In this information-packed episode, Dave Foster, a 1031 exchange specialist, shares his extensive knowledge on using 1031 exchanges to maximize tax savings and build generational wealth through real estate investing. He provides real-world examples of how he utilized 1031 exchanges to retire early and live on a sailboat while raising his family.

Timestamps

[00:03:05] How Dave used 1031 exchanges to convert investment properties into primary residences to generate tax-free profits

[00:06:05] Overview of primary residence capital gains tax exemption rules

[00:09:02] How Dave leveraged 1031 exchanges to fund an early retirement on a sailboat

[00:19:35] Dave explains the “4 D’s” of 1031 investing – Deferred, Delay, Defer, Dodge

[00:23:12] Using 1031 exchanges to relocate and purchase undervalued properties

[00:27:18] Converting 1031 investment properties into primary residences

[00:31:37] Hacking 1031 exchanges to invest in syndications

[00:37:25] Paying some tax to invest in syndications with 1031 proceeds

[00:39:57] Overview of reverse 1031 exchanges

[00:44:13] Advanced strategies for improving 1031 exchange properties

Key Takeaways

  • 1031 exchanges allow real estate investors to defer capital gains taxes by selling one investment property and reinvesting the proceeds into another
  • When timed strategically, 1031 exchanges can be used to convert investment properties into primary residences to generate tax-free profits
  • Portfolios can be built up substantially over time by continually deferring taxes through 1031 investing
  • Towards the end of one’s career, 1031 exchange properties can be converted into primary residences to eliminate deferred tax liabilities
  • Reverse 1031 exchanges enable investors to secure replacement properties before selling relinquished properties
  • With proper planning, 1031 exchange proceeds can be invested into real estate syndications

Resources & Social Media

Dave Foster’s Book: Lifetime Tax Free Wealth

Dave’s Website: The1031Investor.com

Dave’s YouTube Channel: The 1031 Investor

Follow Us On Social Media

YouTube: Truly Passive Income

TikTok: @trulypassiveincome

Instagram: @truly_passive_income

Facebook: Truly Passive

Twitter: @trulypassive

Download Our FREE Passive Investor Toolkit

Everything you need to get started in passive investing – Download Here

Transcript
Neil Henderson:

/If you're a real estate investor, looking to substantially increase your returns, you need to listen carefully to this episode. Our guest, Dave Foster is a true 1031 exchange expert who utilize this powerful wealth creation strategy. To achieve financial freedom and retire early. He'll explain what 1031 exchanges are reveal advanced tax. And share real world examples of how to maximize their benefits. You'll learn innovative ways to defer or even eliminate capital gains taxes. So you can supercharge your investing. This is an episode you can't afford to miss. If you want to build a sizeable passive income portfolio. And generate generational wealth. Now let's dive in and unlock the power of the 1031 exchange. Welcome to the Truly Passive Income Podcast. I'm Neil Henderson.

Clint Harris:

And I'm Clint Harris. Today we have Dave Foster with us. So Dave is a 1031 specialist with the1031Investor. He's a degreed accountant, serial real estate investor. Uh, he's a qualified 1031 intermediary. He's also a consultant and we're looking forward to him sharing his tax saving strategies with us today. Uh, and also just recently launched a new book that is coming out called Lifetime Tax Free Wealth, The Real Estate Investor's Guide to the 1031 Exchange. Dave, how are you today, sir?

Dave Foster:

I couldn't be better. It is so good to be with you guys today.

Neil Henderson:

Finally, we've been fighting a lot of technical difficulties. It's finally nice to be,

Dave Foster:

you know, finally delayed long enough. Yes, the book came out.

Neil Henderson:

So there you go. Perfect, perfect timing. Wait a second. Dave. Was this all part of your plan the whole time?

Dave Foster:

What, what, what? Alright. Of course not.

Clint Harris:

The 1031 specialist who thinks ahead for strategic advantages.

Neil Henderson:

Also apparently a world renowned hacker who can cause communications issues. So, alright, no. Alright Dave, so for... we're going to spend a little bit of time at the low level here, but for people who maybe have never heard of what a 1031 is, what is the basics of what a 1031 is and how it works?

Dave Foster:

Yeah, so the principle is... That you're attempting to harness the power of compounding interest in the form of being able, instead of paying tax on real estate profit, getting to reinvest the tax dollars for your benefit as you go through your real estate investing career. So what the 1031 exchange allows you to do is to sell investment real estate. And purchase new investment real estate, and in the middle, by doing the right process, you get to indefinitely defer paying the tax that you normally would have on the profit. So that deferred tax becomes more buying power for you. And as you go through your investing career, The deferred tax gets higher and higher, but so do the returns that shorten it for your benefit. And that's the whole purpose. You know, it started out, it's been in statute for over 100 years. Who knew, right? And originally it was designed to help our cash strapped farmers as our country was moving into the lighter agra business. Era, they wanted to see the farming industry grow, but the problem was that if a farmer, a young small farmer sold his property to go buy a bigger farm, many times the tax that he had to pay on the profits would not allow him to buy the next farm. So the IRS put this into code so that they would be able to use the tax dollars to buy the new farm. Now, all of a sudden, that young person who wants to become a farmer could afford to buy The first one. And it just becomes this sequencing thing. So throughout your life as a real estate investor, you can sell and buy investment real estate and continue to use the deferred tax for your lifetime. Actually, and beyond. We can talk about that as well. So it's really a form of compounding interest.

Clint Harris:

I want to make sure we get into some how questions about the nuts and bolts of, of how it goes down and how you do what you do. But I think one thing that's really important here is early on in this interview, I want people to hear about some real world application. I know that you got into this because you were doing this on your own with your own investment properties and it allowed you and your family to live on a sailboat and travel for. years apparently, right? Tell me a little bit about kind of your projects, the way that it affected your life in that way and allows you to do that.

Dave Foster:

You know, sometimes it is, you've seen this accessory poster where it says, sometimes the whole purpose of your life is to serve as a warning for others. You all are learning from my mistake. We were trying to get off the corporate train when we had our first child, and we realized time was the commodity. When you guys do this, realize this too, the whole idea of passive income is because it frees up your time, and time is so precious. And we knew that we wanted to do something with our time, and we wanted to spend time, spend it with our kids, as we're having them. So we decided, well, what the heck, real estate sounds like a good thing, let's do it. So, Ready, Fire, Aim, Dave went and bought a duplex, fixed it up, sold it, made a ton of money. And I'm thinking, oh yeah, a sailboat, here we go. Until my accountant reinformed me that I had a silent partner on the deal named Uncle Sam. And Uncle Sam actually made more money than I did. And that's when I realized this is not going to work. So as a bright guy and accountant and someone who just pathologically hates taxes, I started looking into the statutes. And that's when the 1031 had just settled, the IRS had just settled a massive court case that they lost. And now these 1031 exchanges were going to be available to anybody. Regular rank and file mom and pop investors. So we started doing that exact thing. While we were in Denver, we would buy investment property as it appreciated when we got ready to buy our next one. We would do a 1031 exchange, always using tax dollars to increase our holdings. Now there's this other really cool part of statute and we're kind of some things, but this is the really fun part. You guys familiar with the primary residence rules?

Neil Henderson:

A little bit. Why don't you give us, why don't you give us the high level?

Dave Foster:

It's the best, it's the best investment. It's the best gift from the IRS ever. All you've got to do is buy a house, move into it, live in it for at least two out of the five years prior to selling it, and you, if you're married, get to take the first $500,000 of profit tax free. You know how often you can do that? once every two years. Now, statistically, they tell us that we typically will move eight to 10 times in our life. So if you or your listeners do nothing other than buy a house, live in it, and when you're ready to move, sell it, you're going to generate eight to 10 opportunities to take up to $500,000 of profit tax free. Pretty cool, huh? What we did, and this is things we teach in the book, things that we help our clients with, is we found a way to marry those two concepts. So that every time we sold our primary residence, we would not just get another primary, we would convert one of our investment properties into our new primary residence. And so what that meant was that Every time we sold our primary residence, we were getting to take, at that time, you could take all of the profit. Now you can only prorate it, but it's still a good deal. We were able to take all of that deferred tax and turn that into tax free. And so, in order to get a sailboat, you gotta have sailboat water, there ain't a lot of coastline in Denver, so we moved our portfolio to Connecticut. Ahead of that, we purchased one of our investment properties with a 1031 exchange that we ended up converting into a primary residence. So first we turned it to tax deferred, then we turned it to tax free. And after a couple years in Connecticut, we realized something. Number one, we never saw the sun, and number two, Long Island Sun never got warm, so that was not going to be the place. So we headed off to sunny Florida, again, doing the exact same thing. Moving with the 1031 exchange to buy investment properties. Slowly converting those investment properties into our primary residence and literally, Clint, 10 years to the day, to the week of setting our 10 year goal. We cast off our dock lines with a 53 foot sailboat, paid for with tax free cash from 1031 Investing, and we raised our four children on that boat for 10 years. And paid for that with my private clients and with the money from our portfolio of vacation rentals that we at 1031 did too. That's a real world application, and I gotta tell you, I'd do it again in a heartbeat.

Clint Harris:

That's amazing. I love that story. Thank you, first of all, for your willingness to share your story. Secondly, for your willingness to share your knowledge. With everybody that you help, I mean, I've got a couple of people that I've sent your direction just in the last couple of weeks that, that I know it like what you do has the potential, just like it did for you to significantly change the financial trajectory of people's lives, and it affects the amount of time that they get to spend with their children, the amount of time they get to spend with their spouse and fulfilling their, their higher purpose or whatever that that looks like for them. That's, that's the whole point of truly passive income is, Having a lifestyle that you can, afford and get your time back by having income produced by real estate, and this is just, it throws gasoline on that fire. It supercharges it. So I want to ask a follow up question in terms of, make sure I understand this correctly. When you have done several 1031 exchanges in the past, and what you're talking about is, you basically have an idea of where you want to end up, the house you want to live in a couple years from now. So you do a 1031 exchange into that property. You have to use it as a like kind exchange, meaning it's an investment property. First part of the question is, is there any stipulation as to how often, if you do it, like, is it a long term rental or short term rental? If it's a short term rental, are there a certain number of weeks a year that it has to be rented out? And then what's the period of time for it to be a rental before you move into it as your primary? And then from the day you move in, is it the exact same rule as two out of the previous five years as your primary that all profits from that go away and wipe out the 10 31? That's snowballed up to that point,

Dave Foster:

yeah. Awesome questions. So the premise of the 10 31 exchange is that you assigned it, here's and it gets us, because the actual wording is that you are selling property that you have held with the intent of holding it for. Investment Use. And you replace that buying a property that you also intend to use for investment use. So the keyword is not a statutory holding property. The keyword is... But you have to be able to demonstrate that intent. So, let's look at this as a spectrum, a property that you want to convert. You, and by the way, any type of investment property will work. Short term, long term, commercial, whatever. It can all be interchanged. But let's say this is why it works great for later in life. Because let's say I'm living in Cincinnati and I want to retire in Sarasota, Florida. Ahead of that, I'll do a 1031 exchange. And I'll buy a short term rental on Siesta Key. Now, here's the spectrum. How does the IRS know that my intent is to use that for investment? Well, if the afternoon that I buy it, the moving van is backed up with my stuff, and I change my driver's license immediately, and my kids start school there, and all of that, did I buy a property I intended to use for investment? Answers no, that's not going to fly. Here's the opposite end of the spectrum, and that is that is a Revenue Procedure 2008-16, the IRS has a safe harbor guarantee, where if you rent the property for I think it's at least Two weeks in two consecutive years, and if you don't use it for personal use, more than two weeks a year, or 10% of days it's rented, not counting any days you stay in it while you're working on it, they will guarantee your investment use. So there's the other end of the spectrum. Zero days, probably gonna fly. Two years with those limitations? The reality is probably somewhere in the middle for each person. A lot of people feel comfortable in anything more than a year. And don't forget that part about the statute where it says not counting the number of days you stay in it while you're working on it. And I... Can think of a couple people whose names will not be mentioned, who have to go down and spend six months a year in their investment property because the automatic sprinkler system is so glitchy. It's all about what you can defend.

Clint Harris:

That's right. I would paint one square foot a day for six months.

Dave Foster:

I tell people, bring a can of paint down with you, and if you've got electrical problems, just bring a hammer.

Clint Harris:

Gotcha. Got it. Man, that's powerful. Very powerful. Let me ask you a follow up question. Well, it's a little bit off topic. So I've got a quad, an Ocean Access quadplex that I own with a partner and it's in an LLC. Let's say somebody has a property that's owned inside of an LLC and they're interested in selling that 1031ing, potentially 1031ing into something that may eventually turn, become a primary. When you do a 1031, does that LLC entity have to stay exactly the same? Meaning, if I've got a partner in an LLC, the LLC has to be the same person on the new property, which means that partner and I have to carry forward. Is there a way to decouple that or that's the way it is?

Dave Foster:

Yeah, possibly. It all depends. How's that for a great answer? So, but by the way, before I answer that. Don't forget to make me come back and talk about the two out of five rule after conversion, okay? I totally let that slip on the last one. So the IRS requires that the taxpayer be the same from the old property to the new property. So in your case, you and your partner have an LLC because that's a multi member LLC. It files a tax return. So the LLC is the actual taxpayer. The IRS doesn't know where the deed is. The IRS knows what tax return is reporting that property. So in your case, yeah, the LLC would have to sell and the LLC would have to buy. Unless you dissolved the LLC and distributed the property into each of your names as tenants in common. Now each one of you own a piece of real estate. You can sell yours and go your way. They can sell theirs and go their way. That's what's called a drop and swap. It's not always been in favor of the IRS, but over the last... 10 to 15 years, it's actually becoming more and more favorable to them. And it's one of those things where we discuss with, you know, your accountant the pluses and minuses of that. But that's a great way to decouple when the LLC is the actual taxpayer. Now for probably the maturity of people out there They're the only members of their LLC, and the LLC has chosen to be taxed as a sole proprietor. So let's think about that. What tax return is reporting the activity of the property? It's their personal return, isn't it? So if they sell as the LLC, And buy as themselves. We're not changing the tax return, are we? It's still the same taxpayer. And so that's what's key. That's why these, you can get the benefits of the liability protection and get also the benefits of the 1031 simply by using what's called disregarded entities. So it's wherever, whatever tax return is reporting the activity, that's who has to do it. So yeah, perfectly fine to get rid of that LLC and then go and buy your new property. So let's... Talk about my realtor guy down in St. Pete Beach, who did a 1031 exchange and bought three identical, on the same floor, facing the ocean, condos. After a couple years, he moved into the first one. Now here's the lead head. You see where this is going, don't ya? He lived in it for a few years. Now, here's the new rule since 2008. You have to, when the property has been the product of a 1031 exchange, you have to have lived in it, or I'm sorry, you have to have owned it for five years. You have to have lived in it for two out of the previous five years. And then when you sell, you get to prorate the game between the period you lived in it, That's tax free. The period it was a rental, you pay tax on it, and you also have to recapture depreciation. So my guy rented it for two years, then he moved into it, he lived in it for three. Then he sold it. Did he own it for five years? Yep. Did he live in it for two out of the previous five? Yep, so he got 60% of the game tax free. He stroked a check for 40% of the gated tax. That's still better than sacking groceries or delivering pizzas, right? His retirement job, which included a W 2 portion, basically where he had to pay some tax. His retirement job, making coffee and sitting on the back deck, watching the waves come in. Now, Clint, where do you think he moved? To another, to the condo on

Clint Harris:

the next door. It was that far. He moved about 30 feet.

Dave Foster:

I got to think that his neighbors are going to get pretty tired of this after a while. If he's asking them to help. But the whole idea is he turned a massive gain into three little bits of taxable gain and a whole bunch of tax free gain simply by having run away enough. And being able to do that and that's, this kind of takes us into just philosophically because I know there's a lot of people saying, Dave, that's end of the road stuff. How do I get there? Come on. I got one little rental property. It doesn't have that much gain in it. It's only got, you know, $100,000 of gain. Well, that's probably $20,000 to $25,000 of tax. And if you make 10% on your real estate investments, that one property. It's going to generate, by doing a temporary ROI, it's going to generate around $2,000 a month. For the rest of your life. I don't know about you guys, but that's real money to me. And then you start making that work for you by compounding it and getting the compounding of appreciation, compounding diversification, and those types of things. And all of a sudden at the end of your life, you're living on $100,000 a year of the government's money, not even starting your own. And so we tell people don't worry about it at the start. Just like everything, compounding Builds as it goes, and it may not start out as much, but by keeping it compound, that's what it's built. So, we talk about, you guys ready for a test?

Neil Henderson:

No,

Dave Foster:

let's let's let's play Neil versus Clint. All right, here we go. It's it's the finals right here Madison Square So we're gonna talk about the four D's of 1031 investing Okay, so I'll give you the first one the first D of 1031 investing is Deferred simply because of that compounding effect you want to be able to get some tax that is deferred But you can use So that's where it all starts. All right, who's going to go first?

Neil Henderson:

Me.

Clint Harris:

I'll go first. Oh, you go first.

Neil Henderson:

I beat you to it.

Dave Foster:

All right, Neil. What's the second D of 1931 investing? dispose. Clint, the board's open for you. What do you think?

Clint Harris:

well, I was going to say delay, but that's basically the same thing as defer, but I'll go

Dave Foster:

with delay. All right. I'm actually going to give that to you because the board. And here's why. Because the 1031 exchange lets you move. Anywhere in the country, into any type of real estate, into any numbers of real estate, into any market. So as you're growing your portfolio, you can take advantage of every other opportunity that's there. To sell residential and buy commercial. To sell raw land and buy industrial. To sell single family and buy multifamily. To sell a large asset and purchase many small assets. Wherever you're gonna be. The most money. We talk a lot about holes in the market, and I tell you, I've got, they're actually not on my Christmas card list because I've got a whole lot of people in the Bay Area of San Francisco that kept saying, Dave, I want to sell the Bay and I'm going to go buy in Austin. Austin's so treasury, but I think something's going to happen there. Those people are too busy riding jet skis in the Bahamas. to respond to my emails anymore, aren't they? They found the place that was going to become, but wasn't yet. And that's what the 1031 exchange allows you to do. And along the way, all you're doing is just deferring the tax. All right, so Clint's on the board, Neil, it's your turn. What do you think the third D is?

Neil Henderson:

I have no idea.

Dave Foster:

The board's open for Clint.

Clint Harris:

I'm, I'm going to guess diversify.

Dave Foster:

That's a good word, but it's too many syllables for me. Deferred. Defer again, the reason why is that as you move through your career, you not only want to change types and locations, but your energy level changes, doesn't it? And so, for where you guys live especially, you can go from large numbers, of management heavy assets into fewer numbers where management has less intensity or into something where it might be a syndication that qualifies for 1031 where you're able to invest with your 1031 and not have any management. It might be into vacation rentals that you start to enjoy some yourself as you go through life. And like we just got to discussing It might be into properties that you end up converting into your primary residence. Later in life as you go through. So the Tip 31 doesn't exist for, doesn't just exist for places and types. It invests, it exists to use differently to your advantage as you're going through your real estate life cycle. And that's one thing that we spend a lot of time talking about in the book is how to use it when you're at different levels of investing. Whether you're a rank beginner, or whether you're a 20 or 30 year seasoned pro, there's ways to use it. Alright, so that's the third D. Let's ask Clint, because it's his turn. See if he can sweep the board. Clint, what's the fourth D of 1031 investing? I'm gonna go with defer. Neil, did you see the smile? Are you ready? That's so wrong. Fourth D is actually... Now, I know, right? It's not my favorite topic either. Dodge? Dodge? Ain't no dodge in death. But you can dodge taxation. Because when you die, your heirs inherit the property at what is called a step up in basis. Which means all of that deferred tax over your lifetime disappears with your death. You don't pay it. Your estate doesn't pay it. Your heirs don't pay it. And what an incredible legacy that is to give to your children to be able to start over and do the same thing with no tax hanging over their head. So you simply defer, defer, defer, and then die. And you'll have done a great achievement in your life.

Clint Harris:

That makes a lot of sense. It's like you said that now you're talking about generational wealth, right? This is this is powerful stuff that has potential to affect people that aren't even a twinkle in your grandkids eye yet You know, you're talking about way down the line here Along the way you mentioned something that you made me realize so my wife and I moved We moved three times the first six years of our marriage. Every two years, we did the same thing, right? We were trading up, we closed on one of our properties after we lived there for two years in one day, right? And we were just kind of trading up, trading up, and that allowed us to, when we relocated to Wilmington, to have A nest egg to start buying multifamily Airbnb properties and things of that nature. So, I certainly understand the value of that. I don't think I ever put thought into doing it the other way around and essentially weaponizing that. Using a 1031 exchange to buy a property you're going to end up in. as a primary because it's essentially the way I'm hearing it from you. It's an off ramp for the 1031 exchange, right?

Dave Foster:

That's a great way to

Clint Harris:

That's a lot of, a lot of people are scared of the 1031 because you hear the same phrase over and over. Well, you're just kicking the can down the road. Right? Someday you're kicking the can down the road, but someday you got to pay, you know, essentially, yeah, exactly that you're going to pay the piper the idea that I've always thought was, well, the idea is to get into a property you want to hold long term, whether it's a mobile home park or a multifamily apartment building or syndication self storage that you're going to keep forever and get to the point where it's creating passive income and that tax liability goes away. But really what you're talking about is you do have an off ramp. If you have a little bit of foresight and say, where do I want to live two years from now or five years from now or a year from now? where do I want to live? And do I have funds that are in properties right now that I can use to get there? I love that. It's an off ramp for that money and gets rid of that liability. And you can use it to be in a place where you want to be and living your life. There's another thing that you brought up when we were talking with you probably a month or two ago. You gave a suggestion that was something I hadn't thought about either. Another issue with the 1031 is that you've got to buy a property that's greater value than the one that you sold, right? It's incentive to pushes people farther up the investment ladder. And I was mentioning something about a property that we had to sell, and you gave us a great suggestion that was, you said, don't buy a property, buy two properties. And your suggestion essentially was, if you're buying, let's say you sell a property for a million dollars, your suggestion was, Take part of it, you know, $200,000 and put it, a down payment on another investment property as part of the 1031. Take the other $800,000 and buy an $800,000 investment property and then immediately do a cash out refinance. So you're going to have some equity tied up in it, depending on what your LTV is, but assuming it's 80% on both of those properties in that scenario. Of that million dollars, you've got 20%, you know, $200,000 locked up over here on one investment property that hopefully is cash flowing. You've got $200,000 locked up in another property, or actually $160,000, because it'd be 20% of that. But then you get the other $640,000 back in your pocket that is liquid, that you can turn around. It's another, essentially, off ramp, right? And it also allows you to move, let's say you were that guy in California. Right. And you want to move to Austin, but everything in Austin is a lot less expensive. So it's hard to do a 1031 and essentially trade up because you're going in from, you know, small fish in a big pond to at the time was a big fish in a small pond by breaking that up and not breaking it up and buying as many properties as you can, breaking it up and buying one or two and then the rest, or just one pay cash for it and buy it at the purchase price. Of, you know, you want to be a dollar over what you paid for the other property and just pay cash for it and then do either a simultaneous close or very quickly do some value add force depreciation, refi, pull the money out, and now you're rolling and you're tax free.

Dave Foster:

You know, that, yeah, I mean, well said. Now, let's pour a little gasoline on that, shall we? Because it's little tweaks that make all the difference in the world. So the example of selling a larger asset and breaking that into two purchases. One for cash and one with debt, which lets you do a cash out refinance. That's when you can take the cash out refinance money and you can use that to invest in a syndication that you would like. Because most syndications won't qualify for 1031 treatment. So now you've got cash out refinance money that has no limitations. So you can go into a totally passive investment, but that's just part of it. That other property now has debt on it. Shortly thereafter, in a year or so, you're going to sell that to go buy a short term rental someplace where you would like to vacation. And you're going to do that with second home finance money. Because you can't, the IRS doesn't care. What the source of the funds is, and buying a house with second home financing, the requirements are generally only that the property be 100 miles from where you live, and that you agree to use it at least two weeks a year for personal use. None of that contradicts its use for investment as a 1031 replacement, but when you sell that property and buy the vacation rental with second home money, you're buying it with Lower down so you can again bifurcate that and go buy two properties and second home financing is also usually Cheaper interest as well. So you can go from an investment loan into cheaper interest. So look at that within 12 months You're able to do a 1031 and change and get into two better properties. You were able to cash out refinance and get into a passive syndication. You were able to again move into two more and get advantageous financing for each one of them. 12 months, three properties and a syndication investment. I mean, I don't know how impatient you got to be. That's pretty fast.

Clint Harris:

Yeah, that's unbelievable.

Neil Henderson:

Wow. I'm glad you brought up, I'm glad you brought up the syndication finally, because that's, you know, we've been talking a lot of sort of individual property, individual investment property, sort of active, a little more on the active side so far, and I want to dip our toe into how it's Passive investors can use the 1031 exchange, to invest in syndications, whatever. And it is trickier, you know, the first time I ever heard about a 1031 exchange, I was like, Oh God, you can just 1031 exchange out of one syndication to another. And yeah, well, it's not that simple is what I discovered. So why is it not that simple?

Dave Foster:

Right, so the reason it's not that simple is that by its nature, the 1031 exchange has to be a sale of actual real estate, followed by a purchase of actual real estate. And probably 98% of the syndications out there, what you're buying is not real estate. They're selling to you a membership interest in an entity that owns real estate, not real estate itself. And so that doesn't qualify. But! There's ways we can make it work. And the first one we just talked about, which is use your 1031 to buy something and consolidate as much equity as you can to make the cash out refinance work. That's a beautiful hack to it. There are some syndications, and you just have to search, that will allow you to buy a tenant in common interest in the real estate itself. So that you end up owning part of the real estate, the syndication owns part of the real estate, and then they enfold you into the terms of the proforma of the operation. Now that takes a bit of paperwork on their side. So typically, it's a little more expensive, to get into those. They usually require I've seen anywhere from $500,000 to a $1,000,000 to go into. It's a little prohibitive. But there also is a form of syndication called the Delaware Statutory Trust that qualifies for 1031 treatment. You're buying a membership interest in a trust that owns real estate. So it sounds like that wouldn't work, right? But because the IRS blessed it in 2004, it magically is okay. But that's exactly what you're doing is buying a membership interest in an entity that owns real estate. Now, these are very unsexy investments. You know, a lot of the, most of the syndications out there, you get waterfalls, you get some nice returns. With a DST, everybody receives the same. And because they're large institutional assets, The returns sometimes are not as great, but they do fit this need, and that is that they allow you to go from active to absolute passive management. And depending on what your needs are in terms of return, they'll work perfectly. Now, the last way to get into syndication is to simply bite the bullet and pay some tax if you really, really wanna be there. I almost gag saying that, but it'll work. Remember, whether it's one day or 20 years, as long as you can keep that tax deferred, you're going to generate the compounding effect. When you finally decide to sell it and pay the tax, you've still made a bunch of money off of that tax. And nobody ever went broke paying tax on profits. It just feels like it. So, you can't find anything you want? You don't like the DST route? You want to go into syndications? But if you kept that tax deferred for 10 years prior to that, it was still to your benefit.

Neil Henderson:

Well, I, again, I, I think your, the method that you've mentioned beforehand, which is to buy, buy a property for cash or, you know, as little debt as possible, or buy two properties and one for cash and use the cash out refi to then invest is a, is much more advantageous and flexible.

Dave Foster:

Absolutely. It's funny you, you mentioned how everybody always says you're kicking the can down the road, right? I get, I hear it all the time too. And my follow up question always wants to be, So you don't believe in IRAs, or 401ks, or Roths. Well now I've got those, what's the purpose of those? To defer tax and let the tax run free. So my answer to anybody that says that is, You know, why should I do a 1031? I'm going to have to pay the tax anyways, because it's a resounding, no, you don't, you can defer it as long as you live, you'll be deferred into anything else, you can eliminate it upon death.

Clint Harris:

Yeah. That's a great point. If they're using a vehicle like that for their retirement savings. Essentially, it's the same concept, but at some point in time, they force you to use that and start paying it. The reality is, that's not the case with the strategy you've laid out there.

Dave Foster:

That's right. Yeah, the 1031 actually can go on further.

Clint Harris:

That's huge. Man, I love it.

Neil Henderson:

Alright, I want to shift gears here for just a second. can you explain to us what a reverse exchange is, or have you already done that?

Dave Foster:

Sure. So the statutory order of a 1031 is you have to close your sale before you take title to your new property. That has to, a reverse exchange does not change that order. It just allows you to have control of your property. You know, the perfect property you want to buy, but your old property hasn't sold yet. We form an entity called the Exchange Accommodating Title Owner, and that entity takes title to the new property. And we can hold that for up to 180 days while you're waiting for your old property to sell. So that then you can close the sale of your old property, and you do a regular 1031 exchange, and you buy your new property. From us, we've been holding it for you, and that's how it works. Now, there's a couple bugaboos in this, as you can imagine. First of all, they're very complex, so interpret that as expensive. They'll add $8,000 to $15,000 to the price of a regular exchange. And a regular exchange is probably under $1,000, so they're pretty expensive. Secondly, and probably more importantly, the financing component. Because you have to provide the financing. Now, if you've got cash... No problem. But if you're having to borrow money to purchase the property, that lender is going to be asked to lend the money, not to you, but to us. And the entity that we set up is an unseasoned LLC with no history. So they're being asked to loan to an unseasoned LLC. Secured by you, but you're not a member of the LLC. So it's squirrelly enough. that a conventional lender cannot do. It has to be a portfolio lender, like a local community bank that keeps their loans in portfolio, or a private lender, a relative, or like I said, your own cash resources. But these could be used if it's just a timing issue. They can also be used if you, say, sold a property for $500k and you found the perfect property you wanted to buy for $300k, but it needed $200,000 of improvements. We can take title to that and hold it and use your exchange account so that you can improve the property so that within that 180 day period, Now that property is worth $500,000 to $300,000 cost plus $200,000 in improvements. And so your sale of $500,000 buys a property for $500,000, but what's that property really worth? You got it for $300,000 and with the $200k, $600,000 or $700,000 or $800,000 immediately. That's where that's it.

Clint Harris:

Yeah. In that situation. So let's say you, you did a 1031 exchange. You sell a property for half a million. You buy one for $300k, the $200,000 in forced depreciation that you're putting into that property. Are they looking at your invoices of the money that you spent or are they looking at the forced appreciation that comes when you get an appraisal on the back end?

Dave Foster:

It'll be the invoices. If you're ever asked, it's not something that's reported, but we can, you can't. Make phantom appreciation, although you get it, so it's going to be the actual cost of the property, plus the actual cost of the improvements, and that's what you get to count towards your 231.

Clint Harris:

Let me ask a question in this situation. So the scenario is, I've got an investment property that I'm selling. I've found the other property that's absolutely perfect, that I'm going to buy it, I'm going to use it as an investment property for a year or two, but probably end up living there as my primary in the long run. So I'm trying to off ramp some of that cash. So because of that... I care a lot about the property that I'm picking because eventually I want to live there too, right? So I find the perfect property before my other investment property has sold. So we go ahead and we go under contract with it. And I, my job is we've got to close that, but because we obviously don't have proceeds from the sale of the other property. I've got to come up with the cash, right? So it's, it's a 401k loan or it's personal cash. It's private money, hard money, family money. Chances are it's probably expensive money, but this is the property that I want. I'm willing, I've got $100,000 in tax liability from this 1031 exchange. So not only am I willing to pay top dollar for this house that I want, because it's for me, it's also because I had 1031 money coming in. I'm willing to pay the extra 8 to 10, $15,000 for the reverse 1031. To get into the property. Let's say that's the situation. So I'm under contract. I get the property. I'm closing the property. And then does this shut the whole thing down? What if the property that I was going to sell for $500,000 and the house that I bought for $500,000, all of a sudden, or whatever it may be, the property that I am selling goes over ask price, and people bid it up to 550, and now all of a sudden, I've already closed on a property, my intention was to do a reverse 1031 on a property that I bought for 500, and I sold my other one for 550, do I have 180 days to do $51,000 worth of renovations to that property, or is the whole thing thrown out?

Dave Foster:

Because remember, you don't own the property. We own the property, so all of a sudden a swimming pool comes into play, doesn't it?

Clint Harris:

Ha, ha, ha. Yep, it sure does.

Dave Foster:

Now, check this out. Let's use the example that we did before, where you're selling for five, and let's say it was all cash. And you find that perfect retirement property for 300, and it needs a second story and a swimming pool and all kinds of fun stuff. If that's going to close first, so we take title 30 days later, your old property closes. Now remember, we borrowed $300,000 from you. You've got exchange money of $500,000 sitting in your account. So we're going to borrow $200,000 more from you from your exchange account. And that's going to improve the property. So now we've got $500,000 into that property and we owe you $500,000. You have $500,000. sitting in an exchange account. So you buy that property from us and we pay off you and only use your 1031 proceeds to go forward. You can use your 1031 account for the purchase. And the improvements. This is, we're getting into the deep cuts here. Yeah, we are.

Clint Harris:

These are veteran moves.

Neil Henderson:

Yeah, and I also, the thought that was going through my head before we got into this was that, oh, can I, you know, because you're always dealing with the time window and the timing is always the problem with 1031, and I was like, well, what if you You know what, if you were to buy a property for cash and then sell your thing and your 10 31, 10 31 into it, but that's essentially what you're doing, but you're just doing it through, you're, you can't do that. The IRS says, no, you already own it. You can't 10 31 into something you already own. But you're doing, you're acting as the intermediary for the property to hold the property. I don't own it. You own it. Uh, and I'm gonna

Dave Foster:

Because you manage it. Yeah. And I'm the world's worst manager, so you better make sure that the finishes are exactly what you want. Yeah, because I'm not flying down the jet. Yeah,

Clint Harris:

but what I'm hearing here is, like I said, I've done 1031 exchange in the past. It was very bare bones and vanilla. But what I would say is, if you're doing it, if you're not doing it, you should be. And if you are, there is certainly nuance when it comes to the timeline and identifying properties. But I think there's a whole nother level of nuance that we've uncovered here that you have potential to really do some pretty big significant things that have massive value shifts over time. Um, I would say what I'm hearing is you definitely need to read the book and understand it. And the only thing better than that is working with the person who wrote the book. I think that who you choose for your 1031 is, like I said, I've worked with somebody else in the past with this. I've talked to several different people. Sponsors that do this, but now we're, we're getting down in, these are veteran moves, right? We're getting into the deep stuff. So at this point in time, I think that choosing to do it is probably just as important as to who you choose to do it with, because it has significant implications.

Dave Foster:

You know, what's really interesting is that when I was writing the book, I thought I was just writing a book on 1031 exchanges, you know, how to do them. And ultimately at their bottom, the 1031 is a paperwork process. That's all it is. Anybody can hang out their shingle, get a fancy website, do this, do it. But I thought I was writing a book on how to do 1031 exchanges. As I got to the end of it, I realized that's not what I'd written. I wrote a book on how to achieve your dreams, whatever those are, using the 1031 exchange. That's one of the vehicles to get you there. And that's where there's a distinction. Is, know it. It's almost like the t shirt I saw at Key West, where the front said, you know, a, a good lawyer knows the law. The back of the shirt said, a great lawyer knows the judge. That's what this is. It's easy to know the 1031 law, but having lived in it, practiced it, used it for a bunch of years, there's that nuance that can be the difference. So, hopefully that's what I get. Actually, the back page of the book says, So I decided to start with this phrase. It starts with a dream, and then you find, you make a dream, we'll make the plan, the 1031 will work for you.

Neil Henderson:

I just wrote down here, you don't want a 1031 paper hanger, you want a 1031 strategist.

Dave Foster:

Sometimes I feel like a one armed paper hanger, but I think that's exactly right. Strategy is really what's key, to maximize the benefit for me.

Neil Henderson:

If you want to do a vanilla 1031, Sure, go to Dave, but, you can also probably get him to talk you into something more advanced that'll make you more money.

Dave Foster:

Hey, we love vanilla as well.

Neil Henderson:

Listen, I, do you have any more questions, Clint?

Clint Harris:

I don't think so. This is, it's fantastic. This is my favorite interview that we've done so far, and I knew it would be up in every interview. Not the ones with you, Neil. No, we were, I was really looking forward to this and I was really upset we had the technical issues the first time around, but frankly, it gave me more time to just think about how this was going to go and what we're going to uncover. I knew there was going to be a lot that I learned that I didn't know. I didn't know it was going to be this much. So I just appreciate your willingness to share, but no, I don't think anything else is needed here. I'm looking forward to going back and listening to this, honestly.

Neil Henderson:

All right, Dave, you got the book. Lifetime Tax Free Wealth, The Real Estate Investor's Guide to 1031 Exchange. If somebody wants to find out more about you and reach out to you, what would be the best way for them to do that?

Dave Foster:

Come see us at the1031investor.com We got a 32 part YouTube series. If you'd rather watch than read, calculators, access to us, wherever, whatever you need.

Neil Henderson:

Well, it's been great talking to you, Dave. Really enjoyed this.

Dave Foster:

My pleasure. Thanks for having me.

Neil Henderson:

Thank you so much for listening and watching the truly passive income podcast. If you liked the show, if you think it would be useful for someone else, the greatest compliment that you could give us would be to share the episode, leave a comment down below. Or leave us an honest review. If you have any questions, don't hesitate to let us know down below and remember with truly passive income comes freedom of time, place and the freedom to pursue your higher purpose.