1031 Exchange-purchasing from seller who doesn't want to repeat

1031 Exchanges
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1031 Exchange-purchasing from seller who doesn't want to repeat

Ashley GlinkaPro Member
Real Estate Agent · Lancaster, PA · Member since 2022 · 13 posts · 7 votes

Hi all,

I manage a group of 36 townhomes, owned by two older couples who are related to one another.  At our last meeting I approached them about the opportunity to purchase the property from them if they ever choose to sell.  We have a great relationship and I truly love the neighborhood. I hadn't figured out how I would purchase it-but if they gave me the opportunity-I would do what I needed to figure it out!  They did discuss this option and would be willing to give me the opportunity but ultimately said it wouldn't work because they purchased this neighborhood through a 1031 exchange.  They said they'll have to hand it down in their estates.  Does anyone know of anything I can do to make it work for them and me?! There's got to be something I can approach them with so that it would make sense for them to sell to me? Or is there really no way around it? Please send me any creative ideas you may have!

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Steve WoltermanBusiness Member
Attorney / Qualified Intermediary · Cincinnati, OH · Member since 2022 · 49 posts · 26 votes
3y

Actually, this could be on the easier side of things. They obviously don't want the burden of having to buy "bricks and mortar" replacement property that they have to manage. They can sell to you and buy into a DST. The IRS has blessed DST structures (given some particulars) as "like kind property" for purposes of a 1031 exchange. i.e., they could sell and exchange into a fund that will pay them an annual coupon or return of 5.5 to 6.5% return, zero property maintenance obligations. Think of them buying into a fractional interest of a 300m Amazon industrial warehouse. Corporate guaranteed by Amazon. They can still pass on that investment to their heirs and keep the tax deferral and pick up cash payments to take care of their income needs. There are definitely options for them.


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  • Henry ClarkPro Member
    Developer · Member since 2020 · 4k+ posts · 4k+ votes
    3y

    1.  Based on your comments assume they don’t want to sell.

    2.   They want stepped up basis to take care of the taxes on the capital gains. 

    Let’s go with that. 
    A.  Estimate their capital gains and tax impact.  You would need to cover that on top of the purchase price.  Example.  $1mm gain at 20%.  Assuming no depreciation recapture.  You need to come up with $200,000 more on top of the purchase price. 
    B.  See if you can do an option to buy.   Pay them x.  
    C.   Stating the obvious.  They won’t die at the same time.  Thus there will be more than two people to deal with 

    D.  If they don’t both have trusts either of their properties could end up in probate and be tied up for several years.  The property could sit unmanaged. 
    E.  If they both don’t have legal power of attorneys and their health deteriorates the management of the property could be in limbo. 

    If you’re truly interested in this property you have to ask from their point of view.  Then seek out solutions. 

    2Reply
  • Steve WoltermanBusiness Member
    Attorney / Qualified Intermediary · Cincinnati, OH · Member since 2022 · 49 posts · 26 votes
    3y

    Actually, this could be on the easier side of things. They obviously don't want the burden of having to buy "bricks and mortar" replacement property that they have to manage. They can sell to you and buy into a DST. The IRS has blessed DST structures (given some particulars) as "like kind property" for purposes of a 1031 exchange. i.e., they could sell and exchange into a fund that will pay them an annual coupon or return of 5.5 to 6.5% return, zero property maintenance obligations. Think of them buying into a fractional interest of a 300m Amazon industrial warehouse. Corporate guaranteed by Amazon. They can still pass on that investment to their heirs and keep the tax deferral and pick up cash payments to take care of their income needs. There are definitely options for them.


    1031 Federal Exchange
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  • Steve WoltermanBusiness Member
    Attorney / Qualified Intermediary · Cincinnati, OH · Member since 2022 · 49 posts · 26 votes
    3y

    Their heirs will still take the investment at a stepped up basis on the seller’s death and eliminate the tax consequence.  

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  • Account Closed
    Manhattan Beach, CA · Member since 2021 · 76 posts · 40 votes
    3y
    Quote from @Steve Wolterman:

    Actually, this could be on the easier side of things. They obviously don't want the burden of having to buy "bricks and mortar" replacement property that they have to manage. They can sell to you and buy into a DST. The IRS has blessed DST structures (given some particulars) as "like kind property" for purposes of a 1031 exchange. i.e., they could sell and exchange into a fund that will pay them an annual coupon or return of 5.5 to 6.5% return, zero property maintenance obligations. Think of them buying into a fractional interest of a 300m Amazon industrial warehouse. Corporate guaranteed by Amazon. They can still pass on that investment to their heirs and keep the tax deferral and pick up cash payments to take care of their income needs. There are definitely options for them.


    That's exactly what I was thinking. I sent her a message with some more info on DSTs. We're seeing alot of success with brokers offering DSTs to their sellers to push them over the edge of selling. Many people just do not know what to reinvest in, especially in this current market... DSTs are a great solution. If she's open to it, I'll talk to the sellers more in depth about DSTs and see if that will make them comfortable with selling.
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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    3y

    @Ashley Glinka Or just keep it simple and get an option to purchase upon their demise and you keep managing them.  Their heirs get the benefit of a step up in basis.  You can maybe negotiate a very fair strike price right now in exchange for the option fee.  And just maybe, you could structure it so that if they pass at different times you get to purchase the half from the partners who died.

    And I spose you could actually negotiate a master sublease of them along with an option to purchase.  So you even get to control the properties for some time without having to pay for them yet.

    And all the while you continue managing.

    Good DSTS  and a 1031 would be the only other option I would recommend in their situation

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  • Jon Taylor
    Pasadena, CA · Member since 2019 · 136 posts · 148 votes
    3y

    IMO DSTs have extremely low cash flow targets. If it's not a motivated seller, I don't think DSTs are going to push anyone over the edge in this market. 

    2Reply
  • Account Closed
    Manhattan Beach, CA · Member since 2021 · 76 posts · 40 votes
    3y
    Quote from @Jon Taylor:

    IMO DSTs have extremely low cash flow targets. If it's not a motivated seller, I don't think DSTs are going to push anyone over the edge in this market. 

    What cash flow have you seen in DSTs?

    0Reply
  • Jon Taylor
    Pasadena, CA · Member since 2019 · 136 posts · 148 votes
    3y

    3.5 - 5

    1Reply
  • Mohammed Rahman
    Real Estate Broker · New York, NY · Member since 2020 · 2k+ posts · 1k+ votes
    3y

    Hey @Ashley Glinka - if they're worried about the potential capital gains tax, could you workout a master lease option with them? Definitely recommend looking into it as it doesn't seem that they truly want to sell it. 

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    0Reply
  • Jon Taylor
    Pasadena, CA · Member since 2019 · 136 posts · 148 votes
    3y
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    Fees aren't bad actually. That stigma in DSTs has really driven the fees down to be comparable to a typical real estate transaction - if you factor both sides of the transaction... The real problem is that values are still so high and the cash flow is taken up by interest rates that have doubled. Seems like they are betting on residential rent continuing to go up at record-high growth rates. Tough bet to make.

    1Reply
  • Account Closed
    Manhattan Beach, CA · Member since 2021 · 76 posts · 40 votes
    3y
    Quote from @Jon Taylor:
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    Fees aren't bad actually. That stigma in DSTs has really driven the fees down to be comparable to a typical real estate transaction - if you factor both sides of the transaction... The real problem is that values are still so high and the cash flow is taken up by interest rates that have doubled. Seems like they are betting on residential rent continuing to go up at record-high growth rates. Tough bet to make.


     Typically we're seeing 5-5.5% net returns for our clients. Most DSTs now we're bought when interest rates were still low, so they locked in interest rates at 3-5%. And it's not that they're betting that it will continue to go up like it did in the last 10 years, but multifamily with 100+ units with luxury amenities do have a huge growth potential. Considering that Gen Z likely won't be able to afford to buy a house, these multifamily buildings are the next best thing. But that's just my opinion.

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Jon Taylor:
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    Fees aren't bad actually. That stigma in DSTs has really driven the fees down to be comparable to a typical real estate transaction - if you factor both sides of the transaction... The real problem is that values are still so high and the cash flow is taken up by interest rates that have doubled. Seems like they are betting on residential rent continuing to go up at record-high growth rates. Tough bet to make.


    This is where DST can be useful because of its uniqueness.
    We know the DST is not the best-performing asset in terms of expense and cash flow, maybe the actual CF is only 2-4%. 

    Knowing this, a unique vehicle like zero coupon interests me. It's ok if I don't receive any cash-flows, but rather than my capital gain tax per dollar is 25-30 per dollar. I could replace with ZC paying only 14-18 cents per dollar. I think it has value after I do several step transactions.

    0Reply
  • Account Closed
    Manhattan Beach, CA · Member since 2021 · 76 posts · 40 votes
    3y
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    Fees aren't bad actually. That stigma in DSTs has really driven the fees down to be comparable to a typical real estate transaction - if you factor both sides of the transaction... The real problem is that values are still so high and the cash flow is taken up by interest rates that have doubled. Seems like they are betting on residential rent continuing to go up at record-high growth rates. Tough bet to make.


    This is where DST can be useful because of its uniqueness.
    We know the DST is not the best-performing asset in terms of expense and cash flow, maybe the actual CF is only 2-4%. 

    Knowing this, a unique vehicle like zero coupon interests me. It's ok if I don't receive any cash-flows, but rather than my capital gain tax per dollar is 25-30 per dollar. I could replace with ZC paying only 14-18 cents per dollar. I think it has value after I do several step transactions.

    Yes you’re right about Zero Coupon DSTs. We have actually started to do a lot of Zero Coupon business because the cost of money is too high. Investors can invest some of their equity in a zero coupon, which will then replace all their debt. They can then go to the market and will be an all cash buyer and won’t have to worry about financing at 7% interest rates.
    1Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    3y
    Quote from @Account Closed:
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:
    Quote from @Carlos Ptriawan:
    Quote from @Jon Taylor:

    3.5 - 5


     after all the commission and expense :)

    Fees aren't bad actually. That stigma in DSTs has really driven the fees down to be comparable to a typical real estate transaction - if you factor both sides of the transaction... The real problem is that values are still so high and the cash flow is taken up by interest rates that have doubled. Seems like they are betting on residential rent continuing to go up at record-high growth rates. Tough bet to make.


    This is where DST can be useful because of its uniqueness.
    We know the DST is not the best-performing asset in terms of expense and cash flow, maybe the actual CF is only 2-4%. 

    Knowing this, a unique vehicle like zero coupon interests me. It's ok if I don't receive any cash-flows, but rather than my capital gain tax per dollar is 25-30 per dollar. I could replace with ZC paying only 14-18 cents per dollar. I think it has value after I do several step transactions.

    Yes you’re right about Zero Coupon DSTs. We have actually started to do a lot of Zero Coupon business because the cost of money is too high. Investors can invest some of their equity in a zero coupon, which will then replace all their debt. They can then go to the market and will be an all cash buyer and won’t have to worry about financing at 7% interest rates.

    Yes I've been thinking this for years, I do run a lot of complex economic simulations, DST is not interested in the QE environment but DST becoming sexy in QT environment. This could be used as a temporary vehicle to drag tax fees as long as possible. Whoever invented this ZC is an extremely sharp fellow, maybe working at zero bonds investment before.

    to be successful in RE sometimes we just need to be smart in basic maths :)

    0Reply
  • Bobby Levenson
    Member since 2023 · 3 posts · 0 votes
    3y
    Quote from @Mohammed Rahman:

    Hey @Ashley Glinka - if they're worried about the potential capital gains tax, could you workout a master lease option with them? Definitely recommend looking into it as it doesn't seem that they truly want to sell it. 


     This seems like a good idea paired with the Option.

    0Reply
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