Whether you are an investor or a real estate broker, selling investment or business real estate can be an expensive venture unless you are prepared to conduct a 1031 exchange.

Section 1031 of the federal tax code dictates that no gain or loss shall be recognized upon the sale of a real estate property held for business or investment purposes, as long as the seller purchases a replacement property of equal or greater value. This can be a solid opportunity, potentially, to preserve the gain and accrue additional wealth. However, the 1031 exchange can be a tricky process that has frustrated many amateur and professional real estate investors alike.

So, to help potentially avoid having your 1031 exchange blow up, here are six steps to consider as you advise a client on undertaking and entering into a 1031 exchange:

Step 1: Know the applicable deadlines. The IRS requires an investor to identify a replacement property within 45 days, and to close on the target property within 180 days of selling the relinquished property. That doesn’t leave much time to hunt for the right deal, but it’s enough time. Working with an expert 1031 exchange investment firm like Kay Properties can help investors successfully complete their 1031 exchange within these timelines.

Step 2: Get educated about acceptable types of replacement properties. The IRS requires an exchanger to reinvest in a “like kind” property. However, “like kind” does not necessarily mean the same type of property. There are a variety of options available. For example, if you are selling a duplex in San Diego, that doesn’t mean you need to replace it with another duplex. The 1031 exchange allows investors to replace relinquished real estate with a variety of asset types. It can be a medical building, single-family home, multifamily apartment building, raw land, self-storage facility or any other investment real estate. The type doesn’t matter as long as it is held for investment or business purposes. Ideally, investors should know what they are looking for in a replacement property well before going into escrow on the property they are selling. Again, working with a 1031 exchange investment firm like Kay Properties can greatly reduce the stress and confusion surrounding 1031 exchanges.

Step 3: Narrow down the options while in escrow. I cannot tell you how many times I have seen 1031 exchange investors in a desperate panic once they hit day 30 of their 45-day window with not a single replacement option identified for their exchange. This is an extremely stressful position. But don’t worry, this article should help spare you the anguish.

One good strategy is to locate five to 10 potential replacement properties as the closing date of the property you are selling gets closer. But be prepared that as you move through escrow, many of the new properties you have identified will likely be acquired by other buyers or will not prove to be satisfactory under the scrutiny of some due diligence. That’s why developing a short list of potential replacement properties prior to relinquishing the original asset can be one of the most important strategies for preventing having your 1031 exchange blow up!

Step 4: Make sure your financing is lined up ahead of time. Investors will often call me in a panic because they’ve located their replacement property, but they cannot access the financing necessary to purchase the asset. It is important to make sure that they have the financing lined up before closing on the property being sold to spare themselves from a stressful and potentially expensive predicament. That’s one reason fractional ownership structures for 1031 exchanges can be attractive for investors wanting to complete a 1031 exchange. For accredited investors, a Delaware Statutory Trust (DST) investment may be a suitable option. In addition, DSTs have a non-recourse financing component baked-in to each investment so the investor does not need to sign for a loan. A DST may be an ideal opportunity for an investor looking to a 1031 exchange to be a passive, turn-key solution with required financing already established.

Step 5: Have a backup property identified just in case. The IRS code allows investors to identify replacement properties using different rules. The most common rules used are to either identify three properties for their 1031 exchange or identify real estate valued at up to 200% of the property that’s being (or been) sold. This means there is room for back-ups. Take advantage of the opportunity. An exchanger should never leave an empty space on their ID form, which is submitted and filed with a qualified intermediary. More often than not, the exchanger’s primary option won’t work out … even if it looks like a sure thing! Also, I have often seen unscrupulous sellers exploit the buyer’s 45-day time clock in order to press their back against the wall, forcing the exchanger into an inferior negotiating position. Backup property options can strengthen the exchanger’s negotiating power by providing additional options.

For accredited investors, a DST can be an excellent option for a backup strategy. DST properties are already purchased, stabilized, and can potentially provide monthly distributions to investors. There is no negotiating and the due diligence is already complete. Additionally, an exchanger can often close on a DST in three to five business days. I often recommend my clients use a DST as a backup ID if there is room in their exchange and it is appropriate for their situation.

Step 6: Make sure to start to negotiate a 1031 contingency in your purchase and sale agreement. Many buyers are willing to allow a 1031 contingency that will permit the seller to extend escrow on the property being sold if the seller can’t find a replacement property. For example, try to negotiate a clause that extends escrow for you by including an additional 30 days if you are unable to identify a suitable replacement property. This can be a quick and easy way to buy additional time should you have difficulty locating the right 1031 exchange investment.

Bottom Line: a 1031 exchange can be a potentially great tool for building and preserving wealth, but it can be a daunting process if not properly prepared. If you decide to do a 1031 exchange, make a point to start early, get educated, narrow down their options, line up financing, have a backup ID, and negotiate for more time in case they need it. When appropriate and if they qualify as an accredited investor, use a DST as part of your 1031 exchange strategy. There are no guarantees in real estate, so it is always best to plan ahead when considering a 1031 exchange.

Position Realty
480-213-5251

Consider the consequences of renting your property to someone with a history of evictions for non payment of rent or a habit of writing bounced checks. Or the effects of allowing someone who has a criminal record or several collection accounts to live on your property. What about a terrorist or sex offender?

It only makes sense that a conscientious landlord would want to know everything possible about a prospective tenant before renting to them. But sadly, there are many property owners who do not take the time to properly screen their applicants. If they choose to rent based on feelings rather than facts and don’t run a tenant background check, they risk paying the price in the end.

In addition to the information revealed on a person’s background check for tenants, there may be red flags that become apparent as you meet with the candidate and go over their application.

#1 The applicant can’t or won’t give you contact information for their current landlord, employer, or personal references. What are they trying to hide? Perhaps these people have negative information or experiences with the candidate that could negatively influence your decision as to whether you’ll want to rent to them or not.

#2 The applicant provides suspicious pay stubs. If your applicant has not supplied employer contact information, you should ask for their most recent pay stubs to verify their employment. It is imperative that you check all the basic information on the pay stub closely and look for any discrepancies in the numbers, formatting and overall quality. This is a long-used scam that has become more popular with the rise in the number of websites that offer fraudulent pay stubs. Self-employed applicants should supply a tax return document with proof of earnings and income.

#3 The application omits information or is inconsistent. Carefully review the application for omitted information or inconsistencies. The profile on the reports should match the person who filled out the application. Make certain that the date of birth, employment history and most importantly, the Social Security Number match the person’s profile.

#4 The deposit check is greater than the amount you are asking for. Always ask for a cashier’s check or money order in payment for the security deposit and first month’s rent. When an applicant wants to pay the deposit or even their monthly rent in cash, it might be an indication that they run a non traceable business or have an illegal occupation.

Be suspicious if they ask you to accept a deposit check in an amount greater than you are asking for with a request for you to refund them the overpayment. Never accept more money than the specified rent for your property and do not accept an out-of-state cashier’s or paper check, especially if it is for more than you are due. This is a well-known scam that will leave you without your money and without a tenant.

Someone who wants to pay the deposit in installments probably lacks the income to rent the property. It may also be that they are not planning to make those additional payments at all. Do not sign a lease until you know that you will receive the security deposit in full before the move-in date. Keep in mind that there are a few cities that have passed “Renter’s Choice” bills which may allow tenants to pay their deposit in payments, but you can still incentivize tenants to pay the deposit in full.

If they are allowed to postpone paying the full security deposit, you may never see that money or the rent for the following months. Should you begin the eviction process, they know that it will be several months before they must vacate the premises. In the meantime, they are living in your property rent-free.

#5 The applicant insists you use a copy of the credit report they provide. Beware if the applicant tries to give you a copy of their “credit report” rather than have you order your own. This could be an attempt on their part to keep you from seeing their true financial history. With today’s technology available to anyone, it is surprisingly easy to create a favorable credit report that will lead you to rent to someone who is not a reliable tenant. Note, New York has recently allowed tenants to furnish their own credit reports, but that still doesn’t mean you can’t pay for and run a credit report yourself. Always verify.

Position Realty
480-213-5251