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The Secret Weapon For Real Estate Agents In Tough Markets: The 1031 Exchange

By Mike Work · Mar 4, 2016 · Real Estate

The Secret Weapon For Real Estate Agents In Tough Markets: The 1031 Exchange

Image courtesy of Pixabay, Arrows

Are you having a hard time closing real estate deals lately? Today's hack will help.

Investment property has been a hot-ticket lately. From TV shows showing the masses how to flip houses, to everyone’s uncle getting into the business of “real estate investing”. However, one of the more unknown tricks of the trade is the 1031 exchange.

The 1031 exchange is a federal tax code that allows you to defer the tax on the gain of a property sale if you buy another “like-kind” property within certain amount of time.

There are a few conditions you must meet in order to apply the 1031 exchange properly:

  • Both properties must be used for either an investment or in a business. Neither of them can be your residence (either past of future).
  • Both properties have to be “like-kind”. This simply means both have to be real estate (The tax deferment won't apply if you transfer the profit from a real estate sale into stocks for example). You can apply the 1031 exchange from a residential home to vacant land, or an apartment building.
  • You can’t exchange with property outside the United States.
  • You have 45 days to identify your replacement property after you sell the initial property in the exchange. The identification must be in writing, signed and delivered to the person involved with your exchange.
  • You have 180 days to complete the sale of the exchange property.
  • The exchange property has to be of equal or higher value.

The reason why the 1031 exchange is a great transaction for real estate agents is because it’s generally immune to market cycles - it’s driven by other pressures.

For example, there are plenty of scenarios where you’ll have property investment partners. One of the partners may need to liquidate for whatever reason and force the other partner into a 1031 exchange situation. If they sell and DON’T do a 1031 exchange, all the partners will be taxed on the gain of the sale of the property.

For A Real Estate Agent, 1031 Exchanges Are As Good As Gold.

1031 exchanges are as good a gold for realtors

In a slow market, it’s hard to make sales. Inventory gets tight. Competition becomes intense. And in most cases, it’s the seasoned veterans that weather the storm: the real estate agent that’s been consistently producing for over 15 years and has a strong network and trust built up in their neighborhood.

So if that’s not you, what other ways can you compete?

You guessed it: the 1031 exchange.

People who are about to conduct a 1031 exchange have an absolute motivation to buy. If they don’t buy another property – they are going to get hammered with taxes.

The 1031 exchange is recession proof because it’s built on necessity.

If You’re A Real Estate Agent What Are Some Good Places To Look For This Opportunity?

Find every house that is a rental in a high priced residential neighborhood. Approach the homeowner and say, “Can I do an investment analysis on your property?” You will find out that when you perform a cap rate analysis on these homes, every high-priced residential home (that are rentals) has a very poor cap rate.

BTW, here's the definition of cap rate:

cap rate definition

This gives you an opportunity to tell the homeowner, “I can make you twice, 3x or 4x ROI as you’re currently making on this house if you let me show you a few examples.”

So what are the examples?

Notoriously, residential homes get a very low amount of income per dollar value because the investor is usually banking on it going to appreciate more than any other investment class. So a standard house in the beach areas of California will get a 2 or 3% cap rate, which is basically the cash-on-cash return of that value per year. On the other hand, a storage building in Texas will sometimes have a 12% cap rate. And it will qualify as a 1031 exchange because it’s considered a "like-property".

The easiest way to find 1031 deals is to go to your title company and get a list of owner absentee properties. Hopefully, the list your title company gives you comes with phone numbers, if not you’re going to have to use a mailer. Go through the list and contact each homeowner and offer them a free analysis of their investment.

Another opportunity is to find rentals that are currently vacant. Vacant rentals are perfect targets because the owners are not getting their rental income. It’s perfect opportunity to say to the owners, “This is a good time to exchange this property”.

Apartments are yet another opportunity. However, the apartment building might be a little more challenging because property managers (and property management companies) are the gatekeepers between you and the owners. But then it also gives you an opportunity to speak to the management company and say, “I’m a 1031 exchange expert. Do you know of any other property owners that would benefit from an exchange?” Consider offering them an inducement to give you a referral - just be sure it’s RESPA proof.

Finally, go to local exchange companies. All the big title companies have exchange companies. They are called “accommodators”. When people sell their property and they are waiting to find their exchange property, their sale money sits in the accommodator. The seller can never touch the money, or it violates the exchange.

Remember, these people have 45 days to find their next property and 180 days to close. If they violate any of those conditions, it turns the sale into a taxable event. These buyers are under the clock to find something quick and close almost as fast.

Here is where the opportunity lies: All those people who have their money sitting in accommodators are going to buy with whoever shows them the best property. Your job as a real estate agent is to go out and find the best producing investment property. Then go to those people who have their money sitting in accommodators and say, “I have something for you to look at”.

Be Sure To Read The Tax Code

Like-Kind Exchanges Under IRC Code Section 1031

Before you run out to try to find everyone that's in the middle of a 1031 exchange, be sure to educate yourself on the official tax code. This will come in handy when dealing with real estate investors and property owners. Knowing is half the battle!

About the Author: Mike “Net” Work, Founder and CEO of United Estate Consulting. Securing the American right of life, liberty, and the pursuit of happiness, one estate at a time. Feel free to reach out to Mike Work on Twitter: @mikenetworker.

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