Join hosts brothers David and Tom Moore of Equity Advantage as they delve into the world of 1031 exchanges, exploring the crucial aspects of value and equity requirements. In this episode, they uncover the key factors that ensure compliance and help you understand when you’ve satisfied the rules.
The 1031 exchange, often referred to as a “like-kind” exchange, provides a unique opportunity for real estate investors to defer capital gains taxes when exchanging one investment property for another. However, it’s crucial to navigate this process carefully, ensuring that value and equity requirements are met.
Learn from the Experts
During this episode, 1031 gurus David and Tom Moore will guide you through the intricacies of meeting the requirements of value and equity in a 1031 exchange. They will shed light on the essential considerations that determine compliance, giving you the confidence to proceed with your exchange successfully.
Whether you’re a seasoned investor or new to the world of 1031 exchanges, this episode of Advantage TV is a must-watch. Stay tuned for expert insights and practical advice that will help you maximize the benefits of your exchange!Read the Full Transcript
David Moore: Hi, David, Tom Moore, Equity Advantage, 1031exchange.com and I’m testing Tom today.
Tom Moore: Testing.
David Moore: Get my brother on here, so you don’t get to see him very often. It’s great to have you here. And one of the things obviously in recessionary times we deal with is decreased loan to value on stuff and a lot of times decreased equity in a property that’s going away. And a lot of times we’ve got all that confusion about having people being told they’ve got to replace debt by their tax or legal people or their real estate person and that’s not true. So, Tom, what kind of comments, what do we call the formula to get people made whole as far as value and equity and what kind of situations you’ve seen solutions problems, what do you see happening right now or what do you expect might happen?
Tom Moore: Yeah, so we refer to it as the napkin test. And the napkin test is just the basic idea that you go across or up in value, equity, and mortgage. And it’s not a requirement that all three of those things be met for a 1031 Exchange. The two real important things on this is that for full tax deferral, I should say, is that you use all the cash that comes out of the sale and buy something that is of equal value.
And when I say of equal value, you can back out things that are standard transactional closing costs. So, if you had a sale of a $500,000 property, and you had $25,000 in closing costs, then your net value that you need to replace would really be 475. So, if took all of your cash equity after your loan was paid off and you bought something of that value or greater, you’re going to defer all your taxes.
Tom Moore: The mortgage part of the transaction is always questioned, okay, I sold a property and I had, I still had a $50,000 loan on that property when I sold it, but I don’t really want to go out and pay for a new loan. I’ve got some cash and I just want to buy a new property without debt on it. You can certainly replace that $50,000 in debt that was paid off by adding cash to the transaction.
David Moore: We’ve had people call up through the years that have said, “Hey, I think I’m going to pay off the property than giving up because I don’t want any debt on the replacement.”
Tom Moore: Oh yeah. Yeah.
David Moore: And that’s not necessary.
Tom Moore: No, not necessary. And yeah, you’re right, today we get those questions. Yeah. See, I don’t want to have debt, like you said, I’m going to plan to pay off the loan before I close, that way I won’t have debt when I sell the property and I won’t have to have debt when I acquire the replacement property. You don’t need to do that.
Just leave the debt where it is. And when you acquire the replacement property, the addition of cash on the acquisition that you would’ve used to pay off that debt before you sold the addition of that cash will offset any debt relief on the acquisition side of the transaction. Yeah. So, you can always offset that debt by adding cash.
David Moore: Government’s always happy to have you put money in. They just don’t want you pulling it out without tax.
Tom Moore: Yeah.
David Moore: Got it. Yeah. And this is something that we see more and more as the months go along right now because you start looking at the tightening of lending requirements, so reduction of LTVs, and the other time we see this a lot is this topic comes up if somebody’s going in Delaware Statutory Trust or institutional tax where it’s a set LTV and the person is giving up. It’s like well, hey I’ve got this and this and no I’m not going to build cover the value that I need or equity requirements.
Tom Moore: Yeah. Yeah. And just sort of a side point on that note with DSTs. I was just signing off on a couple of closing statements a few minutes ago. And we had a transaction where the client sold a piece of property, it was about a $650,000 sale and they had 200 and some odd thousand debt on that property and went into a couple of different DST properties and one of them was a debt-free acquisition and then they put about 70 grand or so into that.
And of course, they still had a fair amount of cash to spend on a buy side, but they did not pick up any debt. They didn’t want to add more cash. So, they did pick up another DST that had a quite a bit higher debt ratio on it. I think that the other one was leveraged somewhere around 65% to 70%, which is a little bit higher on the DST leverage side. But they were able to pick up their debt that they needed for their exchange without having to add cash to the transaction too.
David Moore: Great. And it’s common if somebody’s buying into DSTs, it’s pretty common they’re buying into multiple offerings instead of just one. Yeah.
Tom Moore: Oh, yeah. Yeah. They want to diversify and a lot of, if they want to go into something that might be medical care, a lot of those might be debt-free properties. And it might put some money towards that and put some other cash into other DSTs that are leveraged.
David Moore: So, something else that people, I think, get confused about is, does somebody have to fully meet the value and equity requirements for the exchange to exist or can you do a partial exchange?
Tom Moore: No, no. Good question. Partial exchange transactions are very common. We’ll get people that, maybe they don’t want to take on debt and they don’t want to add cash, they just go down in value and they end up with some debt relief and pay taxes on that. It’s certainly not going to disallow the exchange. They just get taxed on any boot that they receive boots something that they get back out of the transaction that is not real estate. And boot is usually received in the form of either cash or debt relief. Sometimes it’s personal property, but not that often.
So yeah, they can go down in value and either have some debt relief or cash back to them and not pay taxes on it or maybe they want to maybe they are going across in value and/or up and they’re just wanting to take some cash out. They can certainly do that.
David Moore: So, with that said, when can they get that cash? And is there anything special they have to do to get it?
Tom Moore: Yeah, good question. The IRS is very specific about when an exchanger can receive cash out of a transaction. The first time would be at, right at the close of escrow if the money never comes into the facilitator, if it never is received by us in the exchange account and it instead goes directly out to the client, it would show up as cash boot to the client on the closing statement. So, they might take a hundred thousand cash out and pay taxes on that. That would be a check directly to them from closing. It never comes to us. We get the remaining cash for them to use for their exchange. If they don’t do that…
David Moore: I was going to say a few years ago, they, the government ,rt of solidified, or really sort of clarified their position on how to get it out though too. Right? So, you made some changes on our assignment agreement that would need to be filled out to have that happen.
Tom Moore: Yeah. We’ve got a spot on our assignment agreement that is labeled as retained taxable proceeds. And if somebody wanted to take that cash, say it’s a hundred thousand, again, they wanted to take that cash out and use it for some other purposes besides a replacement property. They would just fill that in on our assignment agreement. And escrow is often the ones that put that in. People might be in signing closing documents and they could do it right at that point in time, you know, I want to pull this money out. They just fill it in on the assignment agreement and that is now not part of the exchange transaction. So, they receive that cash at closing.
David Moore: And the government did have some rulings where they really, they need that to be excluded to keep the contracts valid.
Tom Moore: Yes. It’s not part of the exchange.
David Moore: And so, if the money gets to us, what has to happen for the taxpayer to be able to get those funds?
Tom Moore: Yeah, so if the money comes into the exchange account, now our hands are really tied as far as when those funds can be released to the client. If we get to the 45-day identification period and the client has not identified anything, then we are unable to buy anything for them. And so, on day 46, the exchange is canceled out, contracts are null and void, then the funds can be released to them at that point in time.
So, again, no identification made of any properties, then funds can be released to them on day 46. If on the other hand they have identified properties… And at no point in time during that 45 days…
David Moore: 45 days.
Tom Moore: Can the funds be released to the client. Again, our hands are tied. The IRS has very specific rules on that. They’re called the G-6 rules. But if they have identified properties, let’s say that they identify three properties on their identification form, at that point in time, if they’ve done so, they cannot come into us afterwards and say, you know what, I don’t want to buy any of those properties, just give me my funds. Because they’ve been identified, we now have to wait until the end of the exchange period. And if nothing has been acquired within the 180 day exchange period, then on day 181, those funds are available to them.
David Moore: So, what if the property I ID got purchased by somebody else?
Tom Moore: Doesn’t matter. Doesn’t matter. As far as the IRS is concerned, you can always buy that property from that new owner.
David Moore: So, does the property have to be on the market to be identified?
Tom Moore: No. It doesn’t have to be on the market. It just, when somebody makes an identification to us, they’re going to be listing either a property address or legal description. And as long as that property’s been identified, it is something that they’ve told us that they may want to acquire it in exchange, so we have to treat it as a potential replacement property.
David Moore: So, I think again, a market we’re in like we are right now, I think it’s really critical that you understand 1031 G-6, you understand when you can get the money, and you also understand that when you get to that 45th day, don’t just identify something just in case, because by doing so, it’s going to kick their receipt of funds out to day 181. Right? I mean, or after they purchase everything, they have the right to buy in that identification.
Tom Moore: Correct. And on that note, when they make the identification to us, again, let’s go back to them listing three properties. If they know that of those three properties, they’re only going to buy one of them and no more, then our identification form does have a spot where they can fill in that number. And it’s them stating to us that they are entitled to acquire no more than one of these properties that have been identified.
So if they have now closed on one of those properties, we cannot buy any others. So if they do have some cash remaining in the account, in the exchange account, after that first close of escrow has occurred, at that point in time, we can release the funds to them. So that would be the case. We’re past the 45 days, properties have been identified and they have acquired all of the properties that they are entitled to acquire.
If they don’t list that number one or two, however many they want to acquire, if they just have, still, they still have properties remaining on that ID form and have not limited the number, then we cannot release those funds, even if they’ve closed on something and there’s 10,000 remaining in the account, we can’t release those funds to them until the end of the 180 day exchange period.
David Moore: So basically, what you’re saying is we have people that might ID five properties with the intent to buy five, and they would put five in there and they might ID five with the intent to buy one, they would put one in there. And that would allow them to do what they do and give them the flexibility of doing what it is. By the way, everyone, if you’re working with a company that’s just going to… There’s a term, accommodating accommodators. Right? And you don’t want to be working with them because what happened, you might think, well, I like them because they’ll just give me my money if I change my mind.
The problem is the government’s been very clear on this topic. It’s like you cannot, if the policies and procedures are flawed, it impacts every exchange done by that company. It’s not just your transaction. So it’s really critical that you understand you’re working with companies, nobody that does this business legitimately full-time is going to give money outside 1031 G-6, wouldn’t you agree?
Tom Moore: No. Yeah. Because like you say, it’s going to put everybody’s transactions at risk that they are facilitating.
David Moore: Well, thank you very much David and Tom Moore, Equity Advantage, 1031exchange.com and we’ll be right back. Thank you.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031