1031 Meeting and Client Expectations Agenda and Talking Points

Objectives:

For DFY and the AE to clearly outline the processes and basics of a 1031 exchange, and clearly help clients understand options on how to utilize 1031 exchanges.

AE Responsibilities:

Our job is to educate and help clients understand options. We do not give advice – investment, tax, or legal. We can help clients understand potential options and let them decide. As we provide basic 1031 information and options, we place the client in a position to decide for themselves as to which options they will choose. Ownership of those options/decisions will be the clients.

1031 Agenda
LLC’s and Property Ownership

AE Responsibilities with 1031 Exchanges and Property Ownership

  • Help clients understand the same taxpayer rule and how ownership of an investment property impacts their decision to sell and utilize a 1031 exchange.

Basic 1031 Requirement – Same Taxpayer Rule/Entity

  • Under 1031 Exchanges, the same taxpayer rule will apply, meaning whatever name a property is sold in, the properties being purchased or exchanged into will need to be purchased the same name as the relinquished property.
  • If the property is owned and sold in the name of an LLC, then they will need to purchase property in the name of the LLC to satisfy IRS requirements.

Client Options for Same Taxpayer Rule

  • Sell in the name of the LLC and avoid changing ownership.
    • Lending can do a loan, in the name of the individual using 1031 funds which came from/was sold in the name of an LLC. This will lead to the exchange/sale in the name of LLC and the purchase of property in the name of the individual which will violate the same taxpayer rule.
  • Change ownership before the sale into the name(s) of the individual and then proceed with the sale. (Sometimes called a swap and drop. May be looked down upon by the IRS). If the client chooses to change ownership from an LLC to their individual name, the sooner the better.

Lending

  • Lending/traditional mortgages will only lend to an individual, not to an LLC.
    Lending can do a mortgage using 1031 exchange funds which are held in and LLC, but the loan will be in the name of the individual and thus create issues with the same taxpayer rule.
Using 1031 Funds for Rehab

AE Responsibilities with explaining the use of exchange funds for rehab

  • For the types of exchange which the majority of DFY clients utilize, the IRS states you cannot use 1031 funds to complete rehab/improvements on the properties being purchased or exchanged into for the purpose of the exchange.

Client Options for Rehab

  • Pay for rehab out of their personal funds.
  • Pull funds from the exchange to pay for rehab outside of the exchange (may have capital gain tax on the portion).
  • The client can instruct the exchange company and title company to pay the property management company, ‘up front property management fee’ from the exchange funds. This is usually completed by requesting an invoice from the property management company. Other real estate investors have done this and used this fee to help cover the cost of property management and/or rehab.
    • Please Note – Using option two may have consequences if there were ever an IRS audit.
    • An exchange attorney has stated that approximately 1 in 2000 small exchanges get audited by the IRS. .05%
    • If there was an audit, a few things, but not limited to these two could happen:
    • They are taxed on the amount of money used for rehab from the exchange.
    • The exchange could be disqualified and taxed on the gain.
Allocation of 1031 Funds

AE Responsibilities with helping clients with allocation of 1031 funds

  • The AE is responsible for helping clients know and understand the following:
    • The client is responsible for instructing the exchange company and lending as to how much actual dollars to apply from the 1031 exchange funds to each property.
    • They are responsible for letting the exchange company and lending know if they are going to use all their exchange funds or keep some for personal use.
    • Set expectations that lending is not able to utilize 100% of exchange funds but can be close to using all funds usually within $700-1500.

Client Options for using 100% or Close to Using All 1031 Exchange Funds

  • Lending will not be able to utilize 100% of exchange funds as listed above. Clients have two options the AE will need to help us know:
    • No out of pocket – instruct lending to do their best to utilize most of the exchange fund – knowing that there will be a small amount left in the exchange – $500-1500.
    • Out of Pocket – if the client would like 100% of the exchange funds, they must be willing to add to or come out of pocket for some additional funds to help settle the loan.