The In's & Out's of 1031 Exchanges w/ Michael Velasco
Today we talk the ins and outs of 1031 exchanges—a powerful real estate tool that lets investors defer taxes when selling investment or business property. Michael Velasco, founder and qualified intermediary of Exchangeable, and one of only around 120 certified exchange specialists nationwide.
We discuss what a 1031 exchange really is, why so many property owners still don’t know about it, and the nuts and bolts you need to get started.
We talk about the different types of exchanges (including the elusive reverse and improvement exchanges), strategies to avoid common pitfalls, and the importance of understanding your legal entities and getting expert advice before beginning.
Top 3 takeaways:
1031 Exchanges Are Only for Investment/Business Properties
Personal residences don’t qualify—you must own rental or business real estate to take advantage of these powerful tax deferral strategies.Timelines Matter: 45 Days to Identify, 180 Days to Close
After selling your property, you have 45 days to identify a replacement and 180 days to complete the transaction. Missing these deadlines can kill your exchange.Structure and Expertise Are Key
The nuances of entity setup, property title, and choosing the right type of exchange (standard, reverse, improvement) can make or break your outcome. Work with a qualified intermediary early, and don’t skimp on the expert advice—mistakes are costly!
Connect with Michael Velasco - https://1031exchangeable.com/
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Introduction to the Unconventional Investor Podcast
Welcome to the Unconventional Investor Podcast. I'm your host, Michelle Moses, certified financial planner, licensed realtor, and founder of Me Financial. If you're an accredited investor feeling overwhelmed by managing your portfolio and looking for alternative investment strategies that go beyond the traditional stock market, you're in the right place.
Let's head into today's episode so you can start taking control of your financial future.
Understanding Reverse 1031 Exchanges
So are people mostly doing that when they just find a screaming deal and it's okay I'm not ready to sell this. Like I just haven't whatever, gotten the renter out or, they're just not ready to sell it, but they found this other property and they're like, oh my gosh, I can't pass this up.
Is that Most of the time it's usually that. Okay. It's usually that the higher the net worth, the more experience the investor, the more likely they are to do reverse. I have clients that will not do forwards, they don't like the 45. Day timeframe, they're like, interesting. I don't wanna put this on the market and get caught with a deal that I don't love.
So that's why the reverse is so powerful. If you've got access to capital and you see a great property, you go, I gotta have this. And typically those great properties will have multiple offers, don't want contingencies or it's an off market deal. And so what I've found is the more experience, the better the deal, the more capital access to capital the client has.
They will do a reverse all. Now, they could get under contract and try to sell a relinquished if they could, but if they can't, then they'll reverse. We'll close and they eat, and then we'll continue to market and sell the relinquish property. I just think it's great though that. Even though you've identified a property and you know you need to move fast on it in order to get it.
Yeah. That the 1031 isn't off the table because of it. Exactly. 'Cause most of the time you think about a 1031, it's a slow okay, we've been thinking about this for a few months now. It's one of those investments. Yep. So it's nice that it has the flexibility to move at the pace of what investors move at really.
Yeah. Exactly. Yeah. So that's cool. And sellers don't want contingencies. No, they want to. They wanna know this thing's closing. And so imagine, your net worth growing your portfolio as an investor growing. And I have clients that just go, I'm buying this one. Let's go to the portfolio and decide which one we're gonna sell.
And then the, and they just love the reverses. And which is a niche I've carved out for in the QI space. I love doing reverses. A lot of qis don't like touching 'em. 'Cause they're very complex heavy documentation. But it sounds like a lot of paperwork. Yeah. Yeah. It's a niche.
I really enjoy. I like forwards too. Yeah, they're easy. They're very easy. But the reverses are. And each state's got their own.
Navigating State-Specific 1031 Exchange Rules
Entity issues like California, right? If you're watching this from California, you got, an entity's $800 to set up just an LLC. And California's got their own their own rule rules with the franchise tax board in regards to 10 31 exchanges.
They sometimes don't follow federal guidelines and so they can be very interesting. So there's lots. And my point is there's lots of dynamics as you go in different states, but I really do. So you're able to do any state, in any state in the, in the country for a replacement property, relinquish properties heavily licensed states like Idaho.
We're almost done with our license. I've, that's been a almost a six month project for me to try to finish doing relinquished properties in Idaho, which we're about to do. And then Maine's another one that really, we can't do a relinquish property in Maine, right? Nor do. Want to go through the licensing, so it just gets too complicated, basically.
Yeah. 'cause some of the states are more regulated than others. Yeah. And so you have to just play ball with them. But Idaho's a great state for me because, we're in Arizona, we get a lot of movement up there. And Maine, I don't. I'm not gonna probably, yeah. There's not a lot of people from Maine here, and it's not something I want to probably the headache and adv aggravation.
Yeah. But for for every Welsh we do every other state, every, okay, interesting. Yeah. And I could do replacement properties into Maine too. That's, which isn't a problem. It's the relinquish that you have to worry about. It's a short answer. Yeah. Pretty much everywhere.
Okay. Pretty much everywhere. Yeah. And we do, we, from Hawaii to New York and Florida. I've got stuff in Texas right now. I had one out of Alaska, which was always, which was really fun because of the. The taxpayer was up there as well. And it was dark for, three or four months.
And it was just an interesting thing. He lives there during the winter too, which is, which was cool to deal with. See all kinds of different things. Yeah. And they all have their own nuances. Back east. They have closing attorneys out west we have, escrow Yeah. Title. So Yeah, I know every state is very different Yeah.
When it comes to real estate yeah. Yeah. Very different. Okay, so let's circle back around to the. Third type Oh yeah. Of 10 31 exchange. Yeah. And to put a kind of bow on the reverse thing, I think if you're thinking about the reverse, just make sure you get with a Q qi that has experience with the reverses too.
And really get into an exploration of, one, does this make sense? Two, can I have access to capital?
Improvement Exchanges Explained
The third kind of exchange is an improvement exchange. This requires a little bit less to the less capital. 'cause typically, when we're in a forward construction exchange, and I'm gonna use the example of a 300,000 property, we sell a relinquished property for 300,000.
Remember, equal or greater value, we have to buy at least $300,000 in property. Improvement exchange allows us to use some of the funds to do repairs. Oh, so you could buy like a $250,000 property? Let's talk about that. Let's talk about that. Okay. So we bought, we go out and find a great fix up deal of 200,000.
We acquire that. We have to use the eat LLC because I can't transfer the property to you until the entire $300,000 is spent on the replacement property. So we close on the relinquished, we have $300,000 in the exchange account. Assuming it was all cash and we take 200,000, we acquire the replacement property, now we have a hundred thousand dollars left over, we can use that to improve the property.
And so this works great for value adds. It works great. If you're an investor looking for a good deal and wanna, get something. Yeah. I think sounds amazing. Yeah. And and the other thing as an investor, which you don't want. Is to buy a property, put a renter in there, and then you're constantly doing repairs and repairs.
So the improvement exchange works great. 'cause you can just do the rehab, get everything done right, and then and charge more. And charge more. Yeah. And you don't have to deal with the headaches. So repairs every 10 minutes. So the a hundred thousand, this brings up a question though. So you said I can't release the funds.
Are you actually taking. Possession of the funds. It's not is it held at escrow, like in title or it's held in escrow at our bank. We have a, at your bank. Okay. We have a bank that it's a Raymond James bank, a subsidiary that we use that specializes in helping Qis. Okay. So if I go down to Chase Bank and try to ke set up 15 sub-accounts for my exchanges, they're not gonna know what to do.
So they, they specialize in this type of okay. In this industry they really do. So each client's gonna have their own bank account set up with their name and they have to sign off to for the money to move. And when we have, in this case, we spent 200,000 on the replacement property, we purchased it in the eat.
And in addition to the property management agreement, I'm also gonna give them a construction agreement that states you can work on this property. Now I'm gonna want. Licensed bonded and insured contractors working on the thing, if we possibly can for a variety of different reasons.
And if you are an investor, working with contractors, you got, you want licensed, bonded insured, you don't wanna cut a check, you know that a hundred thousand I have an account I cut a check for 30,000 and the contractor takes off 'cause he's not bonded. And takes off with the funds.
And that happens more often than you would you would. Think or care to know about. So there's some things that I'm, I'm talking with the clients about is, hey let's make sure this is a good contractor and then I'm gonna start cutting checks that a hundred grand, I'm gonna draw it out, for the repairs, as the repairs are getting done.
Oh, so you're in charge of doing all that? It's not okay. That's why the improvement exchanges are what they are cost wise. And depending on the size of the improvement, if we're doing $2 million in improvements, you know the fee's more than 84, 95, there's usually a monthly fee. But we, that's what we're doing.
We're basically going, okay, what's what's the repairs on this? Show me the bid. And then, we'll, as the repairs start getting done, now at the end of this, a hundred thousand dollars is spent, the improvements are done to the property. At that point, I take the entity, the LLC. I changed the membership interest over to the taxpayer and we have a good exchange and so I'm not going to transfer the entity to them until the repairs is done and we gotta get it done within 180 days.
Oh wow. Total. Okay. Yeah, total from the sale of the relinquish property to the to the date we transfer's, gotta be within 180 days. So when we're doing improvement exchanges, especially on like small single family stuff. We're really lining everything out to make sure that those things, the permits are drawn, everything's ready to go, and boom, we can start.
So that you can start right away. Start and get done. Yeah. And do you help people? 'cause I, there's such a price difference between the different options. Do you help them like compare. The different options. Yeah. To make sure that it's worth their time and they're not eating up all their tax savings, basically.
Yeah. Okay.
The Importance of Proper Planning and Legal Advice
One of the, one of the things I do being the sole owner of my company, and I've got some great employees and we have a great process, but I treat 'em all like family. So if this exchange ain't gonna work, I'm gonna tell 'em, I'm gonna tell 'em. The upside. The downside in regards to the is in regards to which exchange might work best for them, and.
I just tell 'em, I don't even know if this, one out of every 10 calls I'm like, why are you doing an exchange? You barely have, $5,000 in realized gain. You get 1195 in fees and headaches. Do you really wanna do this? I'm happy to take, I'm happy to do the exchange, but is this really make sense?
Talk with your accountant. Does this make sense? And some people call and it. A reverse. They didn't even know that the reverse existed. And I'm like this is an option if you're because they're, I didn't even know a reverse existed till today. And I've, most people don't.
I've studied a lot of this stuff yeah. Very interesting. Most people don't, and even CPAs I think the tax codes like 11,000 pages, it's okay if your CPA's not an expert on. On 10 31 exchange. It's okay. But they gotta know how to fill out the ADA 8 24 and they should have experience with that.
And we should visit the CPA A and I'm on the phone every week with a different CPA A talking about the complexities of a different of all different sorts. I be bet. And make sure we're on the same page about how we're, how we're how we're, how this transaction's gonna Yeah.
How it's gonna be reported. Because there, I'm a third party. Qualified intermediary. I'm not a tax, I'm not giving tax advice and legal advice. And so they need those. It's really important to work with their financial advisors and the team that they have. And that's, I think what I've what I advice I could give to investors is.
Spend a little bit of money and time with those people. And I tell you, the ones that do are the wealthiest ones. Oh, it's, they are for reason. I agree. I was talking with I have a, one of my best friends is a real estate attorney. Outta state. And I was talking with her and I go, I am just floored by how much people, what people will do to save a buck, a hundred dollars, even $200, and it backfires.
Biggest way. And she's that's why I have a job. That's what she said. She goes, that's why I have a job, is 'cause people don't wanna pay money. I, and I've had that happen to me where they're like I found a qi to do it for a thousand bucks. I'm like that's hundred bucks. That's, I think that's great.
I consider, some of this value that you're getting a CES, you're getting somebody right, that's been down that road and really. So I, I think that's just be mindful as an investor, somebody that's working at property. Be careful. Yeah. Not to be too cheap on some of this stuff.
And I think with real estate, the legal. Structure and the paperwork. It is, it can all come back to bite you. Yeah. So badly. Yeah. It is really important to get it correct. When you, especially when you are buying property with somebody else, yes, you're buying it with someone else, you're buying it and the structure of a business, anything like that, that it's not your own personal property.
It is just a totally different. Animal and you do not have the experience to do it. Yeah. Unless you are a lawyer or, yeah. Someone in the field. We are constantly working through issues where two individuals buy a property together and one wants to 1031 exchange and one doesn't.
How they take title of that. That's called something called tenants in common where you own a percentage or tendency in common where you own a percentage of the property, where you both own 50% of the of the property, let's say in a partnership. And so we're constantly working through those issues.
So when you're by the property, it's best to know, Hey, what are our long-term goals with this? When do we wanna sell? At what price do we wanna sell for? And do we both want a 10 31 exchange out of this or do we wanna keep it in our partnership or do we wanna own it as 10 a common and go our separate ways?
So those are some of the planning things that people don't think about. They buy a property together and the thing appreciates buy $500,000 and then we got. We got some challenges down the road. So it's really back to just the original point, just do a little bit of planning a little bit.
When I was starting my 1031 exchange company, I found the best attorney in the country and he was a thousand dollars an hour, and I didn't bat an eye. Because I knew there's only so many attorneys in that know this and there's probably about 20 in the country that I think are just absolutely phenomenal at 1031 exchange.
And I just went and hired the best. And I've spent hundreds and thousands of dollars in legal fees, but it. One of the things that I've really gotten out of that was an incredible amount of knowledge, but also we did it right and we know, and I think yeah. It's right. You don't need to go back and redo it.
Yeah. And if I said, Hey, I'll just go, I'll use paperwork from someplace or Right. I'll take it from the internet. Yeah. 'cause I was cheap about my attorney fees and so that investment and back to the original point. It's just really good to start and do it right. Yeah.
It spend a little bit of money up front. You'll save tons on the back end. Yeah. Yeah. And I think that's an inherent. Lie out there about real estate is that it's so easy 'cause I think it's easy for people to understand. Yeah. But the nuances are what people don't understand. Yeah.
And the nuances are what's gonna cost you money and lawsuits and, all of those sorts of things. Or be not being able to do what you want to do. Yeah. And if you like, for the partnership example, if you set up wrong. From the beginning, then you're gonna spend three times as much fixing it.
Exactly. Down the road. Yeah. Yeah. Okay. That's great advice. Yeah. So thank you. Yeah. This is it was really hopefully helpful. Enlightening. Yeah. It's very helpful. I learned something.
Conclusion and Final Thoughts
So I hope all of you guys learned something and I have to appreciate, I just have to thank you for being on.
Yeah. Thank you for coming down, you guys. I just called Michael out of the blue. I found him online and was like, Hey, will you come on my podcast? I wanna talk about this. So thanks for taking a chance. You bet. You guys can get ahold of me at 10 31 exchangeable.com. You go to my website, lots of helpful videos.
You can Yes. Fill out a form bill and that's 10 31 exchangeable and com and I'll have it in, I'll have it in the show notes. And he has lots of videos on his website also that will help you with just different topics of, and you have 'em in short little snippets too, so it'd be easy to learn about.
Yeah. Most of em, most of 'em are a minute between a minute and five minutes. So that's the of video I like. You can learn quickly what you need. That's, yeah, that's what I like. Yeah. I don't like these even eight minute videos. I know. We don't have the attention span for No. I'm like, just get to the point, man.
Where is it not? Yeah. Hey everybody. And I'm available too. I think that's the other thing you get a hold of calls on through our website there. I'm available, so I'm the one that's probably gonna talk to you. Yeah. And so we'll get into the nitty gritty details of what your particular situation is.
Yeah. Wonderful. Yeah. Yeah, so if you guys have rental property or any sort of business real estate as we said, you can, 10 31, don't. You do not have to pay the tax when you sell these things. And so I definitely think it's worth an exploratory call when you are thinking about selling these properties to see if you can do a 1031 exchange either into another property or into an investment.
There's lots of different options out there. Yeah, absolutely. Yeah. Yeah. Thanks for having me today. Yeah. Thank you so much for coming on. And you guys, thank you so much for listening. I appreciate you tuning in. I appreciate the feedback about the show and I hope you learned something and I hope you have a wonderful day.
Thank you. Thank you for listening to the Unconventional Investor Podcast. I hope you feel more confident in how you can grow your wealth using the strategies I shared in this episode. If you're ready to take the next step in diversifying your portfolio outside the stock market with alternative investments, head to me financial.net/contact us to book a 15 minute consult call with me.
Let's discuss how we can work together to achieve your financial goals. Until then, I'll see you on the next episode.
Disclaimer: The information provided in this podcast is for general informational purposes only and should not be construed as professional financial advice. Always consult with a qualified financial advisor or professional before making any financial decisions. The hosts and guests of this podcast are not responsible for any actions taken based on the information presented.