WEBVTT 00:00:00.000 --> 00:00:03.200 Let's start with a headache. A very specific, 00:00:03.419 --> 00:00:06.099 very expensive headache. I want you to picture 00:00:06.099 --> 00:00:09.759 someone. Let's call her Sarah. Sarah is smart. 00:00:10.640 --> 00:00:14.300 Back in, say, 2010, right when the market was 00:00:14.300 --> 00:00:17.059 on the floor, she scraped together a down payment 00:00:17.059 --> 00:00:20.539 and bought a duplex. Good timing. In Austin, 00:00:20.719 --> 00:00:22.579 Texas. Oh, yeah. Great timing. Buying at the 00:00:22.579 --> 00:00:25.019 bottom. I mean, that is the dream. Absolutely. 00:00:25.039 --> 00:00:27.280 And she's been a good landlord. You know, she 00:00:27.280 --> 00:00:29.280 fixed the toilets. She dealt with the tenants, 00:00:29.440 --> 00:00:32.880 paid the mortgage. And now, almost 15 years later, 00:00:32.920 --> 00:00:36.159 that duplex has like quadrupled in value. She 00:00:36.159 --> 00:00:38.219 is sitting on a mountain of equity. She wants 00:00:38.219 --> 00:00:40.759 to sell it, maybe buy a small apartment complex, 00:00:40.939 --> 00:00:42.960 you know, level up her game. Makes sense. She 00:00:42.960 --> 00:00:44.960 feels like a genius. Until she calls her accountant. 00:00:45.240 --> 00:00:47.880 Exactly. She calls her CPA all excited and says, 00:00:47.979 --> 00:00:49.500 I'm going to sell. for a million dollars. And 00:00:49.500 --> 00:00:51.520 the CPA goes click clack on the calculator and 00:00:51.520 --> 00:00:54.979 says, great, Sarah, just be prepared to write 00:00:54.979 --> 00:00:56.920 a check to the government for about 150 grand, 00:00:57.100 --> 00:00:59.619 maybe more. Oof. The silent partner emerges. 00:00:59.859 --> 00:01:03.240 And Sarah is floored. She's thinking, wait, that's 00:01:03.240 --> 00:01:05.560 my money. I took the risk. I fixed the roof. 00:01:05.939 --> 00:01:08.379 But the government says, congrats on the win. 00:01:08.459 --> 00:01:12.280 We'll take our cut now. It feels like a penalty 00:01:12.280 --> 00:01:14.769 for success. It feels like friction. It does. 00:01:14.989 --> 00:01:17.569 And that friction is exactly why so many investors 00:01:17.569 --> 00:01:20.709 get stuck. They call it lock -in. You have this 00:01:20.709 --> 00:01:23.989 asset. It's done its job. It's appreciated. But 00:01:23.989 --> 00:01:26.829 you are terrified to sell it because the transaction 00:01:26.829 --> 00:01:29.790 cost, specifically the capital gains tax and 00:01:29.790 --> 00:01:33.870 depreciation recapture, it just decimates your 00:01:33.870 --> 00:01:36.250 buying power. Right. You literally cannot afford 00:01:36.250 --> 00:01:38.469 to sell and buy the next thing because you lose 00:01:38.469 --> 00:01:40.519 too much of your stack in the transfer. But what 00:01:40.519 --> 00:01:42.560 if you didn't have to? What if Sarah could sell 00:01:42.560 --> 00:01:44.459 that duplex, take the full million dollars and 00:01:44.459 --> 00:01:46.739 roll it into that apartment complex without paying 00:01:46.739 --> 00:01:49.599 Uncle Sam a single dime? I'm not talking about 00:01:49.599 --> 00:01:52.599 evading taxes, you know, briefcases of cash in 00:01:52.599 --> 00:01:54.900 the Caymans or anything. I'm talking about legally 00:01:54.900 --> 00:01:56.939 pausing the bill. Then you were talking about 00:01:56.939 --> 00:01:59.680 Section 131 of the Internal Revenue Code. The 00:01:59.680 --> 00:02:01.379 wealth shortcut. That's what they call it. Yeah. 00:02:01.500 --> 00:02:04.500 That is what we are unpacking today. The 1031 00:02:04.500 --> 00:02:08.280 exchange. And look. I know tax code sounds like 00:02:08.280 --> 00:02:10.719 the cure for insomnia. It usually is. Yeah. But 00:02:10.719 --> 00:02:13.800 this isn't a lecture on filing forms. This is 00:02:13.800 --> 00:02:17.310 a deep dive into. Maybe the single most powerful 00:02:17.310 --> 00:02:20.189 wealth compounding tool in the United States. 00:02:20.629 --> 00:02:22.669 We are going to talk about how the richest real 00:02:22.669 --> 00:02:24.849 estate moguls play a different game than the 00:02:24.849 --> 00:02:26.870 rest of us. It is a different game. It's a game 00:02:26.870 --> 00:02:29.289 of velocity. It's about keeping your capital 00:02:29.289 --> 00:02:32.189 moving and growing without stopping to pay a 00:02:32.189 --> 00:02:34.530 toll every few years. But I have to be the skeptic 00:02:34.530 --> 00:02:37.250 here for a second. Please do. The IRS isn't exactly 00:02:37.250 --> 00:02:39.490 known for its generosity. So if they're letting 00:02:39.490 --> 00:02:41.530 Sarah keep her money, there has to be a catch. 00:02:41.789 --> 00:02:44.129 Is this actually a gift or is it just a golden 00:02:44.129 --> 00:02:45.969 pair of handcuffs that... keeps you stuck in 00:02:45.969 --> 00:02:48.490 the real estate market forever. That is the right 00:02:48.490 --> 00:02:51.090 question to ask. And no, it's not a gift. It's 00:02:51.090 --> 00:02:52.750 a trade -off. You get to keep your money working 00:02:52.750 --> 00:02:55.629 for you. But in exchange, you have to follow 00:02:55.629 --> 00:02:59.009 a set of rules so rigid that one wrong step, 00:02:59.250 --> 00:03:01.969 I mean, literally one day late or $1 out of place, 00:03:02.050 --> 00:03:03.849 and the whole thing just blows up. So today, 00:03:04.030 --> 00:03:06.969 we are going to map out that minefield. We're 00:03:06.969 --> 00:03:08.830 going to walk through the death zone of deadlines, 00:03:08.990 --> 00:03:11.979 the trap of something called boot. Which is a 00:03:11.979 --> 00:03:13.960 hilarious term. It is a hilarious term we will 00:03:13.960 --> 00:03:16.680 get to. And the myths about swapping your vacation 00:03:16.680 --> 00:03:19.379 home. We'll also talk about the tired landlord 00:03:19.379 --> 00:03:21.599 who wants out of the toilet fixing business but 00:03:21.599 --> 00:03:23.840 doesn't want to pay the taxes. Because there 00:03:23.840 --> 00:03:26.139 are solutions for them too. Okay, let's start 00:03:26.139 --> 00:03:28.900 at the foundation. What exactly is this thing? 00:03:29.020 --> 00:03:32.280 When we say Section 131, what are we actually 00:03:32.280 --> 00:03:35.509 defining? At its most basic level... A Section 00:03:35.509 --> 00:03:38.310 1031 exchange or, you know, a like -kind exchange 00:03:38.310 --> 00:03:41.610 allows an investor to sell a property held for 00:03:41.610 --> 00:03:44.849 business or investment and reinvest the proceeds 00:03:44.849 --> 00:03:47.770 into a new property of like -kind. And by doing 00:03:47.770 --> 00:03:50.030 that, they defer the capital gains tax. I want 00:03:50.030 --> 00:03:52.069 to stop you on one word there. Defer. Yes. Because 00:03:52.069 --> 00:03:53.830 people hear tax -free exchange and they think 00:03:53.830 --> 00:03:56.610 of the tax just poof, vanishes. It definitely 00:03:56.610 --> 00:03:59.360 does not vanish. Think of it like an interest 00:03:59.360 --> 00:04:01.360 -free loan from the government. Normally, when 00:04:01.360 --> 00:04:04.719 you sell, you know the tax. With a 1031, the 00:04:04.719 --> 00:04:08.159 IRS says, okay, keep that tax money, use it to 00:04:08.159 --> 00:04:11.620 buy the next building, but... We are keeping 00:04:11.620 --> 00:04:14.219 a tab. We know you owe us. You're just kicking 00:04:14.219 --> 00:04:16.459 the can down the road. You are kicking the can 00:04:16.459 --> 00:04:18.500 down the road. You can kick that can for a really 00:04:18.500 --> 00:04:20.699 long time. You can kick it for decades. You could 00:04:20.699 --> 00:04:23.879 swap from property A to property B, hold B for 00:04:23.879 --> 00:04:26.759 10 years, swap to property C, and you just keep 00:04:26.759 --> 00:04:29.019 rolling that tax bill forward, never actually 00:04:29.019 --> 00:04:31.459 paying it. And as we'll see later, there is a 00:04:31.459 --> 00:04:33.500 very specific way to make that bill disappear 00:04:33.500 --> 00:04:37.040 entirely, but that involves... Well, dying. The 00:04:37.040 --> 00:04:39.139 ultimate deadline. Yes. OK, so the concept is 00:04:39.139 --> 00:04:41.480 swapping. But I assume I can't just call up a 00:04:41.480 --> 00:04:43.560 buddy who has a warehouse and say, hey, I'll 00:04:43.560 --> 00:04:45.579 trade you my duplex for your warehouse. And we 00:04:45.579 --> 00:04:48.720 just like swap keys. You actually could. I mean, 00:04:48.720 --> 00:04:50.480 that is how the law was originally written, a 00:04:50.480 --> 00:04:53.060 simultaneous swap. But how often does that really 00:04:53.060 --> 00:04:55.860 happen? It's almost impossible to find two people 00:04:55.860 --> 00:04:58.399 who want each other's specific properties at 00:04:58.399 --> 00:05:01.019 the exact same time with the exact same values. 00:05:01.160 --> 00:05:04.009 So how does it work in the real world then? Sarah 00:05:04.009 --> 00:05:07.370 sells her duplex to some guy, Bob. Bob doesn't 00:05:07.370 --> 00:05:10.410 have a building to trade. He just has cash. This 00:05:10.410 --> 00:05:12.410 is where the modern delayed exchange comes in. 00:05:12.470 --> 00:05:14.949 And this is actually a fascinating bit of legal 00:05:14.949 --> 00:05:17.430 history. It wasn't always allowed. It took a 00:05:17.430 --> 00:05:20.129 guy named T .J. Starker to fight the government 00:05:20.129 --> 00:05:22.550 to make this happen. Starker. Right. I hear people 00:05:22.550 --> 00:05:24.550 call these Starker exchanges. So who was he? 00:05:24.910 --> 00:05:27.509 TJ Starker was a timber investor in Oregon back 00:05:27.509 --> 00:05:30.509 in the 60s. He made a deal with a big timber 00:05:30.509 --> 00:05:32.930 corporation. He gave them his land. I mean, premium 00:05:32.930 --> 00:05:35.490 timberland. OK. But they didn't have the land 00:05:35.490 --> 00:05:38.350 he wanted in return right at that moment. So 00:05:38.350 --> 00:05:40.149 they basically gave him an IOU. They said, we 00:05:40.149 --> 00:05:42.449 will die you suitable replacement property over 00:05:42.449 --> 00:05:44.430 the next few years until we match the value. 00:05:44.569 --> 00:05:47.009 So he transferred his title, but he didn't get 00:05:47.009 --> 00:05:49.910 cash. He got a credit. Correct. A credit on their 00:05:49.910 --> 00:05:52.519 books. And the IRS looked at this and went ballistic. 00:05:52.759 --> 00:05:55.519 He said, no, no, no. You sold your land. You 00:05:55.519 --> 00:05:58.379 accepted a promise to pay. That is a sale. You 00:05:58.379 --> 00:06:01.100 owe us the tax right now. And Starker sued them. 00:06:01.220 --> 00:06:03.500 He fought them all the way to the Ninth Circuit 00:06:03.500 --> 00:06:07.279 Court of Appeals. And in 1979, the court ruled 00:06:07.279 --> 00:06:10.420 in his favor. They said, essentially, that as 00:06:10.420 --> 00:06:12.759 long as he didn't touch the cash, the intent 00:06:12.759 --> 00:06:15.399 was an exchange, even if there was a delay. Wow. 00:06:15.529 --> 00:06:18.649 That case, Starker v. United States, it revolutionized 00:06:18.649 --> 00:06:20.689 real estate. It created the industry we have 00:06:20.689 --> 00:06:23.209 today. So thanks to Mr. Starker, Sarah doesn't 00:06:23.209 --> 00:06:25.670 need a simultaneous swap. She can sell her duplex 00:06:25.670 --> 00:06:27.550 on Monday, put the money in a special account, 00:06:27.709 --> 00:06:29.730 and buy her new apartment complex months later. 00:06:29.990 --> 00:06:33.329 Yes. But, and this is a massive but, after the 00:06:33.329 --> 00:06:36.069 sugar case, the IRS said, fine, you can delay, 00:06:36.310 --> 00:06:38.730 but we are not giving you forever. They imposed 00:06:38.730 --> 00:06:41.490 strictly rigid timelines. Okay, let's get into 00:06:41.490 --> 00:06:44.509 the rules. The first hurdle is this concept of 00:06:44.509 --> 00:06:47.430 like -kind. This feels like the gatekeeper. You 00:06:47.430 --> 00:06:48.889 know, if the properties aren't like -kind, you 00:06:48.889 --> 00:06:50.769 can't even play the game. But what does that 00:06:50.769 --> 00:06:53.730 actually mean? If Sarah sells a residential duplex, 00:06:53.930 --> 00:06:56.149 does she have to buy another residential duplex? 00:06:56.509 --> 00:06:59.310 This is the single biggest misconception I see. 00:06:59.490 --> 00:07:01.649 People stress out thinking they have to match 00:07:01.649 --> 00:07:04.430 the asset exactly. They think, I sold a condo, 00:07:04.449 --> 00:07:07.970 I must buy a condo. Right. Or, I sold a warehouse, 00:07:08.189 --> 00:07:10.589 I need another industrial building. Totally wrong. 00:07:11.149 --> 00:07:13.930 For real estate, the definition of like -kind 00:07:13.930 --> 00:07:16.990 is incredibly broad. The code says properties 00:07:16.990 --> 00:07:19.949 must be of the same nature or character, but 00:07:19.949 --> 00:07:22.509 they do not have to be of the same grade or quality. 00:07:22.750 --> 00:07:25.410 Unpack that for me. Nature versus grade. So in 00:07:25.410 --> 00:07:28.870 the eyes of the IRS, dirt is dirt. A plot of 00:07:28.870 --> 00:07:31.290 raw, undeveloped land in Nevada is like -kind 00:07:31.290 --> 00:07:34.209 to a skyscraper in Manhattan. Seriously? Yes. 00:07:34.329 --> 00:07:37.269 A strip mall is like -kind to a dairy farm. A 00:07:37.269 --> 00:07:39.230 rental house is like kind to a doctor's office. 00:07:39.449 --> 00:07:41.970 They are all considered real property held for 00:07:41.970 --> 00:07:45.230 investment. That is wild flexibility. So Sarah 00:07:45.230 --> 00:07:47.069 isn't stuck in residential rentals. She could 00:07:47.069 --> 00:07:48.889 sell the duplex and buy, I don't know, a gas 00:07:48.889 --> 00:07:50.990 station. If she buys the land in the building, 00:07:51.110 --> 00:07:54.069 yes, absolutely. She could pivot her entire portfolio. 00:07:54.310 --> 00:07:56.629 She could move from high maintenance residential 00:07:56.629 --> 00:08:00.360 rentals to... you know, commercial industrial 00:08:00.360 --> 00:08:03.120 warehouses. She can move from a cold climate 00:08:03.120 --> 00:08:06.680 to a warm one. Speaking of moving, are there 00:08:06.680 --> 00:08:09.740 geographical limits? Can she sell the Austin 00:08:09.740 --> 00:08:12.439 duplex and buy a villa in Tuscany? She would 00:08:12.439 --> 00:08:15.500 love that, I'm sure. But no, the code is very 00:08:15.500 --> 00:08:18.459 specific here. Real property located within the 00:08:18.459 --> 00:08:21.279 United States is not like kinds to property located 00:08:21.279 --> 00:08:23.899 outside the United States. So it's domestic only? 00:08:24.160 --> 00:08:27.000 Generally, yeah. The 50 states and D .C., there 00:08:27.000 --> 00:08:28.800 are some nuances with the U .S. Virgin Islands 00:08:28.800 --> 00:08:31.579 and Guam, but for the most part, you cannot cross 00:08:31.579 --> 00:08:33.820 international borders. You sell in the U .S., 00:08:33.820 --> 00:08:35.820 you buy in the U .S. Okay. So what about the 00:08:35.820 --> 00:08:37.919 stuff inside the building? Let's say Sarah is 00:08:37.919 --> 00:08:40.399 selling a furnished vacation rental. She's selling 00:08:40.399 --> 00:08:43.100 the house, sure, but she's also selling the sofas, 00:08:43.100 --> 00:08:45.340 the beds, the appliances. Does that count? Ah, 00:08:45.440 --> 00:08:47.659 this brings us to a major change in the law. 00:08:48.009 --> 00:08:50.590 We have to talk about the Tax Cuts and Jobs Act 00:08:50.590 --> 00:08:55.029 of 2017. TCJA. Before 2017, you could do a 1031 00:08:55.029 --> 00:08:57.669 exchange on personal property. Personal property? 00:08:57.850 --> 00:09:00.809 Like heady machinery. Kelty Airlines could swap 00:09:00.809 --> 00:09:04.049 an old Boeing 747 for a new one and defer the 00:09:04.049 --> 00:09:06.450 tax. A construction company could swap a fleet 00:09:06.450 --> 00:09:09.850 of bulldozers. You could even do it with thoroughbred 00:09:09.850 --> 00:09:12.830 racehorses or patents. Wait, really? You could 00:09:12.830 --> 00:09:15.610 1031 exchange a racehorse. You could, but the 00:09:15.610 --> 00:09:19.370 2017 act killed all of that. As of January 1st, 00:09:19.370 --> 00:09:22.950 2018, Section 131 is restricted strictly to real 00:09:22.950 --> 00:09:25.429 property, real estate only. So if you own a construction 00:09:25.429 --> 00:09:27.870 company today and you trade in your old excavator 00:09:27.870 --> 00:09:30.230 for a new one, that's a taxable event. Correct. 00:09:30.409 --> 00:09:32.529 No more deferral for equipment. And that applies 00:09:32.529 --> 00:09:34.710 to the furniture in Sarah's rental, too. The 00:09:34.710 --> 00:09:37.769 house qualifies. The used sofa inside it. Technically, 00:09:37.789 --> 00:09:39.990 that is personal property. It does not qualify. 00:09:40.190 --> 00:09:42.210 That feels like a trap. I mean, if I sell a hotel, 00:09:42.450 --> 00:09:44.169 half the value is the furniture and fixtures. 00:09:44.269 --> 00:09:46.309 It creates a complication for sure. We'll talk 00:09:46.309 --> 00:09:48.129 about how to handle that later. But strictly 00:09:48.129 --> 00:09:50.509 speaking, personal property is out. Oh, and here's 00:09:50.509 --> 00:09:52.769 a fun fact about the old rules. Just to show 00:09:52.769 --> 00:09:55.840 you how granular the IRS gets. Oh. when you could 00:09:55.840 --> 00:10:00.379 exchange animals. Section 1031E explicitly stated 00:10:00.379 --> 00:10:03.519 that livestock of different sexes are not like 00:10:03.519 --> 00:10:07.220 kind. You are joking. I am not. You could not 00:10:07.220 --> 00:10:10.279 swap a bull for a cow. So the IRS was basically 00:10:10.279 --> 00:10:12.480 running a gender reveal party on cattle farms. 00:10:12.659 --> 00:10:15.200 Sorry, it's a boy. Pay your taxes. Essentially, 00:10:15.320 --> 00:10:18.700 yes. I think their logic was that they serve 00:10:18.700 --> 00:10:20.700 different functions in the business. Breeding 00:10:20.700 --> 00:10:22.940 versus dairy, for example. It's moot now because 00:10:22.940 --> 00:10:24.639 livestock isn't real estate, but it just shows 00:10:24.639 --> 00:10:27.690 you Do not assume logic applies here. Only the 00:10:27.690 --> 00:10:30.389 code applies. Only the code. Okay, noted. Don't 00:10:30.389 --> 00:10:32.669 swap cows. And I assume stocks and crypto are 00:10:32.669 --> 00:10:35.870 out too. explicitly out. You cannot swap Apple 00:10:35.870 --> 00:10:38.350 stock for Microsoft stock. You cannot swap Bitcoin 00:10:38.350 --> 00:10:41.529 for Ethereum. Section 1031 is the last great 00:10:41.529 --> 00:10:44.250 tax shelter, and it is reserved almost exclusively 00:10:44.250 --> 00:10:46.690 for real estate investors. Okay, let's go back 00:10:46.690 --> 00:10:49.610 to Sarah. She knows she can sell her duplex. 00:10:49.649 --> 00:10:52.070 She knows she wants an apartment complex. She 00:10:52.070 --> 00:10:54.690 knows she can't catch the cash. Walk us through 00:10:54.690 --> 00:10:57.610 the death zone, the timeline. This is where most 00:10:57.610 --> 00:11:01.190 people fail. The moment Sarah closes the sale 00:11:01.190 --> 00:11:03.870 of her duplex, the minute that deed is recorded, 00:11:04.129 --> 00:11:06.830 a stopwatch starts. Yeah. And this stopwatch 00:11:06.830 --> 00:11:10.750 has no pause button. Day one. Day one. She now 00:11:10.750 --> 00:11:13.769 has two deadlines running concurrently. The first 00:11:13.769 --> 00:11:16.769 one is the 45 -day identification period. 45 00:11:16.769 --> 00:11:18.870 days to buy the new places? No, no, not to buy. 00:11:18.970 --> 00:11:22.870 45 days to simply tell the IRS via her intermediary 00:11:22.870 --> 00:11:25.409 what she might buy. She has to identify potential 00:11:25.409 --> 00:11:28.309 replacement properties in writing. 45 days seems 00:11:28.309 --> 00:11:30.850 like plenty of time. You would think so. But 00:11:30.850 --> 00:11:33.309 let's play this out. Sarah sells on May 1st. 00:11:33.370 --> 00:11:35.570 She spends the first week just celebrating and 00:11:35.570 --> 00:11:37.769 waiting for funds to clear. Okay, now it's May 00:11:37.769 --> 00:11:39.990 8th. She calls a broker. I find me an apartment 00:11:39.990 --> 00:11:41.990 complex. Broker takes a week to send her some 00:11:41.990 --> 00:11:44.250 listings. Now it's May 15th. She tours three 00:11:44.250 --> 00:11:47.210 of them. Tour garbage. One is good. She makes 00:11:47.210 --> 00:11:49.250 an offer. Okay, so she's making progress. But 00:11:49.250 --> 00:11:51.230 the seller of that good property is traveling. 00:11:51.659 --> 00:11:54.639 They don't respond for four days. Then they counteroffer. 00:11:54.679 --> 00:11:57.460 Sarah counters back. Suddenly it's June. She's 00:11:57.460 --> 00:12:00.320 30 days in. If this deal falls apart during inspection, 00:12:00.659 --> 00:12:03.559 she has 15 days left to find a backup. And if 00:12:03.559 --> 00:12:06.440 she doesn't? If midnight on the 45th day strikes 00:12:06.440 --> 00:12:08.799 and she hasn't locked in a list of properties, 00:12:09.039 --> 00:12:12.980 the exchange is dead. Game over. Pay the taxes. 00:12:13.220 --> 00:12:15.000 Can she get an extension? What if she gets the 00:12:15.000 --> 00:12:18.389 flu? What if the 45th day is a Sunday? No. No 00:12:18.389 --> 00:12:21.470 and no. The IRS is brutal. If the deadline falls 00:12:21.470 --> 00:12:23.870 on a Sunday, you better act by Friday. If you 00:12:23.870 --> 00:12:27.350 get sick, too bad. The only exception is a presidentially 00:12:27.350 --> 00:12:29.549 declared disaster like a hurricane or massive 00:12:29.549 --> 00:12:32.250 wildfire that literally destroys the area. That 00:12:32.250 --> 00:12:35.110 is just high pressure. So she has to submit this 00:12:35.110 --> 00:12:37.450 list. Can she just list every property for sale 00:12:37.450 --> 00:12:40.070 in Austin just to be safe? No, you can't just 00:12:40.070 --> 00:12:41.830 copy the phone book. There are three specific 00:12:41.830 --> 00:12:44.269 rules for identification and you have to pick 00:12:44.269 --> 00:12:47.230 one lane. OK, lane number one. The three property 00:12:47.230 --> 00:12:49.809 rule. This is the most common one. You can identify 00:12:49.809 --> 00:12:52.610 up to three specific properties. It doesn't matter 00:12:52.610 --> 00:12:54.909 what they're worth. Sarah sold for a million 00:12:54.909 --> 00:12:58.009 dollars. She could identify three skyscrapers 00:12:58.009 --> 00:13:00.870 worth $50 million each. As long as it's three 00:13:00.870 --> 00:13:04.049 or fewer, she is safe. Simple enough. Pick your 00:13:04.049 --> 00:13:06.230 top three favorites. But what if she wants to 00:13:06.230 --> 00:13:08.929 buy a portfolio? What if she's selling the big 00:13:08.929 --> 00:13:12.450 duplex to buy 10 little rental houses in a cheaper 00:13:12.450 --> 00:13:15.269 market? Then she uses lane number two. The 200 00:13:15.269 --> 00:13:17.789 % rule. She can identify as many properties as 00:13:17.789 --> 00:13:21.610 she wants, 4, 10, 20, as long as the total value 00:13:21.610 --> 00:13:23.870 of everything on the list is not more than 200 00:13:23.870 --> 00:13:25.990 % of what she sold. Okay. So she sold for $1 00:13:25.990 --> 00:13:28.970 million. She can list 20 houses as long as the 00:13:28.970 --> 00:13:30.970 total value of those 20 houses isn't more than 00:13:30.970 --> 00:13:33.610 $2 million. Correct. But if she lists 20 houses 00:13:33.610 --> 00:13:36.490 and they're worth $2 .1 million, she has violated 00:13:36.490 --> 00:13:38.909 the rule. And now she falls into lane number 00:13:38.909 --> 00:13:41.389 three, which I call the suicide mission. That 00:13:41.389 --> 00:13:44.429 sounds promising. The 95 % rule. If you violate 00:13:44.429 --> 00:13:46.669 the first two rules, so you list more than three 00:13:46.669 --> 00:13:50.529 properties, and their value is huge, you can 00:13:50.529 --> 00:13:53.269 still save the exchange. But only if you actually 00:13:53.269 --> 00:13:56.169 acquire 95 % of the total value you identified. 00:13:56.490 --> 00:13:58.990 So if I list 10 properties worth $10 million. 00:13:59.350 --> 00:14:01.789 You have to buy $9 .5 million worth of them. 00:14:01.990 --> 00:14:03.909 You basically have to buy everything on your 00:14:03.909 --> 00:14:07.480 list. If one seller backs out, you fail. Almost 00:14:07.480 --> 00:14:09.799 nobody uses this rule intentionally. So stick 00:14:09.799 --> 00:14:12.399 to the rule of three. It is the safest. But remember, 00:14:12.539 --> 00:14:16.259 once that 45th day passes, you cannot change 00:14:16.259 --> 00:14:19.279 your list. If Sarah identifies property A, B, 00:14:19.360 --> 00:14:23.159 and C, and on day 46 she sees property D, which 00:14:23.159 --> 00:14:27.179 is the deal of the century, she cannot buy property 00:14:27.179 --> 00:14:29.820 D tax -free. She is handcuffed to her list. Completely. 00:14:29.860 --> 00:14:32.360 That is the stress of the 45 days. But then there's 00:14:32.360 --> 00:14:35.019 the second deadline. The 180 days. Right. She 00:14:35.019 --> 00:14:37.179 has 180 days from the initial sale to actually 00:14:37.179 --> 00:14:39.259 close on the new property. It feels like six 00:14:39.259 --> 00:14:41.899 months. It feels doable. Usually it is. Yeah. 00:14:41.960 --> 00:14:44.399 But there is a hidden trap here, too. The rule 00:14:44.399 --> 00:14:47.940 says 180 days or are the due date of your tax 00:14:47.940 --> 00:14:50.200 return for that year, whichever is earlier. Oh, 00:14:50.279 --> 00:14:54.179 that is sneaky. It's so sneaky. Imagine Sarah 00:14:54.179 --> 00:14:57.240 sells her property on December 31st. Her tax 00:14:57.240 --> 00:15:00.340 return is due April 15th. That is only about 00:15:00.340 --> 00:15:04.220 105 days away. If she doesn't know the rule and 00:15:04.220 --> 00:15:07.080 she schedules her closing for May 1st. She blows 00:15:07.080 --> 00:15:09.159 the deadline. She blows the deadline because 00:15:09.159 --> 00:15:12.139 the tax return deadline came first. So she has 00:15:12.139 --> 00:15:14.679 to file an extension for her taxes just to get 00:15:14.679 --> 00:15:18.080 the full 180 days. It's a paperwork trap that 00:15:18.080 --> 00:15:20.580 catches people every single year. OK, so we have 00:15:20.580 --> 00:15:23.019 the timeline. Sarah is sweating, but she's moving. 00:15:23.120 --> 00:15:25.320 Now let's talk about the money. Because you said 00:15:25.320 --> 00:15:27.299 earlier she can't touch it. Correct. This is 00:15:27.299 --> 00:15:29.100 called constructive receipt. If Sarah has the 00:15:29.100 --> 00:15:31.500 right to access the funds, the IRS considers 00:15:31.500 --> 00:15:34.340 them paid. The exchange is over. So at the closing 00:15:34.340 --> 00:15:36.960 table, when the buyer hands over the check. Sarah 00:15:36.960 --> 00:15:39.659 cannot touch it. She cannot even see it. She 00:15:39.659 --> 00:15:42.600 needs a qualified intermediary or a QI. Who is 00:15:42.600 --> 00:15:45.299 this person? Is it her lawyer? Her accountant? 00:15:45.519 --> 00:15:48.419 It generally cannot be her lawyer or her accountant. 00:15:48.779 --> 00:15:51.399 It has to be an independent third party whose 00:15:51.399 --> 00:15:54.860 business is facilitating exchanges. If she uses 00:15:54.860 --> 00:15:57.399 her brother or her employee, they're considered 00:15:57.399 --> 00:16:00.080 agents of hers, and the exchange is disqualified. 00:16:00.340 --> 00:16:03.620 So she has to hire a pro. Yes, and she has to 00:16:03.620 --> 00:16:06.539 hire them before the sale closes. This is crucial. 00:16:06.659 --> 00:16:09.120 I've seen people close the deal, get the wire 00:16:09.120 --> 00:16:11.799 into their bank account, and then call me asking, 00:16:12.019 --> 00:16:15.340 hey, can I send this to a QI now? Too late. No, 00:16:15.399 --> 00:16:17.500 it is too late. The toast is burnt. So the money 00:16:17.500 --> 00:16:20.039 goes from the title company to the QI. The QI 00:16:20.039 --> 00:16:22.379 holds it in a vault, basically. And then when 00:16:22.379 --> 00:16:25.740 Sarah buys the apartment complex, the QI wires 00:16:25.740 --> 00:16:28.360 the money to that seller. Exactly. The QI is 00:16:28.360 --> 00:16:30.679 the gatekeeper of the funds. Now let's talk about 00:16:30.679 --> 00:16:32.559 boot. I mean, you mentioned this is the trap. 00:16:32.720 --> 00:16:35.220 So Sarah sells for a million dollars. She finds 00:16:35.220 --> 00:16:37.620 a great apartment complex for $900 ,000. She 00:16:37.620 --> 00:16:40.720 thinks, great, I saved $100 ,000. And the IRS 00:16:40.720 --> 00:16:43.259 thinks, great, that $100 ,000 is profit you took 00:16:43.259 --> 00:16:46.240 off the table. That is cash boot. So she pays 00:16:46.240 --> 00:16:49.340 tax on the difference. Yes. If she keeps $100 00:16:49.340 --> 00:16:53.120 ,000 cash, she pays capital gains tax on that 00:16:53.120 --> 00:16:56.320 $100 ,000. The rest is deferred, but she writes 00:16:56.320 --> 00:16:58.559 a check for that portion. That makes sense. I 00:16:58.559 --> 00:17:01.240 get the cash. I pay the tax. But there's a version 00:17:01.240 --> 00:17:06.519 of boot that feels unfair. Mortgage boot. This 00:17:06.519 --> 00:17:09.500 is the silent killer. To defer all tax, you have 00:17:09.500 --> 00:17:12.660 to do two things. Buy equal or greater value 00:17:12.660 --> 00:17:15.210 and replace your debt. Replace your debt. Explain 00:17:15.210 --> 00:17:17.829 that. Let's say Sarah's duplex was sold for a 00:17:17.829 --> 00:17:20.329 million, but she had a $400 ,000 mortgage on 00:17:20.329 --> 00:17:24.710 it. When she sells, the bank gets paid off. Now 00:17:24.710 --> 00:17:26.529 she buys the new place for a million dollars. 00:17:27.130 --> 00:17:29.150 But she decides, you know what, I don't want 00:17:29.150 --> 00:17:30.789 a big mortgage. I'm just going to get a $300 00:17:30.789 --> 00:17:33.069 ,000 loan. She's being financially responsible, 00:17:33.470 --> 00:17:36.009 deleveraging. The IRS doesn't see it that way. 00:17:36.250 --> 00:17:38.589 They see that her debt dropped from $400K to 00:17:38.589 --> 00:17:41.910 $300K. That $100 ,000 difference is debt relief. 00:17:42.410 --> 00:17:45.549 The IRS treats debt relief exactly the same as 00:17:45.549 --> 00:17:47.509 receiving cash. Wait, hold on. So she didn't 00:17:47.509 --> 00:17:49.750 get a check. She just owes less money to the 00:17:49.750 --> 00:17:52.470 bank and she has to pay taxes on that $100 ,000. 00:17:52.950 --> 00:17:56.470 Yes, unless she puts in $100 ,000 of her own 00:17:56.470 --> 00:17:59.329 extra cash to offset it. But if she just drops 00:17:59.329 --> 00:18:02.289 the mortgage amount without adding cash, she 00:18:02.289 --> 00:18:04.670 has mortgage moot. It's taxable income. That 00:18:04.670 --> 00:18:07.190 is baffling to the average person. I borrowed 00:18:07.190 --> 00:18:09.730 less money, so now I owe taxes. That goes back 00:18:09.730 --> 00:18:11.869 to the theory of the exchange. You are supposed 00:18:11.869 --> 00:18:15.190 to be continuing your investment position. If 00:18:15.190 --> 00:18:17.410 you reduce your liability, you have effectively 00:18:17.410 --> 00:18:20.450 cashed out part of your obligation. So the golden 00:18:20.450 --> 00:18:23.630 rule for Sarah is buy equal or up in price and 00:18:23.630 --> 00:18:27.069 carry equal or up in debt. Precisely. Or bring 00:18:27.069 --> 00:18:29.250 cash to the table to fill the gap. Let's pivot 00:18:29.250 --> 00:18:31.809 to the fun stuff. The scenarios everyone asks 00:18:31.809 --> 00:18:34.170 about at dinner parties. Can I swap my rental 00:18:34.170 --> 00:18:37.519 for a beach house? Ah, the vacation home. Everyone 00:18:37.519 --> 00:18:39.720 wants to do this. It's an investment, I swear. 00:18:39.839 --> 00:18:41.839 I just happen to test the quality of the sand 00:18:41.839 --> 00:18:45.000 personally for two months a year. Right. I'm 00:18:45.000 --> 00:18:46.559 holding a board meeting with my family and a 00:18:46.559 --> 00:18:49.200 cooler of margaritas. The IRS wasn't born yesterday. 00:18:49.420 --> 00:18:51.779 They know this game. For years, this was a battleground. 00:18:51.940 --> 00:18:55.000 But in 2008, they issued a safe harbor. It's 00:18:55.000 --> 00:18:57.779 called Revenue Procedure 2008 -16. What does 00:18:57.779 --> 00:19:02.150 a safe harbor say? It says... Okay, we will believe 00:19:02.150 --> 00:19:04.490 it is an investment property if you follow these 00:19:04.490 --> 00:19:07.450 rules. First, you must own the property for at 00:19:07.450 --> 00:19:10.089 least 24 months. This applies to the one you're 00:19:10.089 --> 00:19:11.710 selling and the one you're buying. Okay, two 00:19:11.710 --> 00:19:14.849 years, end. During each of those two years, you 00:19:14.849 --> 00:19:17.670 must rent it out to a stranger, not your cousin, 00:19:17.750 --> 00:19:20.690 not your mom, at fair market value for at least 00:19:20.690 --> 00:19:23.089 14 days per year. So it has to be a real rental. 00:19:23.089 --> 00:19:25.869 It has to generate real income. Yes, and here 00:19:25.869 --> 00:19:29.220 is the kicker. Your personal use cannot exceed 00:19:29.220 --> 00:19:33.000 14 days per year or 10 % of the days it is rented, 00:19:33.119 --> 00:19:36.059 whichever is greater. So if Sarah buys a beach 00:19:36.059 --> 00:19:39.099 house in Florida with a 1031 exchange and she 00:19:39.099 --> 00:19:42.339 rents it out for 300 days a year. She can use 00:19:42.339 --> 00:19:45.279 it for 30 days, 10%. But if she only rents it 00:19:45.279 --> 00:19:46.799 out for two weeks. I can only use it for two 00:19:46.799 --> 00:19:49.140 weeks, 14 days. If she stays for three weeks, 00:19:49.259 --> 00:19:52.019 she violates the safe harbor. It becomes a residence, 00:19:52.119 --> 00:19:55.440 not an investment. And the 1031 is disallowed. 00:19:55.640 --> 00:19:57.880 That is strict. So you can't just buy a retirement 00:19:57.880 --> 00:20:01.880 home and leave it empty. No. However, peep do 00:20:01.880 --> 00:20:04.500 play the long game. This is the moving in strategy. 00:20:04.740 --> 00:20:07.440 Explain that. Sarah buys the house in Florida. 00:20:07.680 --> 00:20:10.400 She follows the rules. She rents it out for two 00:20:10.400 --> 00:20:13.980 years. She limits her visits. Then, after two 00:20:13.980 --> 00:20:17.579 years, her intent changes. She decides to move 00:20:17.579 --> 00:20:20.380 in. She makes it her primary residence. Is that 00:20:20.380 --> 00:20:24.180 legal? Yes. You can convert a rental to a residence. 00:20:25.640 --> 00:20:28.279 And listen closely, if she wants to sell it later 00:20:28.279 --> 00:20:31.099 and claim the primary residence tax exclusion. 00:20:31.559 --> 00:20:34.799 That's the Section 121 exclusion. If you live 00:20:34.799 --> 00:20:36.519 in a house for two of the last five years, you 00:20:36.519 --> 00:20:39.859 get $250 ,000 off profit tax -free. Right, or 00:20:39.859 --> 00:20:42.579 $500 ,000 if you're married. But if you acquired 00:20:42.579 --> 00:20:45.299 that house through a 1031 exchange, the rules 00:20:45.299 --> 00:20:47.579 are much tighter. First, you have to hold it 00:20:47.579 --> 00:20:49.859 for fully five years before you can sell, not 00:20:49.859 --> 00:20:52.420 two. Okay, five years. And second, you cannot 00:20:52.420 --> 00:20:54.809 wipe out the depreciation you took. And third, 00:20:54.990 --> 00:20:57.109 under new rules, you have to prorate the gain. 00:20:57.490 --> 00:21:00.029 You can't just say, oh, it's my home now. All 00:21:00.029 --> 00:21:02.670 the tax from the last 20 years is gone. No, the 00:21:02.670 --> 00:21:04.730 IRS will allocate the gain between the rental 00:21:04.730 --> 00:21:06.430 years and the residence years. So there's not 00:21:06.430 --> 00:21:08.950 a magic eraser. Used to be, but they closed that 00:21:08.950 --> 00:21:11.490 loophole. It's still a good strategy, but it's 00:21:11.490 --> 00:21:12.869 not a get -out -of -jail -free card anymore. 00:21:13.190 --> 00:21:15.609 What about the reverse? Sarah finds the dream 00:21:15.609 --> 00:21:18.210 apartment complex, but her duplex hasn't sold 00:21:18.210 --> 00:21:20.900 yet. In a hot market, sellers won't wait for 00:21:20.900 --> 00:21:23.519 you to sell your old junk. She has to buy N and 00:21:23.519 --> 00:21:27.220 now W. That is a reverse 1031. How does that 00:21:27.220 --> 00:21:29.799 even work? You can't exchange something you haven't 00:21:29.799 --> 00:21:32.519 sold. You can, but it is complex. You cannot 00:21:32.519 --> 00:21:34.700 hold title to both properties at the same time. 00:21:34.900 --> 00:21:37.680 So Sarah hires an exchange accommodation title 00:21:37.680 --> 00:21:41.859 holder, or EAT. An EAT. The EAT basically steps 00:21:41.859 --> 00:21:44.640 in and buys the new property for her. They hold 00:21:44.640 --> 00:21:47.000 the title in a special LLC. They park it. So 00:21:47.000 --> 00:21:50.099 the ET owns the apartment complex? Yes. While 00:21:50.099 --> 00:21:52.920 Sarah frantically tries to sell her duplex, once 00:21:52.920 --> 00:21:55.059 she sells the duplex, the money goes to the QI, 00:21:55.200 --> 00:21:58.019 and the ET then transfers the apartment complex 00:21:58.019 --> 00:22:00.599 to Sarah. It sounds expensive. It is. The fees 00:22:00.599 --> 00:22:03.519 are higher. The legal work is denser. But if 00:22:03.519 --> 00:22:06.059 you're trying to save $200 ,000 in taxes, paying 00:22:06.059 --> 00:22:08.220 $5 ,000 or $10 ,000 in extra fees is worth it. 00:22:08.339 --> 00:22:11.740 But remember, the 180 -day clock still applies. 00:22:12.299 --> 00:22:15.380 The ETT can only hold that property for 180 days 00:22:15.380 --> 00:22:17.940 if Sarah can't sell her duplex in six months. 00:22:18.099 --> 00:22:20.640 The deal unwinds. The whole thing unwinds. Now, 00:22:20.700 --> 00:22:23.059 I want to address a specific listener. Let's 00:22:23.059 --> 00:22:25.559 call him Tired Tom. Tom has been doing this for 00:22:25.559 --> 00:22:29.059 30 years. He owns 10 rental houses. He is sick 00:22:29.059 --> 00:22:32.500 of calls about broken furnaces at 2 a .m. He 00:22:32.500 --> 00:22:35.440 wants to sell, but his basis is so low. I mean, 00:22:35.440 --> 00:22:37.779 he bought these houses in the 90s that his tax 00:22:37.779 --> 00:22:40.660 bill would be millions. He feels trapped. He 00:22:40.660 --> 00:22:42.839 wants a 1031, but he doesn't want another property 00:22:42.839 --> 00:22:45.779 to manage. Tom is the perfect candidate for a 00:22:45.779 --> 00:22:49.460 DST, a Delaware Statutory Trust. We touched on 00:22:49.460 --> 00:22:51.440 this in the intro, but let's go deep. What is 00:22:51.440 --> 00:22:54.440 a DST? Imagine a massive institutional -grade 00:22:54.440 --> 00:22:57.240 property, a $100 million apartment community 00:22:57.240 --> 00:23:00.339 in Dallas, or an Amazon distribution center, 00:23:00.460 --> 00:23:02.460 or a portfolio of medical offices. Obviously, 00:23:02.480 --> 00:23:05.299 Tom can't buy that himself. But a sponsor, a 00:23:05.299 --> 00:23:07.599 big real estate company, buys it and places it 00:23:07.599 --> 00:23:10.119 into a trust. They then slice that trust into 00:23:10.119 --> 00:23:12.700 hundreds of little pieces. Tom can sell his rental 00:23:12.700 --> 00:23:14.779 houses and buy a beneficial interest in that 00:23:14.779 --> 00:23:17.440 trust. And the IRS accepts a piece of a trust 00:23:17.440 --> 00:23:20.180 as real estate. Yes, that was the breakthrough. 00:23:20.420 --> 00:23:23.920 Revenue ruling, 2004 -86. The IRS confirmed that 00:23:23.920 --> 00:23:26.359 owning a slice of a DST is like -kind to owning 00:23:26.359 --> 00:23:29.440 a rental house. So Tom moves his money from his 00:23:29.440 --> 00:23:32.019 headaches into this giant, professionally managed 00:23:32.019 --> 00:23:34.609 building. What does he have to do? Nothing. He 00:23:34.609 --> 00:23:36.710 checks his mailbox. He gets a distribution check 00:23:36.710 --> 00:23:39.289 every month. No tenants, no toilets, no trash. 00:23:39.509 --> 00:23:42.170 It is purely passive. That sounds too good to 00:23:42.170 --> 00:23:44.390 be true. Give me the skepticism. What's the catch? 00:23:44.650 --> 00:23:47.890 The catch is control. Tom used to be the king 00:23:47.890 --> 00:23:49.650 of his rental houses. If he wanted to paint them 00:23:49.650 --> 00:23:52.170 blue, he painted them blue. If he wanted to raise 00:23:52.170 --> 00:23:55.950 rents, he raised rents. In a DST, he is a silent 00:23:55.950 --> 00:23:58.890 passenger. He has zero vote. If the manager does 00:23:58.890 --> 00:24:02.430 a bad job, Tom can't fire him. And fees. I imagine 00:24:02.430 --> 00:24:04.539 there are fees. The fees can be heavy. Upturned 00:24:04.539 --> 00:24:07.380 loads, management fees. You are paying for the 00:24:07.380 --> 00:24:09.960 convenience. Also, it's illiquid. You can't just 00:24:09.960 --> 00:24:12.480 sell your share on a Tuesday like a stock. You're 00:24:12.480 --> 00:24:14.759 usually locked in for five to ten years until 00:24:14.759 --> 00:24:16.839 the sponsor sells the property. So if Tom needs 00:24:16.839 --> 00:24:19.759 emergency cash, he's stuck. He is stuck. But 00:24:19.759 --> 00:24:22.440 for someone whose primary goal is deferred taxes 00:24:22.440 --> 00:24:25.500 and stop working, it is a lifesaver. It's also 00:24:25.500 --> 00:24:27.740 great for spare change. What do you mean by that? 00:24:27.920 --> 00:24:30.819 Let's say Sarah does her exchange. She sells 00:24:30.819 --> 00:24:33.789 for a million, buys for $900 ,000. She has that 00:24:33.789 --> 00:24:36.569 $100 ,000 of potential cash boot left over. She 00:24:36.569 --> 00:24:38.369 doesn't want to pay tax on it. She can put that 00:24:38.369 --> 00:24:41.950 leftover $100 ,000 into a DST. Oh, so you can 00:24:41.950 --> 00:24:44.490 mix and match. Exactly. It's a great filler to 00:24:44.490 --> 00:24:46.809 soak up excess equity so you don't pay tax on 00:24:46.809 --> 00:24:49.009 the scraps. We've covered the how, the what, 00:24:49.109 --> 00:24:51.230 and the traps. Now let's talk about the why. 00:24:51.869 --> 00:24:54.009 Why go through all this torture? Why not just 00:24:54.009 --> 00:24:57.230 pay the tax and be free? The math has to be compelling. 00:24:57.490 --> 00:25:00.259 It is the math of compounding. Let's do a simple 00:25:00.259 --> 00:25:04.740 comparison. Sarah has a $500 ,000 gain. If she 00:25:04.740 --> 00:25:07.079 pays the tax, let's say 20 % federal capital 00:25:07.079 --> 00:25:12.180 gains, 3 .8 % NII tax, maybe state tax, plus 00:25:12.180 --> 00:25:15.440 depreciation recapture, she might lose 30 % of 00:25:15.440 --> 00:25:19.400 that gain. So $150 ,000. $150 ,000. Gone. Poof. 00:25:19.539 --> 00:25:22.819 So she only has $350 ,000 of equity to reinvest. 00:25:23.539 --> 00:25:27.740 If that grows at 7 % for 20 years, she ends up 00:25:27.740 --> 00:25:30.400 with a certain number. But if she keeps the full 00:25:30.400 --> 00:25:33.960 $500 ,000 working, that extra $150 ,000 is also 00:25:33.960 --> 00:25:38.019 growing at 7 % for 20 years. The difference isn't 00:25:38.019 --> 00:25:40.599 just the tax saved. It's the growth on the tax 00:25:40.599 --> 00:25:43.140 saved. It's the snowball effect. Exactly. Over 00:25:43.140 --> 00:25:45.180 a lifetime, the difference can be millions of 00:25:45.180 --> 00:25:47.440 dollars. It's the difference between being comfortable 00:25:47.440 --> 00:25:50.819 and being wealthy. But eventually... The tax 00:25:50.819 --> 00:25:54.180 man comes, right? If Sarah sells that final apartment 00:25:54.180 --> 00:25:56.859 complex when she's 80, she owes all the back 00:25:56.859 --> 00:25:59.220 taxes from every single exchange she ever did. 00:25:59.400 --> 00:26:02.059 If she sells, yes. But if she doesn't sell? Here 00:26:02.059 --> 00:26:04.480 it is. The swap till you drop strategy. It's 00:26:04.480 --> 00:26:07.599 the ultimate loophole. Under current law, when 00:26:07.599 --> 00:26:10.400 you die, the cost basis of your assets gets stepped 00:26:10.400 --> 00:26:12.880 up to the fair market value at the date of your 00:26:12.880 --> 00:26:15.359 death. Explain basis one more time for the non 00:26:15.359 --> 00:26:17.799 -accountants. Basis is basically what you paid 00:26:17.799 --> 00:26:20.940 for the property. If you bought for $100K, your 00:26:20.940 --> 00:26:23.519 basis is $100K. If it's worth a million, your 00:26:23.519 --> 00:26:27.079 taxable profit is $900 ,000. Okay, got it. So 00:26:27.079 --> 00:26:30.299 Sarah has been swapping for 40 years. Her basis 00:26:30.299 --> 00:26:32.400 is incredibly low because she kept carrying it 00:26:32.400 --> 00:26:35.099 forward. She might have a property worth $10 00:26:35.099 --> 00:26:38.539 million with a basis of $500 ,000. If she sold 00:26:38.539 --> 00:26:40.640 the day before she died, she would owe millions 00:26:40.640 --> 00:26:44.299 in tax. Right. But she dies. Her heirs inherit 00:26:44.299 --> 00:26:47.190 the property. The law says, OK, the new basis 00:26:47.190 --> 00:26:50.029 for the heirs is $10 million. The current value. 00:26:50.190 --> 00:26:52.549 The current value. So if the heirs sell it the 00:26:52.549 --> 00:26:55.730 next day for $10 million, $10 million sale price 00:26:55.730 --> 00:26:59.430 minus $10 million basis equals zero gain, zero 00:26:59.430 --> 00:27:02.750 tax. So all that deferred tax decades of it just 00:27:02.750 --> 00:27:05.710 evaporates. Gone. Wiped clean. The heirs get 00:27:05.710 --> 00:27:08.839 the full value tax -free. That is staggering. 00:27:09.079 --> 00:27:11.500 It effectively means capital gains tax is voluntary 00:27:11.500 --> 00:27:13.819 for real estate investors as long as they never 00:27:13.819 --> 00:27:16.059 cash out during their life. Correct. It is a 00:27:16.059 --> 00:27:18.559 massive incentive to hold property forever. And 00:27:18.559 --> 00:27:19.980 that leads to the provocative thought I want 00:27:19.980 --> 00:27:21.900 to end on. We've talked about how great this 00:27:21.900 --> 00:27:24.500 is for Sarah, for our investor. But what does 00:27:24.500 --> 00:27:27.180 this do to the rest of the world? If every investor 00:27:27.180 --> 00:27:30.039 is incentivized to swap till they drop, to never 00:27:30.039 --> 00:27:32.920 actually exit the market, it freezes the market. 00:27:33.470 --> 00:27:36.410 Think about it. In a normal market, prices go 00:27:36.410 --> 00:27:38.809 up, people sell, they take their cash, they buy 00:27:38.809 --> 00:27:41.710 a boat, and new inventory opens up for young 00:27:41.710 --> 00:27:44.910 families or new investors. But Section 1031 encourages 00:27:44.910 --> 00:27:47.750 hoarding. It does. It encourages the old guard 00:27:47.750 --> 00:27:50.710 to keep circulating properties amongst themselves. 00:27:51.109 --> 00:27:53.910 I sell my apartment to you, you sell your strip 00:27:53.910 --> 00:27:58.049 mall to me. We both defer taxes, but neither 00:27:58.049 --> 00:28:00.990 of us releases the asset to the open market in 00:28:00.990 --> 00:28:03.049 a way that creates liquidity for a newcomer. 00:28:03.259 --> 00:28:04.920 So when you drive through your city and you see 00:28:04.920 --> 00:28:07.079 those same families owning the same blocks for 00:28:07.079 --> 00:28:10.160 50 years. It's not just sentimental. It's tax 00:28:10.160 --> 00:28:12.640 strategy. Section 1031 is a brilliant wealth 00:28:12.640 --> 00:28:15.160 builder. But it might also be a contributor to 00:28:15.160 --> 00:28:17.240 the inventory shortage we see in housing. That 00:28:17.240 --> 00:28:19.819 is a heavy thought. It's a tool, but tools have 00:28:19.819 --> 00:28:21.839 consequences. They do. But for the listener, 00:28:21.920 --> 00:28:24.819 for Sarah, for Tom, the tool is there. And if 00:28:24.819 --> 00:28:26.940 you don't use it, you are voluntarily giving 00:28:26.940 --> 00:28:29.079 away 30 % of your wealth every time you trade 00:28:29.079 --> 00:28:32.779 up. So the lesson is, use the tool. But respect 00:28:32.779 --> 00:28:35.720 the tool. Get a QI. Watch the calendar. Don't 00:28:35.720 --> 00:28:39.240 touch the cash. And maybe, just maybe, don't 00:28:39.240 --> 00:28:41.140 try to claim your beach house as a business trip 00:28:41.140 --> 00:28:43.700 unless you really like auditing. And please leave 00:28:43.700 --> 00:28:45.279 the cows out of it. Leave the cows out of it. 00:28:45.339 --> 00:28:46.740 Thanks for diving in with us. We'll see you on 00:28:46.740 --> 00:28:47.119 the next one.