Overview
In this episode of ‘Be A Better Landlord’, we are joined by Kayla Mahoney, a Commercial Real Estate Advisor from Capital Property Group, to discuss the topic of 1031 exchanges.
Krista and Kayla discuss the intricacies and advantages of 1031 exchanges, a method for real estate investors to defer capital gains taxes through property exchanges, created in 1921. A 1031 exchange allows investors to sell a property and reinvest the proceeds in a new property while deferring all capital gain taxes.
Key Takeaways
- Definition of 1031 Exchange: A 1031 exchange, created in 1921, is a tax-deferred real estate transaction that allows investors to swap one investment property for another while avoiding capital gains taxes.
- Like-Kind Property: To qualify for a 1031 exchange, the properties being exchanged must be considered “like-kind.” This generally means any investment property that generates rental income, such as duplexes, four-plexes, or even land and oil properties.
- Timeline and Requirements: After selling a property, investors have a 45-day identification period to identify at least three potential replacement properties in writing. The closing on the new property must occur within 180 days of the sale of the original property.
- Benefits of 1031 Exchanges: By deferring capital gains taxes, investors can use the full proceeds from the sale of a property to invest in a larger or higher-value property, potentially increasing their cash flow and diversifying their real estate portfolio.
- Expert Guidance: To navigate the complexities of a 1031 exchange, investors should work with a qualified intermediary (QI) who ensures compliance with tax laws and regulations. Additionally, experienced real estate brokers well-versed in both commercial and residential properties can provide valuable guidance throughout the process.
- Real-Life Example: An investor could purchase a duplex for $600,000 using an FHA loan with a 3.5% down payment (approximately $20,000). After making improvements and holding the property for a few years, the property’s value may increase by 30% ($200,000). The investor can then use a 1031 exchange to trade up to a larger property, such as a four-plex, to increase their cash flow and diversify their portfolio.
Transcript ▼
Transcript
Krista Reuther:
I’m Krista and this is Kayla. We’re here to help you be a better landlord. So we’re here to talk today about 1031 exchanges. Now that is a light kind property exchange that intimidates a lot of real estate investors. So I’m so thrilled to have you here. Thank you for having me TurboTenant. Of course. So as the expert, what is a 1031 exchange? Yeah.
Kayla Mahoney:
So a 1031 exchange was created in 1921. It’s essentially a way in which you can avoid capital gains taxes through the exchange of property. Say you have a duplex, right?
Okay. And you are like, okay, I really want to, I leveraged FHA to get into this duplex. I implemented some value add strategies. It’s a prime time for me to sell this property. And with the appreciation, I can essentially invest in a larger down payment to have a better cash flow on a larger investment property. So within that, you have a 45 day identification period where within 45 days after selling your property, you have to have three properties in writing, at least identified. And then you have to close within 180 days. And then instead of having the taxation on capital gains, you’re able to have a non-taxable real estate exchange.
Krista Reuther:
Tell me a little bit about the like property portion of 1031 exchanges, because ideally, you are taking one type of property and finding a like kind. But what does that really mean?
Kayla Mahoney:
That’s a great question, actually. A like kind property is essentially any sort of investment property that has a rental income. Land also always counts as 1031. And oil can count as 1031 as well. A good rule that I do is always try to trade equal or higher. So trading to a property that’s of equal value or a higher value, because then you’re able to increase your cash flow or maintain the same cash flow.
Krista Reuther:
Beautiful. Okay. So let’s say that I’m starting my first 1031 exchange. I have a duplex and it’s worth $400,000. How would you start looking for a property that would be considered like kind?
Kayla Mahoney:
So first off on there, I would ask how much debt you have on that $400,000, because that’s really that debt is going to have to be serviced no matter what. The money that you’re going to have is going to be the capital gains. And those capital gains will have to be enough in order to implement a down payment on there.
If you have a duplex that’s worth $400,000, so let’s say $200,000 a door, pretend there is $100,000 in debt on it, you’re going to have $300,000. So with that $300,000, you could go multiple verticals and it really, it’s just going to depend on the client’s motive and what they want to do with that $300,000 down payment. You can get into a four plex, an eight plex, or you can completely pivot and find a property that is suitable for your business.
And the biggest thing I suggest is always make sure that you have an expert who is well versed in commercial as well as residential real estate in order to help counsel you to get that best return.
Krista Reuther:
That said, people get really nervous about 1031 exchanges either because they think it’s too complicated or because they’re not sure of the rules.
Kayla Mahoney:
I understand why 1031 can be overwhelming because if you don’t understand tax law, you’re essentially in a vulnerable place. But that’s why it’s required when you do a 1031 that you have a QI, which is a qualified intermediary. And they essentially have no fiduciary duties to the seller or the buyer. But their job is to ensure that all of the proper tax compliance and tax laws in place, it’s a one time fee, but you’re going to need a QI for any 1031 you do. And if you really have educated brokers as well as a really strong QI, we’re able to walk you through that process in a white glove service.
Krista Reuther:
Could you tell us some real life examples of the gains that people could expect to see or why people actually do this, maybe with some numbers?
Kayla Mahoney:
Yeah, absolutely. So I think that 1031 is really the ultimate tool for accumulating wealth through real estate. And you can go into a… We’ll stick with Denver just because it’s our local market with understanding of Denver and TurboTenant. You can get into a property leveraging FHA, putting 3.5% down on a duplex. And pretend that duplex is worth 600,000. So if we’re putting 3% down on 600,000, you’re essentially need a little over $20,000. With a little over $20,000, you put it into the property. You hold it for a couple years. That property is on average in the Denver market, properties accumulate at 15%. So you’re getting a 30% accumulation on that, excluding any sort of value add components you put in, like new finishes and pretend you want to improve the landscape. Some people say, paint lipstick on a pig. I say, make the property beautiful.
Yeah. So if you’re going in and you’re beautifying the property, pretend you put $50,000 into improvements on it. So all in all, you put in $70,000. You’re leveraging your debt and it increased in value by about $200,000 with the work you’re putting in.
You essentially made $125,000 give or take in a few years just from having real estate. And then from there, you can always trade up. And when you trade up, you get higher cash flows on it. And when you have more assets on your portfolio, you’re able to diversify as well. And you could take out asset-based loans and asset-based mortgages in order to help stimulate your personal real estate portfolio. And anywhere from five to 10 years, you could have upward of five properties that are all cash flowing and you’re able to really truly have financial freedom.
Krista Reuther:
Wow. OK. So it really builds. Yeah. Unlocks a lot of opportunities down the line for you to be diversified, having cash flow just flowing in. Yeah. That is beautiful. And you’ve seen it work for yourself as well. Yeah.
Kayla Mahoney:
So it’s a tried and true method. I’m fairly new into investing for myself. I worked really hard on it. I own a condo in Congress Park. I’m holding that condo for a couple years and I plan to 1031 it into a duplex.
Nice. Also this year, I am leveraging my FHA. I’m going to forgo my commission on a fourplex. I’m personally looking in the Colorado Springs Market because it’s a little lower of a price point to get into. So I’m planning on investing in a fourplex there and going through the house hacking process myself. Incredible.
Krista Reuther:
Yeah. So I hope we get to be there along the way.
Kayla Mahoney:
Absolutely. Yeah. And I highly suggest TurboTenant too. I’ve used you guys for all of my tenant real estate applications. I’ve had 100% success rate with all of the background checks and verifying.
I love my tenants in my condo right now. And I don’t think that I would have been comfortable moving forward without a comprehensive background check that TurboTenant’s provided for me. And it wasn’t any cost for me as the landlord. My tenants paid $50. I had a credit report background check right in front of me and we were able to execute a lease fairly quickly. And I suggest TurboTenant to all my real estate clients who are investing in residential.
Krista Reuther:
That is so fantastic. Yeah. Thank you for sharing. That really fills my cup. Absolutely. Well, I really appreciate having your time and expertise in the building. What an honor. Well, thank you. If you want to find Kayla, where can people look you up? Absolutely.
Kayla Mahoney:
So you can look me up on LinkedIn. My name is Kayla Mahoney. I am also known as the Denver Commercial Broker and check out capitalproppgroup.com.
Krista Reuther:
If you have any questions about 1031 exchanges or you have experience of your own, please drop it in the comments below. Don’t forget to subscribe.
