much sizable portfolio.
So yeah, that’s what I would say about that.
Tommy Hinson: Yeah, it really is. When I got into this business, we’re not supposed to consult. So, it’s taught by all the larger firms that if somebody asks, how does this all work? You have to direct them back to their CPA. You know, and for us, that’s kind of a silly thing. We need to be able to sit down and consult with people, show them, you know, what it is. We’re not going to get into the exact numbers because there’s a lot of factors that go into it. But as far as the code goes and the way to use this tool, it’s important for us to be able to share that with our clients and show them that this is not a way to get out of paying taxes. This is a way to keep all your wealth in your family.
And so, we do, you know, a lot more consulting than what other companies will. But, you know, we’re very confident in what we know, and we know that it works. So, it’s important to, for people to have that comfort, to know that we’re holding your funds. And the number one thing that you should find out from your Combinator is the security of the funds.
This is other people’s money that we’re holding onto and have the ability to move around. And so, you want to make sure. You’re Combinator is using segregated trust accounts, meaning that your money is in its own bank account. It’s not pulled with a bunch of other investors money that they have the insurance policies in place that they have FDIC insurance, you know, and all those different factors. But if you can get all of that, plus be able to have one of our advisors sit down and really go through your overall plan. It’s a great thing.
We have a lot of clients that come to us and say, we want to exchange this property and we’ll look at it. I don’t know that this is a good time to sell this property. You still have a lot of appreciation left. It’s a fairly newer property. You are cash flowing at a great rate right now, if you sell this and take that money and go look for another asset, you’re probably not going to find one that’s as good as this property, but in the process of doing that, we find out they own 10 other properties that are what we call asset rich and cash poor. You know, they’ve got a bunch of money tied up into them. They’re worth a lot of money and they’re making no money on an annual basis. And then we’ll be able to show them those are the ones that you should be trading out of at this point.
So, it’s a gray area with how far we go with advising and we do suggest that you talk to brokers, and you talk to CPAs and real estate attorneys and all of that, but we can give you a pretty good idea of how the whole system works. And then that way you’ll at least be able to go back to those professionals with good questions.
Jason Lee: No, that’s huge. I mean, I feel like there’s always got to be a positive motivation or maybe even negative to doing a 10th of an exchange. Like one negative example is you’re not making enough cashflow. And I want to find a property where I can get more cashflow or I don’t like the location of my property. It’s in too rough for an area. I don’t like managing it. I want to move closer to the beach or one huge thing I’ve came across as I’m sick of managing property. I want to go into a more stable, more passive income asset, like a triple net lease property or a DST.
And the cool thing about an exchange is if you work with Tommy or his company, you can go from an apartment complex to an office building or to a DST, which to Delaware statutory trust some more stable asset where you don’t have any management costs. So, I feel like that’s one of the coolest things about exchanges. You can Literally go from something that’s causing you pain, whether it’s not enough cashflow, not enough or too much management and, and move that into a different asset and completely change your life.
Tommy Hinson: Yeah, absolutely. And we’re seeing a huge push into those passive type deals. You know, we’ve got the baby boomers who are the richest generation to ever come out of the United States or to come back into retirement. They’ve accumulated a lot of real estate wealth. But they’re tired of, you know, what we call the three t’s, trash, toilets, and tenants. All right. I just want to go to an island now and drink a Mai Tai. And, but I don’t want to pay taxes, so I’m not going to sell this stuff and I need the income. So, you know, what am I supposed to do with this?
And so that’s the real beauty of a 1031 exchange is, Now I can sell these highly managed properties that are such a headache, not pay taxes through the 1031 exchange. Take all that money diversify put it into several different deals, but what you were hitting on is the Delaware statutory trust. And then there’s the tenant in common, which are just two platforms that allow you to exchange into syndicated properties. And so, what that means is, you know, we’ll have a sponsor is what they’re called. You know, they’ll buy a $50 million property. They’ll go get a 50% loan on it. Which means they have $50 million in equity that they put into it.
And they’ll allow investors to change into positions on that property and buy fractional ownership interest. So, and these are some of the largest real estate companies in the world that can negotiate good deals. Good loans, do all of it. They manage the asset. You literally get a check on the fifth of every month or some pay quarterly, but you’re going to get your portion of the rent each year. Then you’re going to get a K one at the end of the year that shows your portion of the depreciation.
But it’s a good way to spread out you. Ride the coattails of some of the largest real estate companies in the world. But you know, most importantly as you’re earning that money, not managing the property, you’re not worried about tenants leaving, you know, maintenance, stuff like that. So, it’s a big push right now for those deals to be shared with some of the investors who are tired of managing their own real estate.
Jason Lee: A hundred percent. That’s a great point. And do you ever see exchanges ever being taken away by the IRS?
Tommy Hinson: You know, it comes up every year. Mainly when the Democrats take office it’ll pop up. You know, we had the Federation of exchange accommodators is our lobbying group out of DC. And we spent. $5 million back during the Obama era on what would happen if 1031 exchanges went away, and it got pretty far until the banks were involved.
And when the banks found out that, you know, if I’m a seller and I have this asset that I’ve gained a million-dollar equity on. And if I go to sell that property and I have to give 500,000 of my million away, I’m just not going to sell it. No investor’s going to give away half of what they made on something unless they’re in a desperate situation. And so, with that happening, you got real estate brokers who are not going to get paid now because sellers aren’t going to sell, you’ve got appraisers who aren’t going to appraise.
You’ve got all these different factories title and escrow companies are not getting paid anymore. So, the whole system starts to gridlock, which didn’t seem like a huge deal until it got to the banks. And when they said, well, wait, the banks aren’t going to be loaning any more money on new properties because no one’s going to be selling and buying new properties. They kind of stopped at that point. You know, the banks have a pretty big stick to swing, you know, when it comes to Washington lobbying.
So, it really doesn’t work. There are different factors that could come into it. They’re saying that any gain over a million dollars, you know, you don’t have to pay taxes on. So, there could be some different levels that they put in on it. But it’s been through it several times. It’s been brought up on more than one occasion on getting rid of it. It still doesn’t seem to be something that’s really going to happen, but if it does, I’m sure there’s going to be other ways to avoid some of those taxes. But at this point it’s lasted this long, and we don’t really see it changing anytime soon.
Jason Lee: Yeah. I couldn’t agree more. I mean, if you take away 1031 exchanges, it just takes away so many jobs. It’s not even just the brokers in the appraisers, the contractors, it’s the, like you said, the lenders, the loan brokers, the escrow title. It’s huge. And I feel like if exchanges aren’t there, sellers won’t be motivated to create volume in the market. So, agree 100%.
Tommy Hinson: I was going to say one other factor is that if you have a piece of real estate, that you’re never going to be able to get the gains out of, you’re never going to be able to recognize it. The value of the asset, because if you don’t sell it, then there’s no recognition of the value there, it turns a lot into slumlords because why would I put any money into this property if I’m never going to be able to realize any gain out of it, same thing goes into the rent controls and stuff like that.
So, it’s a real, it’s a great tool that the IRS gave us. But at the end of the day, if they took it out, it could really change the face of, you know, investment real estate. And so, I don’t really see anything really happening with it at this point.
Jason Lee: A hundred percent. Well Tommy that was also like really good information. I appreciate your time. Here are some questions I ask after every show is what is one thing you would tell your younger self if you were to go back in time?
Tommy Hinson: One thing to tell my, probably what I tell people every day on the phone. You know, I coach youth sports and, you know, I work with a lot of younger guys, and they asked me questions like that all the time, man. You know, if I could go back, I would say, you know, start buying real estate as early as you can. And that might be a condo that’s very affordable and a bad part of town, whatever that might be. But the only way that I’ve seen people really create wealth, they’re not born into it, something brand new, which isn’t done very often, but real estate over a 10-year period has never lost its value. It’s always become worth more after a 10-year period, and that’s hard to beat in any sort of market.
So, I tell people. Start now. And you don’t have to just, like I mentioned, you don’t have to buy your own rental property. You can buy one of these fractional ownership interests with as little as $25,000 are what a lot of those investments require. So, you could now start out in life and start buying real estate. And it won’t take long through the 1031 process and through everything else that you could be sitting at, you know, 35, 40 years old and own several doors and have passive income coming in all the time and really start to build wealth from a young age.
You know, people don’t realize it’s not that expensive to get into it. You know, they think they’ve got to save 20% for down payment and qualify for a loan and have all this stuff. And, you know, we really sit down and show people that you can really get involved early.
Jason Lee: Yeah, no, that’s great advice. I feel like time is the most important thing when it comes to real estate. If you hold real estate for 10, 20 years, I’ve never heard anyone saying that they lost money. Every single time they made a fortune or did it really well and they trade up into a bigger building and now they’re doing amazing. So, these older investors who’ve been in the game, I feel like just kept buying, kept trading. And now they’re in a very good position. And my second question is what’s your favorite business book of all time?
Tommy Hinson: You know, probably winning, you know, Jack Welch’s book winning. I got a lot out of that. Just recently I read shoe dog, which is the Phil Knight story on Nike, which is a pretty amazing story just with how much competition he had to deal with and coming up on Nike.
But those are probably the two, you know, there’s a lot of investment real estate books that I read that can really put you asleep, but you can learn a lot from them. But really, I think those two books really guided me a lot in what I’m doing today.
Jason Lee: Nice. I’ll need to check those out. And my last question is what’s the most successful thing in order to become a successful real estate investor?
Tommy Hinson: I think really understanding the rules, understanding like what we’ve been talking about today, depreciation, how the 1031 exchange works. You know, a lot of the wealthy have been using these tools forever. The normal, common people don’t know a lot about it. So, you know, educate yourself. There’s a lot of information now online, but really to understand the different levels of taxes and taxes are a huge factor when it comes to buying real estate, like we talked about real estate continues to gain every single year It gains. We will have peaks and valleys, but overall, it’s going to gain. And if you have to give away a lot of that money in taxes doesn’t really work.
And so really pay attention to taxes, pay attention to ordinances that are put out, but really just focus on the deal itself. You know, I always tell clients, all these things we’re talking about are great, but at the end of the day, you need to focus on what’s important, which is the asset itself.
And so regardless of all the different schemes and tax ways to get out of it, if the real estate itself, if you have a bad gut about it, generally, the gut is true, you know, and so focus on that first.
Jason Lee: That’s great advice. Well, Tommy, thank you so much for your time. Drop a ton of value in this last hour here. How can people contact you and learn more about you? If they want to learn more about a 1031 exchange or just want to get in contact with in general?
Tommy Hinson: Yeah, so they can always email me. So, I use a simple email. It’s TWH1031@gmail.com. Our office line is 8585391031. It’s a pretty easy one to remember, but you know, those two, well, we’ve got a lot of analysts that work here that can really look at your situation. You know, we are consultants and so we will come to your house. You can come to our offices, we can sit down with you, look at everything that you have on the real estate side, and really help make some of those decisions, you know, on what to sell and what to buy.
Jason Lee: Awesome. Yeah. Thanks Tommy. I will catch you in the next deal.
Thank you for joining us on the multifamily millionaire podcast. The show that interviews, multimillionaire real estate investors and top producers in the real estate industry. We’re here to help you create passive income and achieve financial freedom so that you can do what you want whenever you want. We’ll catch you next time on the multifamily millionaire.
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