SHOW NOTES FOR EPISODE 421:
FREEDOM FROM CAPITAL GAINS TAX WITHOUT A 1031 EXCHANGE

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Have you ever sold a property and used a 1031 Exchange to defer capital gains tax?  Have you ever felt trapped by the 1031 Exchange’s unrealistic deadlines to locate and close on a replacement property?  In today’s information-packed podcast, commercial broker, real estate investor and capital gains solutions expert Brett Swarts shares an alternative to the 1031 Exchange that allows you to utilize optimal timing, without the deadlines, and provides maximum investment flexibility for significant wealth creation.

What You Will Learn

• How to avoid paying capital gains tax on your property profits without using a 1031 Exchange
• Why you should never overpay for a property just to meet a 1031 Exchange deadline
• How to gain tax deferral, liquidity, freedom, flexibility and diversification with your funds so you can purchase properties at optimal timing
• What a Deferred Sales Trust is and how it’s better than a 1031 Exchange
• Strategies for Retirees that will get you out of debt, create liquidity, bring investment diversification and help your nest egg grow
• How you can defer capital gains tax from your property sale and invest your profits in other investments besides real estate

About Our Guest

Brett Swarts

Brett Swarts is the Founder of Capital Gains Tax Solutions and host of the Capital Gains Tax Solutions Podcast.  Each year, he equips hundreds of business professionals with the Deferred Sales Trust tool to help his high net worth clients solve capital gains tax deferral limitations.  His experience includes numerous Deferred Sales Trusts, Delaware Statutory Trusts, 1031 exchanges and $85,000,000 in closed commercial real estate brokerage transactions.  He’s an active commercial real estate broker and investor with brokerage experience and ownership in multifamily, senior housing, retail, medical office, and mixed-use properties.  He is a licensed California Real Estate Broker who holds Series 22 and 63 licenses.  Brett lives in Roseville, California, with his wife, Melanie and their 5 children.

More About Brett

• From the Bay Area (Mission San Jose, California)
• Grew up with his father, building custom homes
• Learned the “sticks and bricks” of real estate, from the ground up completed
• He invested along with his parents – single family cashflow opportunities
• Studied business in college

Moving Into Real Estate as a Career

• Got a job with Marcus and Millichap (commercial investment real estate firm)
• Specialized in multifamily
• Learned about 1031 Exchanges
• This was between 2006 and 2011
• in 2008, just as he was getting his business going, the Great Recession happened
• A lot of people got hurt and a lot of brokers fell out
• He was a relatively new broker, didn’t have high expenses and loved the business and helping people solve challenges with their investment real estate
• What he found out along the way was that the 1031 Exchange is just not everything for everybody at all the times
• That’s how most tools are.  They have their limitations and they have their challenges
• After he saw people get completely wiped out and lose everything, take on too much debt and overpay for properties, he set out on a mission to find a better way
• Where clients never have to…
  • feel trapped
  • overpay for properties
  • stay in debt
  • and can find diversification, liquidity and can find “optimal timing” – the ability to buy real estate when it makes sense for them
• His boss brought someone into their office to talk about Deferred Sales Trusts
• This changed his work and “calling” – he had a new option for clients

Brett as an Investor

• Brett believes that, hands down, commercial real estate, cash flow real estate, value-add real estate is the best risk-adjusted rate of return you can have on any asset class, not only for the depreciation offset of income but also for the appreciation and the opportunity where you can be hands-on with your investments
• He personally and professionally focuses on Senior Housing, Assisted Living, Memory Care, Independent, as well as Conventional Multifamily as well as mobile home parks as his favorites right now
• He also invests in industrial, office, medical office, retail, etc
• He primarily focuses on operators who have proven track records and who can find value-add opportunities
• His strength is in raising capital for these groups and investing along side them
• With 5 kids and two businesses, he stays very active on his businesses and he invests as much as he possibly can on these cash flowing real estate deals
• His first deal was in Arizona
  • 50,000 sq ft
  • 2010 foreclosure
  • Half-built retail property
  • The operator built and bought the project
  • Brett rolled his fee into it
• Others
  • Retail center in Yucaia, CA
  • Broken condo deal in Sacramento
  • Ground-up Senior Housing in Elk Grove, CA
  • Does Industrial in Texas

Deferred Sales Trusts

• Most commercial real estate owners or high net worth individuals who own a business or high-end primary home, struggle with capital gains tax, where they pay 30-50% of their gain when they go to sell their property
• For his clients, he uses a Deferred Sales Trust, which is an alternative to the 1031 Exchange, to help them gain tax deferral, liquidity, freedom, flexibility and diversification with their funds, so they can purchase properties at optimal timing – never using a 1031 exchange again – so they can create and preserve more wealth

Largest Wealth Transfer in the History of the Planet

• In the U.S. right now
  • We’re in the midst of the coronavirus is one thing that’s really shaking up everything
  • Demographics are such that we have what is called the “largest wealth transfer in the history of the planet” taking place – and this is happening over the next 20 years
    • This is the Baby Boomers, passing 17-20 trillion dollars from their generation to next generation over the next 20 years
    • 10,000 Baby Boomers are turning 65 every day in the U.S.
    • There are 77 million Baby Boomers in the U.S. alone
    • They’re faced with toilets, trash, liability, debt and frustration with owning properties and assets that they have built over the last 20-50 years
    • They are looking for a way to retire from this and, at least, downsize or simplify their lives so they have more time and energy to be a little more passive
    • However, if they sell, they will get hammered with 30-50% in capital gains tax
    • They are looking for a way out and a solution
    • The first thing they think of is the 1031 Exchange
    • Some look at a Delaware Statutory Trust
    • Both are the same as a 1031 Exchange
    • The Deferred Sales Trust is different – it’s based on a tax code called IRC-453, also known as an installment sale
    • They both are but tax deferral strategies but the challenge is they solve different things in different ways
      • A 1031 Exchange works best in a buyer’s market where you can find a forced value-add opportunity, where you can find a deal that makes sense on its intrinsic value, meaning you’d buy the deal regardless of your tax liability
      • But the 1031 has some challenges, especially in a highly appreciated marketplace and especially when there is not a lot of opportunity to find value-add, forced appreciation opportunities
        • 45-day identification period – If you sell a property today you have 45 days to identify the deals you want to buy
        • 180-day sprint – You have 180 days to close on those deals
        • That creates a “Sell High, Buy Higher 180 Days Later” – that is not “optimal timing”
        • “Optimal Buying” means buying when it makes sense and when the deals and the prices are low
        • Our parents taught us to sell high and buy low, not sell high and buy higher 180 days later!
        • This is what he saw when he worked at Marcus and Millichap in 2005 and 2006 – people overpaid for properties
          • They were in 1031 Exchanges
          • They loved to be sellers but not buyers
          • They thought they had no other options but to do the 1031 Excvhange
          • Then the market shifted and some people lost everything
          • The major reason why was that they took on too much debt
        • The number 2 reason not to use a 1031 exchange has to do with taking on something of equal or greater value – which means oftimes you have to take on equal or greater debt
          • When you take on more debt, you take on more risk, especially if you’ve overpaid for a property and there’s little room for forced appreciation for he rents to grow
          • In California, we’ve seen rents at all time highs and values at all time highs
          • It may be different in different parts of the U.S.
          • But right now, the cap rates don’t make sense
          • Same thing happened in 2005-2006
            • They took on too much debt
            • The music stopped and they lost everything
            • The solution is to get out of debt when the market has appreciated
              • Take your cash and put it on the sidelines
              • Wait for the deal timing to shift
              • That’s what the Deferred Sales Trust does
                • There is no restriction on time
                  • The funds can sit in the trust
                  • You can invest the funds in:
                    • stocks, bonds and mutual funds
                    • hard money lending
                    • commercial real estate syndications
                  • You can do it when you want
                • It doesn’t have to be equal or greater value

Real Life Example

• Client of Brett’s
  • Peter
  • 70 something investor
  • Owns 18 unit apartment building
  • Drives 2-3 hours 3 days a week to his apartment complex to manage the property
    • Banging on doors to collect rents
    • Managing the manager
  • Tired of all of it
  • Wants out
  • Found out about the Deferred Sales Trust
    • Can sell his property now
    • Pay off all his debts
    • Not have to do equal or greater value
    • Not have to buy another property
    • Not have to have more problems like the 18 problems he has with his 18-unit apartment
    • He doesn’t want to trade it for 36 problems by buying a 36 unit
  • He sold the property, paid off debts, deferred all the tax, put the remaining money in the Deferred Sales Trust
    • Invested in a conservative allocation that protects him from the downside (stocks, bonds and mutual funds)
    • His biggest vision is waiting for the market to shift so he can buy at a discount
  • The third reason why the 1031 Exchange is not that good
    • The depreciation schedule traveling
      • If you owned real estate for long enough, you’re faced with depreciation that is dwindling (multifamily is 27.5 years and commercial is 39 years) every time you use it and eventually, you’ll run out
      • And if you’ve done multiple 1039 exchanges, your depreciation travels with you and eventually you run out
      • With the Deferred Sales Trust, when you buy a new property, you start a brand new depreciation schedule, which, in turn, creates more wealth
      • Can use Cost Segregation
  • What it looked like for Peter:
    • Sold the property for $1.8 million
    • Paid of a $500,000 loan to the bank at closing
    • $1.3 million went into the Deferred Sales Trust (where it must be for business purpose or investment vehicles)
    • Deferred all of his capital gains tax – which would have been $580,000
    • It’s like having an interest free loan from the government
    • Brett’s company, Capital Gains Tax Solutions,  is kinda like a:
      • 1031 Exchange accommodater
      • Custodian for a Sep IRA
      • They are a 3rd party, unrelated
      • Maintain non-constructive receipt for the client
      • The funds are held in a major bank, protected, can be viewed anytime
    • Peter, in the meantime, is living off the $1.3 million
      • He has to pay ordinary income tax on the interest it’s earning
      • If he takes out principle, he’ll pay capital gains tax as he receives it
    • At the heart of this is that it is like an “installment sale”
      • It goes back to the 1920’s tax law (Brett’s company has done thousands of these – has been tested by the IRS 14 times without one issue)
      • Peter just “carried a note” against the trust for $1.3 million
      • The trust gave him a zero down payment in exchange for his $1.3 million, that the buyer actually put into the trust because the buyer bought it from the seller and sold it to the buyer
    • The benefit for the owner is that he has
      • Flexibility
      • Diversification
      • and is out of debt
      • Can save a failed 1031 Exchange

Transferring from a 1031 Exchange Into a Deferred Sales Trust

• Brett has a client who just sold a $7 million apartment complex property in Georgia
• He hadn’t found any 1031 properties that made sense
• Coronavirus hit
• Stock market dropped by 30%
• He’s using the DST as an opportunity to sell high (which he already did), pay off all his debt and put the remaining $3 million into a DST to buy stocks low to ride the stocks back up, take it out of there to buy real estate when it is lower
• If the 1031 Exchange company sends his money to him, he taking constructive receipt, but if the 1031 Exchange company sends it to a trust (the DST), he hasn’t taken constructive receipt, the trust has the money for zero gain, therefore there’s no capital gains
• Most of Brett’s company notes earn 8% and, after fees, earn 6.5% and go for 10 years.  After 10 years, he can renew for another 10 years and keep doing that for as long as he wants and then he can pass it on to his kids and they can inherit his position

 Deferred Sales Trust Doesn’t Only Work for Real Estate

• A DST can also work for
  • Primary homes
  • Bitcoin
  • Stocks – Public & Private
  • Race horses
  • Businesses
  • Private Practices (doctors, dentists, etc.)
  • New construction/development

Biggest Mistake(s)

• Overpaying for properties in a highly appreciated seller market via a 1031 Exchange
  • Sometimes you fell trapped and have to overpay to meet the deadline
• Not finding your niche soon enough
  • Know what your strengths are before getting in a deal
  • If you want to scale and grow, find people that compliment your skills

Your Biggest Success

• A very successful investor sold a property in the Midwest 2006 to a buyer who paid too much for the property
• Put the profit in a DST where the funds stayed for a while
• 5 years later, the buyer defaulted on the loan and the bank took the property
• The bank called the seller and asked if he wanted to buy the property back.  He said yes but only at a discount
• They said they would sell it at 60 cents on the dollar from what he sold it for.  He said yes
• He bought it through his DST, all tax deferred, and he got a brand new depreciation schedule
• The key was optimal timing
• He also did a play with his estate tax, through the DST, saving him millions

 Advice for Old Dawgs looking at Real Estate Investing to help in their retirement years

• You need to be smart and take action
• You need to develop a Tax Deferred Wealth Plan
• Like you would sit down with you financial advisor or CPA and you’re developing tax strategies, wealth plans, budgets
• You need to do this with your highly appreciated assets because when you sell, you are looking at the largest expense you are ever going to face – capital gains tax
• You need to pre-plan, kick the tires and find a plan that meets your goals with four things:
  • Liquidity
  • Diversification
  • Debt freedom
  • Optimal timing
• This is especially important for those in their retirement years as they move from wealth creation mode to wealth preservation mode and more into the mode to:
  • Spend it
  • Have access to it
  • And to keep it!
    • The way to do this is to:
      • Pay off all of your debt
      • Diversification – i.e. moving into multiple syndications (different asset types, locations, etc.) and maybe ground-up development
        • You’re receiving cash flow from these investments
      • Liquidity for
        • Health care
        • Travel
        • Things you enjoy

Current Business

• He just wants to help as many families out as possible to achieve their financial goals
• Also, to help them unlock capital so they can give more to causes that mean the most to them
  • You can do that through the DST
• A wealth transfer is happening – 50% of America’s is tied to high-end primary homes, commercial real estate and private equity or businesses
  • Much of that is not liquid
  • They are going to sell and it’s going to go into liquid assets

Rap-It-Up

• Favorite real estate book: Rich Dad Poor Dad by Robert Kiyosaki
• Favorite business book: Expert Secrets by Russell Brunson and Story Brand by Donald Miller
• Most valuable web site for success (other than your own): Asana.com and Loom.com
• Favorite quote: “Learn to work harder on yourself than you do on your job.  If you work harder on your job, you’ll make a living but if you work harder on yourself, you’ll make a fortune!”
• If you had to start all over, knowing what you know, and you only had $1,000, what would you do to launch your real estate investing business? Take the knowledge that I have and start a sales funnel that is focused on education and adding value to others.  This, in turn, would help me grow my business.

 

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