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How to Make 1031 Exchanges Part of Your Real Estate Business
The tax code is complicated, but realtors who learn its niches stand to profit.
A perfect example of this is the 1031 exchange, a provision of the tax code that states a taxpayer is allowed to exchange one investment property for another by deferring the tax consequence of the sale.
This lucrative and highly specialized market can be a boon to any real estate agent willing to learn its nuances.
“It is one of the best investment strategies available to property owners,” explains Real managing broker for California Jason Lopez. “But they need a knowledgeable agent to help guide them through the process.”
Here’s how you can make 1031 exchanges part of your business:
1031 Exchange Requirements
Timeline: An investor looking to complete a 1031 exchange has 45 days from the sale of their property to identify an exchange property of equal or greater value. Once found, the investor has 180 days from the day of the sale to acquire the property.
Lopez recommends investors identify multiple properties as a hedge in case one of the deals falls through. If the 45th day is approaching and an investor hasn’t found a property to their liking, Lopez recommends stashing the money in a tenant-in-common investment (TIC). This means investors would be co-owners with numerous other investors in a property. While TICs can be harder to sell, they allot the investor more time to find a property to their liking.
Like-Kind Property: The law states that an investor must acquire a “like-kind” property to the one they are selling, but this doesn’t mean they can’t trade up.
“Like-kind means investment property for investment property,” explains Lopez. “So you can sell a 2-unit apartment building and buy a 6-unit apartment building.”
Equal or Greater Debt & Equity: An investor needs to purchase a property that is equal or greater in value to the combined equity and debt of the property they sold. So if an exchanger sells a property for $500,000 in which $250,000 was equity and $250,000 was debt, they need to purchase $500,000 or more worth of property.
Exchange Property Must Be An Investment: Investors cannot do a 1031 Exchange where they sell their primary residence and purchase an investment property. Exchange properties must be held for investment or business purposes.
However, Lopez notes that there is an interesting workaround where the investor purchases a multi-unit property and then moves into one of the units. After two years, the investor could sell the property for a lowered capital gains tax, given that it is now their private residence.
Intermediary Needed: An exchanger cannot receive cash from the sale of their property, as this would trigger a taxable event. Instead, the IRS states that a “Qualified Intermediary” (QI) must facilitate the transaction. The QI is a 3rd party — usually an escrow company — that holds the proceeds from the sale of an investment property and purchases the exchange property on the investor’s behalf.
Tips for Realtors
Because 1031 Exchanges are such a specialized market, your marketing can be highly targeted and educational.
To find clientele, Lopez recommends signing up for a service that collects data on homeownership. Most subscription services allow you to conduct highly specific searches.
“I like to search for people who own property in one place but have a primary residence in another place, because that lets me know they are absentee owners,” Lopez says. “From there I’ll add more filters, like properties that were built within a certain time frame, until I have a very targeted market.”
Once you have your leads, you can make a pitch tailored to your clients.
“I like to reach out and explain to them how they stand to benefit from a 1031 Exchange,” Lopez says. “It’s not about generating cash flow, it’s about planning for retirement and strengthening your portfolio while kicking the can down the road in terms of taxes.”
Benefits for Agents
Because the 1031 Exchange market is so specific, it tends to be underserved by realtors. Lopez says when he works with clients on 1031 Exchanges, he often gets referrals to other potential clients in similar situations.
“It’s common for these owners to know other people who own similar types of properties,” Lopez says. “So if they have a good experience working with you, they’ll refer you.”
There is also a great opportunity for multiple transactions. Realtors who work with a client on the sale of their investment property often help them with the purchase of their exchange property. If the client wants to purchase an exchange property in another location, connect them with another specialist knowledgeable in 1031 Exchanges and collect a referral fee.
For more information on how to make 1031 Exchanges part of your business, reach out to Jason Lopez at email@example.com. Lopez also recommends reading about 1031 Exchanges on the Asset Preservation website.