David Moore, CEO at Equity Advantage, joined us on the podcast to discuss everything investors should know about 1031 exchanges.
David Moore is chief executive officer of Equity Advantage, Incorporated, a nationally recognized leader in 1031 Exchange facilitation. David founded Equity Advantage with his brother Tom in 1991 after a successful career in real estate investment. Since then, Equity Advantage has developed an outstanding reputation for partnering with their investment clients to develop unique strategies for the 1031 Exchange, reducing their clients’ tax risks and increasing the value of their property portfolios.
David is a recognized 1031 Exchange expert, and is regularly invited to share his knowledge with realtors, investors, attorneys and property owners through seminars and classes. He is a power sponsor of the Certified Commercial Investment Members (CCIM) and is a former board member of the Federation of Exchange Accommodators (FEA). David played an instrumental role in the FEA’s expansion throughout the Pacific Northwest and served as chairman of the FEA Ethics Committee. He is active in Rotary Club and serves on the boards of several charity organizations.
Tyler Stewart - All opinions expressed by Adam, Tyler and podcast guests are solely their own opinions and do not reflect the opinion of Real Crowd. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing, please consult your advisors. Hey listeners, Tyler here. Before we start today's episode, I wanted to quickly remind you to head to realcrowduniversity.com to enroll into our free six week course on the fundamentals behind commercial real estate investing. That's realcrowduniversity.com. Thanks.
Adam Hooper - Hey Tyler.
Tyler Stewart - Hey Adam, how are you today?
Adam Hooper - Tyler, you know, I feel like a broken record here but it's a pretty great day.
Tyler Stewart - It is a good day, another good day here in Portland, Oregon.
Adam Hooper - We say that a bunch but no bad days here in the RealCrowd Studio.
Tyler Stewart - I haven't seen one yet.
Adam Hooper - Especially when we have a guest in the studio with us. It's always fun to have a guest in studio. Today, we had David Moore who is the founder and CEO of Equity Advantage. Yeah so David, I've known him for a long time. He's a expert in the 1031 exchange world and a fair warning, we got pretty technical on this one and it's not entirely applicable to all the deals that we see on RealCrowd, but we get emails from listeners all the time and clients and investors on RealCrowd that they have 1031 exchanges that they might have questions about. So this was a really good in depth look at what goes on in the 1031 exchange world.
Tyler Stewart - Yeah there's a lot to consider when looking to do a 1031 and David dove each one of those points and he hit each point fairly hard. It was a very in depth episode. So definitely take your time going through this one. From time to time, you'll see a handful of deals on RealCrowd that are 1031 applicable. But for the most part, this is more for your offline investing.
Adam Hooper - Yeah and as we've said, feel free to put this one at 75% speed if your player allows that or get ready to use that rewind button 'cause there's a lot of technical stuff again that we did talk about. Really good information though. It would be great, as we do episodes like this that are maybe a little bit more in depth, let us know if you like it. Do we need to do more of it? Is it too much? The only way that we know is if you send us an email. So please send something to firstname.lastname@example.org, let us know how you think or feel about these kinds of episodes. But with that, Tyler, let's get to it.
RealCrowd - This podcast is brought to you by RealCrowd, the leader in online real estate investing. Visit realcrowd.com to learn more about how we provide our members with direct access to commercial real estate investments. Don't forget to subscribe to the podcast at iTunes, Google Music or SoundCloud. RealCrowd. Invest smarter.
Adam Hooper - Well, we're in the studio today with another guest, David Moore, Equity Advantage here in Portland. Thanks for coming by.
Tyler Stewart - Thanks for having me.
Adam Hooper - And hanging out today for the conversation. Why don't we take a little bit of a step back, tell us your history in real estate, how you got in the business, what you do today and then we'll dig into 1031s.
David Moore - Sure, be happy to. My brother and I actually grew up in Santa Cruz, California, moved to Oregon in 1990 to buy property. And when we moved up here, we actually moved to Salem, not Portland, because we knew we missed the turn in roughly '88 and state capitals typically lag the rest of its state's economy. So we went to Salem and actually bought some stuff in Olympia too and how I got started in all of it was one of my father's friends was a commercial real estate broker, a gentleman that started an exchange company in the mid-'80s and he was a guy that just really took investing very, very seriously. He came out with the yield analysis programs and everything in a day where people didn't have it. So we just did what he did. He taught us, he mentored us and the exchange process was sort of an evolution out of the investments that we came here to do. When we needed exchange work to do, we couldn't find anyone to do it. And I guess, I laugh, because today we have all these advertisements on the radio, on TV, with respect to flipping properties and my brother and I were doing that. It was a modified flip where we could actually utilize 1031, we didn't have dealer status issues that normally you're going to be dealing with. But the funny thing today, I look back on it, sort of laugh or cry, I don't know what I'm going to do most but I say, we just weren't smart enough to do a TV show in those days. So here we are still working all these years later.
Adam Hooper - We've got a podcast now,
David Moore - Exactly.
Adam Hooper - Instead of a TV show, we have a podcast. It's stepping stone. So you're saying, basically, you guys missed the opportunity had you been able to exchange these, or were you doing exchanges at the time?
David Moore - We were utilizing exchanges in that time period but there really wasn't exchange companies here where we were. And the gentleman that mentored us, we had all that background and the whole deal is if you just buy and flip stuff, it's normal income tax and it's not a question of the holding period, it's what you're doing, dealer status, it doesn't fit, you're paying normal income tax plus you don't have the ability to exchange. So we would buy, fix, rent out for a period of time and then over a period of time, three to five years, you have two choices. Your equity gets to a level where it no longer makes sense, you have a choice to get out of it via refi, cashout refi, get the leverage where you want it again or do an exchange. We just felt, obviously we couldn't do our own exchanges but we thought, hey there's a need is here and when the final guidelines came down in the fall of '91, it just sort of put pieces back in place, gave a lot more notoriety at 1031 and sort of legitimized it and opened it up a lot.
Adam Hooper - So that was, background was just in the investment side, saw this opportunity for other people that needed this service, essentially and that's what turned into Equity Advantage, yeah.
David Moore - I always say, you get too close something, you don't do it 'cause you know too much. We didn't know any better so we just went and did it. So don't tell us what we can't do. But I'll never forget putting the company together, the lawyer he said, "Now, people are going to pay you, they're going to give you their money and they're going to pay you to do this?" And I said, "Yeah, this is what's happening." Ya know. "Okay." And he smiled at us and put it all together. But that was in 1991 so we've been doing it a few years.
Adam Hooper - Yeah, still here.
David Moore - Yep.
Adam Hooper - I know you also do some self-directed IRA work. We were talking about that before.
David Moore - Yeah. So during the ensuing years, what happened is people would come to us and say, "Gee, I've heard I can take my retirement account "and go buy real estate or make loans, buy notes, "that type of stuff." And so we had to sort of figure that out just for informational purposes. And as an exchange company, we're not supposed to give tax or legal advice on stuff but ultimately what happens is you deal with things day in, day out, you know the answers to things and it's that whole retirement side really dovetailed in. Most of our clients on the 1031 side had retirement accounts. Most of em liked real estate. They wanted to be able to do some more and they were running out of capital and how to do it. And the interesting thing, if you ask somebody on the Wall Street world looks at real estate as an alternative investment. And I say, "No, it's a real investment. It's tangible." Name an older investment than real property, right?
Adam Hooper - Yeah, it's one of the most original, property investments.
David Moore - So in the investment world, anything that's not sold, there's an alternative investment, makes it sound intrinsically risky. Well, we just look at it as further diversification. And I think, the numbers are probably changed now, but about a decade ago when we were put the exchange, or the retirement side of the business together, about 2% of retirement money was in real estate. So anybody in the financial world's going to say, "Gee, diversification's your best tool." And yet, 2% is in real estate, and most of that's in REITs. So you've got a primary residence that falls outside that, but they sort of look at that as something different. But it was a result of people wanting to do it. And we had to figure out how to do it, and then when the crash happened, it really sort of changed things, and we ended up doing a lot of stuff that we didn't really plan to do in that space. But it's really been a great experience and after all these years, something I've been doing since '91, you get tired of talking about the same thing all the time so it really was fun to get it out there and talk about some new concepts.
Adam Hooper - So how has, or has the business changed from early '90s when you were doing this through a couple cycles now 2018, same, different, I guess at a fundamental level has the, have any of the exchange provisions changed or how has your business changed over that period of time?
David Moore - The exchange world, really you don't have a whole lot of case law that comes down on it. You've got a situation where tax law, you've got lots of gray, not a lot of black and white. Every few years we get some guidelines that tighten things up, or the government sees money going through a crack, they want to stop it. So if we look at changes, we've had more proposed changes than actual changes, but if we look at things that impacted 1031, in '97 we had Section 121 come in and replace 1034, the old residential rollover, and you think, "Well that doesn't really impact exchanging." but it does, because you're lookin at allocations on things. If you've got a, let's say you've got a duplex. Somebody's first investment. Maybe it's their home, They're living in half, half's owner occupied half not owner occupied. What are you selling? You're selling one asset allocation Section 121 and 1031. A farm with a farmhouse. A home with a home office, even. But you start looking at those numbers, and in '97, numbers 250 and 500 the exclusion limits, they were big. But today...
Adam Hooper - Not as much.
David Moore - Not so much, yeah. I mean if you look at it, inner northeast Portland you've got buildings being purchased for a half million bucks in scrapes, right? So it's a half million for the dirt. Well what'd that person pay for it? How long ago? If they're single, odds are they're going to have gains in excess. So then you start looking at how those things sort of interact is we're going to take investment property, convert it into residential, residential property, turn it into investment. Somebody in the West Hills that has a house they've owned for years, maybe they got a half million basis, things worth three million bucks. Well, a half million in excluded gain doesn't do much. So we'll tell em to move out of the house, convert it into investment, go buy what they want to live in, maybe they take and when they do sell the property, as long as they sell it within three years of moving out, they still get that two out of five that 121 requires. So they can do the exchange. I have one client, sold a house in Los Gatos, and you guys were down there, so you know prices and stuff down there. But they got referred into us by a law firm and said, "Gee, these guys are going to, they've got millions in gain and they're going to get killed on it." we told em move out. Move out of the house. Seizing it as investment, they held it a year, then they did an exchange, still took the exclusion, they're still entitled that, but they bought 24 different investment properties. And they closed em all inside the 45 days.
David Moore - I mean, it was one of those things where changes, and what we're seeing, a change that happened in 2008, you got to let, okay. So in 2000, we had guidelines on reverse exchanges, which really took away the way it should have been done. Made it more complicated where we have to warehouse or park properties.
Adam Hooper - And we'll get into the more specifics on the different kinds of exchanges in...
David Moore - So that impacted us with Improvement Exchange and Reverse Exchanges, and in 2008, we had the Housing Assistance Tax Act of 2008, which is anything but assistance. It traits the property acquired via 1031 convert it into a residence. If you sold it inside five years, this happened a few years earlier, the five year hold, if you sold it inside five years, it's fully taxable sale. And then the Housing Assistance Tax Act, when it came and said, "Hey, you got to hold this thing for no less than five years before selling it", even at that point, you're going to get prorations of the 250 or 500, you don't get the whole thing.
Adam Hooper - The full thing, yeah.
David Moore - So that thing changed, and then when tax reform came through, we had the change on what qualifies.
Adam Hooper - And this is just, this is this years.
David Moore - Yeah, just this, yeah. So we just...
Adam Hooper - Which further tightened it, and further defined it as specifically real estate now, right?
David Moore - Just real property.
Adam Hooper - Just real property.
David Moore - So if you look at 1031 what it use to say, it use to say any property held for productive use, da-da-da-da-da. And now it says any real property.
Adam Hooper - Real property.
David Moore - So I'm a car guy, I love cars. And we used to do some great car transactions. So one that, do you guys like cars at all?
Adam Hooper - Of course.
David Moore - So the best transaction we ever did in that space was we did a Ferrari FXX. So that was, I think that was a three and a half million dollar car, a Ferrari 288 GTO, which is two and a half million, and a Porsche GT3 RS 4.0, which is about a $700,000 car. Those three cars were exchanged into one half of our clients McLaren F1. Our client had bought the F1 two years earlier for eight million. And it went from eight to 12 in two years. He took those other three cars to get rid of his partner in that car. But I thought that was pretty interesting. That was fun, but we should have had a qualifier in there that any time we do a deal like that, we get a ride.
Adam Hooper - Some kind of grandfathered access to drive.
David Moore - Exactly.
Adam Hooper - Right?
David Moore - So we lost cars, planes, I mean we honestly didn't do much in the boat space, heavy equipment, all that.
Adam Hooper - That all used to be able to exchange into for capital gains on.
David Moore - Yep.
Adam Hooper - No longer.
David Moore - No longer. That 1%, horrible one percenters, I guess. Yeah, you look at that and the only other real change that impacts, that could potentially impact people is partnership interest are specifically prohibited from 1031 treatment. But they came out with some clarification on certain partnerships that actually would qualify. It has to do with the proper filing election and it's got to be set up from inception, that way you can't retroactively do it. But anyway, that hasn't become as big a boon as we thought it was going to be. It would have really been nice if they just cleaned it up and said, "Hey, any limited liability company interest would be looked at as the tax payer owning the underlying assets, not just a membership interest in that entity." Which is a partnership interest.
Adam Hooper - So let's kind of take a bunch of steps back here. A high level, what is a 1031 Exchange?
David Moore - Basically, it's really no different than a IRA or 401 . You're talkin about kicking the tax obligation down the road. So you're lookin at tax deferral of a given investments tax consequence. So when we look at it, I like simple, so I'll break an exchange into four basic components. Obviously we want to make sure that it fits, number one. It's simply an exchange. Somebody put something on the market to sell, they find what they want to buy, we step in the middle and turn it into an exchange. You don't have to have us if it's a true swap. If you got a property, I've got a property, we're going to swap, you don't need that. But a third party, a three way exchange where you're paying somebody, an accomodator, intermediary, facilitator, don't like the term anymore, but used to be straw man. It's somebody else being paid a fee to step into the transaction. We've got a business purpose, and we're going to take that sale and purchase and turn it into an exchange. So one, it's got to be an exchange, two, what's getting received have to be of like kind, like kind requirement refers the nature of the investment where in the form any real property held for investments, kind of with any real property, it's your intent to hold as an investment. For total deferral, we need to go across or up in value and equity between the relinquish and replacement. And in one common I've got, and it probably impacts what you guys are workin on too, is people look at their debt and equity, and there's an old saying out there that, well, couple of em. One, buyers are liars, which I think was a result of,
David Moore - I think that was the result of 1031s, pre-1991 because you could have somebody idea county. But these days I think if you've got somebody in an exchange going to buy one of your properties, you probably got a much more motivated person buying that thing than somebody walking out the street. But the other part that I wanted to really stress, and I had somebody writing a book, call this morning and we went over it, because it's so commonly misunderstood, or misstated, where you have to replace debt in an exchange. People are always saying now, and you don't. Debt can go away two ways. Debt can go away by going down in value, which triggers tax, because you went down in value. The other way debt goes away is by adding cash to the transaction. So think about it, I mean you guys, you were in this business. pre-crash, You started lookin at things, what happened to loans? Loan-to-values changed during the crash. All of a sudden, and people's equity disappeared during the crash. So we had lots of people that maybe couldn't get financed, or maybe couldn't get the LTV that they used to have, their equity evaporated, they had to add money, and they were concerned about it. I'd have people say, "Gee, I don't want any debt on the replacement property, so do I have to pay off the relinquish before close?" No, don't. So just think value, equity, and when you're lookin at that debt component, you can give up a property that had 90% of loan-to-value, buy a new property outright as long as the value and equity numbers meet. As long as you're going across or up
David Moore - in value and equity, it's fine. Your debts going to go for the ride. Add cash, or you're going to have tax.
Adam Hooper - And now, the role of an accomodator or facilitator is...
David Moore - We're just paid a fee, one thing before that, so the cornerstones, the three, it's got to be an exchange, got to be like-kind, satisfy that napkin test, says across or up in value and equity, and finally we have continuity vesting, and that comes back down to my comment on partnerships and all. But the biggest issue, biggest issue with any exchange, you guys tell me. Time, right?
Adam Hooper - Right.
David Moore - The second biggest issue is this vesting issue. Because so often in today's world, somebody will give up a property, or maybe somebody that's got a half dozen properties and their attorney says, "Hey, you ought to hold those properties in an LLC to protect yourself." so husband and wife, Oregon's not a community property state. Husband and wives don't, we can't go in and out of an LLC in this state, even with a husband and wife. So the lawyer says, "Hey, put em in the LLC." So the taxpayer puts it in the LLC. Husband and wife in the LLC. Now they go to sell the property, can they get financed going into residential properties, going forward? And a lot of people say, even finance people say, "Well, no you can't." well, you can, it's got to be a portfolio lender. Freddy, Fannie, those loans aren't going to allow it. So that's how easy, because now going forward, they're mad at me because I'm tellin em they have to buy in the LLCs name or they've got a problem.
Adam Hooper - To qualify for the exchange.
David Moore - Yeah, to qualify, yeah. And so they don't want to. It's one of those things where it really gets complicated quickly. As far as the exchange company and what the exchange company's job is, it's really, purely, you're being paid a fee to structure an exchange, that's it. As I said earlier, we're not supposed to be giving tax or legal advice. What we try to do is look at the transactions, number one, justify it. Understand what the person's basis gain is, and see whether or not it's worth doing. We don't want to have somebody payin us to do some transaction that doesn't do anything for em. You're going to look at that, and we're going to try to make all the pieces fit. If we see some problems with the transaction, we're going to have em talk to their tax and legal people and hopefully, they've got em. Unfortunately, a lot of people don't. That's the bottom line. But the exchange company's just there to handle the transaction and we like to say they're facilitators and intermediaries or accommodators. Accommodators accommodate. A facilitator's going to take an active role and we certainly consider our selves, a facilitator's going to take an active role and hopefully get people where they want to go.
Adam Hooper - So time and vesting. Vesting I think is probably more applicable to our listeners because most of what happens on platforms like ours is vestments in LLCs, right? They're not a sole owner. We've had a couple deals that have been structured as TICs, Tenants in Common, but most of them are just investments in a partnership, not a LLC. Limited liability company. So how does that play with the 1031 rules?
David Moore - It doesn't play.
Adam Hooper - It doesn't.
David Moore - It doesn't play very well. If we've got to situation where one person, if they're going to be the sole member of the LLC, that's fine. If you've got to single tax payer exchanging in to, an individual can go in and out of a limited liability company, but you can't have that partnership interest. Soon as you're adding other parties, now if you've got a partnership interest and it doesn't fit. If you think about an UPREIT. An UPREIT, basically somebody's acquiring a property that's going to be absorbed by the REIT. The tenancy in common structure, it got a bad rap during the crash. I won't say it's a structure, I think it was just who was involved and what was being done. And unfortunately the structure got a black eye because of it. I think that things are opening up some more again with that structure, but if the three of us go to buy something, four of us, I'm sorry, go to buy something, the preferable form of ownership's probably going to be the LLC. But that's not going to allow us, anybody that's had a partner in something, on a property or something, five, 10 years later, you're probably, you're going to want to make a change. So really I look at it, and sort of encourage people to look at what they're going to do over time if they want to get in, they go tenancy in common then absorb in the LLC and then, same thing going out. We call em swap and drops, drop and swaps, any combination of things. When our retirement accounts are involved with stuff, they can receive a membership interest in your assets, no problem. The only issue,
David Moore - when we're looking at qualified money coming in, if it's IRA or 401 funds it's got to be non-recourse loan. Often, what'll happen is maybe we've got the other investors over here, and we've got an LLC that might contain the group of qualified funds. That might be the IRA/401 money, and maybe that's excluded from actually being recourse on that group. I've seen that structure used one.
Adam Hooper - So this conversation today is primarily going to be for listeners out there that own their own assets, independent from ownership with other people. Again, unless all of that entire group of people in that entity want to trade that into another asset, right?
David Moore - Yeah, and you...
Adam Hooper - So if the four of us own an asset, we sell that asset, we can all agree that that same entity can exchange that into other property, right?
David Moore - Definitely. So that entity can go forward. So the issue it's the partnership interest that is the problem. It's not the entity, the entity can go forward. But once again, we couldn't, so that LLC that has all of us in it, that entity we can do the exchange for. That entity can be the member of a new limited liability company but that member could, or that LLC could not be a member of a new LLC.
Adam Hooper - Got it.
David Moore - You can look, and talk to your tax and legal people about structuring what they talked about in tax reform was LLCs filing under a 761 election. And you can talk to your tax and legal people about application, that application, and your application and whether or not that's something that would fit what you guys are working on.
Adam Hooper - So that's what you said earlier, some partnership interests now do apply? Can apply.
David Moore - Can apply.
Adam Hooper - And do you want to get into that a little bit?
David Moore - Well, that's just really, it's a 761 election that's going to allow it. And I've, as far as anybody that we've worked with since that change, I've got people looking at it, I don't think anyone's actually put anything together with that election yet. Anyway, so it's one of those things I think the legal community's still trying to figure out exactly what fits and how. It's interesting, soon as tax reform went through, I'm on the board for CCIM Chapter here in Oregon, southwest Washington. I run the programs with a couple other people. First thing we did, we got tax people in for the January meeting because I wanted, "Hey, let's get a jump on this, and let's get some good tax people in here to give us all the answers." I think it was a little bit early, because nobody really... Nobody knew. Had any feet on the ground with respect what was goin on. I'm scannin through that stuff, they're scannin through it, everybody's still clamoring. And if you look at the first quarter here, people were just sayin, "Hey you all, the government hasn't even gotten the forms out for tax returns yet." Anyway.
Adam Hooper - So we'll see.
David Moore - So we'll see how it all settles down.
Adam Hooper - And then timing. That's one of the biggest kickers is trying to figure out the timing and order of events in exchange. So plain vanilla, straightforward exchange, run through that timing for us.
David Moore - 45 days from settlement, ID what you'd like to buy. 180 days total time to get it done. Those timelines start transfer the asset. Typically, we're lookin at settlement dates of closing. Sometimes, during the crash, and even we probably got a couple more we're going to unfortunately have to deal with before the end of the year, where we've had giant TIC foreclosures. And in those situations, what happens is, is we're going to be assigned into the transaction pre-foreclosure and that transfer from the taxpayer to us is what triggers the 45 and 180, so there's no sale at that point. That brings up, so we're talking back to my comment on debt in a transaction, or the value and equity requirements in it. You think about you want a home, and a foreclosure on a home situation, your primary residence, you had some tax relief. But the really ugly thing that came up during the crash, and I shouldn't be jokin about it, I'm not jokinng about it, it was an ugly, ugly deal. But the government's going to treat the debt in a foreclosure or a short sale as a sales price. So if the debt exceeds the basis on a property, people are losing properties to foreclosure and actually having to pay tax for the pleasure of doing that. So we had lots of transactions and like I said, we'll probably have a couple more before year's end. I understand they're working through right now but their choice is pretty simple. They come out of pocket the money to pay the tax obligation for losing everything or they come out of pocket roughly the same amount
David Moore - to go buy something. That's what a lot of times we do this deal, no money's comin in, the clock started at that transfer date, and they're scramblin to find stuff. But yeah, the timeline's both the 45/180 start, and let me say this too, this is something, earlier you asked me things that are sort of impacting us today. There was a ruling that came down on releasing funds. So, 1031 contains what's called the G6 Rules on when you can receive funds. Years ago, if somebody wanted to kill a deal, our attitude was, "Hey, if they want to kill the deal, let em kill the deal, and pay the tax that they need to pay, and why should the government care about that?" There's ruling that came down that basically says that a taxpayer cannot in any way have access to those funds out side the G6 Rules. And what that means and why I'm bringing up now is, are we in a tight market? We're in a tight market. Are we in a market where we've got transactions that aren't being completed, because people can't find stuff? Yes, we are. If somebody get annuitant exchange, let's say they get to that 45th day, they better be committed, all the way in or out with respect to what's happening. If they have identified properties and those properties go away, people say, "Well can I add other ID properties, and the answer's no.
Adam Hooper - No, cause your 45 days are up.
David Moore - And they say, "Well, what happens, its sold?" If I go back to '91 when we put the company together and I look at Audit Manual there, one of the questions in the Audit Manual was, was the property on the market at time of ID? Which is irrelevant. Does a property have to be on the market to be sold? No, it doesn't have to be listed with anybody. The bottom line is, somebody IDs property and they leave those properties ID'd, and now we're on day 47, and they say, "You know what, give me my money." I'm stuck, I can't give em the money til day 181. So it's really important when people get into an exchange today. Number one, they can't get the money for any reason short of the 45 days, so day 46 would be the first day they've got access and then day 181.
Adam Hooper - Period.
David Moore - Yeah, period. They can't access period.
Adam Hooper - They can't take it out and take the boot.
David Moore - So think of this, and this would be important for you guys too, because let's say that they're identifying one of your assets as maybe not as the primary but in a fallback. And they think, well they're doin that because maybe it'll be there a little longer. So now the stuff they really wanted went away and then they think, "Okay, they're going to buy your stuff, and then think, Nah, maybe I'm going to go do something else instead. Just give me my money, because, give me my money, I'll go buy this other thing that wasn't identified." We can't. We can't give them the money.
Adam Hooper - It's locked up.
David Moore - It's locked up. So they're going to buy your stuff or they're not going to buy anything. It's just, it's tough for us, I really, I wish they would've just said, Hey. If somebody wants to pay tax, let em pay tax, but the idea is that it's a flaw in our process. It's not whether that person cares about paying the tax obligation, it's the company's processes aren't in compliance with 1031 G^, therefore, it doesn't jeopardize just that persons transaction, it jeopardizes everybody. So it's really important when your working with companies these days that they're understanding the rules, following the rules, and taking care of it correctly.
Adam Hooper - Which would also be again your role as the...
David Moore - Facilitator, accommodator.
Adam Hooper - Facilitator, right.
David Moore - Intermediary.
Adam Hooper - Not providing tax advice but making sure that those timelines and frameworks are understood going in. Exactly.
Tyler Stewart - You said that is new that the cash has been locked up? When did that come in?
David Moore - Well, probably mid-2000s now. It's been awhile, but it's just, it hadn't been that big an issue because people were completing transactions. Now the market's tighter now, more people are not completing the transactions.
Adam Hooper - So sell a property, I've got 45 days to identify, what?
David Moore - Identification, good question. Who do you identify to, and what constitutes a satisfactory identification? ID could be a common address, as long as it states the city, state, zip. It needs to be a specific address, if you're going to buy a portion of that property, then you need to ID the portion that you intend to buy. What you identify has to be an unambiguous description, what you receive has to be substantially the same thing. So if somebody asked me, What would I do if I wanted to cause problems for people and get some tax revenue if I work for the IRS? I'd just go through IDs all day long. Because I know that they're going to not be accurate. So you've got to really be careful on what, you're doin that. If you're goin in with other people, as long as you're getting 50% or more, you're getting substantially the same thing. But if you getting a piece of something it's always fine to go out and get a tenancy in common interest in something, but you need to identify that portion you intend to receive. And the identification, I made the comment, "Well, who's it go to?" it's got to go to somebody that's a party to the transaction without an agency relationship. It could go to the seller of the property, it could go to the seller's broker, it could not go to the buyer broker, couldn't go to their tax or legal people, could go to us, obviously, or it could go to escrow. I tell people, "Look, if I don't have it, and you get audited and they call us, you're probably going to have a lot of explaining to do, so I'd encourage you to get it to us,
David Moore - get it in a file."
Adam Hooper - Restrictions or guidelines around identification.
David Moore - Three different rules, and this is one of those things, once again, very, very commonly misunderstood, each rule works independently of the others, so the first rule says you can ID up to three properties of any value. Once again, we're lookin at value numbers, so if we look at the three property rule of value doesn't mean anything. Soon as they exceed three, then you're lookin at the 200% rule, or the 95% rule. The 200% rule says you can ID more than three properties, but the total value of the properties ID can't exceed 200% of the relinquished properties value. Well, what's the property worth? Is it worth what it's listed for? But we just talked about the fact it doesn't even have to be listed. So what is something worth? So you've got some room there probably. What you're going to pay for it, I mean, my youngest brother's an MAI appraiser. You've probably worked with him in Bend. I ask him, I say, "Greg, how do you know when you've done the right job, or done a good job on something?" he said, "Oh, it's easy." "What do you mean by that?" he says, "No, nobody's too happy or too mad." it's just, it's what you agree to. But if you don't have a sale, and you don't have that buyer and seller come together, what is it worth, once again? So the 200% rule is dependent upon valuation. And then you've got a third choice that says you can exceed three, you can exceed 200%, but you got to close 95% of the aggregate value of all properties ID'd. Once again, we're looking at percentages and what things are worth. Most of the time, I'm going to tell people
David Moore - if they're working at 95% rule, they probably ought to get the deal done inside the 45 days, because you have one sale failure, you're going to have a problem.
Adam Hooper - The example you said before where they sold a home in Los Gatos and bought 24 properties.
David Moore - Yep, she was a CPA. She was a CPA and she knew...
Adam Hooper - She knew the game?
David Moore - The cost of failure, so she got it all closed inside the 45 days.
Adam Hooper - So that was, was that a 95%?
David Moore - Well, she got 100%, but yeah, in fact, the rule didn't matter because she got it done inside the 45 days. So if she closed, if she didn't get em all closed inside the 45 days, she had one sale fail, then she's lookin at that 5% variable there, that could have sunk the whole thing. Or would have.
Tyler Stewart - What is your perfect client doing in that 45 day period, what's kind of, checking all the boxes. In your world what's...
David Moore - Well, I'm going to say, yeah, I'll answer your question, the perfect, what they should be doing is they probably should have found the property, the replacement before they ever closed on the relinquished, and then they're just looking at getting the financing in place. Which in today's world, and this is something that you guys, your product probably solves for people a little bit, because what's happening, we've had several transactions recently where that lending world, the banking world is so tough right now, and you've got to change a source of funds. I had a client that was, they wanted to do an exchange into a property, they've tied up the replacement property, working in financing for it, and they had the relinquished property on the market, they didn't really think it was going to close, but it did end up getting closed. So they were going to do the exchange. Well, the source of funds changed, and the lender said, "No, you can't do that. You're going to kick it down the road another 60 days if you change the source of funds." And they're going to lose the deal, so they weren't able to do the exchange, which is just ridiculous. You can clearly see where the money's coming from. But the thing I joke about is for brokers, you think about their ability to get deals closed. And I always say, "Well, you've closed everything you've ever written, right?" but the other thing, if you ever had an owner think a property's worth more than it really was, and everybody laughs, because of course we do. But if you find us the perfect replacement property,
David Moore - if somebody's excited about one of your projects and they've got some rental house that's eatin em alive, or especially think about the laws we're staring at these days, with tenant rights, or seismic upgrades, or whatever it might be, and they're tired of dealing with the Terrible T's, right? Toilets, trash, tenants, turnover, they don't want to deal with that stuff anymore. My mom doesn't want to deal with it, but they get in maybe one of your projects, and they don't have to do any of that stuff. So giving them a place to go is so important. If you're just asking somebody for a listing, they're not that motivated to sell, right? But if you give em that nice, shiny, new item to buy, they're probably more motivated to get rid of something they have already decided a long time ago they didn't want to deal with anymore.
Adam Hooper - We've sold our property, we've identified some number of targets within that 45 days. What happens between day 45 and 180?
David Moore - Well, same thing that could happen between day 0, or day 1 and day 180. You're just workin to make the acquisition.
Adam Hooper - Just got to close the transaction.
David Moore - Yeah, just get it done. Which, with the financing these days, it can be tough, and what is needed on different things. Once again, I encourage people to be looking for the replacement from the moment they list the property. Don't let the 45 days be a problem if you don't have to. Really get it set up, and I think in general, people, if you go back to the old days and like I was joking about, the buyers are liars, or what's been identified, and where you are in the 45/180, I think people are much more likely to work together than they used to be on stuff, because both buyers and sellers maybe have been stung. People argue 1031s are a reason prices have gone up where they are, and that's clearly the case. Because if you don't have the thing set, let's say you get outside the 45 days, and you're bickering over $20,000 worth of work that was done on some multi-million dollar deal, and a failed exchange is going to cost ya half million bucks, you're going to pay the extra 20.
Adam Hooper - You're going to pay it.
David Moore - So really just do what you can to get the deals done, locked up. If I came to you and said, "Hey, I'm going to sell this dirt." And they list it, and fried it to get it sold, today we list it, tomorrow it's sold, it's going to fund cash next week, do I really want it to happen that way? Unless I know where I'm going, I don't. Ask for the time you feel you need. As far as acquisition, if they want to buy into one of your projects, they can put earnest money down today. They can work to make the acquisition do everything short of closing on it before that sale happens. And we can reimburse the earnest money that they put down if they want to, or they can leave the earnest money in. When we get their funds, later. If they haven't made the offer with you guys yet, then we can forward the earnest money on their behalf. So really do anything short of close.
Tyler Stewart - Just for clarification, on our platform, people are investing again in LLCs. So are they able to exchange from an existing asset that they own by themselves, if they're selling into a partnership?
David Moore - Not into a partnership interest. So once again, they can buy into an LLC as the sole member...
Adam Hooper - But not as a limited, so again, typically on our site, all the deals are just membership interests in this LLC, so, that wouldn't work.
David Moore - Our entire recording session is pointless today. I'm joking, of course. So yeah, if you're looking at community property states, then people, husbands and wives can go into, but they couldn't go into with other people. So we're just looking at the tax payer that relinquishes ask to receive period. And that 761 is the one thing, I'd probably say, "Hey, talk to your legal people about it, look at that structure and understand what it's going to allow or not allow, and see if it's applicable."
Adam Hooper - And these timelines are loose?
David Moore - Not extendable, period.
Adam Hooper - They're firm. There's nothing you can do?
David Moore - Well, short of a Presidentially declared national disaster, no. That's the deal. We'd never had an extension before 9/11. Now when we have storms and you can document, you can show that that situation has impacted your deal. Maybe the accommodators in that area, maybe you want to use an accommodator that's in the hurricane zone all the time, because the chance you might have an extension, I don't know. Anyway, but if you've got a property that's impacted by something like that, then it's going to be okay. But short of that, no.
Adam Hooper - Firm on timing? Let's talk about...
David Moore - And actually, one last comment on that too, when you get closer to the years end, you got to be careful, because it's 45 or 180 or the due date of the tax return. So when we have deals late in the year, you need to complete the exchange before filing the tax return.
Adam Hooper - Completing the exchange means, buying the replacement property.
David Moore - Buying what you're going to buy. So if you're going to buy after, let's say, April 15th, don't be too eager to get your tax return in there. If you did and you didn't complete the deal, you're done. I really think that was a question of recording, what year is the tax consequence in? Is it in the year the deal was started, or the funds received? And that's a whole nother conversation for another day.
Adam Hooper - So let's talk about the different kinds of exchanges. We've talked about the reverse exchange, got an UPREIT, few different kinds of exchanges. So I guess plain vanilla exchange is just selling one property, replacing with another.
David Moore - Exactly, people look at a delayed exchange, they don't think of it that way, but it's, a delayed exchange is a normal transaction. So sell first, buy later, and we've got the timelines you were talking about. Reverse exchange, is really, so pre-2000, we used to do true reverse exchanges, which would mean that you'd have ownership of the new and old properties at the same time. We just work at the opposite of a delay. So from the date of acquisition, you have 45 days to say what you're selling, and 180 days to sell it. And that was a nice, logical application, and it didn't require anything fancy in financing or anything else. The government didn't give that as an option. They gave us safe harbors as Rev. Proc. 2000-37 that gave us safe harbors for warehouse transactions. So warehousing, or parking a property. So we use, in the exchange world, it's called the need in exchange accommodation title holder, which is really just a single member LLC that we're the member of. We either do a warehouse relinquished, or a warehouse replacement. Meaning that we're going to create an LLC or that EIT to take ownership of the property to be disposed of, or the acquisition and the replacement property, one of the two of those. That decision is driven by the anticipated net equity coming out of a property, versus how much money they've got to put down on the new property. You're going to factor in lending, whether or not there's a bank involved, and whether they'll allow us to take ownership. Because you think about from a bank's perspective,
David Moore - if we're doing what's called a warehouse replacement, they're going to finance the property in the LLCs name. The LLC has as its member, us, Equity Advantage, and yet the taxpayer's securing the financing, and ultimately will have the, so you've got a loan that's still guaranteed by the taxpayer, secured by the asset.
Adam Hooper - Owned by you.
David Moore - Owned by us. And a lot of times, if we have the ability the way we like to do it, is we'll create the LLC, that EIT in a name that they ultimately want to own the property, and then we'll just assign a membership interest in the LLC to complete the deal. Which should make the banks happy and everything else. But if they're going through a traditional lending, that's going to require a regional bank. Some portfolio lender that's going to do that type of stuff. If we just can't get it done, then we're going to warehouse the relinquish property. Either way, if we do a warehouse replacement, think of it this way, the taxpayer shows up at the purchase with the money required to make that purchase, we sign a note saying we borrowed that money from them, we buy the property, they in effect manage the asset if we work within the safe harbor's, they can have some of the benefits and burdens of ownership. Because if I own the property, I would love to have some of the upside, my client doesn't want me to have the upside, but I'll tell ya, I don't want any of the downsides. As long as we're working within the safe harbors they've provided, the taxpayer can be on the hook for that stuff and we don't have to worry about agency, we work outside and we've got issues.
Adam Hooper - Which would be like in the interim cash flow, anything like that.
David Moore - Yeah, the income off the property, the obligation of debt, and all those other costs of ownership. But really, if it's a warehouse replacement, it's a simultaneous exchange that happens when their property sells. If it's a warehouse relinquish transaction, the exchange actually happens when we make the acquisition. Because at that point, they're giving us the property to be sold.
Adam Hooper - So that's the triggers that start...
David Moore - That transfer date either way is what's going to start that clock, and if safe harbor's only give us 180 days to be on title to something. Which isn't that horrible in a reverse application, but when we're building things, doing improvement exchanges, it is. Which would lead me to the next one. So a warehouse replacement is where we're taking ownership of the new property and improvement exchange is really the same structure as a warehouse replacement. It's just a question of whether we're building on that thing. We can build from the ground up. Something that's pushing it a little bit, but we're doing a fair amount of these days, is improving property already owned. And that's, we call that a leasehold improvement exchange. In that situation, we're actually literally creating new real property that's of like kind. Anytime we're looking at improvement exchange, the project doesn't have to be done within the 180 days. And think about weather. You're native Oregonian, so you think about what happens here certain times of year. We might have people runnin off to fish, or ski, or hunt, or whatever. And California's like, hey, the waves are up, surfers. Your contractors disappear, or we got weather that really slows things down. So you might, if you're looking at improvement exchange, you really got to sort of look at the year and when you're going to get the work done, and when you want things to close. And if you're able to get a project, so the trigger date for the exchange, doesn't necessarily have to be the settlement on the closing,
David Moore - they could do a reverse improvement exchange, where we could buy first and build out earlier, or we could, if we're doing that leasehold process, as soon as you've got everything set to go, then we can start that exchange process, but we've only got the 180. So we've got delayed, we've got simultaneous exchanges, reverse exchanges, improvement exchanges, and there's something we call a blended transaction, where maybe you're giving up a portfolio properties, and we can get five, six done sold before the acquisition has to happen. But at some point, we got to close on the acquisition, right? So maybe they're buying one of your projects, they're giving up a half dozen properties to go do it, they get four done, they've got the money representing the two that have yet to sell, so we're going to do a delayed out of those four, a reverse out of the other two, and you've got almost, you can go almost out to 180 days to get the whole deal done.
Adam Hooper - And you keep that straight for everybody?
David Moore - Yep.
Adam Hooper - Okay. cause that seems like it can get pretty complex.
David Moore - Oh yeah. I joke, one of the brokers we do a lot of business with, she's, her first ever exchange, was two brothers giving up eight properties and it was a blended transaction. And I just give her a hard time to this day about, well, you didn't start the easy way. Everything was easy afterwards.
Adam Hooper - What makes for an ideal exchange? Why would someone do this?
David Moore - Well, the ideal exchanger, one, has good tax people. Tax and legal people too, so they're going to be giving them guidance and understand what our job is, and understand where to push things. It's really something that you've got to look at, and I never make judgements. Years ago, I would, if you look at what we do, and what, we're deferring gains, you're kicking the obligation down the road, you can swap till ya drop, and get rid of it like we said earlier. But the deal is, that you're going to look at the gain on disposition and what are you doing? I think today, we've got real, something we got to look at and understand that savings accounts don't do anything for ya anymore, right? So in the old days, you didn't find a property, you just sell the property, have the money sit in the bank, and you make a nice return. Well, today, you get nothing. So the question is, you're selling a property, what are you going to do with the money? Hopefully they're, you guys have product that's out there that's going to hopefully fit somebody's need, and if they're aware of that, they're going to be more motivated to give that other thing up, but they're going to move forward on it. If we're looking at the perfect client, the gain is not going to be the trigger. I just want a happy client. I want somebody that we're doing something for, I don't want em buying something they don't want just to hide from a tax, necessarily. And I think anytime we're in a market like we're in, you start having that conversation with people. It's like, "Look, you're concerned about time,
David Moore - you're not really finding what you want. Are you buying this thing just to hide from a tax? If so, maybe you ought to step away, pay the tax, look at what else you've got, time that closing, and maybe you got some other losses to offset the gains and you got the money ready to go."
Adam Hooper - And that's something we've talked about before, is not letting the tax, tail wag the dog, basically.
David Moore - Exactly.
Adam Hooper - Make the decision based off what's best for the strategy, and then if there's a way to do it in a tax advantage way, then do that, but don't let that drive your decision.
David Moore - Exactly. And so the thing is, it's like, how much is enough? How much gain, how much tax is enough to justify the transaction? Well, basic delayed exchange, going to cost a grand, roughly, from one relinquish into one replacement. If you're looking at reverse exchanges, you're looking at reverses, improvements, you're probably looking at five to 15 thousand for those. Which none of it's very much, but if you've got a $5,000 tax obligation, does that justify you racing around, trying to find something right now, when you're paying 1,000 to the exchange company, now you got a $4,000 delta. And you might be in a situation where you're paying easily that much extra for a property you don't really want. So don't do it. Then on the other hand, I'll have people that will flat, I had a CPA flat out refuse. She wanted to do an exchange with $5,000 benefit. I said, "Are you sure you want to do that?" Yeah, she said she was positive. I had another client years ago now, that said, "Oh, you know what, I'm not finding what I want, and it's only going to cost me 800 thousand, so I'll just pay the tax this time." So I'm not the guy to say, "Okay, hey, this is not enough, or this is too much or whatever." It's really a person by person situation.
Adam Hooper - Again, just to reiterate, this is a deferral of the tax consequence for that gain. So it's not an elimination or a forgiveness, it's a deferral. So it's that you can address it at a later time. You don't have to pay that tax.
David Moore - If it's tax deferral, and a lot of times, people say, "Well, gee." somebody in the tax legal world would say, "You're going to have to pay the tax at some point, so why not pay it today?" and I'll ask that same question to somebody with a retirement account. "You have an IRA? You have a 401 plan? Why? You're going to have to pay the tax at some point anyway, why not pay it today?" And it's worse, actually with retirement accounts, because at the end of the day, you're not looking at the long-term capital gains tax consequence, you're looking at normal income tax. So really when we start looking at those situations, when you're looking at 1031, looking at, people say, "Well you're going to have to pay it at some point, why not pay it today?" Well, swap till ya drop, that gets rid of it. You never paid it. Buy things that you're gifting. If I've got to kid and I gift her $15,000 in cash, I don't have a tax consequence. If I gift her $20,000 in cash this year, I'm going to have to pay some tax to do that. If I gave her maybe a $30,000 interest in a piece of property, that's too much, maybe 25, okay the reason, where I'm going with this is you can discount if you're giving something, an in-kind gift. If you're giving a piece of something, you can discount that piece by maybe up to 40%. So it's a tax planning benefit if you're giving something, ya know, you got three kids, get em all a property, give em, ya know, husband and wife, gift the stuff out over time, and the kids end up owning it. Maybe somebody, they buy into one of your properties, and they just start gifting
David Moore - that membership interest over time. They don't even have to change the deed, right? So when we're looking at retirement accounts, my comment about hey, you're going to have to pay the tax at some point, why not today? You're looking at what's in there and what's the best way to get it out. And we use a lot of that in-kind instead of think about distributions on IRA 401 plan, they buy one of your projects with one of those instruments. Now instead of taking a cash distribution, they take an in-kind distribution that assign that membership interest in your LLC that was owned by their IRA or 401K. They take that as an RMD, and they can discount that piece, dramatically. So you can accelerate distributions while minimizing the tax consequence of it. What else do people do? They exchange into a property, they move into and retire into. And then we've got different rules we've got to look at, and I mentioned that Housing Assistance Tax Act earlier. Those things, there's something called, obviously everybody knows there's installment sales. My comment about installment sales is, make sure that you understand what the tax liability's going to be on disposition, and understand that a broker involved probably wants to get paid, title escrow probably wants to get paid, whoever else is involved with that closing probably wants to get paid, so you better get enough down payment to cover those. But the things that sneak up on people is depreciation recapture and debt relief. So you're going to pay tax on those two items if you've got em in the year of disposition,
David Moore - even if you never got a principal payment. So you got to be aware of that. But along those lines, in addition, installment sales maybe, your structured sales will take a cash sale and give installment sale treatment. You got CRTs, Charitable Remainder Trusts. These are all things at the end of the day, they're the end games.
Adam Hooper - And that would be something they're going to talk with their tax professional about.
David Moore - Hopefully.
Adam Hooper - Hopefully. Before they come to you.
David Moore - Exactly. Well if they talk to me, I'm going to send em to their tax people, but yeah, definitely.
Adam Hooper - And then back on the specific types again with this most current tax change, limiting it to real property, let's just talk briefly. Real property qualifies, what qualifies as real property?
David Moore - It could be beach, it could be dirt, office building, strip malls, just any real property held for productive use and trade business or for investment. Even some oil, gas, mineral rights, a 30 year leasehold interest in property qualifies. So it refers the nature of the investment, rather than the form. And that's one of those things where the government's proposed a couple times to make it true like-kind, which I really believe would be devastating. If you look at 1031...
Adam Hooper - Which would be like office building for office building.
David Moore - Yeah, because what happens, you've got, and the last time they proposed that they were concerned about the amount of farm land or ranch land that was getting taken out of production by somebody that just wanted a place to go hunt, or something like that. They were putting it out, they were going to say on AG property, that like-kind had to go AG for AG, that type of thing. Fortunately, it didn't happen. But you think about 1031, if you, somebody's first investment is typically going to be their home. And then they move out of it, and they see it as an investment and they keep moving the thing. But 1031s one of the only real big tax benefits, or tools that the average Joe has. You don't have to have some lawyer, or accountant that's well-versed in this stuff to be able to do it, it's one of those things that anybody can do, it is a very nominal cost at doing it, and it's available to everybody. And when they took the personal property away, that was, hey, the big, bad one percenters.
Tyler Stewart - So can I sell my home and exchange into my new home?
David Moore - Well, your home, so think about, we got to define and look at what is a home? How do you prove something is your home? I would say, we live in Oregon, it gets a little bit gray, and a little bit dark, and a little bit wet during the Wintertime, right? So lots of Oregonians, call themselves Oregonians and they actually live in the desert more time of the year than they do here. Car registrations a little nicer here, too. But if you look at, how do you define a primary residence? You're going to look at utility bills, voter registration, drivers license, those type of things. Tax returns. But you could have multiple homes that both qualify, and you're looking at that two out of five requirement. But when you sell a home...
Adam Hooper - Two out of five requirement being?
David Moore - So, Section 121 on the universal exclusion just says you have to have lived in a property for two, for an aggregate of two out of the preceding five years for it to qualify for Section 121, which gives you that 250 exclusion personally, and a half million for a married couple. You can have a property, so think about what I just said, with somebody's first investment, it's their home. They move out of it, they rent it, if they sell it within three years of moving out, what are they selling? So back to your question, what am I selling there? I'm selling something that could go 1031, and still qualifies for 121. Back to the Los Gatos example, they're entitled to the 500 exclusion, as long as they get it sold within three years of moving out, and then they just 1031 the overage. If it's something where you've got the gains or within the 250 or 500, you've got just a straight exclusion. So in '97, we had 1034. It said 55 and a half or older, you got a one-time lifetime exclusion of 125,000 in gain. You sell your house, you got two years to buy a new one of equal or greater value. 121's just a straight exclusion on gain, period.
Adam Hooper - In that case, are you able to bifurcate that? So if I've got, two million dollars in gain on my residence, I can take that $500,000 exclusion and then exchange that other million and a half of gain into something else?
David Moore - Yes. Pretty nice.
Adam Hooper - Pretty nice.
David Moore - So when we look at that situation, that Los Gatos couple, they were staring at about a million dollar tax consequence on dispositions. And then they ended up doing the exchange, getting those properties, they paid no tax. So they were happy. So back to my comment earlier, the happy client's the best thing.
Adam Hooper - Good. What else is something people should be aware of, like a top three things you should be looking out for, or what haven't we talked about that people should consider before doing an exchange?
David Moore - Well, financing. They need to be aware of, you wouldn't believe, I mean, I've had people quit their job halfway through an exchange. It's hard to get financed without a job, right? It really comes down to like the vesting issues, and financing these days. You've got to make sure you're financing things, you're working with a lender that understands what you're trying to do, and is going to get you there, so we don't have that change in the source of funds at the 11th hour. So working with people early on, I'm going to say, do your homework, understand where you're going before you ever let things close, hopefully. Understand what you're going to need to get financed, and really, if we're thinking about ownership and I'm going to, people ask all the time, when do I want to, somebody think about an exchange, or when do I want to hear about the exchange? I'm going to tell em, I want you to think about it when you're buying the property. Because you probably not going to own it forever. And then when you get in the exchange, you definitely have got to be hustlin to find what you want to find. But it's that timeline, and so often, if you've got, and once again, back to this state, we've got husbands and wives and things. Back to the person that quit the job. So now they need a spouse on title with them, or somebody else to be on title with them, where are they in the 45 and 180? What did they identify, now they're adding somebody. Even if it's a spouse, so gifts between spouses is no big deal, right? There's no issue there,
David Moore - but if we start up that exchange with one on title, and they want to add the spouse on title the replacement, the spouse that's being added needs to come in with money representing their down payment, and whatever they own, is not being owned by our exchanger. So we've got to make sure the ratios work. So if somebody is needing help or needing to add people for finance purposes, they're going to add things, we want to make sure that our client is getting the portion that they need and that, if we're having to add somebody for finance purposes, let's see if we can put em on as a guarantor to the loan, if we can't put em as a guarantor, let's put, nothing says they have to be 50/50. Let's put em on at 1%. But that's just something that, right now, the lending world it's just, it's so rigid and you've got to understand, talk to those lenders early on. Once again, going into the stuff you guys are working on, it's more of a, I won't say institutional stuff, but it's commercial stuff, and the lenders in that space are different than if we're talking about, especially one to four units. I mean we got, most of that stuff's through some broker that wants to sell it to somebody and that loan's got to be sellable.
Adam Hooper - Any geographic restrictions? If I sell a property in one state, can I exchange into any other state?
David Moore - Yeah, anywhere domestic for domestic, foreign for foreign. Great question though, because you got to understand that the state doesn't want to give up what they feel they're owed, right? So in Oregon, we've got a state tax. In Washington, we don't, Nevada, let's say, Texas, Florida. So a lot of times people think, "Well, gee, if I exchange out of Oregon, into lets say, Washington, we'll just go buy something in Camas, hold it for a year or two."
Adam Hooper - You're talking, income tax.
David Moore - Well, yeah. So when you sell something, back to the initial premise of the exchange. Why do an exchange? Well, you're doing it to defer tax. What's the tax based on? The tax is based on gain, which has nothing to do with profit, which leads us back to why we were doing those foreclosure transactions. But gain's simply the adjusted sales price, minus the basis. The basis is the purchase price plus capital improvements minus depreciation. That purchase price number varies dramatically depending on how somebody got the property. If I gave you a property, your basis is what mine was. If I died, you got a stepped up basis to current market value. So you could turn around the next day with no issue. If you did 1034, once again, the basis carried forward. 1031, you've got basis carried forward in these things. So the acquisition, that purchase price, I just call it the purchase price, but it needs some quotation marks on it, isn't necessarily accurate. Then you started looking at capital improvements during the time you owned it. Did you do work to it? And I'll say, okay, yeah, "Did you do any work to this property during the time you owned it? Oh, yeah we put 150 grand into it." I said, "Did you write anything off? Oh, we wrote it all off." Well, they expensed it. So it did nothing for the basis. Depreciation, what's the government's position on depreciation? "You've got a rental house, you never take depreciation? Oh, I never took that. So I don't have that problem." Well, what the government's position is you should have, therefore, you did.
David Moore - So you could, in an audit, be in a situation where you didn't get the benefit of depreciation, and yet you're paying for the recapture of it. So you really lookin at those things, and understanding what's happening with that person going forward and think about from day one, does the exchange make sense? Two, where are we going with it? Is there going to be any finance issues involved with that, and let's eliminate as much of a problem early on as possible.
Adam Hooper - When should someone engage a facilitator, accommodator in the process?
David Moore - Well, I'd say when they first list the property would probably be a good idea because...
Adam Hooper - If they're thinking about exchanging.
David Moore - If they're thinking about an exchange. If it's an income property, sometimes they, like I said, they don't even know. It could be a home with a home office. That home office needs to be exchanged. Well, it doesn't get done, is it ever a problem? Probably not, but yeah. When they first list is they can understand what's going to be needed going forward. Whether we're adding somebody. Because think about it, a title report. Think about title to a property, does title to a property indicate ownership? Typically, it does, but if you sell to me on a land sale contract, you've got title until I pay it off. So the title report says you own it. I own it. We've got to always look at that stuff and understand what's going on. If we've got spouses that are coming in the transaction, only one of em's on title, have they been married for years? Do they file jointly? If so, then we add that person, but I want em to talk to their tax people.
Tyler Stewart - What questions should someone ask you when they're looking to do an exchange, to see if it's a good fit. What are the good questions up front?
David Moore - They want to know, anytime they're looking at an exchange, companies, they need to understand how long that company's been there, what they do to protect the money that's coming in, because people, with an exchange, they literally give us their money, right? So when we are told go, we draw up an exchange agreement and assignment agreement, which allows us to assume all rights and obligations of them as the seller or the relinquished buyer of the replacement. And in escrow instructions and different things. That assignment, literally we become the seller of the property. That money, when it closes is ours, it's not theirs. And you know what's really interesting to me too, is that, I've been doing this so long, but rarely do I have 1031 clients come in the office. And it just really sort of floors me. I mean, our URL's 1031exchange.com. I'll have somebody in Florida call us up doing a deal, and the money just comes in.
Adam Hooper - Just shows up.
David Moore - Yeah. When we're looking at IRAs and 401 plans on the other hand, people come in every single day. And I say, "Well, what's the difference? Why? Well this is my retirement." I'm goin, "Well, what's the other?" I don't get it.
Adam Hooper - Just play money.
David Moore - But yeah, so we talked about some things that came up during the crash earlier. So you want to know how long they've been in money, been in the money, how long they've been in the business. What they're doing with the money, and to be in this business today, it needs to go. It's got to go into a FDIC account. You can't put it into Path to Progress dirt, or something like that. It's got to go into the bank, sit there. Understand that if they're part of the Federation of Exchange Accommodators, they require bonding and E&O. Fidelity bonds are in place, there is an emissions are in there. Ask questions about what's going to happen? How would they apply the process to that, your transaction? Obviously cost is a component, but you know, it really costs ya, from the highest to the lowest, you're probably only talking a few hundred dollar difference on a basic transaction. So that's really not an issue. As far as location, anywhere in the United States you can transact things. Idaho has one, it's the only state that we can't initiate a transaction out of Idaho right now because to do an exchange out of Idaho, you've got to be licensed as an Idaho escrow company. So you've got to be registered through that. And then they mandate using Idaho bank, and then you've got to, anyway. It's just a different deal there and we don't do that much in Idaho so we just have word about it. So we do lots of transactions, where they finish in Idaho, but we can't initiate one there. We do foreign transactions too.
Adam Hooper - You said that's foreign for foreign so...
David Moore - Foreign for foreign.
Adam Hooper - If I'm a U.S. citizen and I own property in Canada, I have to keep...
David Moore - Keep it foreign.
Adam Hooper - Keep it in Canada, just foreign.
David Moore - Just foreign.
Adam Hooper - In the country of origination?
David Moore - Just foreign.
Adam Hooper - Just foreign.
David Moore - But you're looking at, any time we're doing international transactions, thing I don't like about em is dealing with the money, especially now, it's gotten harder and harder. And you start looking at, what's interesting too, is you start looking at cryptocurrency and those things.
Adam Hooper - That's what I was going to ask.
David Moore - If you look globally.
Adam Hooper - Is there?
David Moore - Yeah, globally, that would really simplify things, right? So obviously we don't work with any of that stuff right now, but five years from now, I don't know, it could be very interesting because then we'd get away from all of that stuff, that would be great. And then there's lots of people sort of pushing for that, and it could really change money as we know it obviously.
Adam Hooper - That's one of the things, just as you're saying that, so we've been pretty heavy exploring how blockchain's going to impact our space. Both in the investment side and traditional kind of financing place and one of the low hanging fruits that everybody talks about in real estate is title tracking ownership. That could be a really interesting application that would really relieve any ambiguity of who owns, what, when. And could have a pretty big impact on how that process could unfold, I'm looking at if you're saying you have to spin up an LLC to hold this property for a certain period of time, that complexity could maybe be a potential solution.
David Moore - Oh, yeah it would be wonderful. I laugh when you talk about people confused about what's owned by whom, and I was down in Central America, actually, Honduras, and my brother-in-law did a development down in Roatan, and we were, he bought some property up in Guanaja. So you think about once in awhile, we have problems here figuring out who owns stuff, a Banana Republic like that, that's really entertaining stuff. It's like, "No, you don't own that, you bought this over here. No, I didn't, I bought that." No, yeah, it's just unbelievable. So yeah, I would be a big fan of having some standardized rules that would take care of stuff.
Adam Hooper - There's a project out there, the thesis is that because, so Third World countries that don't have chain of title that you can prove ownership, that asset base never enters the economy. And so economies that are far more developed that have that capital base are typically more progressed. There's a group of people that are working on a blockchain based kind of global ownership system so that people that own, quote, unquote own that farm, because they've lived there forever can actually have title to that through this blockchain solution. They can go get debt against that and that asset base can then enter the economy. Which is fascinating.
David Moore - That'd be great. Sounds like a program we need to put together.
Adam Hooper - Well there was our obligatory blockchain diversion there.
David Moore - That's right, that's right.
Adam Hooper - But yeah, I think that's a really good overhang. That's all that we've got. Is there anything else that you want to add that we didn't touch, or anything you want to ask us?
David Moore - Well, I just, as far as you guys and the product, as far as what kind of product that you typically put out there?
Adam Hooper - Most of it, we do, again, it's investments in LLCs, right? So these are...
Tyler Stewart - So how many members of the LLC typically?
Adam Hooper - It varies on the deal. Our average total cap value of the deal that we see is like, 25 million, total purchase price essentially, so of that, equity is anywhere from 8 to 12 million, typically. Some are smaller, 4 to 6 million. Usually from RealCrowd, I have anywhere from 15 to 50 different investors go into that deal, as you get members of that LLC typically. Outside the few that have been structured as tenants in common, we've had a few Delaware statutory trusts that'll accommodate exchanges. Most of it's just kind of limited passive investing in these LLCs.
David Moore - So you guys do work with DSTs too.
Adam Hooper - We've done a couple. The return profile's usually pretty low, so compared to what other options are on the marketplace at the time, it's a pretty specific scenario that someone would choose to go into a DST, if it's not an exchange requirement, right?
David Moore - So is the debt on these, is it recourse, nonrecourse, what's...
Adam Hooper - Mostly nonrecourse. There've been a few...
David Moore - So if it's nonrecourse, you could take IRA/401 money?
Adam Hooper - Yeah. So we do have a large number of investors that do self-directed.
David Moore - And then, as far as the benefits and burdens of ownership, they are getting the deductions?
Adam Hooper - Yep. All passes through just as a typical LLC.
David Moore - So that's the thing with, a lot of times the Wall Street world will say, "Well, gee, you want real estate, buy a REIT." Well, you don't get those things. So that's why, DSTs even will have people pull money out of their pocket, throw it in and with the retirement accounts, that's something that the big, the problem with them is getting a nonrecourse loan, right? And we used to have regional source that would provide those, and that bank just got purchased by another bank, so now that channels gone. We've got some banks nationally, like if you look at iralending.com, myiralender.com, those are nonrecourse IRA compliant places. We do actually have some other banks that are doing a lot more of that stuff now. But that would be a space that I could see the qualified money going to your projects because it fits, and the great thing about retirement side, 1031's highly timed money. You got to get it done, when you got to get it done. Where the qualified money is patient money, and so it can sit there. The only other thing that I just would mention for people that want to use retirement accounts to buy into your stuff, is you just need to be aware, not you guys, but the investors need to be aware. And it's a great deal, because it's so hard to cause any prohibited transactions when they're goin in one of your things, but the taxpayer needs to understand, with an IRA, even with a Roth IRA, they're going to pay tax, they've got tax exposure on debt, finesse, income, and gain. So any income or gain of tributal leverage,
David Moore - they've got exposure on. 401 plans, no. So that's just one thing that people just don't realize very often, and I'd just like to get it out there. But I could see with your product and people wanting to do some stuff, it would be a great fit.
Adam Hooper - We've done a couple episodes on self-directed, so 401Ks and self-directed, we didn't talk about that much today. That is another part of your business, and we will have ya back in the studio here to talk about that next time.
David Moore - I look forward to it.
Adam Hooper - Perfect.
David Moore - Thank you very much.
Adam Hooper - Thanks for joining us.
David Moore - My pleasure guys.
Tyler Stewart - Hey listeners. If you enjoyed this episode, be sure to enroll in our free six week course on the fundamentals of commercial real estate investing. Head to realcrowduniversity.com to enroll for free today. In RealCrowd University, real estate experts will teach you the important fundamentals like, the Start With Risk approach, how to evaluate real estate sponsors, what to look for in the legal documents, and much more. Head to realcrowduniversity.com to enroll for free today. Hope to see you there.
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