Don’t Start a 1031 Exchange Until You Listen to This

Aviva (00:00)
This week's listener of the week is Morpho Loose. Morpho, thank you so much for leaving us a five star review. And for those of you listening, if you leave us a five star review below, you might be next week's listener of the week. Week, week.

this week on Commercial Real Estate Secrets, we have Mr. Dave Foster. Dave is the owner and CEO of the 1031 Investor. Dave, thank you for being on the show this week.

Dave Foster (00:33)
Great to be here, and thanks for having me.

Aviva (00:35)
Yeah, so Dave, tell us how did you get into the wild world of the 1031 exchange? Take us through the story.

Dave Foster (00:44)
the wild, wild world, right? Yeah, you know what's funny? For people that are in, generally in commercial real estate or the deeper into the pool, 1031s are not a mystery. But for most people, they go, what is that? And they don't realize that this has actually been a statute since 1920. So early on when we decided to start the company and do these for others,

People would come up to us at like events and they'd say, where are you guys from? And we'd tell them and they'd say, what's a qualified intermediary? And we'd say, well, if we told you, we'd have to kill you. And of course, right away I said, this is not good marketing. We gotta find a better way to do this. How can we educate people? Because really the only way that I got into it was finding out the hard way by myself 30 years ago.

when I sold my very first piece of property and went to my accountant, feeling great about it, till he said, you're gonna write a check for $30,000. I said, wait a minute, this was not part of the plan. And he said, yeah, if you would have done a 1031 exchange, I said, all right, teach me, let's learn about this. And to this day, Aviva, you know it as well as I do. If I would have had that $30,000.

for 30 years to invest for myself. What would I have right now? Crazy! 

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But that's what the 1031 exchange does is it allows you to sell investment real estate where you've got a profit or it's been depreciated and buy new investment real estate and indefinitely defer paying that tax on the profit. Well that was the game changer for me.

when I realized what that would happen. So 30 years ago, through my own stupidity, I learned about this and now I've been doing it for myself and for others ever since.

Aviva (02:42)
You know, when I call those five figure, six figure, hopefully never seven figure mistakes, I call them like my college education for that year. When you make a really, really expensive mistake and you're, and you sit back and you're like, wow, that cost college, you know, that was a year in college and I will learn from that mistake because that's the reality of...

Dave Foster (02:57)
Ha ha.

Aviva (03:10)
The business and doing business is you will make those costly mistakes and you just have to learn from them.

Dave Foster (03:17)
You know, funny you should say it like that because many would say, including a bunch of my classmates, that my whole college education was a six-figure mistake. But only because, well, okay, for other reasons too, but for the main reason that, thinking about the 1031 again, I'm a great accountant. You would think I would have known better. But the sum total of my experience learning about 1031s in college

was one half of one class period. That's it. How can you expect, and of course the IRS is not gonna market it for you. So these are those little known secrets that you just kind of have to funnel around and until you find them, when you do, they change your life.

Aviva (03:50)
Shit.

So will you tell us on a very high level what a 1031 exchange is and what dates and deadlines we should be looking for if we're selling a property?

Dave Foster (04:19)
Yeah, for you as an investor, the process itself is relatively transparent. You do exactly like you normally would. List a piece of property to sell, sell it, find a new piece of property, buy it. When you use the process of the 1031 exchange, which requires a number related third party, such as myself to administer it.

So we're kind of like Switzerland where everybody's money because you have to use us. So that's okay. But when you follow that process, you get to keep all of those tax dollars working for yourself. So again, think about that $30,000 compounded over decades. If you do that with your as many transactions as you can, the compounding effect is ridiculous.

And I say indefinitely because you can do it throughout your entire life and beyond. And we'll talk about that in just a minute, but as far as the nuts and bolts go, the things that you have to watch out for, the QI, the Qualified Intermediary, has to be in place prior to the closing of the sale. From that date, you've only got 45 more days to identify your potential replacement property.

You've got a total of 180 days to close on it. Now the 180 days generally, not such a problem, but particularly in the commercial world where we have much longer LOI periods and due diligence periods and those types of things, 45 days is not a lot of time. As a matter of fact, you'll barely be through your first round of due diligence when the 45 days is over.

And the key with that is that once day 45 passes, you cannot alter your list anymore. So what a lot of our commercial clients will do is they will actually go into contract for their new property well before they sell their old property. So they're working through a bunch of the due diligence before their old property sells and the 45 day period starts. Does that make sense?

Aviva (06:33)

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Yes. Is that or can you explain a reverse 1031?

Dave Foster (06:37)
That is not a reverse exchange because there's really no such thing except for there's a statutory order that a 1031 exchange has to take. And that is you have to close the sale of your old property before you take title to your new property.

So that's the order. You have to sell first and then buy. So what I just described, you're still selling first and then buying, aren't you? It's just that you're already under contract. That's perfectly fine. What a reverse exchange does is it makes it look like that has been reversed. And what has to happen, it's the deep end of the gene pool. What has to happen is that we have to take title to the new property.

in a separate entity from you. And then we can hold title to that for 180 days while you complete the sale of your old property. And then you buy the new property from the entity that we formed that's holding it. So you're still selling your old property and then buying your new property. You're just buying it from this entity that we created.

Guess what? They're a lot more expensive and complex. But it can be done.

Aviva (08:02)
So I am currently in a house, my house, that I bought under a reverse 1031 exchange. I didn't know they existed until we were selling some ground and I know there's like a lot of legalities and details and I hope, I wouldn't do well in jail so I hope I don't go to jail. But.

I thought it was so interesting when I learned about a reverse exchange because it was like, holy smokes, I'm a real estate professional. We never were taught this in school. How does somebody learn about their options when it comes to a 1031 exchange or reverse exchange or anything else?

Dave Foster (08:51)
Yeah, that's, you know, that's by the way, what we'll do is we'll simply say that you're talking about a hypothetical situation, of course. Yeah. Just, just if that ever happened. Now you're, you're fine. And as a matter of fact, 

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reverse exchanges can be huge when you're looking at moving from say a very highly and expensive asset and you want to do a value add improvement project.

Aviva (08:59)
Yeah.

Dave Foster (09:19)
Say you were selling for a million dollars and you want to buy a $600,000 replacement property but it needs $400,000 of work. And once it's done and improved, it'll be worth two million. So we would do a reverse exchange. You would sell your old property. We would buy the new property.

and then while we are entitled to it, you're putting the other 400,000 of improvements into it. Then it's worth a million dollars and you complete your exchange and you were able to sell a used property for a million dollars and end up with this like new two million dollar property using a 1031. So they do have a great place. These and so many more things.

Aviva (09:47)
Hmm.

Dave Foster (10:11)
are all out there within the statute. But here's the problem. All of section 1031, the way we know it today, has come about because of a court case that the IRS lost back in the mid-90s, 20-year court case called Stoker versus the commissioner. Well, I don't know, imagine a ticked-off IRS who's embarrassed. They're not exactly gonna make it easy, even though they have to let us do it. So...

That's the first reason is they just not going to publicize it. The second reason is that because there is an attorney on every street corner these days, everybody has started to get into the litigation battle, right? So the way that 1031 is applied is being shaped every year by hundreds of court cases. And the IRS is having trouble keeping up, right?

Aviva (11:00)
Hmm.

Dave Foster (11:05)
So we've got this huge animal of information that nobody really knows how to keep it up with. And then the third and biggest thing is that because people like us cannot have any other relationship with the client, we can only do the 1031 exchanges. You've got to find someone like us to learn. Your accountant is not going to know.

Aviva (11:32)
Hmph.

Dave Foster (11:32)
because if they were focusing on that, they couldn't do your taxes. Your attorney is not going to know because if they did, then they wouldn't be able to do your trusts and your legal work. So it's this very... One of my colleagues once said, it's like being two miles deep in a two-foot wide creek and only nerds like us dare go there. But when you find...

a qualified intermediary who can help you strategically. We're a small part of the puzzle, but we're a very important part of the puzzle, because we opt to fit into where you and your financial advisors and your accounting staff and your legal advisors are all trying to take you. And we kind of fill that picture. So that's why it's so hard. But if I may ask, how long have you been a licensed realtor?

Aviva (12:25)
I'd say eight or nine years.

Dave Foster (12:28)
Okay, so like 2014-ish, 16-ish, something like that. So this little thing happened when you were in middle school. It was called the Great Recession. Remember this? Okay, you were a freshman, what are you talking about? At some high schools, that's still middle school. But here's what really happened.

Aviva (12:31)
Yeah.

I was in high school but and yes.

Dave Foster (12:54)
The Irish did not start keeping track of 1031 exchanges till 1996. And the first year that they did, there were only 70,000 done. Now, when we started in 2000, we started to see it really grow, right? By the time the market peaked right before the crash, we were seeing about 600,000 exchanges.

being done here. But then the crash occurred. Every investor lost their shorts. When we every time it got I quit trying to call my old clients, because they either broke in jail or had dementia. So there was just no point in it after a while. But we lost a whole generation of investors who lost everything. We lost

Aviva (13:44)
Wow.

Dave Foster (13:46)
Interestingly enough, a whole generation of realtors, two thirds of the realtors at that time went out of business, because for the next couple years, there was nothing and they couldn't live. And what is now the greatest buying demographic of real estate are people like yourself, who were 15 or 16 when 1031 exchanges were last popular.

So there's nobody to share that campfire knowledge. And that's why things like what you're doing by having me on, things like what we're trying to do by focusing our company on education first and service along with that. Or hopefully helping to bridge that gap.

Aviva (14:31)
I am completely obsessed about talking about this online for that very reason. It's when I grew up in a real estate family and the topic at the dinner table was real estate every single night. What I recognize today is that that's a insane privilege that most people don't have. So now I've taken it upon myself to talk in public online about it.

to share the knowledge that I was just born into by the luck of the draw. And yeah, it drives me nuts that something like a 1031 wouldn't be, it's like you said, people are not educated on this topic and the IRS is not incentivized to educate people on this topic.

And so I was reading a bit about you, and it says that you have the four Ds of 1031 investing.

Dave Foster (15:24)
Right.

Aha! You want to take a quiz?

Aviva (15:34)
What are the four Ds? Oh, gosh.

Dave Foster (15:38)
I mean, come on, you're the realtor, let's take a quiz. Okay, so there are four key factors about the 1031s that all start with the letter D. Easy enough, right? I'll give you the first one. It is defer. And we've sort of already hinted at it. It's because when you do the 1031 exchange, you get to indefinitely defer paying that tax back. And every day that you defer it,

Aviva (15:40)
Alright, let's go.

Okay.

Dave Foster (16:06)
The money that you make off of that comes to you instead of going to the government. So over the course of 20 or 30 years, we actually have an example that we use in one of our classes where we show a realtor, I mean, an investor in four transactions over 20 years, not hundreds, just four, turn a portfolio of a hundred thousand dollars into $12 million.

simply using the deferred tax to buy more real estate. That's massive. Okay, so that's the first D. You ready to take a stab at what the second D is? You want me to give that one to you too?

Aviva (16:42)
Define.

Dave Foster (16:43)
That's a really good one, but it unfortunately is defer.

Aviva (16:45)
Okay.

Okay. Wait. Okay.

Dave Foster (16:51)
You may start to see a trend here. I don't know. Defer. Because the 1031 exchange can be used very effectively to meet whatever the real estate market is telling you. Right? When we're looking at investing, you got this from your parents, I'm sure. I mean, the talk was about where to invest, what to invest in, how to do it right now, what interest rates, all of that stuff.

The market has a voice. And if you listen to it, the market will tell you what to do to make a lot of money. The market talked to a lot of people in Palo Alto about 15 years ago. And it said, sell this San Francisco property at a ridiculous price. And go buy dirt next door to Elon in Austin, Texas. What do you think happened to those people?

To do that, they used the 1031 exchange. It might be telling you that it's time to move out from Southern California rentals, where appreciation has been great, but there's no cash flow, and move into Kansas City or Omaha, where I can get good cash flow now. Or maybe it's telling you it's time to leave single families and move into multifamilies or commercial, or...

Aviva (17:59)
Hmph.

Sure.

Dave Foster (18:13)
with all the incentivization that we're starting to see for first time ownership. Maybe it's tying the ridiculous prices that multifamilies are commanding. Maybe the market is saying, move out of those, back into single families. Whatever the market tells you, because the 1031 exchange can be used to go into any type of investment real estate, anywhere in the country.

Aviva (18:29)
Hmph.

Yeah.

Dave Foster (18:42)
So you really, and including numbers too, you can sell one property and buy multiples. You can sell multiples and buy one. So what a great opportunity to listen to the market and react to it, but do it without having to pay tax.

Aviva (18:58)
Sure. Yes.

Dave Foster (18:59)
Are you ready? What's the third D?

Aviva (19:03)
differ.

Dave Foster (19:04)
Yes! Bells, Clay, it's the golden buzzer, yeah! Because just like the 1031 exchange can help you to react wherever you see the market, the 1031 exchange can react to help you pursue your goals wherever you are at in your personal journey. And I caught on something you said. We're going to talk about it in just a quick second.

But when we all start out generally, we've got more energy than we do money. So we're OK buying fix-up properties and painting at night and doing drywall repairs, whatever it takes to get our investment career going. But at some point in time, we start to have more money and less time and energy.

Well, the 1031 exchange will let you sell several properties and consolidate them into one larger property that's easier to manage. Or provide you with more cashflow per doors. Or there also comes a time for a lot of us when we want to start to enjoy. It's no fun just buying and selling and buying and selling and never getting to enjoy it. So maybe we start to 1031 exchange.

Aviva (20:09)
Hmph.

Dave Foster (20:23)
into vacation rentals where we can start to have some personal use as well and commoditize our family's vacation time. By the way, every trip to see your vacation rental is a business right off, right? Theoretically, hypothetically, of course, right? Yeah. So no matter where you're at in your life cycle. Now, here's something that I think you did that's so key to this exact point.

Aviva (20:38)
Absolutely.

Dave Foster (20:53)
You did a 1031 exchange and you sold some land and you bought a property and then later you converted that into your next primary residence. Am I correct?

That's perfectly allowable, by the way. We don't have to talk hypothetically. Perfectly allowable to do that. There is nothing that stops you from converting. Here's where that could be key. Is that let's say I'm an investor in Cincinnati and I want to retire in Sarasota, Florida. So a few years before I retire, I start to position my real estate in Sarasota.

Aviva (21:07)
Yeah.

Okay, cool.

Hmm.

Dave Foster (21:36)
using 1031 exchanges. When I'm finally ready to retire, all I got to do is move down there, don't I? And my portfolio awaits me. So I sell my primary residence in Sarasota. By the way, that money's tax free, right? Because when you sell your primary residence, if you lived it for two years out of the five before selling it, as a married couple, you would get the first $500,000 in profit.

tax free. Now, you could use that money to go buy a new place in Sarasota. But what if one of the places you bought was this real drop kicking, dead nice beachfront rental, and you decide it's time to just move into that thing. So you convert it into your next primary residence, and the tax free money from the sale of your primary goes into your pocket.

Aviva (22:04)
Hmm.

Dave Foster (22:30)
Go have a cruise, buy ice cream for the grandkids, whatever. But it's yours to keep. And then guess what happens? Slowly over time, as you live in that converted 1031 property, you will start to eliminate some of the deferred tax. And turn it from tax deferred into tax free.

Aviva (22:35)
I'm sorry.

Hmm.

Dave Foster (22:59)
I have a client on St. Pete Beach that bought, with a 1031, three identical beachfront condos. He used them for rental for a couple years, and then he moved into the first one. All he did was live in it, but once he had owned it for five years, that meant that he had lived in it for three, so he was able to sell it and take three-fifths.

Aviva (23:13)
Wow.

Wow.

Dave Foster (23:27)
or 60% of the game tax free.

And where do you think he moved?

Aviva (23:31)
Next door? Okay.

Dave Foster (23:32)
Absolutely.

Wow, right? That's his whole retirement plan is sitting down on his back deck watching the ocean. While his money converts from tax deferred to tax free. In my book that I wrote, I don't know if you've got a if you've got your copy there yet or not. But we actually tell the story of ourselves, where we moved our portfolio from Denver to Connecticut to Florida, and ended up by using these conversions.

to buy a 53 foot sailboat with tax free dollars and move our family on it and raise our four children for 10 years on a 53 foot sailboat using money from our vacation rentals to finance the excursion, all without being a penny in tax. That's really how doable it is.

Aviva (24:15)
Wow.

Where was your favorite place you sailed to on the 53 foot boat?

Dave Foster (24:33)
You know, domestically in the US, a little island 70 miles off of Key West called the Dry Tortugas. And that was, that's pretty awesome. It's a little Civil War fort that you can only get to by boat or seaplane. And that was a pretty awesome place. But I would say Frazier's Hog Key in the Bahamas. Again, a little known place. Nobody knows about it.

Aviva (24:55)
Hey.

Dave Foster (24:58)
Those are the best. And now I just probably gave a TikTok curse to it. Didn't I? Darn it. Everybody's going to go there now. Okay. Yeah, do a bleep out. Let's bleep that name out. There we go.

Aviva (25:05)
Well, we'll protect it. We'll protect it. I... Okay. Yeah. You gotta protect the... Protect it at all costs. That's funny. That's unbelievable.

Dave Foster (25:18)
So yeah, so the opportunities to actually benefit yourself all the way through retirement. Okay, now I would play a very cruel trick on you and ask you to try the name the fourth D, but it's a trick question because it's not defer. It is actually die. I know, right? It's not my favorite one either, but we're all heading that way. Be much sooner than you since you're one of those millennial folks or whatever you are.

Aviva (25:33)
Okay. Oh. Like.

I am one of those.

Dave Foster (25:48)
Yes, indeed. So when you die owning real estate, your heirs will inherit that at what is called a step-up in basis. So they inherited it as if they paid market value for it. So you could literally defer the tax throughout your life.

convert some of them into your primary residence, turn some of them tax free, and when you die, your estate doesn't pay the tax, you don't pay the tax, your heirs don't pay the tax, it becomes a tax-free legacy of wealth to your heirs. The government never can sit back. Now, God I just don't know how I can get any better than that. But this is like right when everybody asks the question, well then, why would they let us do this?

Aviva (26:21)
Yeah.

Dave Foster (26:33)
This is too good to be true. It's gotta be a loophole. It's gotta be something. One of my mentors challenged me once to not look at the tax code as a way that the government uses to get your money. He said, they get your money, that's okay, but they can do it a number of ways. Think of the tax code as the government's behavior incentivizer.

Aviva (26:57)
Yeah

Dave Foster (26:59)
And when you do what they tell you to do, because they want you to do it, you will be rewarded. Well, I started to think about that and process it when you get the, you know that's absolutely right. In 1920, the reason 1031 was put into place was to help us grow our nation's agribusiness industry. We were coming out of the homestead period, right? Where everybody got 160 acres.

Aviva (27:07)
Hmm.

Interesting.

Dave Foster (27:28)
They all had a farm, but they could not grow. Because if they went to sell that property to buy something bigger, by the time they paid the tax, they wouldn't have enough money. So they could not grow, but not only that, all of these young kids that wanted to break into farming couldn't because there were no small farms to buy.

So 1031 exchange was put into statute. Today, and yes, every president talks about it, and yes, President Biden's administration puts it in their budget every year to get rid of it because they see it as low-income fruit. Let's get the money from those fat real estate investors. As soon as calmer heads prevail and they see the numbers.

Aviva (28:16)
Sure.

Dave Foster (28:21)
They see that the amount of money that they would get by taking the capital gains money from real estate investing would be offset to the tune of billions of dollars. Because what they would lose, the real estate market would stagnate in that part. And what they lose is to real estate trade out commissions. Because every tip that he wants is sale and buy.

Aviva (28:46)
Yeah.

Dave Foster (28:46)
two realistic emissions, two title policies, two closings, two painters preparing the properties, two attorneys reviewing documents, two appraisers, two inspectors. And one thing all of you guys have in common, you all pay ordinary income tax, which is much higher than the capital gains tax that 1031 investors pay. So they would give a little bit of money. Yes.

Aviva (28:54)
Oof.

Wow.

Dave Foster (29:15)
but they would lose so much more. And the other fact that I got to tell you, because it's crazy, the average 1031 exchange sales price is just a little under $400,000. Does that sound like that's the Hiltons and the Astors and the Rockefellers? No, that's you and me.

Aviva (29:39)
No?

Dave Foster (29:40)
If you take away 1031 exchanges, you're taking it away from mainstream America, people that are trying to grow. So it's been safe for a hundred, a hundred years. And I think it's still going to be safe because the government really does want a vibrant real estate industry.

Aviva (29:52)
Wow.

That's fascinating. And, you know, it was one of my questions is, you know, what is the future holds for 1031? But it makes so much sense that the ripple effect of eliminating it would be so much more damaging than keeping with the past 100 years of deferring your gains.

Dave Foster (30:26)
Yeah, well, I mean, in the commercial world, if you think interest rates rising above cap rates have screwed around with everybody, just wait until they also take away the ability to sell a tax deferred. The commercial real estate industry will grind to a halt. And I don't think the government really wants that.

Aviva (30:35)
Yeah.

Phew.

Yeah.

Dave Foster (30:48)
I certainly don't.

Aviva (30:50)
No, I'll try to avoid that, but at all costs, and hope the government sees us there. So Dave, this has been really, really fascinating and educational. Let me ask you, what makes you happy in your day to day as a QI and real estate investor?

Dave Foster (31:11)
As a QI, I really, I get an obscene amount of joy from talking to people who are where I was 20 years ago and helping them through their first 1031 exchange and they get to see what they can buy. It's just so much fun and I guess a couple that I've got a teacher's heart and I see that people there's so much out there whether it's 1031 or this just

financial training that people are not getting. To be able to give them that opens up a whole new world. And so that's, I get a crazy amount of joy from watching others' success like that. What was the second half of that question?

Aviva (31:41)
Sure.

Yeah, what brings you happiness in what you do? That's all. I think with real estate, there's a really common misconception that anybody in real estate is evil. But what people don't realize is how much we help one another, educate each other, save each other, help each other build.

There's a lot to be happy about in real estate and all the fun intricacies that go into it.

Dave Foster (32:24)
We're not quite like used car salesmen, are we? You know, interestingly enough, I've done quite a bit of development in REAP projects large scale. I had never heard this term used before, but it just resonated in my heart. I was working with a bunch of designers and architects on a master plan for a college campus, an honored acre college campus, awesome project. And...

Aviva (32:27)
No, I don't think so.

Okay.

Dave Foster (32:53)
They were running me through what they saw. And they started to talk about, when we turn the corner on this street to go to this facility, we wanted to create a moment right here. I said, stop, a moment is time. And they said, no, a moment is something that takes your breath away. And ever since that time,

That's been my goal in all of my rehab projects is I look at I say, how can I create a moment here where someone who buys my house, walks in with their newborn child, or has their grade schooler jump up on their lap in this family room, or enjoys this part of the yard. Real estate is I think really just it's a composite of our lives.

And it should be a collection of moments that take your breath away.

Aviva (33:58)
That's so beautiful. I agree. And hopefully they're on an island somewhere. Yeah, I don't know which one. Yeah, you're gonna hate it. Dave, thank you so much for your time today. Where can the folks on the internet or who are listening find you and find your company and your book? Books.

Dave Foster (34:03)
Absolutely. Just not the one I talked about. Those were really ugly. They're not good. Don't go.

Ha.

Three places. Amazon has got the book, it's called the 1031 Exchange, the Lifetime Tax Free Wealth, the 1031 Investor's Guide, or the Real Estate Investor's Guide to the 1031 Exchange. Sorry about that. Just look up Dave Foster, 1031 Book, Amazon. It'll get you there. By the way, we put tons of case studies. This is not just nuts and bolts, blah, blah.

These are actual people who have used these for their careers. It's been fun to watch them through it. Our whole website's educational, the1031investor.com. It's got links to our YouTube channel, where we've got right now 52 videos on everything 1031, how to use them, how to structure them, how to be strategic. Doesn't it go without saying, please like and subscribe? It helps us out.

Aviva (35:13)
Dave, you got it!

Dave Foster (35:13)
The 1031investor.com. Kids share everything you need.

Aviva (35:18)
Hey, Dave, thank you for being on the show. I really, this was a really fun episode. You brought a ton of value and for everybody listening, we'll see you next week.